The header is a playful provocation: in truth I am probably closer to a value investor than any other type. But I place little credence on the historical superiority of value investing (which has faltered in recent years anyway), and I have little sense of affiliation or identity as a value investor. It’s not quite that I don’t want to be a member of any club which will have me; rather it’s that that I’m nervous about a club which is now so crowded and where all the members think alike.
The problem with value investing is that it is now a popular and widely followed investment philosophy. Analytical techniques which historically worked well when used by a small minority of investors will work less well as more investors use them. This is inherent to the nature of markets: a matter of arithmetic, not opinion.
The misleading header is useful if read as a prompt: are there any ways in which my thinking differs from value investing orthodoxy? Here are a few.
Scepticism about intrinsic value Many value investors place great stress on the concept of intrinsic value – the discounted future cashflows of a company, as distinct from its book value, liquidation value or market value.
As I explained in a previous post, I seldom write down an estimate of intrinsic value. I think mainly in terms of heuristics. Some heuristics are directly related to value, such as: P/E ratios, dividend yields, and price/sales ratios. Other heuristics have only indirect connections with value, such as: the presence of counterparties with non-investment motivations, director purchases, and patterns of affinity (ie previous associations of the management and advisors to a company).
Scepticism about deep research I generally do not want to read 20 years of past accounts, visit factories, or conduct interviews with customers, competitors and suppliers. I’m also lukewarm about meetings with management. I don’t deny that such deep research can further your understanding of a company, but I think it is subject to strongly diminishing returns. After a certain point, deeper research doesn’t make the risk sufficiently smaller to be worth the time. Rather than looking deeper and deeper into one investment (and often, convincing yourself to buy more and more of it), it is better to spend the time looking more broadly for new investments.
Small bets on large discrepancies, superficially understood When I find a price which looks very wrong for seemingly robust reasons, I sometimes prefer to make a small bet without fully researching the company. Although I might do deeper research later, the price often corrects before I do. This is fine – I just sell and go on to the next one. By keeping positions small I keep them easy to sell, that is I preserve options to change my mind as prices and my expectations change.
Summarising all three points so far: in a noisy information environment with more choices than I can process, I prefer to spend most time looking for new and obvious anomalies, rather than refining my assessment of anomalies I’ve already found. I aim to maximise the quality of my whole portfolio of insights, not my depth of insight on any particular companies.
Willingness to look foolish I actively look for investment ideas which are likely to seem silly, embarrassing or trivial to those who think of themselves as “serious” investors (eg value investors!). Apparent silliness doesn’t necessarily mean that the investment is a good one, but it does mean that fewer “serious” investors will be looking. One example of a silly investment is ASOS under 5p in 2003 – “a start-up website selling teenage fashion?!” (I actually bought ASOS in 2003, and I was acutely conscious of both its potential and its silliness at the time. I sold far too early. The current price is around £50.)
I also look for risks with the following characteristic: if the bad outcome materialises, it will seem obvious with hindsight, making those who took the risk look foolish. Again this doesn’t necessarily mean the risk is a good one, but it does mean less competition from professional investors with career concerns.
The Keynesian short-cut By “Keynesian short-cut” I mean the observation in Chapter 12 of Keynes’ General Theory that financial markets operate under a convention that “the existing state of affairs will continue indefinitely, except insofar as we have specific reasons to expect a change.”
In other words, we expect prices tomorrow and next month and next year to be unchanged (in real terms) from prices today, except where there is relevant new information. So if I expect some future change when other investors don’t, I can buy at current prices and wait for the change, without thinking much about intrinsic valuation in the current state.
If the current price is already far above intrinsic value – in other words the price is already a bubble – then this approach can lead to trouble. Implicitly, I do look out for and avoid situations where this might be the case. But my main focus is on looking for early indications of a knowable future change, rather than on intrinsic valuation in the current state.
This mode of thinking is particularly helpful for highly cyclical businesses such as shipping and house-building. High cyclicality makes discounted cashflow or accounting ratio valuations very difficult, so it may be better not to think about them very much. Better to look for early indications of change, such as freight rates or housing starts increasing.
Avoiding the three R’s Aswath Damodaran critiques value investors with three R’s: rigid, righteous, and ritualistic. Rigid, because they have firm views and rules about analytical techniques or preferred investment sectors (albeit the rules are different for different value investors). Righteous, because they believe theirs is the only true creed, and that success with other techniques is in some sense inferior or illegitimate. Ritualistic, because they see value investment education as a sequence of sacred rites: read The Intelligent Investor, read Security Analysis, read all of Buffett’s shareholder letters, attend a Berkshire Hathaway annual meeting, etc. I have followed many of these rites, and I don’t deny their usefulness; but I try not to be too reverent (a fourth “R”!) about them.
Those are some of the ways in which I believe my thinking differs from value investing orthodoxy. A difficulty with this exercise is that it’s hard to distinguish useful differences from capricious contrarianism or mere idleness. Some of the points above could be characterised as reflecting my lack of diligence. Although I worry about this, I don’t think diligence is an end in itself. My aim in investing is to make money, not to burnish a personal narrative or sense of identity as any particular 'type' of investor.
Perhaps a more accurate version of the header is to say that I don’t care whether or not I am a value investor.