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Keith Smith: Value Investing In A Volatile Environment

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Willow Oak Asset Management hosted a panel discussion following the Berkshire Hathaway Annual Shareholder Meeting in Omaha, NE on May 4, 2019. The event included remarks from Scott Miller of Greenhaven Road Capital, as well as insights from panelists David Waters (Alluvial Capital), Steven Kiel (Arquitos Capital), Keith Smith (Bonhoeffer Capital), Dan Roller (Maran Capital), Matt Sweeney (Laughing Water Capital), Bill Chen (Rhizome Partners) and Jessica Greer (Willow Oak Fund Management Services).

Value Investing In A Volatile Environment, Omaha, NE, May 4, 2019

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I think for me it's the same thing that Steve sort of the leverage issue when I was doing doing this stuff as a private investor. I basically bought a decent business a cable business in the UK that was over levered and at the time I didn't realize it. I continued investing and went down eventually went to zero and then I bought it when it came out of bankruptcy and it was it actually turned out to be a good investment and what that did what that did to my investment process is that now for every company that I look at I do a a credit analysis on the business and all the other thing that's really available now which is sort of interesting is for most for pretty much all my businesses I look at what the debts doing because the debt is another sort of indication of whether there may be and what the debt yield really is compared to let's say the free cash flow yield on a particular company. And if the spread is relatively wide the real question is who's right is that the debt market or is it the equity market. In my experience the debt market for the most part is a lot more reliable. Their their equation is a lot simpler or all the debt market people are worried about who's making their money back into the equation is can I make my money back and what's the probability of that and I'm going to put that in terms of coming up with a value for the debt the equity is much more difficult because you not only have to worry about the possibility of loss but you have the possibility of gain. So one thing I've learned through that process is actually using the debt markets and sometimes if the security is liquid enough look using the options market to take a look at where these other markets telling you about the specific security and so that's something that's over time it sort of helped the process at least that I go through in terms of some of these more leveraged businesses which can be interesting but you have to be aware of sort of the leverage issue in terms of it blowing you up gotten into trouble before investing in a company where the leadership clearly was not interested in making decisions on the basis of what generates the most the highest increase in value on a per share basis.

I invested in a company our natural resources company not long after they went through bankruptcy where everything seemed incredibly cheap lots of cash flow good assets but then leadership decided that they wanted to be the CEOs and leaders of a much larger natural resources company and so they went about Rican binding with their hived off bad assets. They shed into bankruptcy and set about becoming a top five producer rather than a top 10. They just wanted the glory and the glamour of being hot shot CEOs and didn't really care much about what the share price did. And looking back I should have realized that because this was the same CEO and team that led the company into bankruptcy in the first place and there was little indication that anything had changed. So I now spend a lot more time looking at the track record and the motivations of the people I'm investing in because I found that in small companies especially they can be extremely personality driven. There's not much institutional culture sometimes these companies in the way there might be at a large cap or multinational company and the leadership in the direction and the inspiration that's coming from the top is absolutely critical and in the direction of the company a number of us got a chance to spend some time with any Duke last fall who's a professional poker player.

We talked a lot about our process and understanding outcomes as and judging outcomes as based on being right or based on luck. Because in this business you get off things that you make money on that are actually mistakes and vice versa. You kind of can hit all four quadrants and so you guys are probably all heard. Buffett and Munger talk about no called strikes in this business. You don't have to. You should be fine about missing things that work right and I'm fine about missing lots and lots of things. But one thing that came out of that conversation with Duke which kind of caused me a little a little bit more introspection is trying to think about the things that are in the circle of competence that you that I do the work on and that maybe I go as far as buying a starter position and I actually commit some capital and then never take it beyond that. And they wind up really really working so there's this kind of errors of omission element. I'm fine with errors of omission on all sorts of you know bitcoin and different things but there should be errors of omission that were more upset about and trying to quantify those and avoid those. So it's something that I've been spending some time thinking about.

I think you know most of the mistakes that we made over time and we thought a lot about improving the process is good business qualities. I think there's you know a bunch of them pals have mentioned about this quality in the past about screening for low P low price to free cash flow and I think over time we learned that.

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