Review – There’s Always Something To Do

There’s Always Something to Do: The Peter Cundill Investment Approach

by Christopher Risso-Gill, published 2011

A short read, There’s Always Something to Do was nonetheless an entertaining and informative one. Peter Cundill’s life serves as an example of what a value investor can be and should be– consistent, disciplined, well-traveled, philosophical and patient. One of Cundill’s comments in a journal entry stood out from the rest, and not just because it was over-emphatically written in all caps:

THE MOST IMPORTANT ATTRIBUTE FOR SUCCESS IN VALUE INVESTING IS PATIENCE, PATIENCE AND MORE PATIENCE. THE MAJORITY OF INVESTORS DO NOT POSSESS THIS ATTRIBUTE.

As an investor, you always have to ask yourself what your edge is in any particular situation. For a value investor who tries to “buy dollars for 40 cents” (the slogan of the Cundill Value Fund) and who insists on a margin of safety, often that edge is patience. Buying at a steep discount to perceived value with no concern for relative and contemporary outperformance of arbitrary benchmarks means the patient value investor is often in a position to be paid to wait. This puts him ahead of the game because, as Peter Cundill observes, most investors can’t or aren’t this patient.

The other prime lesson to be learned from Peter Cundill’s life is that value investing is hard work. As the title of the book, an Irving Kahn quote, implies,

There’s always something to do. You just need to look harder, be creative and a little flexible.

Cundill traveled thousands of miles every year, establishing networks of trusted value investors and other local eyes-and-ears he could get ideas from and visiting the world’s stock exchanges in search of the ones with the worst performance record over the previous 11 months. “Given the dearth of bargains today, it pays to search for them everywhere,” Cundill said.

Unending effort and determination came with the territory. Cundill reveled in the difficult, a complicated or hard to decipher balance sheet, particularly one belonging to a foreign company, was not a reason to get upset about the hardships of the business but was rather an opportunity in disguise because such a balance sheet represented a “barrier to entry” for other investors. Cundill’s creativity often led him to look for a “colony of success”, believing that if he found one amazing business story in a particular industry or country that was otherwise depressed, there might be others nearby. In time, Peter came to surround himself with people who believed that “having a hangover was a waste of a day.” Time spent nursing oneself of the effects of the night before was time one couldn’t spend pursuing investment excellence.

Cundill embraced the constant struggle, philosophically choosing to focus on enjoying the journey rather than focusing on the destination. In a piece of personal poetry Cundill observed “no fortunes are made in prosperity, ours is a marathon without end: enjoy the passing moments.”

Cundill was not just a great investor but a great thinker. He spent a lot of time in moments of reflection, contemplating the perfection of his process in various aspects of his investing career and personal life. Below I have captured and organized a few of my favorites to come back to for inspiration in the future.

The Investment Process and Understanding Business

  • I think that intelligent forecasting should not seek to predict what will in fact happen in the future. Its purpose ought to be to illuminate the road, to point out obstacles and potential pitfalls and so assist management to tailor events and to bend them in the desired direction.
  • In a macro sense it may be more useful to spend time analysing industries instead of national or international economies.
  • It must be essential to develop and specify a precise investment policy that investors can understand and rely on the portfolio manger to implement.
  • In the end, it is always the economic facts and the values which are the determining factors.
  • It is also dangerous to rely on a single strategy in a doctrinaire fashion. Strategies and disciplines ought always to be tempered by intelligence and intuition.
  • The boards of charitable foundations are convenient meeting places for influential people. Their ostensible purpose is intimately bound up with the social and commercial ones.
  • I will never use inside information or seek it out. “All you get from inside information is a whiff of bad breath.”
  • If there’s no natural skeptic on an investment maybe it would be wise to appoint one of the team to play Devil’s Advocate anyway.
On Value Investing
  • Being out on a limb, alone and appearing to be wrong is just part of the territory of value investment.
  • Very few people really do their homework properly, so now I always check for myself.
  • The great records are the product of individuals, perhaps working together, but always within a clearly defined framework. In reality outstanding records are made by dictators, hopefully benevolent, but nonetheless dictators.
  • Accounting is a bear market phenomenon. (on people overlooking accounting oversights in bull markets)
  • Every company ought to have an escape valve: inventory that can readily be reduced, a vision that can be sold, a marketable investment portfolio, an ability to shed staff quickly.
  • We always look for the margin of safety in the balance sheet and then worry about the business.
  • We go short on markets, not individual securities.
  • When there aren’t a lot of net-net situations around I get worried about the market and start to sell into cash.
  • When things get so bad that you’re really scared, that’s the time to buy.
  • You have to be willing to wear bellbottoms when everyone else is wearing stovepipes.
  • The problem with big businesses that have moats around them is they tend to over-expand.
  • Search out the new lows.
  • IPOs for the most part are dreams engineered by the hope that pro forma estimates will be met. We deal to a certain degree with the nightmares that everyone knows about.
  • I am a bear market buyer; I like to sell into strength.
  • When a stock doubles, sell half — then what you have is a free position.
  • I pay much more attention to the balance sheet than the profit and loss statement and am always looking for hidden assets on the books.
The Philosophy of Life
  • Good poets borrow and great poets steal.
  • Retirement is a death warrant.
  • An ability to see the funny side of oneself  as it is seen by others is a strong antidote to hubris.
  • Routines and discipline go hand in hand. They are the road map that guides the pursuit of excellence for its own sake.
  • Patience, patience and more patience.
  • Curiosity is the engine of civilization.

Other Notes

  • Peter got together conferences of people with different perspectives and interests and invited guest speakers who were experts on things other than investing to broaden everyone’s mind through inter-disciplinary thinking
  • Peter moved his fund’s operations to London when it was the finance capital of the world; where is today’s London?
  • Peter would automatically sell investments as they got far beyond their intrinsic value (as measured by P/B), thereby creating a “safety valve” that caused him to go to cash heading into bubbles/crashes
  • In emerging markets, Peter looked for an asset-based margin of safety through large fixed assets, which were a lot more difficult to steal or carry off than a pile of cash.
  • Peter sometimes used the “Magic 6s”– stocks trading for 60% of book value, a 6x P/E multiple and a 6% dividend yield.

More Thoughts On Lone Ranger Investing, Informational Asymmetries And “Going Private”

A few days ago I linked to a post from Hedge Fund News in which the author expressed some deep skepticism and reservations about common stock investments in the present era. The primary concerns were that the market is “rigged” to a large extent via Fed front-running and black-box trading algorithms. Stock market investing is largely about an informational edge. Without friends in high places, an army of analysts and a mainframe computer, how is the little guy supposed to have an edge anymore?

First, a contrarian take on the contrarian take.

Front-running the Fed works, until it doesn’t. Many try to front-run the Fed without any real, personal insight into what’s going on there (aka, having a whisper network that’s tapped in to the Fed) and those people get steamrolled in periods like the one we just witnessed in August 2011, when many market participants hit the “Eject” button all at once and the Fed isn’t there with a trampoline to catch everyone. Some do have those networks and their front-running is largely successful (though you have to wonder what the hell happened at PIMCO over the last two months with Alan Greenspan on retainer) and to that I have no response besides to observe that “Life isn’t fair, deal with it.” Some people are born with a Golden FRN lodged between their butt cheeks and some aren’t. It’s obviously not the majority of the market because if it were that’d defeat the whole purpose of having that kind of informational advantage.

For the average, little guy investor, all the Fed does is introduce extreme volatility into the picture. And volatility isn’t risk. In fact, volatility provides true opportunities for the value investor that he otherwise might never have gotten as the inevitable panics that ensue tend to drag down the good companies with the bad. Then, you buy good companies cheaply.

I look at the black-box trading the same way. So what if there are black-boxes? They add volatility to markets. Volatility is opportunity, not risk. Use limit orders if you’re worried about getting manipulated by these robots putting out false bids.

The concern about informational asymmetries caused by institutionalism and hedge fund analyst armies is more substantive. But it still doesn’t mean doom for the little investor (or maybe better to call him the “lone ranger investor”, because he might have a few thousand or he might have a few million). I am going to paraphrase a few points from Jason Zweig’s commentary from chapter 8 of The Intelligent Investor:

  • Institutions (and hedge funds) have billions of dollars under management; this massive AUM forces them to gravitate towards the same large-cap stocks
  • Investors tend to pour money into institutional vehicles as markets rise, and pull it out as it falls; this forces these players to buy high and sell low
  • Many institutions are obsessed with relative benchmarks, the performance and composition of which shape their trading patterns and selections; their creativity and independence is stifled as a result
  • Many institutions box themselves in with an arbitrary mandate or theme which forces them to make their investment decisions within a confined space, often without regard to absolute value found elsewhere in the market place

Now, let’s flip each of these points around to see how the lone ranger investor is advantaged by each:

  • The lone ranger has comparatively little AUM so he has the flexibility to allocate his portfolio into nearly any stock he wants, from nano-cap to mega-cap
  • The lone ranger is in sole control of his buying and selling as he doesn’t face redemption requests or sudden influxes of hot money like institutions do
  • The lone ranger doesn’t have to compete with any benchmark if he doesn’t want to, instead he can just chase absolute returns and not worry about how he measures against a given index or benchmark over a given period of time
  • The lone ranger is free to choose any style, theme and type of investment strategy he likes and never has to worry about a regulation or outside investors having a problem with it

A video of Ray Dalio over at Credit Bubble Stocks features Dalio riffing on the high degree to which average hedge fund returns are correlated with the broader markets. The implication is that hedge funds aren’t being creative and independent in their strategies and trades. What good is an army of analysts, in other words, if you’ve got them looking at the same exact companies (AAPL, NFLX, BAC, etc.) that everyone else is looking at? What good is it to be a hedge fund when all this really means is you can hold more than 5% of your portfolio in something like AAPL and then lever the hell out of it and cross your fingers hoping Ben Bernanke’s got your back?

Informational advantages come in three flavors:

  1. Investments no one else is interested in, ensuring you have little to no competition for information (for example, a micro-cap with no institutional sponsorship and no analyst coverage)
  2. Investments in which you have a special relationship with insiders or other connected people, ensuring you have better quality information
  3. Investments in which you have a unique perspective or framework for understanding, ensuring that even if information is fairly distributed amongst all participants, only you will know what to do with it

Number two is damn near impossible (and extremely legally risky) to get in the current era of financial market regulation for most people. But there is nothing to stop the lone ranger investor from focusing on numbers one and three. In fact, this is where he should be focused.

The real risk, and this was suggested in the Hedge Fund News piece, is that number two might be so pervasive in particular situations that it overwhelms number one and number three. But for the most part, those situations are fairly obvious and can be avoided. For example, don’t buy AAPL if that’s what everyone is trading.

So, that’s some of the advantages the lone ranger has, in spite of it all. But the HFN piece wasn’t total fluff and he’s right to still be skeptical. I was particularly struck by his suggestions about corporate governance. This is a big problem as I see it.

Yesterday I spent some time listening to Albert Meyer talk about his experience with uncovering numerous well-publicized frauds and accounting shenanigans of the last decade ($KO, $TYC, Enron and the New Era Philanthropy Ponzi). The way Albert made it sound, corporate governance in this country is in shambles and a true embarrassment to the idea of free and honest markets.

Albert talked about the problem with option issuance overhang. Even though these items are now expensed following a FASB rules change, Meyer insists that the true costs of executive compensation for many (most?) companies listed on US exchanges is severely understated. He called into question the practice of huge stock buybacks by most companies, which he said is really just the way in which companies cover up the inevitable dilution that would otherwise occur from executive stock option exercising– and it all comes at the expense of shareholders and mutual fund investors whose mutual funds buy the new shares of recently exercised options. One example he gave was $EBAY, which he said reported income of $800M in a particular period but should’ve reported an $800M loss (a swing of $1.6B) once you had factored in the option issuance and subsequent buybacks to prevent dilution.

Albert said there were only 7 companies in the US that do not compensate executives with stock options. He cited numerous examples of Congressional and regulatory (SEC) corruption with regards to the protective relationship these cretins have with American corporate boards and C-level management teams and the stock option issuance scam. He said there is a lot less of it going on outside of the US which is yet another reason why he finds himself seeking out investment opportunities there.

I’m getting into a digression here when I don’t mean to be, but I assure you this is all related. The point is this: the predominating corporate structure for business in this country, specifically amongst publicly-listed companies with career professional management teams who are not also owner-operators of the company, creates a uniquely perverse set of incentives that truly pits the interests of shareholders (the actual owners of the company, its assets and cash flows) against management and even their own boards! The reality in many cases is that executives and obedient, captured boards work together the milk the wealth of the company for themselves with outsized compensation packages based primarily on stock option issuance, leaving shareholders with all the risks and none of the rewards.

And as the HFN piece points out, the entrepreneurial spirit is particularly absent in these kinds of arrangements because it must be. There is no real connection between the performance of the business (good or bad) and the compensation of the board and management. In the event that the company does well, the gains are secretly dissipated through executive stock option exercising and subsequent colossal buybacks. In the event that the company does poorly, management and the board issue themselves numerous stock options at rock-bottom prices with long duration expirations, virtually guaranteeing that should the business ever turn around they’ll be there to siphon off all the gains for themselves and leave shareholders with nothing.

In effect, it’s a game, and a dirty one that the lone ranger investor doesn’t have many tools besides selectivity that he can use to win. It’s such a widespread practice that you really have to either get in at the absolute bottom or find a company where the corporate governance is much more shareholder aligned (high percentage of insider ownership, predominance of cash compensation for executives without major options issuance, share buybacks that occur at market lows not at market highs when management is cashing in their chips and exercising options, low percentage of institutional sponsorship and a truly independent board where ideally executive management doesn’t have many or any seats) if you ever hope to win it.

That is why I’ve been thinking a lot about “going private.” By going private, I don’t mean taking companies that are public, private, though that might be a good start as I honestly think that in many ways having access to public financing is simply an excuse for poorly managed companies to engage in Ponzi finance without it looking like such.

Instead, what I am talking about is being an enterprising, entrepreneurial investor primarily within the private investment space. This means not only starting your own businesses, but making contacts and seeking out investment opportunities that are not party to the public capital markets. In many cases, it means investing locally and investing in what you know about. It also potentially means outsize returns via informational asymmetries and reduced competition (amongst yourself and other potential investors).

In that vein, I was struck by this comment from Mark Cuban that I saw quoted on Tim Ferriss’s 4 Hour Blog in a post about rethinking investing:

YM: Do you have any general saving and investing advice for young people?

CUBAN: Put it in the bank. The idiots that tell you to put your money in the market because eventually it will go up need to tell you that because they are trying to sell you something. The stock market is probably the worst investment vehicle out there. If you won’t put your money in the bank, NEVER put your money in something where you don’t have an information advantage. Why invest your money in something because a broker told you to? If the broker had a clue, he/she wouldn’t be a broker, they would be on a beach somewhere.

Cuban’s sentiment echoes my own here and I find myself sharing this perspective with friends and family members who ask me for investment advice or what to do with their 401k.

The first thing I tell people is, don’t put your money in your 401k if you don’t know what you want to do with it once it’s there. People get taken in by the idea of pre-tax investing and employer matching, but ultimately those advantages are wasted if you are just going to make clueless, doomed-to-fail investments with that money. What good is having 6% matching or investing with 35% more money because you don’t pay taxes on the principal when you put it in, if you’re just going to lose 100% of it anyway?

The second thing I ask them is, what kind of options do you have and what kind of informational advantages do you have when you put your money into your 401k or the stock market in general? Most don’t have a clue. That’s a warning sign! If you don’t know what your informational advantage is, you don’t have one and you’re basically investing blind. Meanwhile, your opponents not only aren’t blind, they’ve got Lasik. They will take your money and run the first chance they get.

The final recommendation I make is, instead of investing in the stock market or a 401k (which the person admittedly knows nothing about), I suggest they save up to start their own business or invest in the business of a friend or family member who they know, trust and have tangible proof of their success. It would be much better to make private arrangements to invest equity or loan money privately in a situation like that than it would be to dump their hard-earned wealth into a Wall Street rucksack and then wake up 20 years later wondering where it ran off to.

When I make those suggestions to others I start to wonder if we would all be better off if we did the same.