One of the value investors we like to follow closely at The Acquirer’s Multiple is John Huber at Saber Capital Management LLC. Huber writes some of the best shareholder letters for his clients. In his latest 2016 investor letter he wrote a great piece that provides some awesome value investing nuggets:
- Investing is a marathon, and each year can be thought of as just one mile marker along the route.
- By the very nature of the ever increasing focus on the next quarter, I believe this long-term mindset—when actually implemented—is a sustainable advantage, and one that is likely to strengthen over time.
- Capitalizing on others’ desire to avoid volatility is what makes this strategy work. Dealing with this interim volatility is the price of admission, but it’s more than a fair trade.
- Do nothing until there is something really obvious to do.
- I really believe that, unlike in years past where investors’ main advantage was finding hidden gems or uncovering information that others didn’t have, the biggest advantage today is to leapfrog the short-term noise by maintaining a multi-year view and to patiently wait for great investments to present themselves.
Here is an excerpt from the 2016 Saber Capital Management investor letter:
Performance Comments—It’s a Marathon
Regarding our performance in 2016, I want issue a reminder that I really place very little weight on any one year’s results. Our results this year exceeded the return of our opponent (the S&P 500), but my expectation is that this variance could be much greater in future one-year periods, both in the positive or the negative direction. I consider results in one year to be more or less random, and our performance measuring tools should always be calibrated for multi-year periods.
Investing is a marathon, and each year can be thought of as just one mile marker along the route. Some years will feel like Heartbreak Hill, the grueling 21st mile of the Boston Marathon, while other years will be more akin to the 2nd mile in New York, where, from the crest of the Verrazano-Narrows Bridge, you glide downhill all the way into Brooklyn.
We should all fully expect to have our fair share of both uphill and downhill years, but to complete a marathon you first must concentrate on the pavement in front of you, putting one foot in front of the other. That’s what I’m fully focused on each day when I come into the office. I hope and expect that by adhering to our investment process regardless of the current terrain, excellent long-term results will follow over time, and I hope to be judged not on each mile split, but over the full 26.2 mile course.
Our investment approach is squarely focused on producing the best possible long-term results with a minimum of risk. This involves an unconventional (but—I firmly believe—less risky) approach to portfolio management. The byproduct of this approach can lead to results that vary much more widely than the market in any given year.
Of course, I’d prefer our results to always vary widely in the positive direction, but unfortunately, the market gods didn’t design their stock market universe with my wishes in mind. Human nature and the impact it has on markets creates volatility, which can be a tool that we use to our advantage rather than an obstacle that we attempt to avoid.
As Ben Graham said, Mr. Market can be our servant or our master. I’ve always liked being my own boss, and so on behalf of all of us, I’ll choose the former.
Saber Capital Investment Approach
Every so often, it’s helpful to outline Saber’s basic philosophy. Since we have a number of new investors who have yet to be indoctrinated, I thought it would be a good time to make a few comments on our approach.
Saber’s investment strategy focuses on making carefully selected investments in high-quality businesses at attractive prices. This ubiquitous description of a well-trafficked investment philosophy does not take away from the soundness of the approach, nor does it compromise our ability to capitalize on its merits, for two main reasons that I’ll describe below.
Some of the key tenets to my investment approach are:
- Understanding the business model and how the company makes money
- Considering the value that customers place on the company’s product or service
- Focusing on durable businesses with predictable cash flow
- Preferring a management team that thinks and acts like owners
- Demanding an obvious gap between price and value (margin of safety)
When it comes to stocks, simplicity and common sense work well. I try to focus on restricting our investments to companies that implement a business model that makes sense to me. I want to not only understand how the company makes money, but I want to understand the value proposition it offers its customers. Good businesses have good economics such as high returns on invested capital and consistent free cash flow, but they also provide a product or service that offers value to the buyer on the other end of the transaction (the customer).
As I’ve learned over the past few years watching debacles such as Valeant and SunEdison, a business with good economics that is coupled with a business model that extracts value from its customers (rather than adds value to its customers) is not a good business. The financial metrics might appear attractive, but a parasitic relationship with customers usually ends up destroying shareholder value at some point. So guarding against this type of business risk is a major focal point at Saber.
Also, while my twin two-year olds would quickly challenge this assertion, sleeping well at night is a must, and so I like businesses with strong balance sheets and preferably without much debt.
And since my economic crystal ball has never worked well, I look for durable businesses that can withstand a variety of economic headwinds, which are certain to occur over time.
Two Important Advantages (Our “Edge”)
Finally, I believe there are two requirements in order to implement this approach successfully:
- Maintaining a long-term time horizon
- Focusing on only the very best investment ideas
Both principles are often preached, but very rarely practiced. Institutional constraints and good old fashioned human nature can make it very difficult to actually utilize those two advantages. This difficulty is the reason the advantages exist, and I believe—since human nature is here to stay for a while—these advantages are permanent for those who can capitalize on them.
The Long-Term Advantage
The first is to maintain a long-term time horizon, which I believe is now a bigger advantage than ever. Fifty years ago, the average stock was held for 14 years—today it is disposed of after about 11 months. The short-termism that is pervasive in the stock market creates lots of irrational buying and selling for all sorts of reasons that have everything to do with the short-term direction of the stock, but nothing to do with long-term value of the business. By the very nature of the ever increasing focus on the next quarter, I believe this long-term mindset—when actually implemented—is a sustainable advantage, and one that is likely to strengthen over time.
Technological innovations over the years have vastly increased the breadth of available information, the speed at which the information travels, and the ease with which that information can be obtained. With so much human and physical capital spent on trying to gain an information advantage, it’s best to bypass that short-term focus completely, and quietly consider the bigger picture. This helps identify the key variables that really matter, and those variables are rarely the consensus estimates for next quarter’s EPS or the decimal-point accuracy of the gross margins.
Predicting an acquisition based by tracking the cities that an acquirer’s executive airplane travels to, or using satellite imagery to track the number of cars in a retailer’s parking lot to better predict this quarter’s revenue numbers (two things hedge funds have done recently to try and gain an information advantage) is not a game that I can (or desire) to play. But the fact that so many resources are focused on competing in this short-term arena leaves an opportunity for those who can look out past the noise and think about the situation from a different view.
Capitalizing on others’ desire to avoid volatility is what makes this strategy work. Dealing with this interim volatility is the price of admission, but it’s more than a fair trade.
Waiting for Great Ideas
“I just wait until there is money lying in the corner, and all I have to do is go over there an pick it up.” – Jim Rogers
I’ve always felt that Rogers, who helped build the foundation for one of the greatest investment track records in history during the 60’s and 70’s, perfectly encapsulates this second main pillar of my investment approach: do nothing until there is something really obvious to do.
Charlie Munger said that it isn’t possible for humans to know “everything all the time”. But, he said, it is possible to occasionally find something of value. When that happens, it’s important to capitalize on it in a big way. But the other variable to this equation that is probably even more important is to avoid investing in less-than-great ideas just to fill out a portfolio or meet some sort of arbitrary quota for diversification.
The benefits of focus investing are well known (and talked about ad nauseam), but there is a dichotomy between what investors say and what they do. Portfolio managers have a bias toward activity to justify their high fees. They also would much rather act conventionally (make frequent investments and own lots of stocks) than risk their jobs. The drumbeat of “what have you done for me lately” is very rarely muted in professional investing circles.
Unfortunately, individual investors succumb to many of these pitfalls as well. This conventional wisdom is like a powerful magnet that eventually attracts most market participants. Social proof is a powerful force.
Everyone knows that to obtain results that are different from the crowd, you must behave differently than the crowd. But the reality when it comes to performance is that 90% of the people will make up the bottom 90%. I think it’s imperative to recognize the reasons why this is the case, especially since we desire to be among the 10% of the people who are in the top 10%.
I really believe that, unlike in years past where investors’ main advantage was finding hidden gems or uncovering information that others didn’t have, the biggest advantage today is to leapfrog the short-term noise by maintaining a multi-year view and to patiently wait for great investments to present themselves.
This article was originally posted by Johnny Hopkins at The Acquirer's Multiple.