Would you believe it is not math but empathy which is the key?
“Empathy is the capacity to understand or feel what another person is experiencing from within the other person’s frame of reference, i.e., the capacity to place oneself in another’s position.”
Warren Buffett’s Annual Letter: Mistakes, Buybacks and Apple
Warren Buffett published his annual letter to shareholders over the weekend. The annual update, which has become one of the largest events in the calendar for value investors, provided Buffett's views on one of the most turbulent and extraordinary years for the financial markets in recent memory. Q4 2020 hedge fund letters, conferences and more Read More
Learning which information carries the highest investment value is what makes the difference between better investors and less than average performance. The drive to employ evermore powerful computers and sophisticated algorithms misses the fundamental basis that it is individuals who invent and create value. Corporations do not self-assemble and produce iPhones or cures for Hepatitis C. Only individuals do this!
Learning to identify the individuals who create value and manage capital successfully is the basis of being a Value Investor. Listen carefully to Warren Buffett, Ken Langone, Leon Cooperman or any successful Value Investor and you will hear them discuss the qualities of the CEOs in which they invest. Good CEOs do far more than produce good financial performance. They can be trusted more than any others when they explain their business philosophies, offer their perceptions of the current business climate and provide an overall investment context. The better CEOs provide fundamental investment insight not available from any other source. Empathy is how one learns to trust this source of investment intelligence.
‘Empathic Logic’ is the process of connecting CEO/manager skills with security performances. Empathic Logic is a developed skill. One learns though careful analysis over time how a particular individual thinks. One makes connections between individual skill sets, financial performances and extends this to how the market prices securities. Each security has unique pricing based on historical performance and investor perception. Understanding a particular market valuation requires understanding this mix of tangibles and intangibles deploying one’s Empathic Logic.
While markets operate in an environment of continuous flux, individual personalities and skill sets do not change. Once an investor has developed an understanding of individuals’ skill sets, one can trust that over time they will likely repeat past outperformances. Not only will they likely outperform financially, the securities of their companies typically outperform and their business/economic commentary often provides the best continuous stream of investment insight available. The greatest investment risk occurs when a CEO one does not know well replaces one who is a known quantity. We saw this type of risk balloon in 2008-2009 when Hank Greenberg was replaced by an unknown at AIG. Danaher’s corporate culture is a prime example of a corporate culture which produces manager successions with skill sets well-tuned to the nature of its business. Danaher’s successful CEO successions are the basis for long-term security performance.
In the Russell 3000, one can identify ~300 CEOs (~10%) who outperform the index which can form the basis of diversified portfolio of 40+ issues. Essentially, once one identifies good management, one can trust it to perform in the future. Human personalities do not change over time. Human behavior is such that someone who has developed the complex skills needed to manage an enterprise successfully through circumstances which change unpredictably will more than likely continue to do so. Empathic Logic is the heart of assessing people skills, making the connections between people, financials and security prices. This is what Value Investors do best, but rarely discuss in detail. If one listens carefully, one will hear them speak of the quality of the people managing the companies in which they are invested.
The investment recipe then becomes:
- Identify good managers, measure their financial performances and market pricing.
- Buy good managers when markets underprice long-term performance, ie: when markets are out of sync with economic fundamentals.
- Hold till the economic/market cycle peaks or a change in CEO management style changes.
The group of CEOs and portfolio managers whose collective commentary becomes the basis for judging business/economic data becomes a ‘Virtual Staff’. My ‘Staff’ comprises more than 200 highly skilled individuals. Investment insights fill my InBox everyday. It is the combination of trusted CEOs and portfolio manager insight (‘Bottom Up’) with broad market indicators (Top Down’), analyzed daily, which forms the overall context for individual market suggestions.
In my opinion, this is the most effective approach for ‘Modern Security and Market Analysis’