Feynman Investment Research LLC is an independent investment research firm that focuses upon providing actionable and timely investment ideas on undervalued and under- recognized companies.
In this interview, we will be chatting with Brian Grosso. Grosso is currently finishing up his senior year of undergrad and jumping right into the investment business, as an investment advisor at Rugged Group, LLC, that he recently formed. I met Brian 3-4 years ago, on an investment blog on Facebook, when we were both beginning our trek down the road of investing. Since then we have bounced investment ideas off each other and have chatted multiple times. Grosso has a passion for investing, is very skilled at analyzing companies, has deep insight and understanding of business and is way ahead of many of his peers, given how young he is.
Feynman Investment Research Interviews Brian Grosso
So Brian, tell us about yourself (school, work, hobbies, etc.)
Brian Grosso: Sure Nick, Thanks for interviewing me!
I’m currently in my senior year at the University at Buffalo and will graduate with a degree in Accounting in the spring. This past summer, I interned at a large bank, which gave me a lot of perspective on Corporate America and my own personal work preferences. I’d been thinking about the possibility of opening an advisory business for several years at that point, but the internship experience and some discussions with a key mentor catalyzed me to go through with my plans. Rugged Group LLC was formed in early August and we are now over the regulatory hurdles and doing business.
As for hobbies, I really enjoy reading, walking, hiking, and spending time with family (not necessarily in that order!), as well the occasional obsession with Zynga Poker.
Has an accounting background helped you with analyzing companies? What major would you suggest aspiring student investors to jump into?
Brian Grosso: An accounting background has definitely helped. I would recommend accounting to prospective investors. Accounting is necessary to understand how businesses are performing and what they are worth. Learning accounting has led me to be much more skeptical of GAAP accrual basis numbers, because there is a good deal of discretion and assumptions involved in those numbers, and it is certainly not the only way to report results. In fact, GAAP has changed over time, if that says anything about its infallibility.
Here is a brief example of how GAAP results can be distorted. When a company has a defined benefit retirement plan for its employees (read: pension), it creates both an asset and liability. The assets are tangible – the securities that the plan actually owns such as bonds and stocks that it is trying to earn a return on. The liabilities are not – they are projected future cash outflows to employees the company will have to pay out, discounted back to the present using a discount rate. Clearly a lot of assumptions are involved and one that is problematic is the discount rate that is used. The discount rate that actuaries normally use is interest rates on high quality (AAA, AA, etc) corporate bonds. When interest rates get very low as they are now, the discount rate is very low (like 3%), and in turn the present value of the liabilities skyrockets without any change in what actually must be paid out in the future.
In reporting the plan on the financial statements, the plan assets and liabilities are netted together to get a net asset or liability. In this low-rate environment, many companies have very large pension liabilities that investors perceive as debt and are including in enterprise value calculations, but the crazy thing is that if interest rates increase 100bp or so, many of these liabilities will vanish without any fundamental change at the company. Having learned accounting, I’m much more aware of these kinds of nuances and since much of accounting is principles, if I come across a nuance that I’ve not learned directly, I can often still put the pieces together from what is disclosed in the footnotes.
That is really interesting in regards to GAAP EPS. I always use FCF myself when valuing companies, but never knew that there was an issue with GAAP when it comes to pension plans. I can really see how an accounting background has been of value to you. How did you end up picking Rugged as a name for your advisory business (I am sure it has some meaning)?
Brian Grosso: Great question. Rugged has two meanings. The first is a rough, uneven surface that is difficult to traverse. Think rugged terrain. I think this is symbolic of financial markets, or at least the way I want myself and clients to think about them. The journey to wealth through stock ownership is not an easy, straight, or paved path. There are ups and down. Big ups and downs. And it’s tough. Which brings us to the second meaning of the word rugged: strong, tough, resilient or determined in the face of challenge or hardship. These are qualities that the rugged financial terrain demands of investors. You need to be unfazed in the face of the big moves. The big red days that keep you up at night. That is hardship that needs to be overcome.
That’s a salient metaphorical name for an advisory business in relations to the overall pendulum swings of the stock market. I’ve always liked names of advisory businesses that had meaning to them, instead of just someone’s first or last name. What attracted you to the investing world?
Brian Grosso: After graduating from high school, I still didn’t really know what career I wanted to pursue. I was set to enter college as an engineering major. Early in the summer, I stumbled across some articles on Buffett and value investing. It’s funny – I had some savings from working part-time in high school and vividly recall googling “best investment strategy.” Information begot information (the internet is a wonderful thing) and I’m still digging into this endless chain of information today.
That sounds a lot like how I ended up getting into investing, I was also the same in regards to not knowing what to pursue as a career. Could you elaborate upon your investment style?
Brian Grosso: I’m a bottom-up value investor. I go through screens of mostly small, cheap stocks looking for situations where:
- I understand the business
- I expect annual returns over the next 3-5 years of at least 20-25% from the stock
- An adverse outcome does not seem to imply I am losing money, or as Mohnish Pabrai would say, “Tails, I don’t lose much”
I’m a firm believer that the future is uncertain and the way I approach valuation reflects that. There is always more than one potential outcome and I model returns for each, and then assign probabilities to get an expected return. I’ve also noticed over time that many of my worst decisions have been made very quickly, so I am trying to slow down my decision-making process through the use of watch-lists, articles, and starter positions as means of delaying gratification.
That is interesting how you have a process to delay the