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Professional investors have teams of analysts who scour the world looking for investment ideas, databases full of historical investment information, and in many instances access to the CEO’s of the companies they invest in. However individual investors have advantages over the professionals that they can exploit to help them outperform. Below are two simple techniques smart investors use when constructing portfolios and making their investments.
- Stick to an investing style that works for you (through thick and thin)
It has been a lonely time for value investors. The Russell 1000 value index has underperformed its growth counterpart for 10 of the past 11 years. This has led some pundits to declare the death of value investing, arguing that the aforementioned investing metrics are no longer valid (similar pronouncements were made during the dot.com mania). This has caused some prominent value investors after underperforming for many years to pepper their portfolios with some of the favorites of the day in an effort to temporarily bolster performance and ameliorate dissatisfaction among clients. This is eerily reminiscent of the late 1990s/2000 when once highflying value managers threw in the towel and embraced growth investing just in time to see the NASDAQ decline by almost 80%.
Russell 1000 Growth Price vs. Russell 1000 Growth ValueBoyar Value Group
While I am partial to value investing as I believe it is the best way to preserve and create wealth over the long-term: the style of investing an individual employs is less important than sticking to whatever investing framework you are comfortable with and never materially deviating from it. The worst thing an investor can do is abandon their style because it is not currently working and pivot to a methodology which is long in the tooth (such as now when growth investing has outperformed value for 10 of the past 11 years), and arguably might go into hibernation for a protracted period. Instead of focusing on how others are doing, investors should be laser focused on preserving and protecting their capital and pay little heed to how much money other people are making. Measuring your performance versus others has the unintended consequence of taking on too much risk at precisely the wrong time. I have seen too many money managers self-destruct trying to play catchup. Individual investors have the luxury of not focusing on how others are doing, most professional investors do not.
2. Be patient
By being patient and looking for opportunities that are either underfollowed (i.e. spinouts or post-bankruptcy reorganizations) or out of favor (due to circumstances that you believe to be temporary), it is possible for individuals to outperform the pros, as many professionals are hamstrung with clients who will fire them if they underperform in the short term. This is a significant competitive advantage for the non-professional investor – the only “client” you need to answer to is yourself. If you adopt the mindset of treating each stock as something you intend to hold on to for many years and pay no heed to the day-to-day stock price fluctuations, you will put the odds of investment success in your favor.
Being a value investor oftentimes entails taking a contrarian position. This is psychologically difficult to do as it can be quite lonely going against the prevailing “wisdom” of the crowd. Value investors are often early to the party but if you conduct proper research and determine that a given company is selling at a significant discount to intrinsic value, it can be quite rewarding provided that you are patient. As legendary investor Jesse Livermore once said, “throughout all my years of investing I’ve found that the big money was never made in the buying or the selling. The big money was made in the waiting.”
In this Feb. 25, 1936 file photo, Jesse Livermore, right, New York stock broker and his present wife (formerly Mrs. Warren Nobel) are shown as they arrived in New York on the liner Santa Maria from a South America cruise. In the abyss of financial ruin, faced with sure disgrace and possibly prison, several of the newly scandalized rich have taken desperate measures in these despairing times. (AP Photo/John Rooney, file)
What is a professional investor to do?
For a professional investor, a corollary of being patient is having the “right” clients. Investors who judge you on your short-term performance results are, a hindrance to you and your other investors. You need to find clients who are true partners that believe in your strategy and will allow you to make investments that are measured in years and not months. During the dotcom bubble when Boyar Asset Management did not purchase a single internet stock we were called dinosaurs. We were told that traditional valuation metrics like price-to-earnings and book value no longer mattered and had been replaced by such reliable financial indicators as “eyeballs”. It was frustrating watching companies with no earnings and questionable prospects become market darlings, while companies with solid balance sheets and good long-term growth prospects were left for dead. However, we stood by our investment philosophy and while we did not participate in the upside, we more than made up for any underperformance when the dotcom bubble burst and our style of investing became in vogue again.
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Its déjà vu all over again
Today we are beginning to experience that same lonely feeling as we did during the internet bubble as stocks like Amazon and Netflix have become the market leaders and our style of investing has underperformed. Our bet is that history will once again repeat itself and purchasing companies for less than they are worth will prove to be the best way to invest over the long term.
Patience in practice
The benefits of patience -and having the right clients -were brought home to me in a particularly memorable meeting shortly after the global financial crisis. I was visiting the office of a successful hedge fund manager client who wanted to know our two highest conviction stock ideas.
“Two of our favorite ideas right now are Home Depot and Madison Square Garden,” I told him. I then went through our investment case for both companies, and the multiple catalysts we had identified for each.
I discussed how MSG had recently been spun out of Cablevision and one of the reasons we believed it to be undervalued was that it received very little sell-side coverage. According to our calculations, if you took the value of its “trophy” assets – which included the Knicks, the Rangers, and the Garden itself – they were worth significantly more than the current enterprise value of the company.
For Home Depot, we believed that poor industry fundamentals were masking the operational progress made under CEO Frank Blake. In addition, you had a margin of safety because we estimated that the company’s owned real estate accounted for a significant percentage of its current market capitalization.
The manager was intrigued. He asked, “What are the catalysts?”
I explained how Home Depot could profit from an eventual housing recovery, as this would cause both new houses to be built and current home owners to embrace major home improvement projects. Either of these would translate to significantly improved sales and margins.
MSG, I explained, was in the middle of a costly renovation that we believed was masking the firm’s true cash-flow-generating ability, as capital expenditures were temporarily elevated. Also, the new arena would help the Knicks and Rangers command higher ticket prices and create opportunities for high-margin sponsorship revenue. There could also be additional spinouts on the horizon and we believed that the end game for James Dolan, the owner, was to go private.
“So what’s the time frame?” was the hedge fund manager’s next question.
I told him it was impossible to provide a cast-iron time frame. All of it would take time – but meanwhile he’d be owning great assets at a significant discount to intrinsic value. Value gets recognized: it’s just a matter of how long it takes. He had to pass on both ideas.
“If I underperform for a year or two, my investors will disappear,” he said. “These are perfect investments to buy – for my kids.”
MSG increased its value by ~400% in the ensuing years. Home Depot increased in value by ~350%.
Madison Square Garden (MSG) stands in Manhattan at dusk in this aerial photograph taken with a tilt-shift lens above New York, U.S., on Friday, June 19, 2015. The Standard & Poor’s 500 Index fell, with the gauge dropping below its price for the past 50 days, while Treasuries retreated. Photographer: Craig Warga/Bloomberg
Perhaps I was lucky by citing him these two examples. However, I knew how inexpensive these high-quality businesses were and believed overtime the stock market would value them in a more favorable light.
Patience and persistence pays off.
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DISCLAIMER:*Past performance is no guarantee of future results. The performance of The Madison Square Garden and The Home Depot is not necessarily representative of that of any Boyar Asset Management account. Boyar Asset Management owns shares in The Home Depot and The Madison Square Garden.
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