Arnold Van Den Berg on His Experiences in Life and Investing

November 2, 2019 in Curated, Full Video, Timeless Selections

Famed value investor Arnold Van Den Berg, founder of Century Management, was hosted by Dave Sather, president of Sather Financial, at Texas Lutheran University in 2012.

Arnold talked to TLU students about his life and how his past experiences have influenced his investment strategies.

Arnold Van Den Berg founded Century Management in 1974. Most recently, he served as a principal of the firm, the chief executive officer, co-chief investment officer, and a portfolio manager.

Arnold had no formal college education. It was through rigorous self-study, tremendous dedication, and more than five decades of industry experience that Arnold has gained his market knowledge. Prior to starting Century Management, he worked as a financial advisor/consultant for Capital Securities and John Hancock Insurance.

Listen to Arnold’s conversation with noted author William Green at Latticework 2019.

Robert Hagstrom on Liberal Arts Investing

November 2, 2019 in Curated, Full Video, Timeless Selections

Robert Hagstrom, noted author, investment strategist, and portfolio manager, spoke about using multidisciplinary investment decision models at a CFA Institute event in 2019.

Robert is author of numerous books on investing, including two books on multidisciplinary investment approaches: Latticework: The New Investing (2000) and Investing: The Last Liberal Art (2013).

Lauren Foster commented on Robert’s talk in a related article

“…Hagstrom took delegates on a wide-ranging intellectual journey that started with physics and biology and ended with art appreciation — with a literary stop along the way to discuss some of the habits of literature’s greatest sleuths.”

Listen to Robert Hagstrom discuss his book, The Warren Buffett Way.

Not Your Father’s Developed Markets Buyout Environment

November 1, 2019 in Commentary, Equities, Fixed income, Macro

This article is authored by Sebastián Miralles, Managing Partner at Tempest Capital, based in Mexico City, Mexico.

“Arise! ye spirits of the storm” –The Tempest, Thomas Linley[1]

In our 2018 year-end letter we delved passingly on the absurdly high levels at which developed market buyout transactions were occurring. Since we were of course talking out book, a great many of our investors and colleagues expressed surprise and disbelief. We decided to take some time this Summer to take up the issue in further detail. Given the skepticism regarding Latin America and its perceived political risks, we thought it is critical to show our investors the implicit trade-off whereby they are forgoing LATAM risk in favor of the perceived lower risk associated with Developed Market Buyout and similar levered strategies.

The numbers are not encouraging. US M&A transactions are occurring at an average of 5.3x net debt to EBITDA. This number by itself should give allocators pause, however this is not the whole story. Current EBITDA margins are at historically high levels. If we normalize EBITDA margins to the 1990-2015 average margins, this same ratio goes up to a whopping 8.4x.

But just like a trite infomercial, that is not all folks! It can and will likely get worse. If we assume a recessionary environment akin to the 2008-2009 Great Recession, then EBITDA margins contract further to gift us 9.3x net debt / EBITDA. A truly frightening prospect given we are entering the first stages of a recession (Tempest “victory lap”: you may recall we predicted a US recession beginning in 2019 H2 back in our 2017 year-end letter).

We would need to write a paper on its own to delve into the specific opportunities and risks intrinsic to each country in Latin America (we hold it is a grave mistake to think of it as one single region). However, we could simplify our argument by stating our belief that that local government and country specific risks can be mitigated through diligent target company selection.

Emerging Markets Have Outperformed the US with Less Allocated Capital

Since 2014, emerging markets have consistently outperformed the US centric PE strategies. Though small, bear in mind that this outperformance has been occurring with only a fraction of the leverage available to US buyout strategies.

Despite this outperformance, in the past five years, investors have allocated 3.9x more capital to the US private equity than to the entirety of emerging markets. When viewed as investments, the situation is even more glaring with 6.7x more capital deployed than that deployed in the emerging markets.

Clearly, investors are significantly overweight United States and developed markets. Investors appear unaware they are trading off political risk for financial risk.

Hidden Financial Risk in the US Allocations

USA buyout has performed well in the past years and attracted increasing amounts of dry powder. To keep up with return expectations, it seems managers have resorted to ever increasing leverage, and subscription lines. The level of risk hidden in these portfolios, may be significantly higher than is apparent at first sight.

In 2018, M&A transactions crossed at an average net debt-to-EBITDA of 5.3x. However, we must remember that margins are at historically high levels. If we assume mean reversion to average historical levels, adjusted net debt-to-EBITDA shifts to 8.4x. This is a nose-bleed level of leverage that would keep up at night a great many portfolio manager.

However, the situation could be worse; much worse. A great many investment professionals would agree that we are currently heading into a recession. If we adjust current EBITDA margins to the average EBITDA margin of the Great Recession, we arrive at a net debt-to-EBITDA ratio of 9.3x.

Conclusion

The high liquidity environment in developed markets buyout is clearly encouraging managers to add increasingly more aggressive levels of leverage. This game of debt musical chairs can only continue for so long as the economy continues to expand. As we approach the end of this business cycle, the strategy´s sustainability should be questioned. The entire strategy could be sitting on a powder keg of insolvencies and a contraction of exit multiples.

Allocators are either blissfully unaware of these underlying risks, or they are placing an even larger premium on emerging market political risk. The latter seems unwarranted. Political risk is not entirely unpredictable, and its impact on industries can often be priced into transactions.

Furthermore, political risk is no longer exclusive to developing markets. Populism and political risk have become rampant throughout developed and developing economies with the only difference that in LATAM, investors are being paid to bear it.

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Legal disclaimer: This research note is for information purposes and should not be construed under any circumstances as a public offering of securities in any jurisdiction. Tempest does not guarantee the accuracy or completeness of information which is contained in this document and which is stated to have been obtained from or is based upon proprietary best estimates, trade and statistical services or other third-party sources. Any data on past performance, modelling or back testing contained herein is no indication as to future performance. Certain statements in the research note are forward-looking. These forward-looking statements are based on certain assumptions and reflect Tempest current expectations. As a result, forward-looking statements are subject to a number of risks and uncertainties that could cause actual results or events to differ materially from current expectations. There is no assurance that any forward-looking statements will materialize. You are cautioned not to place undue reliance on forward-looking statements, which reflect expectations only as of this date. Except as may be required by applicable law, we disclaim any intention or obligation to update or revise any forward-looking statements. This Research Note contains confidential information and is intended for the exclusive use of the Recipient. You may not be copy, fax, disclose, forward or distribute to third parties in its full or partial form without prior written authorization of Tempest Capital S.C. Reception and acceptance of the document should be considered as acceptance of the confidentiality of the document.

Rodrigo Lopez Buenrostro Discusses His Investment Approach

October 31, 2019 in Diary, Equities, Interviews

We had the pleasure of speaking with MOI Global instructor Rodrigo Lopez Buenrostro, investment principal at KUE Capital, about his investment philosophy.

MOI Global: Tell us about your background and interest in investing.

Rodrigo Lopez Buenrostro: My interest in value investing had been silently building since I was a kid. My grandmother and father were the first people to teach me the difference between value and price. I recall observing them buy simple goods and negotiating with the seller on the value of the good. Their sense of the value of things was embedded in their behavior toward the seller and it wasn’t until later that I noticed the implicit message behind this back and forth: essentially they had combined their good judgement with the accumulation of empirical evidence that provided them with a fairly accurate sense of value which served them as the anchor to negotiate with the seller who was selling at market price.

If you come to think of it, this is not quite different than how the stock market works. An investor must have a good sense of value, through financial statement analysis as well as good judgement, in order to accept or decline Mr. Market’s daily offerings of a stock.

I took these teachings to heart and began to apply them in university in Mexico City. In Mexico, you can open a brokerage account until you are 18 years old and I remember opening an account with $500 to trade stocks as soon as I was able to. I wanted to learn how to translate my growing sense of value of a company into numbers. What frameworks were the most useful? How do you determine the value (not the price) of a company? I decided to study a double degree in Accounting and Business Administration at ITAM, one of the most respected business schools in the country. I sought out finance courses as much as possible and even took some extra classes in the Actuary department. For my graduating thesis I decided to study the hedge fund industry as it was an elusive industry I knew little about but was attracted to it. Specifically, my hypothesis was to the test the viability of launching a hedge fund in Mexico. This research piece represented my first contact with the institutional investment management world.

My first formal job was in Investor Relations where I started to build relationships with sell-side analysts and buyside investors. I then transitioned to investment banking at BBVA where I was the channel between the companies and the equity markets and learned how to create models and sell stories. The main reason I chose the equity department at BBVA was to discover the way IPOs were set. How does a bookrunner set the initial price for a previously private company? What is behind this number? After a promotion within the bank, I started to look forward and recall what really passioned me: investing. I looked around and realized that the asset management business in Mexico was too limited and I wanted to invest globally not only in my home country.

So I took my four years of technical work experience, college hedge fund thesis, and my insatiable drive to learn and applied to business schools in the US. I was fortunate enough to get accepted in 2013 at my first choice: University of Chicago Booth School of Business. Since day one I focused 100% in Investment Management (IM). I wanted to meet everybody who was recruiting for the same industry, I participated in all recruiting and social groups related to investing: Warren Buffett Club, Hedge Fund Group, Student Managed Investment Fund (SMIF), you name it. As I was proactive outside the classroom I was more so inside. I actually never cared about the MBA concentration I would achieve: I just signed up for the classes that I thought would make me a better investor.

Frankly, the people that most helped me make the formal transition to my career in investing were my classmates. I recall four or five of us would often get together at somebody’s apartment and just talk stocks. We would pitch each other ideas and challenge each other’s assumptions in a collegial environment. Although we were ultimately fighting for the same jobs we all knew that if we helped each other out we would all be better in the future. I am humbled to say that I continue to have these great conversations with the same friends to this day in a scheduled call once a month.

I landed an enviable internship at a small hedge fund called Castle Union (most recently renamed to SW Investments) in Chicago for the summer of 2014. My portfolio manager would give me a ticker each week and I had to come up with a recommendation for each. Steve, my PM, taught me the value of independent thinking and to be different if you want to achieve different results from the market.

During my second year at Booth I really enjoyed mentoring the first years who were coming into IM and sharing what I had learned. Recruiting for full-time was a bit easier and I had already developed a pretty decent network of investors in and outside of school. I ultimately received two offers: one from a reputable mutual fund in Chicago and two, from a family office in Mexico called Kue Capital.

After a thorough self-reflection I decided to accept the offer at my current firm, Kue Capital, in 2015. Today, I am part of their asset management division where I spend my time pitching stocks for a public mutual fund we launched as well as vetting managers for a potential investment. Although I have a challenging time management issue, I believe that these symbiotic responsibilities are very enriching. On one hand I am constantly looking at stocks and pitching them for the mutual fund as well as implementing our internal investment process. On the other hand, I study and learn from many great investors, whether they are hedge fund managers or private equity principals, and in some cases develop a close relationship with them. I believe both projects will ultimately help me in my continuous and never-ending pursuit of becoming a better investor.

What are Kue Capital’s investment criteria? How have they evolved over time?

We simply try to find great businesses at great prices. This is easily said than done and it does require a team that follows the same philosophy as well as an investment process that serves as our north star in order to find these investments. We have a general rule that the minimum IRR we seek is 14% in USD across an economic cycle (five to seven years). We try to find a balance between the art and science of investing because we don’t want to fall prey to the biases that sometimes haunts investors. Approaches such as “we will never invest in bank stocks” or “we will only invest in companies where insiders have at least 5%” are mantras which makes your investment universe easier to swallow but may lead the investor to miss out on interesting opportunities.

The most important mindset we cherish is ownership. All members of the team are invested in our mutual fund with their personal money and therefore approach a new investment idea different than perhaps a traditional buyside analyst at a large shop. We are the largest LPs in our fund. The question ends up being, would I like to own this company? Is the margin of safety enough for me? Having this initial mindset helps look for good investments and compounding companies that we would like to hold on forever.

How do you generate new investment ideas?

We have several sources of new investment ideas. We are subscribed to value investor newsletters and the whole team is constantly reading investing material throughout the week. However, I would say that the bulk of new ideas we generate comes from the network of investors we have created. We are constantly in contact with investors that we like and in some cases we actually invest as a limited partner in their funds.

As we read investment letters and have the opportunity to interact with the investment teams of several of these funds we naturally get interested in some of their ideas. In some cases, these funds serve as a bouncing board, especially if they are short one of the stocks that we are long. Once we identify companies that we like we start with a first dive on the company and present it to our Investment Committee.

How important is management in your research? How do you assess whether management is good or bad?

Quite a bit actually. Another important lesson I learned from my summer internship at SW Investments was that incentives matter, and they matter a lot. Within our investment memo template we actually have a separate section on management and how they are aligned with minority shareholders.

I have found that one of the most valuable SEC filings is the proxy statement where the company describes how they compensate their top management. We also look for skin in the game, at least for the CEO.

How do you find the balance between aggressively sizing your best ideas versus diversifying enough to control drawdowns?

More than risk of drawdowns, we focus on risk of losing our capital. As part of our investment process we define three buckets for our investments: mid conviction, high conviction, and opportunistic.

Mid conviction ideas have a position size of 4-6% and high conviction ideas go from 7-10%. The conviction level is defined by the quality of the business as well as the margin of safety.

Furthermore, the opportunistic bucket includes investments that can range from 1-3% depending on how attractive we find the opportunity. Generally, the stocks in the opportunistic bucket are deep value stocks with a margin of safety above 40% and they often are not high quality business nor have admirable management teams. For this bucket, we set a pre-defined entry and exit price that we closely monitor in order to avoid losing our capital in the investment.

The mid and high conviction ideas tend to be more long-term compounders that we think are trading at attractive prices relative to intrinsic value.

Tell us about one or two of your biggest investment mistakes. Is there a company you would have liked to buy?

I have many investment mistakes. Actually, before I get into two of my notable mistakes I have created a habit of writing about my failures and successes on my investment diary. Every time I get into or out of an investment I take a moment to record my entry/exit price, the date and the reason why I was buying/selling the security. I am confident this will help me (and hopefully my team as well) to figure out what are my biases; where am I good and bad at investing and what turns out to be the real driver of my positive/negative returns.

Violin Memory

I invested in VMEMQ in August 2014 at approximately $15 per share. VMEM is a B2B company that designs and manufactures computer data storage products. I was excited about the stock because one of my PMs from my hedge fund internship was bullish on the stock and had issued a detailed investment memo on VIC (Value Investors Club).

His thesis was compelling, arguing that 1) the proprietary flash array technology pioneered by VMEM was the top performing offering in an industry where flash memory drives were displacing traditional spinning hard disks, and 2) strategics such as HP, Dell, IBM, Samsung were hungry for flash arrays and there were signs of a potential bidding war for VMEM’s assets, and thirdly 3) VMEM’s newly appointed CEO was incentivized to sell the company as part of his compensation package. I sold all my shares at less than $2 per share right before it filed for Chapter 11 in December 2016.

The two lessons learned here were 1) always do your own research work! Don’t blindly buy into someone else’s thesis. I vaguely understood what the company did and how the competitive landscape was behaving. 2) Although VMEM had an amazing technology it ultimately lacked scale and a robust sales force. This was the main cause for the cash flow drain and they were not able to solve it on time. When you invest in a small cap tech company make sure they have the distribution figured out!

Precision Castparts

I am now going to talk about an error of omission. During my last months at Chicago Booth in the spring of 2015 I was recruiting and my star long pitch was Precision Castparts (PCP). In March 2015 it was trading at $210 per share. This stock price implied that the market was expecting PCP’s FCF to grow at merely 0.1% in the following five years. Furthermore, PCP was trading at a 30% discount to its historical EV/ Invested Capital ratio, a similar level to that of 2008.

I pitched the stock for well over three months to several buyside asset management firms with the objective of getting a job. I was more concerned on making sure my five-page thesis was solid rather than putting my money where my mouth was. On 8/10/2015, BRK announced it was acquiring PCP for $235 per share or according to my estimates 18x P/E or 5% FCF yield. In my humble opinion I think Buffett acquired PCP at a very good price given the business’ high RONIC of more than 20% and a clear path for PCP to increase its market share per new plane built in a couple years.

I was too focused on getting my dream job that I forgot one of the basic principles of investing: eat your own cooking.

What great investors do you admire and why?

Howard Marks: I have always admired the soft gaze that Howard frequently goes into when asked a difficult question. It seems as if he rethinks the answer to the question even though he has decades of experience investing. I read this as Howard’s acceptance that there is no one golden answer in investing and that he may have changed his mind. He seems to go back to his investment foundations, adds what he has learned in the past few years, all in just a couple seconds, and gives his answer. This continuous self-reflection and humility is a virtue I aspire to have.

Another aspect I admire from Horward is his writing capabilities. It is a true achievement to be good at investing AND transmitting his experience through the written art. I think that a person’s writing skills are correlated to their reading habits and clearly Howard has been able to master both these skills.

Li Lu: If you haven’t read his book “Moving The Mountain” it is a definite must. His personal story reflects the courage and natural leadership he showed before and during the Tiananmen Square events in 1989 in Beijing. I aspire to have his mental stamina and am humbled with his endless pursuit of the truth and freedom. His leadership has also been applied to investing. His very successful fund called Himalaya has had impressive and consistent results since inception in 1997 in a market that he knows well and is misunderstood in the western world. He is one of the few examples I have encountered that really tries to think independently and spends hours reading and writing in his office every day.

Share with us a couple of books that you have read recently and have given you new insights into becoming a better investor.

The Art of Learning, by Josh Waitzkin

I read this book twice, back-to-back and in both instances I was marveled by one of the many insights of the book: Investment in loss. This book is basically the story of how Josh Waitzkin, the author and multiple national chess champion as well as world champion in Tai Chi Chuan, discovered that the driver of his success was having the right learning mindset. Beyond his intellectual genius, he claims that the best way to become a better person/investor/chess player is to invest in loss. This means that one should embrace failure as a mean to become better. It means to look for the hardest competitor in your field and compete with him/her because at the end you will become better. This is directly applicable to investing. The best way to learn is to lose money. Obviously we all try to lose small amounts of money while gain large amounts (risk reward 101) but the whole process of losing at something is very enriching if you know how to channel it internally. Don’t hesitate to pitch an unloved stock because you are afraid of not beating your benchmark or hurting your ego. Do your best, pitch the stock and if it turns out to be a poor investment learn from it and try again: each time I guarantee you will improve.

Accounting for Value, by Stephen Penman

This book, written by Columbia University professor Stephen Penman, makes a magical interconnection between value investing and accounting. Note the play on words with the title. One of the trends I have noticed in my years in the investment management industry is that we all get carried away with the economics’ approach to valuing a company. Metrics such as EBITDA and “economic value add” have been stretched too far in my opinion that we have forgotten the essence of accounting and the reason why GAAP accounting exists in the first place. This book has helped me return to my accounting background and tie it with a logical and conservative valuation framework that uses accounting as its ally and not tries to adjust it.

Rodrigo Lopez Buenrostro works at Kue Capital where he invests to preserve capital over time. He pioneered the asset management division within the firm and divides his time between equity research and manager selection with a global mandate. Previously, Rodrigo worked as a summer equity analyst at SW Investments, a value-focused hedge fund in Chicago. He began his professional career as an Investment Banker at BBVA. Rodrigo is also an MBA graduate from Chicago Booth ’15 where he earned a concentration in Analytic Finance and was actively involved in the Investment Management community. He studied Business and Accounting at ITAM (Mexico Institute of Technology) for undergrad where he wrote his thesis on hedge funds and started to invest personally. Rodrigo has always had an interest in finding the real value of assets while negotiating with Mr. Market, reading, and volunteering at NGOs to teach basic concepts related to investing.

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Some Thoughts on Downside Protection in Investing

October 30, 2019 in Commentary, Equities, Featured, Portfolio Management, Risk Management, Wide Moat

This article is authored by Christian Billinger, Investor at Billinger Förvaltning. Christian splits his time between Sweden and the UK.

I want to share some thoughts around how we think about downside protection at Billinger Förvaltning. Like most significant ideas we have adopted as part of our process, this is based on various adaptations of thinking around downside protection by investing greats, including Warren Buffett (“rule number one, never lose money; rule number two, don’t forget rule number one”), Charlie Munger (“invert, always invert”), Mohnish Pabrai (“worry about the downside, the upside will take care of itself”), George Soros (describing his big bet against sterling as low-risk despite the significant amounts of money and high leverage involved), as well as thinkers like Karl Popper (the scientific method and the concept of falsification) and Nassim Taleb (“via negativa”, etc).

Foundations

A number of elements form the foundations for this kind of thinking, in my view.

At its most basic level, the foundations are formed by the scientific method proposed by Karl Popper and others, which views falsification as central to any type of scientific enquiry. While it would take a great leap to label investing (and, in particular, equity investing) a scientific endeavour, I think any process that aims to be robust can benefit greatly from adopting this way of thinking. Essentially, we start out by looking for flaws in any potential investment case and, only once we have failed to detect any obvious issues, will we move on to considering the upside potential. What we really want to find in an investment is limited downside and unlimited or at least very significant upside. This may sound like common sense but I would argue that in the world of institutional money management the emphasis is on large potential gains more than anything (recall the number of times you have sat through “best ideas” presentations where all that seems to matter is the percentage upside potential for the stock in question in a “blue sky” scenario without any regard to the potential downside).

Looking at the world around us and evolutionary processes, there is also another key argument for applying this kind of thinking, which has to do with survival. For anyone looking to compound capital over a long period of time, the number one consideration has to be to stay in the game by not blowing up. Much of modern portfolio theory is based on thinking around cross-sectional returns (e.g., the average return for fifty money managers during a year) rather than time series returns (e.g., the average return for one money manager over fifty years). It is all very well to say that equities return say 10% annually on average or as an aggregate but this is only relevant for those investors that have managed not to blow up. The average number is not relevant for a time series that includes a zero (i.e., a blowup) anywhere along the way.

There is also the fact that our ability to forecast anything to do with meaningful drivers of equity returns is limited at best. Our solution at Billinger Förvaltning to this problem has not been to attempt to improve our forecasting but rather to limit our exposure to any forecasting errors through a number of measures outlined below, all with the ultimate aim of creating redundancy in our investment process and its resulting portfolios.

The ultimate test, though, is that this approach seems to work, for us and for others. I am not suggesting, of course, that it is a universal truth in investing. All we can claim is that with our structure and temperament, trying not to lose money is a sensible approach.

Aspects of downside protection

In the following I want to describe four aspects of how we aim to achieve downside protection in our portfolio.

1) Security selection

First, we have chosen to invest in the equity part of the capital structure as we find the asymmetry between downside and upside appealing.

What we then effectively do is to invert the investment problem i.e. how do I lose money on this investment? We can then figure out ways of hopefully avoiding such losses. The idea here is that not losing money is the best way of making money. For instance, if I think up a business that would be likely to result in losses over the long term, I would probably imagine a business with no moat or real competitive advantage (e.g. selling a commodity product), highly cyclical revenues, a significant fixed cost base (which in combination with volatile revenues will result in periodic losses), high financial gearing (which together with the above increases the likelihood that we will end up in financial distress), lack of liquidity in the shares (so that we are unable to exit the position without incurring significant losses), etc.

When we have identified businesses within our circle of competence, we can apply the above inverted thinking and analyse these businesses through several lenses to try and make sure that they are robust by displaying the opposite characteristics, e.g.:

  • Revenues (we look for diversified revenue streams, recurring revenues, limited cyclicality, low exposure to potential technology disruption, etc)
  • Cost structure (we look for flexibility/limited operating leverage)
  • Balance sheet (we look for strong balance sheets, limited complexity in terms of the capital structure, etc)
  • Governance (long-term owners, often in the form of families, tend to focus on the survival of the business; their primary focus is preserving the business for their children and beyond)

In addition, we want the companies we invest in to be time-tested with long track records across different types of environments, etc. The reason for this is that regardless of the amount of work and analysis we perform on a business, time is a much better arbiter of its ultimate durability, often through filters that are not visible to us as investors. This is a case of what Charlie Munger would probably refer to as “looking at what works and what doesn’t, and why”. I also come to think of Terry Smith of Fundsmith who often likes to say that, “we are not trying to pick the next winner, we are looking for businesses that have already won”. There is valuable information in a company’s paper record, and we like to use that information as much as we can.

Overall, this would tend to lead us towards “good” companies for which time equals optionality. In fact, I often find that a useful way to identify ‘good’ companies is to look at whether a business has a history of throwing up positive or negative surprises; good things tend to happen to good companies. In my view, this is really what Buffett is getting at when he says that ‘time is the friend of the wonderful company and the enemy of the mediocre one’. One of the advantages that I find in this approach is that we end up invested in businesses that create value (e.g. as measured by a high return on capital) in almost all environments. Looking at track records over the 2008-2010 e.g. can be very instructive; most of the businesses that I would classify as ‘good’ generated healthy returns on capital also in this kind of environment. What this does is to reduce the importance of timing in our entry into an investment (a poor business could e.g. find itself in financial distress or even bankruptcy in a 2008-2010 scenario and we would need to know “when to own it” rather than just own it over time).

Other advantages are that we find these robust businesses are easier to value (partly due to the fact that their earnings are less volatile and therefore a more solid foundation for working out the earnings capacity and present value of the business) and easier to operate for management (in terms of resourcing/budgeting, managing the balance sheet/leverage, etc).

Some examples of businesses that we feel meet many of the criteria listed above would be found in consumer goods (e.g., beverages, luxury goods), engineering (e.g., elevators and escalators), TIC (testing, inspection, and certification), and real estate.

2) Portfolio construction

Once we have identified suitable securities, we combine them into a portfolio. No matter how much work we do, there will always be unknowns and factors beyond our control. We try to manage this exposure by some diversification. This needs to be balanced against the risk of excessive diversification with the potential for dilution of our best ideas, difficulties in keeping on top of all of our portfolio holdings, etc. In our case, this means holding around twenty positions at any time across different industries and geographies.

Beyond diversification, we also want most of our holdings to be relatively liquid. This gives us a “right to change our mind”, whether because our analysis was wrong or because new facts emerge.

At the portfolio level, we want to maintain financial flexibility, which means avoiding leverage as much as possible.

In terms of position sizing, we like to build positions over time as we get to know a business better and as its track record builds. I like the way the great Tom Gayner describes the gradualism that is practised at Markel by the expression ‘crawl, walk, run’; this is what we aim to emulate.

3) Structure

The idea of downside protection and the approach I have described cannot be seen in isolation from the vehicle through which we aim to implement it.

First, we need to consider asset/liability matching. In mutual fund terms, the liability will be in the form of potential redemptions from investors, which will often make it difficult to implement a strategy that focuses on downside protection first (there is pressure to perform on a quarterly or even monthly basis and therefore to look for “triggers”, etc).

We have chosen a structure with permanent capital in a private environment which is well-aligned with our long-term approach and focus on downside protection. I also think having a simple organisational structure helps.

4) Process

In terms of daily activities, one important way of building optionality into one’s business is to allow plenty of time for reading and thinking. While we do see a meaningful number of companies each year, we try to keep our diary as free as possible (think of Buffett and his “haircut days”).

We also aim to learn and improve through identifying and analysing investment mistakes. This is an important aspect of robustness, i.e., improving over time. One especially productive way to incorporate mistakes into the process is to use investment checklists based on previous mistakes, e.g., leverage, technology risks, and governance issues.

Crucially, in an activity as inherently uncertain as equity investing, we should be prepared to reassess our positions, financial and otherwise. As an example, consumer staples has historically been seen as a defensive, safe place to invest for the long term. Is this still true given the suggested rise of challenger brands and private label, changes to the distribution model, etc? My answer is “I don’t know”, but I believe there are still parts of this industry that offer rewarding long-term investment opportunities. What I do know is that we have to constantly reassess this view, and this in fact takes up much of our time. Most businesses end up in the “too hard” pile.

Conclusion

Investing, especially in equities, inevitably exposes us to uncertainty. While the approach I have described will not allow us to avoid mistakes and losses, it does seem to offer us a reasonable chance of growing our capital in real terms over the long run with limited risk of ruin.

There are certainly relevant questions to ask around the types of positions that result from this approach. Are time horizons compressing with regard to great businesses remaining great? Perhaps. Have some great businesses become overvalued, at least temporarily? Perhaps. However, I firmly believe this is the best we can do in attempting to grow our capital over the long run given our setup and temperament. This is not to suggest that it is an approach that is universally appropriate, but it suits us well.

What we are really trying to achieve is to avoid being ‘obviously stupid’ rather than trying to be smart. We are not ignoring the potential upside of an investment but want to do everything we can to limit the downside first.

I haven’t really mentioned valuation. That is by design; while most institutional investors focus more on valuations/ratings (than the quality of the business) as these often drive returns over the kind of time horizons that the industry focuses on, we believe that over the long run returns will be determined by the trajectory of the underlying earnings capacity of the businesses we own. Thus, while valuations matter, to us they matter a lot less than the characteristics of the companies we invest in.

Looking at all the above aspects and more, we are trying to add layer after layer of redundancy to “build a fortress” that will last a long time. Being in the game a long time really matters in investing.

I do identify with how Tom Russo describes his investment approach, which is that of a farmer rather than a hunter. This idea of slow, gradual accumulation suits us well. Over a long enough period of time, we are hopeful this will result in rich harvests.

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Long-Term and Cold-Minded Thinking Behind Some Investments in Greece

October 28, 2019 in Case Studies, Commentary, Europe, European Investing Summit, Letters

This article is authored by MOI Global instructor Raphael Moreau, fund manager at Amiral Gestion, based in Paris.

In 2019, Greece came back on the radar of global investors as pro-market Kyriakos Mitsotakis got elected as Prime Minister. Over the last decade, the country has dramatically suffered from a lot of self-inflicted pain alongside very demanding European partners on budgetary measures. Over the last years, we’ve been travelling many times to the country in a period when investor interest was at record lows and company roadshows almost inexistent. We thought about sharing our experience with MOI readers and draw some conclusions, as investing in Greece during this period was in a way looking like investing in an emerging market with a European Union touch.

This experience is certainly not exhaustive as we have stayed away from the most complex situations like banks or politically dependent businesses like Lamda Development. We have also not discussed more recent additions to our portfolio.

Ensemble Capital’s Investment Thesis Update on Tiffany & Co.

October 28, 2019 in Commentary, Ideas, Letters

This article is excerpted from a conference call with MOI Global instructor Todd Wenning, a senior investment analyst at Ensemble Capital Management, based in Burlingame, CA.

When we think about luxury goods, two things tend to come to mind. First, we tend to think of European brands like Louis Vuitton, Chanel, and Cartier. In fact, according to the consulting firm Deloitte, French, Italian, and Swiss companies together accounted for just under half of global luxury good sales in 2017. Second, we tend to recognize a luxury brand when we see one. A Ferrari, for example, is unmistakable, as are Louis Vuitton handbags with their ubiquitous LV insignias. That’s largely the point in purchasing a luxury item, of course – to communicate status to others.

Curiously, Tiffany does not fall into either of those buckets. It’s one of just a few global American luxury brands and the casual observer cannot tell a Tiffany diamond engagement ring from one purchased elsewhere. There’s no room on a diamond for logo placement.

So how does Tiffany do it? Like its European luxury counterparts, Tiffany is draped in a wonderful narrative and history. You might be as surprised as I was to learn, for instance, that Tiffany has been around since 1837 and has been in the diamond business since 1848, when Charles Lewis Tiffany opportunistically purchased diamonds from fleeing French aristocrats in the French Revolution of 1848. His timing couldn’t have been better, as new American millionaires clamored for royal jewelry to show off their recently achieved status. That’s what got the ball rolling.

As a company, Tiffany is older than Cartier (founded in 1847), Louis Vuitton (founded in 1854), and Burberry (founded in 1856). This durability matters in luxury because it communicates a brand’s ability to endure all kinds of major socioeconomic changes and remain relevant over successive generations. It also communicates a certain timelessness of core products that remain in fashion despite intermittent fads and trends.

Tiffany is one of the few brands in the world that can be identified by a color alone. Its trademarked robin egg blue provides instant recognition, from near or far. And that color communicates elegance, exclusivity, and sophistication. To be sure, more than one would-be suitor has tried his hand at putting a non-Tiffany item in a Tiffany Blue Box to achieve the desired effect. It’s a risky move, of course, for if the ring doesn’t fit, you have some explaining to do when the recipient needs it to be resized. But that speaks to the power of the Tiffany brand – that the color of the box can multiply the value of what’s inside it. Assuming the item was properly acquired, a Tiffany ring in a Tiffany Blue Box communicates to the recipient that you’re worth the extra money.

Tiffany’s narrative has been carried forward into the modern era by popular media, such as the classic movie Breakfast at Tiffany’s starring Audrey Hepburn, and more recent movies like Sweet Home Alabama and The Great Gatsby. The most recent advertising campaigns feature millennial celebrities like Zoe Kravitz, Lady Gaga, and Elle Fanning.

To be sure, the Tiffany brand has been mismanaged at various points in its history. However, we think current CEO Alessandro Bogliolo, who joined the company at the end of 2017, has been a fantastic brand steward and is executing well in the areas the company can control. Notably, we are encouraged by his focus on “informal” luxury to better resonate with the Millennial generation. Last year, for instance, Tiffany opened a “style studio” in London’s Covent Garden, about a mile away from its ritzy high-end storefront on Old Bond Street. The “style studio” format is more informal than the main store, with barstool seating, fragrance dispensers, and opportunities to interact with and customize Tiffany-branded jewelry. We think this is a healthy way for Tiffany to reach out to new consumers without diluting the core brand value.

Like other luxury brands, Tiffany is seeing growth in emerging Asian economies, some of which are adopting Western-style engagement ring culture. In August, Tiffany announced a partnership with India-based luxury retailer Reliance Brands Limited to open new stores in Delhi and Mumbai. As the CEO of Reliance Brands put it in the press release announcing the deal, “Tiffany needs no introduction in India – it is iconic and timeless.”

That quote brings up an important point about Tiffany’s brand-driven moat. It’s extremely challenging to attach a brand (and command a related price markup) to a piece of jewelry that from a distance cannot be differentiated from a similar item. Given its rich heritage and place in popular culture, Tiffany, as the Reliance Brands CEO put it, “needs no introduction.” This is a huge advantage against would-be upstart competitors.

In many other areas of the luxury goods market, we’ve seen direct-to-consumer brand startups leverage social media to take on incumbents. But it’s far more difficult to start and scale high-end jewelry, as the product doesn’t outwardly advertise the brand. It takes decades, if not generations, to be considered “iconic and timeless.” And this says nothing about the expensive input costs – gold, platinum, diamonds, skilled artisan wages – that would go into a high-end jewelry operation.

In summary, we’re confident in Tiffany’s moat and have growing confidence in Tiffany’s management. The company is set up well for continued relevance in future generations.

Read the full transcript here.

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Warren Buffett on His Investment Philosophy in 1992

October 26, 2019 in Curated, Full Video, Timeless Selections, Transcripts

Legendary investor Warren Buffett spoke to the Omaha Press Club in September 1992. The talk was one of Buffett’s earliest recorded and preserved speeches.

Here are some impressions by Jeremy Harris Lipschultz, Isaacson Professor at the University of Nebraska at Omaha:

“I decided to take the only VHS camcorder that was available, just in case the event could be recorded. From the back of the packed room, I taped a piece of history. The other day, while doing research for a documentary titled Mr. Buffett the Teacher, I carefully removed the old tape from its sleeve, copied it to DVD and then ripped and uploaded the video in its entirety to YouTube.”

Read more of Jeremy Lipschultz’s impressions from the event.

Explore MOI Global’s resources on Warren Buffett.

Warren Buffett: Howard Simons used to comment at the Washington Post about the authority of journalists. He was the managing editor at the time of Watergate under Ben Bradlee. Later, he went to the Nieman program. People constantly complain, as you in the news business know, about how journalists can write about business when they haven’t been in business. How can you write about sports when you haven’t been a football player yourself? His retort was you don’t have to be dead to write obituaries!

On the topic of dealing with the news media, the best advice I can give is that it’s like making love to a porcupine. You must be careful. Nevertheless, I have fond memories of the media because I wouldn’t be here if it weren’t for the newspaper business. In 1905 my grandfather bought the Cuming County Democrat in West Point, Nebraska. Believe it or not, there were two newspapers in West Point, a community of about 2,000 people in those days. They were the West Point Republican and the Cuming County Democrat. His grandson learned something of what it’s like to operate the two newspapers. My grandfather and his family – my mother, her sister, and her brother – lived above the newspaper in a little string of rooms on the second floor.

When my mother was 11, she could run the linotype. In fact, the Intertype people who made linotype in those days wanted her to travel to Des Moines to exhibit the operation of a linotype to prove their claim it’s such a simple machine, even an 11-year-old could operate it. Twice a day she would go down to the train station and get on the train when it stopped. The news was sparse in West Point. She’d interview people and write stories for the paper. She sold ads for the paper. When she was older in her high school years, she started the West Point High School paper. When she got out of high school, she was 16. She continued working for three years for the newspaper to get the money to go to school. She attended the University of Nebraska. When she got to school, one of the first things she did was to go to The Daily Nebraskan and apply for a job. It was my dad who interviewed her; he was the editor of The Daily Nebraskan.

A few months later, after the first semester, my granddad lost his foreman who bought a paper in Eustis, Nebraska. He called my mom and asked her if she’d come back to help with the paper, which she did. She took off a semester then returned to the University of Nebraska. A year or so later, she married my dad.

It was remarkable that two sides of the family had a strong interest in the newspaper business coupled with interest in the stock market price. My dad was a blind editor in a small town in Nebraska he was going to work for, but he had that idea at the time, which was long cast out of favor, that he would let his father, who had paid for his education, call the shots on his first job. My grandfather on that side had different ideas. He came to Omaha and became a stock salesman. I was born in 1930, but I was conceived right around November 30th. Most of you can put together what it would be like selling stocks in the fall of 1929. Through my conception, you’ll understand what happened.

That’s the story of how I got here, and I spent the rest of my life trying to figure out how to avoid having the media in my life. I guess that’s the subject of our seminar this evening, and I think the best way to do this is just throw it open for questions. I’ve been around newspapers for a long time. I worked for The Lincoln Journal in college. I delivered five newspaper routes when I was in Washington. I had 2/10 of 1% of all the Washington Post circulation in 1944. I had this marvelous system because I delivered both the Post and its competitor, The Times Herald. If my service was a little sloppy and people changed papers, they found my smiling face there, too. There was a publisher in Alabama many years ago who said he owed his prosperity to two fine American institutions, monopoly and nepotism. I figured out the monopoly aspect of it.

The following are excerpts of the Q&A session:

Participant: I take The Washington Post national weekly edition. Several years ago, Hobart Rowen wrote that the real national debt was something close to $14 trillion. That was three or four years ago. I was shocked by the statement. Nobody seemed to pick it up. I’m just wondering, was there nothing to it?

Buffett: It’s a good figure, $14 trillion. Bart was probably referring to the actual debt, which might have been $3.5 trillion. Also, he might have been talking about the present value of actuarial promises to people in the social security system. When you promise virtually everyone a retirement income geared to inflation and you present value that, you get a huge sum. On the other hand, the federal government has the power to tax people in those future years to, in effect, make transfer payments. Social security isn’t an insurance fund or an insurance operation. It started out with that idea in mind, but it’s exactly what they call it, intergenerational transfer payment now. As long as the federal government has the power to tax, it might have to tax more and more because it’s under-taxing now in relation to its actuarial cost, but it has enormous assets, too. The value of all American corporations is $4 trillion. The government gets 34% of their profits. The stockholders get 60%. I’m leaving out state income taxes. You can say the government owns 34% of those corporations in terms of their earnings power, and it has the right to increase its ownership merely by passing a bill that they’re going to get 40% or 50% of the profits. There are enormous assets and liabilities. You can play around with either side of the equation. But the country has more taxing power than it uses, which is why people don’t get too upset about the $400 billion national debt. They know there is untapped taxing power. Maybe the politicians don’t have the will to tax, but that keeps government bonds selling as probably the safest investments in the world.

Participant: The Buffalo News has endorsed a candidate. Will you be participating in that endorsement?

Buffett: The Buffalo News endorses candidates. I think they had that policy when I went there, but I know they would have that policy under our ownership which began in 1977. Murray Light, editor of The Buffalo News, wrote a column on that just a few weeks ago. He writes a column every week. By and large, they determine their own endorsements. It’s interesting. We had five congressional candidates some years back from Buffalo. We made five endorsements. That was 1982. I think Jack Kemp was still a congressman then. I think he was a congressman because we endorsed Barber Conable, Jack Kemp, and Hank Brown, among others. If you look at these fellows’ voting records, you can see no similarity whatsoever. I discern that our policy at that time was to endorse incumbents. I don’t know what we’ll do this time, but we do have a policy of endorsing. We give opinions daily on every other subject in the world. If we back off giving an opinion, it doesn’t seem to make sense. I don’t think people pay much attention when you get to the presidential race. I think the less the public is interested in a race, the more a newspaper endorsement means. In the presidential race, I would guess the endorsement means virtually nothing, but I still think we ought to do it.

Participant: What stories do you think the media is missing the boat on these days? I’m thinking particularly along the lines of business stories, but feel free to take it beyond that. Are there stories you think they’re blowing out of proportion or ignoring? Is there a story ripe for exposure now?

Buffett: I’ve gotten this question over the last 20 years. When I attend the Pugwash Conference, they always ask about the big stories. Then you tell them, and then they groan. The trouble is the big stories are not the ones that happen like Hurricane Andrew. They’re the ones that happen over time. They get boring, and there’s never a news peg that grabs you where you can say it’s dramatic. No one has ever run a story on the fact that I gained three ounces today because I ate 500 calories more than I burned up. But, if 20 years later I weigh 200 pounds more than I weighed coming in, suddenly that might become a story. It’s hard on anything that has a slow, glacial-like impact on society to write about those things. It’s also difficult to legislate about. They say the problem is that often, on the important questions, the policy cycle is longer than the electoral cycle. The policy cycle is also longer than the news cycle. It’s easier to write about them after they happened, whether it’s the S&L debacle or whatever. But writing about them while they’re happening – because they’re happening one inch at a time – it’s difficult to cover them. The big story is the fiscal imbalance we have at the national level, but it’s been around so long. What more can you say on it? How much different is it if the deficit will be $378 million or $377 million? It’s tough to write about those subjects.

The second thing is that sometimes they get intricate. At the Sun, many years ago, I talked to Paul Williams, a marvelous editor, about the industrial loan scandal that you could see would come in Nebraska. If you looked at the balance sheets, which were sketchy, of the industrial loans and you saw the regulation on it and you knew there was going to be a significant problem, we didn’t have anyone at the Sun who could write that. We debated bringing in somebody from the outside, just hiring somebody who knew a lot about accounting and banking to work on a special assignment for it. We didn’t have the depth of manpower or specialization to write that story. It’s easy to write it after it happened; it’s a cinch. But that is the tough problem.

Take the population problem over time. If we started writing about it, it means taking a lot of abuse for a couple of hundred years. It’s no fun to be a hero 50 years after you die. To come on the news some night and say, “We have this terrible problem. We’ve got 28,000 more people in the country than we had yesterday, five billion,” and run for Planned Parenthood or whatever, it’s a little difficult. It’s best to attack something like that by occasionally doing something in a way of a special. I think the fellows down at the Enquirer have two or three of it in the last five or six years. They have enormous requests for reprints. Those will probably have some impact. The undiscovered flaw to something like that – if I knew about it, I’d be shorting the stock. It’s hard to come up with a blockbuster story that also has reader or viewer impact.

Participant: Have you lost your confidence in Wells Fargo?

Buffett: I won’t comment on the stocks. I never get into recommending or even commenting on individual companies.

Participant: If you were limited in your reading to two financial publications, which two would you buy?

Buffett: I would have answered differently 5 or 10 years ago. Now I’d probably go with The New York Times and probably Fortune. I’m assuming I can still get all the things from Value Line and all the statistics.

I’ll tell you an interesting story about that. Roughly four or five years ago up in the lead paragraph of Sulzberger’s New York Times letter, it said The New York Times was distributed on a same-day basis to virtually every important metropolitan city in the United States. But it wasn’t distributed in Omaha. I wrote a letter and said, “It’s a shame to have a qualifier in there.” I said, “I find it galling to have a friend in Des Moines, which has a population half of Omaha’s, who gets the paper delivered daily. Here we are in Omaha, and we can’t get it.”

I sent a copy to my friend in Des Moines who did not know Sulzberger, Joe Rosenfield, and he wrote him a letter. He said, “Dear Mr. Sulzberger, I understand you’re hearing again from that nut in Omaha.” He went on to say it’s true that Des Moines is smaller than Omaha. He said, “Those people spell the name of their state backwards.” But he said, “I’ve considered his request,” and he said, “You probably should do it because you could look at it as part of your outreach program.” He said, “First, they’ll only read the horoscope, but later, who knows what will happen.” Consequently, we started getting The New York Times. I don’t know if it was my letter or Joe’s, but I got it in the same day.

Participant: Would you comment on your attitude or policy on interviews? You particularly do not give interviews, as I understand, to anyone who wants to write a profile type of interview. I’m wondering how long ago you started that, why you started it, and do you think it’s a good idea?

Buffett: I have probably spent more time over the last 10 years and over the last year with media people – reporters – than any other CEO I know. Each one takes a lot of time. I’ve had five profiles in the last four years by some form of national media including Linda Grant in the LA Times, L. J. Davis in The New York Times. I can’t think of the gal’s name in Forbes. On top of that, I get all kinds of people calling me on special aspects of certain things. Now, I don’t know whether I average two hours a week or something like that, but if I didn’t control it, it would be 80 hours a week. The number of reporters wanting to talk individually is astronomical.

I never knew L. J. Davis or Linda Grant and those people before. But in terms of specific stories, somebody’s calling about the S&Ls or accounting or banks. I try, as much as possible, to talk to people who know a fair amount about the subject because, otherwise, you can spend 45 minutes or an hour giving a course on insurance 101 or something of the sort. Then it’s especially disappointing to discover they don’t know how to write a good story. Some of the issues get complicated. I’m willing to spend 45 minutes or an hour with somebody who knows a lot about it already but is looking for the nuances.

I spend a fair amount of time, but on some of the stories that broke, we might have had a hundred calls. Each would take 10 minutes, and we don’t have a public relations function. Salomon Brothers has a dozen people or so in public relations. When the scandal broke, Salomon Brothers took on all kinds of temporary help. I don’t know what the maximum number of people they would have had at one time there. Twelve was the normal component in that department, and I wouldn’t be surprised if they got up to 30 or 40 people. They answered phones all the time.

We’re not equipped to do that. We don’t need to do it. I find it interesting to talk to some journalists sometimes, but I don’t find it productive or interesting to do it full time.

The guideline is this: If I know they’re good, I want to spend more time with them. Of course, I know some that are good right now, and I’m not inclined to do a lot of experimenting. I don’t go to a lot of new restaurants either.

Participant: Here’s a quote from the book Feeding Frenzy: “Public officials and many other observers see journalists as rude, arrogant and cynical, get into exaggeration, harassment, sensationalism, and gross insensitivity.” How do you comment on that?

Buffett: I might be wrong about this, but there are 1,600 newspapers in the country and the only one I can think of with a media critic that writes regularly is the LA Times with David Shaw. David writes some good stuff. In fact, maybe they’ve already done it, but I would think it a good idea to put some of his pieces together in a book. David interviewed 40 editors, probably all of whom with names you recognize. They include Brokaw and a few people like that. David asked them about the stories written about them. Of course, they came out with a lot of those adjectives. He found the biggest problem they had was accuracy. The second biggest problem they had was with a predetermined conclusion.

That’s the problem when talking to anybody who calls. So often you have somebody who’s already written the story in their minds. They know what they want. They’re looking for one sentence they can get from you in a 45-minute interview they can use to support their predetermined conclusion. They are disinterested in a logical development of the subject. They’re quotation shopping. They can afford to spend 45 minutes with you to get the one sentence they’ll stick in.

These editors Shaw interviewed – Tom Winship, all the people you know – that was their second biggest peeve. Once they had it done to them, it made them a little more sensitive. One guy said he tried subsequently to write a good story, and it didn’t work out as he hoped.

You get people under deadline, which creates a certain pressure you don’t get with, say, the magazine field or something of the sort. You get a bell-shaped curve of human behavior and of talent. If you look at the military, religious organizations, business, or anyplace else, you get some people who are talented. Then you get some people who are not talented at all. You get a lot in the middle. You get a lot of mediocrity. You get some people who are super ethical. And you get a great majority who are reasonably ethical, but if the story’s big enough, they might forget to mention they’re a reporter for just a few minutes into the interview. Then you get a few who are unethical. It’s not an unusual selection or distribution of people compared to other activities.

If you deal with a lot of people over a lot of time, you have a lot of different experiences. Overwhelmingly, people are just as you would expect. The people at the Nebraska Furniture Mart, or any other place, are trying to do their job well and achieve various levels of compliments, partly related to their talent, partly related to their experience. You have mostly good experiences, but we have some people at the mart who will have a bad experience when buying something. We’ll have the rude salesperson. It’s not way different, I don’t think, in the press. If you have a lot of experiences, you’ll have a few bad ones.

The tough part about it is that there is no one, with the exception of an assassin, who can do you as much damage as somebody can in the press if they do something the wrong way. There are other people out there who might be innocent – or it might be intentional, but it depends on the circumstances. There might be doctors out there whom you initiate the transaction with. You go and see the guy and they make you sign a consent form. Or maybe lawyers can do you way more trouble. But you mostly have the ability to opt in or opt out of the transaction.

You walk into Furniture Mart and you might have a bad experience. But most of the time you get a good experience.

In the news business, you don’t have the choice to opt out of the story. You can decide how you’ll maintain the relationship, and you can’t opt out. If you do get the worst of either human nature or reporting skills or something, there’s no way that you won’t be a participant.

That’s an unusual arrangement in society. One person who has a similar power, but again, largely involves somebody else initiating, federal prosecutors or any prosecutor have the decision to prosecute or not prosecute. The fact they prosecute can do a lot of damage whether you’re innocent or not. That person has the power, simply by initiating something, to cause you all kinds of trouble no matter how innocent you might be. That isn’t used that extensively, but the news business has that power. It’s the nature of it.

The other unusual aspect of the newspaper business is that, unlike in my grandfather’s day, there are 1,600 plus daily papers in the United States. Essentially, with the exceptions you can almost count on one hand, there are no competing papers. The reason, of course, is the essential economics of the business drive toward one newspaper for a city or town or metropolitan area. There’s nothing evil about it or anything of that sort. It’s just what Tom Lynch called survival of the fattest. There is no red ribbon in the newspaper industry. If you come in second, you don’t come in. There’s virtually no business like that in the country. If you had 1,600 towns, each with one hamburger stand, each with one bank, each with one women’s shoe store, each with whatever it may be, there would be competition that would come in against them. The guy that runs the best shoe store in the country or the best hamburger chain in the country will look at the town with the worst and he would come in on top of them. But that doesn’t happen in the newspaper business.

Ten years ago, everybody talked about how terrible the Manchester Union Leader was when Loeb ran it. They said it was the worst newspaper in the country. These were great news organizations with enormous resources, money coming out of their ears. They said, “We can put out our wonderful newspaper while Loeb opens up a terrible newspaper,” but they didn’t want to compete with him because it doesn’t lend itself to competition. Therefore, you essentially have a business that will make a lot of money if you’re terrific. It will make a lot of money if you’re lousy. There’s no difference. You pick a paper you think is lousy and I will show you one with 30% profit margins. People always laughed at Roy Thomson, but he knew the figures. I don’t have any feelings about that at all, but a lot of people knocked Thomson’s newspapers in those years, but they had the highest profit margins. All of these people who wanted to say excellence produces profitability and we’re rich because we’re good, it doesn’t hold water because on that basis, Thomson was the best of them all. There is no correlation between profits and excellence. So that means how good a newspaper is depends entirely on the wishes of its owners.

It’s interesting. There’s nothing quite like that in American business. If you saw a hamburger stand, you turn out lousy hamburgers, McDonald’s is going to be next to you or whomever and you won’t be around a year later. If you give terrible service in a business or the prices are too high or anything else, you will be put out of business by somebody else unless you have a regulated monopoly but then, your profits are limited, like when you have an electric company or phone company.

In the newspaper business, you are as good as you want to be, and you’re as bad as you want to be. There are 1,600 papers, and there’s a wide variety of excellence among those papers, but there is no correlation between excellence and probability. That’s something publishers hate to talk about. Maybe it’s a good idea not to talk about it because you can whip up the troops all the time and tell them, “The only way we’re going to stay alive is if you guys are terrific.”

Participant: Would you apply those same thoughts to television journalism? When will the central economics of the business create one television station, one television news organization?

Buffett: If you take the hundred top markets in the country, and I have, and you look at who leads in the nightly news broadcast, whoever leads – whether it’s Brokaw, or Rather, or Jennings – it will be whoever leads the local news before that. In other words, it’s the feed-in that counts.
In Philadelphia, we had as great an audience for Jennings, probably still do but I know we did in the past, as Rather and Brokaw combined, but we had this terrific feed-in from the local news before them. This is tough on the anchorman’s ego, but it’s true.

What’s the biggest factor in what local news is watched? It’s the feed-in before. That’s why you wanted Oprah. It’s dynamite to have the feed-in from a 40 share or something like that coming from Oprah. You say, well, this is all circular. You’re going to have trouble at some point. Incidentally, Good Morning America, the morning show on NBC, used to get a benefit from the feed-in from people that dialed in on Carson from the previous evening. It’s amazing. Somebody wants to set their dial and it runs around the clock.

Cap Cities/ABC is number one in local news in every market they’re in. They’re in New York, Chicago, LA, San Francisco, Philadelphia, Houston, Fresno, Raleigh-Durham. It’s hard for me to figure out exactly why those guys are terribly smart programmers. I mean, they’re dynamite. In Buffalo, the ABC affiliate has been there 30 years. People build up real followings. That’s why an anchorperson who is drawing, particularly in a larger city, a huge audience is worth a lot more than anybody on the newspaper.

It’s sad for those of us who like newspapers, but you can be the world’s greatest newspaper writer and you can’t make a fraction of what an anchorperson can make that draws an extra share point or two on the news in LA or New York. When I watch those local news shows in those bigger cities, I have trouble seeing the difference myself. I know they’re in the sweeps period. We jazz them up.

The newspaper and television business are two fundamentally different businesses because people only want to read one newspaper a day. You can’t attract them by offering it for $0.20 instead of $0.25, or $0.15. When you’ve gone through a paper, 9 people out of 10 don’t want to read a second paper. But with a television station, you can jump from station to station. It would be different if the television set had developed like the VCR, so you had to make a decision between VHS and Beta, you literally had to go with one or another. Let’s say when you bought your television set, let’s say technology forced you to only buy one channel. Now, we’d have 12 television sets, around a thousand bucks each and you go from set to set. If the world had developed that way, you would have had one network become preeminent and drive the others out of business because you would have gotten, again, a survival of the fattest type thing where as it happened to VCRs where the VHS format went far enough ahead of the Beta, it puts the other out of business. But essentially, with television, you can roam among newspapers, and you can do it easily. They’re just sitting there. You don’t have to move and you don’t have to buy another product or anything else. That creates a whole different dynamic. It’s an awful good business, but it’s a different dynamic.

Participant: Can you comment on another branch of journalism? I’m thinking now of the journalistic books such as Michael Lewis’s Liar’s Poker. Do you read them? What do you think of them?

Buffett: Yeah, I read them. I read everything. I spend about seven hours or so a day reading. My family thinks it’s more. The journalistic book is just like the docudrama on television. I’ve just gotten through reading a screenplay for Barbarians at the Gate. I know a lot of the characters in it. I read the book. I’ll tell you, what 10, 20, 30 million people are forming an opinion on Henry Kravis and Ross Johnson and all of them, it is entirely on some screenwriter who wrote that. The screenwriter sticks, to some extent, to facts, but he makes them interesting. He makes them caricatures to some degree. I know the guy that bought screen rights. 25,000 bucks. He tried to get Henry Kravis to cooperate with him. He said, “Henry, cooperate and I’ll have Arnold Schwarzenegger play you. And if you don’t cooperate, I’ll have Danny DeVito play you.” I don’t know whether he cooperated or not and whether he got the Danny DeVito treatment. Having known the real facts about a number of books, you get suspicious about what you read in them, but I still find them interesting and I read them.
Participant: Will you comment on Liar’s Poker?

Buffett: I can say some things are dramatically inaccurate. For example, just the lead part of it, Lewis was never in New York. I know John Meriwether well, and I just think it’s unlikely that took place. But it’s a good story and there’s nothing you can do about it. Once it’s written, millions of people will believe it’s true, and there’s nothing John Meriwether or John Gutfreund or anybody else can do about that. I personally would bet a lot of money it isn’t true, but I can’t prove it either. I wasn’t standing on the trading floor every minute of the day. But it makes a better book, and there’s an enormous temptation. I know authors working on books where the publisher is pushing them to jazz up the book. They want to sell books. After giving somebody $500,000 or $1 million – I’ve gotten big advances offered to me, and I would never take an advance on a book. I’ll write the book, but I wouldn’t take an advance on it because I wouldn’t want to feel indebted to any publisher until I decided what I want to do when I got all through with it. But if somebody’s giving you $500,000 or $1 million, they expect a book that’s going to sell.

I feel sympathetic to anybody, especially on the docudrama. What you can do to somebody on that is just terrible. It doesn’t mean everyone that’s done is terrible or anything like that, but the potential to be taken and put on a screen. I don’t know whether Nixon was down on his knees praying with Kissinger during Watergate, but it doesn’t make any difference. Once you’ve put it on the screen, that’s what tens of millions of people will think. That’s what I personally hated about JFK. I think the odds of that being an accurate rendition of history are extraordinarily low, but 20 years from now, more people may believe that than any other rendition. The screen is powerful. Books are powerful too, but the screen is incredibly powerful.
Participant: What’s your response to the criticism that you used the media in handling the Salomon debacle?

Buffett: There’s no question we had to talk to people. They’ll write something every day. The first day I went in there, we called a press conference. It was a Sunday in August. All the journalists, I think a couple of hundred of them, showed up in shorts. I had to tell them what I had learned in the previous 48 hours to the best of my knowledge. I couldn’t be sure that every fact was right, and I told them that ahead of time, but I could tell them exactly what I knew at that time. I didn’t have any problem doing that. At least they had the opportunity of starting from the same fact base I started from. I had the further opportunity in talking before Congress because we made these 50 to 60-page submissions which laid out every fact we knew, and we told them what we got every time we knew additional facts. But there’s no question that if you have a scandal on your hands, the best thing to do lays out everything you know, and never lie under any circumstances.

Don’t pay any attention to the lawyers. I’m probably offending half the audience, but I’ll get to the other half later. If you start letting lawyers get into the picture, they tell you not to say anything. The world is out there making a judgment about some fast story they don’t quite understand. They don’t even quite know the name of these people yet. Remember Watergate originally? After a while, you started to get things straightened out for you. You have these characters coming and going, and people making self-serving statements, and the press getting it wrong sometimes on a lot of things. You got to do the best you can beginning with your fact base.

The biggest problem, of course, is if you get surprised and you find out something you had told was wrong and it’s something major. Then, just lay it out, and I think it will be obvious you probably didn’t know it earlier. But run straight through, I figured that if we told everything we knew, we could waive attorney-client privilege. We gave all our material to the government. A lot of that became publicly available immediately.

We ran into people who used the press in other ways. We had short sellers in the stock that would call a set of committees or subcommittees, call the press. There was a call from the LA Times telling me four or five different rumors about foreign exchange problems and other things. It’s a multidimensional thing and you can’t do it perfectly, but you’ll never get tangled up if you just play it out as you see it. It’s fortunate when you aren’t implicated in any way yourself. It would be a different thing if you’re John Lehman or something. Incidentally, my friend Jim Burke had a problem with Tylenol. He ignored the lawyers. He was told about product liability and everything out there, but Jim kept running it as he saw it. He was up 18 hours a day doing that, but it only lasted about five or six weeks. It’s not a bad example.

Your problem is what everybody has called the lowest common denominator in journalism. Somebody will write it, and then once they write it, it moves along the food chain. Arthur Ashe, I wouldn’t write that story myself. Now, if I’m editor of some major paper and every other paper in the country is carrying it, or I’m the news director at the network, I think the momentum tends to push it along once it starts. There’s nothing in the constitution about the peoples’ right to know. We trot that out occasionally when we want to justify something we’ve done we feel we shouldn’t have, but there’s nothing there about peoples’ right to know. What you’ve got is the right to say something, but I don’t have any right to know, as far as I’m concerned, constitutionally or any other way, about Arthur Ashe’s health. He’s not playing tennis. He’s not taking my daughter out. It’s not a concern to me. But it will keep coming. It won’t stop.

Participant: Is the media a good investment today? And if not, what general areas might be without naming specific companies?

Buffett: I wrote a section in the 1991 annual report of Berkshire, which we’ll be glad to send you, about media investment. What I say is it’s terrific, but it’s not quite as terrific as it used to be. That’s one of the reasons the American Newspaper Publishers Association is fighting with the telephone companies. They are not wild about the idea about freedom of speech for the federal companies.

I was with my friend, Todd Murphy, watching a Monday night football game at my sister’s house, terrific 45-inch picture. I said to Murph, and this was ABC, of course, “What a terrific picture.” Of course, then there were only three of us. When Anheuser wanted to sell a beer, they came to us. When General Motors wanted to sell Buicks, they came to us. Another year, we just raise the prices, and it was a great business. That business has gotten diluted.

There were three electronic highways in the United States 30 years ago pumped into virtually every household in the United States. Think of that. The short factor in distribution were these highways. There’s lots of talents, lots of heavyweight fighters out there, lots of people watching at the other end, only three highways. The highway guy makes all the money then.

There are all kinds of highways, so Mike Tyson makes all the money or whomever, because talent is the short commodity now. We’re just another electronic highway, and that diminishes. The newspaper is terrific, but of course, an ad bill comes along. The US Postal Service is the biggest threat to the newspaper business. Let the Washington Star have top draft pick of a hundred journalists, any person in the United States. All they need to do is name the name and they all come over to Washington Star. It’s not worth an eighth of a point of the Washington Post stock. But ad bill, let the US Postal Service drop its third class rates 20%, then you can have an appreciable effect on a paper. That’s where the competition comes.

Participant: You’ve written about the impact emotions have on the market. To what extent can the media influence those emotions on a macro basis? To what extent does the media have influence on the market?

Buffett: The media generally are on a short time cycle, so it’s hard for them to say anything of any importance. What I want to know is what’s going to be – if you bought Coca-Cola in 1990 and you paid $40, you got $1.8 million for that $40. I want to know what the next Coca-Cola is, but that’s a little slow in unfolding for newspapers so you’re not going to get a lot out of that. But there is this interesting aspect. I was thinking about this on the way down. News people and I are in the same business. I go out and I try to report on a company. I try to evaluate its management. I try to value its competition, its product, its services, its prices, its cost, everything. I try to do a reportorial job on that business. I may never have heard of it before, and that is my job. I assign myself a story. Every morning when I come to work, it may be triggered by some event, but I assign myself a story. The story always happens to be what is X worth, but that’s a story.

In 1973, we were buying The Washington Post company with a total valuation of $80 million and Woodward was working on Watergate. Let’s say Woodward had assigned himself a story, just exactly like Bradlee coming in and said, “Woodward, I want you to spend the next week doing a story on what The Washington Post company is worth.” If Woodward had that assignment and he’d gone out for the week, he’d have come in with a pretty damn good story at the end of the week. He would have come in with a story that would have said The Washington Post company is worth about $400 million, and it was selling for $80 million. If he’d assigned himself that story, he would have made a ton of money. It’s assigning yourself the right story. I’ve said this to him, “Why don’t you just assign yourself a story to work on between 6 and 7 in the morning? And the other 8 or 10 hours, you work for Bradlee?”

Essentially, that’s a lot easier story than stories he’s trying to get. He’s trying to get a story at the CIA or something, or what he’s mumbling up in his hospital room. Essentially, it is a hell of a lot easier to figure out what The Washington Post company is worth. They had, at that time, four big TV stations. You go interview some TV brokers. You find out what other sales were. It is not a tough story.

The interesting thing to me is that all of the journalists that have covered Berkshire over 25 years – they come in, they write about Berkshire and look at the facts, but virtually none of them bought the stock. It’s usually not against the code of ethics. In most publications, certainly all the big magazines, they must only give the information to their editors as to what they’re doing and not buy right before an article publishes. But here are all these people, they’ve done all this work on Berkshire, they’re trying to figure out what I’m thinking and what we’re doing. They look at the record, but they never do anything about it. They write a story and then they go on to something else. I just say that somehow, their brain isn’t quite connected to their eyeballs. All the time they’re saying, “What will I do with my money?” I say 90% of investment is assigning yourself the right story. The reporting of it is fairly easy.

Participant: What are your thoughts about using network news for information about presidential elections?

Buffett: I’ve said this every four years about elections. It is tough because people love the horse race aspect of the elections. Journalists love the horse race aspect of it. In the network news, it’s tough, and I don’t get much about the campaign on the network news. I’d say the New York Times and the Post do a good job covering the candidates. If you get the Washington Post weekly, there was a lot in there. They make a good attempt. You won’t get it on network news. 22 minutes doesn’t do it.

Peter Lynch on Making Money in the U.S. Stock Market

October 26, 2019 in Curated, Full Video, Timeless Selections, Transcripts

Legendary investor Peter Lynch, former manager of Fidelity’s Magellan Fund, gave a lecture on equity investing and the U.S. economy at the National Press Club in 1994.

Peter Lynch is one of the most successful and well-known investors of all time. He is the legendary former manager of the Magellan Fund at the major investment brokerage Fidelity. He took over the fund in 1977 at age 33 and ran it for thirteen years. His success allowed him to retire in 1990 at age 46. His investment style has been described as adaptive to the prevailing economic environment at the time, but Lynch always stressed that you should be able to understand what you own.

For a deeper understanding of Peter Lynch’s investment philosophy, read his classic, One Up On Wall Street.

We are pleased to provide the following transcript as a courtesy. The transcript has been edited for space and clarity. It may contain errors.

Peter Lynch: I will speak about some of the ideas I used when I was an amateur, when I ran Magellan, and which I still use today. They can make sense for investors.

It’s a tragedy in America that small investors have been convinced by the media – the print media, radio, television media – they don’t have a chance. These media giants have convinced many small investors they can’t compete with big institutions – with all their computers and degrees and money. It just isn’t true. When this happens, people act accordingly. When they believe it, they buy stocks for a week, and they buy options, and they buy the Chile fund this week. Next week it’s the Argentina fund, and they get results proportionate to that investing style. That’s bothersome. The public can do extremely well in the stock market on their own. The fact that institutions dominate the market today is a positive for small investors. These institutions push stocks on usual lows. They push them on usual highs. For someone that can sit back and have their own opinion and know something about the industry, this is a positive. It’s not a negative. So that’s what I want to talk about.

The single most important thing to me in the stock market for anyone is to know what you own. I’m amazed how many people who own stocks would not be able to tell you why they own them. If you press them, they’ll say, “The reason I own this is because the sucker’s going up.” That’s the only reason they own it. I’m serious. If you can’t explain to a 10-year-old in two minutes or less why you own a stock, you shouldn’t own it. That’s true of about 80% of people who own stocks.

This is the stock people like to own. This is the company people adore owning. These are relatively simple companies, and they make a narrow, easy-to-understand product. They make a one-megabit, SRAM, CMOS, bi-polar risk, floating point data IO array processor, with an optimized compiler, a 16-bit dual-port memory, a double-defused metal oxide semiconductor monolithic logic chip with a plasma matrix vacuum fluorescent display with a 16-bit dual memory with a UNIX operating system, four whetstone megaflop poly-silicone emitter, a high bandwidth – that’s important – six-gigahertz double metallization communication protocol, an asynchronous backward compatibility, peripheral bus architecture, four-way interleaf memory, a token ring interchanging backplane, and it does it in 15 nanoseconds of capability. If you own a piece of crap like that, you will never make money. Somebody will come along with more whetstones or less whetstones, a bigger megaflop or a smaller megaflop. You won’t have the foggiest idea what’s happening, and people buy this junk all the time.

I made money in Dunkin’ Donuts. I can understand it. When there were recessions, I didn’t have to worry about what was happening. I could go there, and people were still there, I didn’t have to worry about low-priced Korean imports. I can understand it. And you laugh. I made 10 or 15 times my money in Dunkin’ Donuts. Those are the stocks I can understand. If you don’t understand it, it doesn’t work. This is the single biggest principle.

It bothers me that people are careful with their money. The public, when they buy a refrigerator, they go to Consumer Reports. They buy a microwave oven, they do that. They ask people what’s the best radar range or what car to buy. They do research on apartments. When they go on a trip to Wyoming, they get a Mobil travel guide. When they go to Europe, they get the Michelin travel guide. People hear a tip on a bus on some stock and they’ll put half their life savings in it before sunset, and they wonder why they lose money in the stock market. When they lose money, they blame it on the institutions and program trading. That is garbage. They didn’t do any research. They bought a piece of junk, they didn’t look at the balance sheet, and that’s what you get for it. That’s what we’re being driven to, and it’s self-fulfilling. The public invests terribly, and they say they don’t have a chance. It’s because that’s the way they’re acting. I’m trying to convince people there is a method. There are reasons for stocks to go up. This is magic. It’s a magic number, easy to remember. Coca-Cola is earning 30 times per share what they earned 32 years ago. The stock has gone up thirtyfold. Bethlehem Steel is earning less than they did 30 years ago. The stock is half its price of 30 years ago. Stocks are not lottery tickets. There’s a company behind every stock. If a company does well, the stock does well. It’s not that complicated.

People get too carried away. They try to predict the stock market. That is a total waste of time. No one can predict the stock market. They try to predict interest rates. If anybody can predict interest rates right three times in a row, they’d be a billionaire. Certainly, there’s not that many billionaires on the planet. I took logic, syllogism, when I studied at Boston College. There can’t be that many people who can predict interest rates because there’d be lots of billionaires, and no one can predict the economy. I know a lot of people in this room were around in 1981 and 1982 when we had a 20% prime rate with double-digit inflation, double-digit unemployment. I don’t remember anybody telling me in 1981 about it. I read. I study all this stuff. I don’t remember anybody telling me we’ll have the worst recession since the Depression. It would be useful to know what the stock market will do. It would be terrific to know the Dow Jones average a year from now, to know we’ll have a full-scale recession, or to know interest rates will be 12%. That’s useful stuff. You never know it, though. You just don’t get to learn it.

I’ve always said if you spend 14 minutes a year on economics, you’ve wasted 12 minutes. Now, I must be fair. I’m talking about economics in the broad scale, predicting the downturn for next year, or the upturn, or M1 and M2, 3B. All of these economic terms are less useful to me than when you talk about scrap prices. When I own auto stocks, I want to know what’s happening to used car prices. When used car prices rise, it’s a good indicator. When I own hotel stocks, I want to know hotel occupancies. When I own chemical stocks, I want to know what’s happening to the price of ethylene. These are facts. If aluminum inventories go down five straight months, that’s relevant. I can deal with that. I want to know about home affordability when I own Fannie Mae, or I own a housing stock. These are facts. There are economic facts and there are economic predictions, and economic predictions are a total waste. Alan Greenspan is an honest guy. He would tell you he can’t predict interest rates. He can tell you what short rates will do in the next six months. Try and stick him on what the long-term rate will be three years from now. He’ll say, “I don’t have any idea.” So how are you, the investor, supposed to predict interest rates if the head of the Federal Reserve can’t do it?

You should study history. History teaches you the market goes down. It goes down a lot. The math is simple. There have been 93 years this century. The market has had 50 declines of 10% or more. With 50 declines in 93 years, the market falls at least 10% about once every two years. We call that a “correction,” a euphemism for losing a lot of money rapidly. Of those 50 declines, 15 have been 25% or more. That’s known as a “bear market.” We’ve had 15 declines of at least 25% in 93 years, so every six years, the market has a 25% decline. That’s all you need to know. You need to know the market will go down sometimes. If you’re not ready for that, you shouldn’t own stocks.

It’s good when the market goes down. If you like a stock at $14 and it goes to $6, that’s great. You understand the company. You look at the balance sheet. They’re doing fine. You hope for $22; $14 to $22 is terrific, $6 to $22 is exceptional, so you take advantage of these declines. Declines happen, and no one knows when they’ll happen. People tell you they predicted it, but they predicted it 53 times. You can take advantage of the volatility of the market if you understand what you own. That’s a key element.

Another key element is that you have plenty of time. People are in an unbelievable rush to buy a stock. I’ll give you an example of a well-known company. Walmart went public in October of 1970. It already had a great record with 15 years’ performance and a great balance sheet. You’re a conservative investor. You’re not sure if Walmart can make it. You want to check. You see them operate in small towns. You’re afraid. They make it in seven or eight states. You want to wait until they go to more states. You keep waiting. You could have bought Walmart 10 years after it went public and made 35 times your money. If you bought it when they went public, you would have made 500 times your money, but you could have waited 10 years after it went public and made over 30 times your money. You could have waited three years after Microsoft went public and made 10 times your money. I know nothing about software. If you knew something about software, you would have said, “These guys have it. I don’t care who’s going to win, Compaq, IBM. I don’t know who’s going to win, Japanese computers. I know Microsoft, MS-DOS is the right thing.

Stocks are not a lottery ticket. There’s a company behind every stock, and you can watch it. You have plenty of time. People are in an amazing rush to purchase a security. They’re out of breath when they call up. You don’t need to do this.

You need an edge to make money, too. People have incredible edges and they throw them away. I’ll give you a quick example of Smith Kline. This is a stock that had the successful drug, Tagamet. You didn’t have to buy Smith Kline when Tagamet was doing clinical trials. You didn’t have to buy Smith Kline when Tagamet was talked about in the New England Journal of Medicine or in the British version, Lancet. You could have bought Smith Kline when Tagamet first came out or a year after it came out. Let’s say somebody in your family or you are a nurse, a druggist, or a physician writing all these prescriptions. Tagamet was doing an amazing job of curing ulcers. It was a wonderful pill for the company because if you had stopped taking it, the ulcer came back. It wasn’t a crummy product, you took it for a buck and then it went away. You could have bought it two years after the product was on the market and made 5 or 6 times your money. All the druggists, all the nurses, all the people, millions of people saw this product, but instead they’re out buying oil companies or drilling rigs. It happens. Then three or four years later Glaxo, an even bigger company, a huge company, a British company, bought Zantac which was, at that time, an improved product. You could have seen that take market share and do well. You could have bought Glaxo and tripled your money. You only need a few stocks in your lifetime. They’re in your industry.

If you’d worked in the auto industry – let’s say you have been an auto dealer for the last 10 years – you would have seen Chrysler come up with the minivan. If you were a Buick dealer, a Toyota dealer, a Honda dealer, you would have seen the Chrysler dealership packed with people. You could have made 10 times your money on Chrysler a year after the minivan came out. Ford introduced the Taurus Sable, the most exceptional line of cars in the last 20 years. Ford went up sevenfold on the Taurus Sable. So, if you’re a car dealer, you only need to buy a few stocks every decade. When your lifetime is over, you don’t need a lot of five-baggers to make a lot of money starting with $10,000 or $5,000. In your own industry you’ll see a lot of stocks, and that’s what bothers me. There are good stocks out there looking for you. People aren’t listening and they’re not watching.

People have big edges over me. They work in the aluminum industry. I see the aluminum industry has been coming down; the inventory has declined for six straight months. I see demand improving. In America today, it’s hard to get an EPA permit for a bowling alley, never mind an aluminum smelter. You know when aluminum gets tight, and you just can’t build seven aluminum smelters. When you see this coming, you can say, “Wait a second. I can make some money.” When an industry goes from terrible to mediocre, the stock goes north. When it goes from mediocre to good, the stock goes north. When it goes from good to terrific, the stock goes north. There are lots of ways to make money in your own industry. You can be a supplier in the industry. You can be a customer. This thing happens in the paper industry. It happens in the steel industry. It doesn’t happen every week, but if you’re in some field, you’ll see it turn. You’ll see something in the publishing industry. These things come along, and it’s just mindboggling that people throw it away.

I want to throw out a couple of rules I find useful. People buy when they see a stock has gone down. They ask how much further it can go down. I remember when Polaroid went from $130 to $100 and people said, “Here’s this great company, great record. If it ever gets below $100, just buy every share.” It did get below $100 and a lot of people bought on that basis saying, “Look, it’s gone from $135 to $100. It’s now at $95. What a buy!” Within a year, Polaroid was $18. This is a company with no debt. It was just so overpriced, it went down.

I did the same thing in my first or second year in Fidelity. Kaiser Industries had gone from $26 a share to $16. I said, “How much lower can it go at $16?” I think we bought one of the biggest blocks ever probably on the American stock exchange of Kaiser Industries at $14. I said, “It’s gone from $26 to $16. How much lower can it go?” At $10, I called my mother and said, “Mom, you got to look at this Kaiser Industries. How much lower can it go? It’s gone from $26 to $10.” It went to $6. It went to $5. It went to $4, and it went to $3. I am fortunate this happened rapidly, or I would probably still be caddying or working at the Stop and Shop. It happened fast. It was compressed.

At $3, I figured out there’s something wrong here because Kaiser Industries owns 40% of Kaiser Steel. They own 40% of Kaiser Aluminum. They own 32% of Kaiser Cement. They own Kaiser Broadcasting, Kaiser Sand and Gravel, and Kaiser Engineers. They own Jeep. They own business after business, and they had no debt. I learned this early. This might be a breakthrough for some of you people. It’s hard to go bankrupt if you don’t have any debt, and the whole company, at $3, was selling at a total market cap of about $75 million. At that point, it was equal to buying one Boeing 747. I said there’s something wrong with this company selling for $75 million. I was a little premature at $16, but I said everything’s fine, and eventually this will work out.

Kaiser effectively gave away all their shares to their shareholders. They passed out shares at Kaiser Cement. They passed out shares in Kaiser Aluminum. They passed out the public shares in Kaiser Steel. They sold all the other businesses, and you got about $50 a share. But if you didn’t understand the company, if you were just buying on the fact the stock had gone from $26 to $16 and then it had gone to $10, what would you do when it went to $9? What would you do when it went to $8? What would you do when it went to $7? This is the problem people have. They sell stocks because they didn’t know why they bought it, then it goes down and they don’t know what to do. Do you flip a coin? Do you walk around the block? What do you do? Psychiatrists haven’t worked so far. I haven’t seen the psychiatric or psychological fund file with the SEC and make it through as a mutual fund. They haven’t seemed to help. I’ve tried prayer. That hasn’t worked. If you don’t understand the company, you have this problem when they go down. Eventually, they think it will always come back. This line of thinking doesn’t work, either. People think RCA just about got back to its 1929 high when General Electric took it over. Double knits never came back. Remember those beauties? Floppy disks, Western Union, the list goes on and on. People say it’ll come back. It doesn’t have to come back.

Here’s another one you hear all the time. I’ve had people call me up saying, “I’m thinking of buying this stock at $3. How much can I lose?” Well, you may need a piece of paper for this, but if your neighbor put $20,000 at $50 into the stock and you put $20,000 in at $3 and it goes to zero, you lose exactly the same amount of money, everything. If people say, “It’s $3. How much can I lose?” If you put $1 million on it, you can lose $1 million.

This may be a reason to research a stock. The fact a stock is down $3 from $100 doesn’t mean you should buy it. In fact, short sellers – people who make money in stocks – don’t short Walmart. They don’t short Home Depot. They don’t short the great companies like Johnson & Johnson. They short stocks down from $80 to $7. They’d like to short it at $22, but they figured out at $7, this company will go to zero. They just haven’t blown taps on this thing yet. It’s going to zero, and they’re selling short at $7. They’re selling short at $6, at $5, at $4, at $3, at $2, at $1.25. And you know what? If you sell something short, you need a buyer. Somebody must buy the damn thing! You wonder who’s buying this thing. The buyers are people saying, “It’s $3. How much lower can it go?”

You can’t get too attached to a stock. You must understand there’s a company behind it. You can’t treat this like your grandchildren. You must deal with the stock and say, “I understand the company.” If it deteriorates, if the fundamentals slip, you must say goodbye to it. Remember the rule that the stock does not know you own it. This is a breakthrough. You must understand it and say, they’re doing well and as long as they’re doing well, I’ll hold on to my position. My best stocks have been the stocks I owned in my fifth, sixth, and seventh years, not my fifth, sixth, or seventh day.

I’ll switch through to my long shots. Avoid long shots. I bought about 30 long shots in my life. I’ve never broken even on one of them. I call the bad ones “whisper stocks.” If Arthur Levitt were here, he’d appreciate these stories. These are the times that somebody calls you up and says, “Hi, Peter. How’s Carolyn? How are the kids? I’d like to talk to you about international blivit. Earnings will be unpredictable. They’ll be small. It’s $3 a share,” and they keep whispering all these things. What are you talking about? I don’t understand. Either they’re so surrounded by people that are going to run out and buy this stock because it’s so exciting, or they think the SEC is listening in. They’ll get a shorter term –they’ll get six months in the camp rather than two years in the camp. But whisper stocks don’t work.

I want to conclude by saying there’s always something to worry about if you own stocks. You can’t get away from it. What happened in the 1950s, people were worried about. The only reason we got out of the Depression was World War II. We got another recession in the early 1950s. We said we’re going to go right back into a depression. People were worried about a depression in the 1950s, and they were worried about nuclear war. Back then, the little warheads they had then, they couldn’t blow up a McLane in West Virginia, or a McLane in Virginia or Charleston. All of these countries that end in -stan – there’s nine of these “-stan” countries that came out of Russia. They all have enough warheads to blow the world up and no one worries about it. When I was a kid, people built fallout shelters. We used to have civil defense drills. Remember this one in high school? You get under your desk. I never thought, even then, that was a particularly good thing to do. They’d blow a whistle, somebody would put on a hat, and we would all get under our desks. But in the 1950s, people wouldn’t buy stocks. Except for the 1980s, the 1950s was the best decade this century of the stock market. People wouldn’t buy stocks in the 1950s because they were worried about nuclear war and they were worried about a possible depression.

Remember when oil went from $4 to $40 and was headed for $100 and we were going to have a depression? About three years later, the same experts who said oil would go to $100 are higher paid now and they said it was headed for $4 and we’re going to have a depression.

Remember how the Japanese were going to own the world, and we were going to have a depression? And then about two years later, we were all worried about Japan collapsing. This is the most absurd thing I’ve ever heard. This is a country with a 20% savings rate, incredible work force, incredible productivity, and people were saying we’re going to have a depression because Japan is going to collapse. In their prayer list, they’ve lowered Mother Teresa and crippled children and they’re praying for Japan at night. It’s unbelievable.

Remember the LDC debt? Chase had lent their net worth to Brazil, Chile, Peru and those other countries. They were not going to pay it back and we were going to have a depression. It always ends in we’re going to have a depression, or we’ll have the Great Depression. Now, I understand what these are called – then, they were called “less developed” countries. We used to call them “underdeveloped” countries. Those are all wrong terms. Those are not politically correct. You must call these “emerging” countries. The other day I heard the politically correct term for somebody that’s overweight: laterally challenged. There is always something to worry about.

The key organ in your body in the stock market is your stomach. It’s not the brain. If you can add 8 and 8 and get reasonably close to 16, that’s the only level of math you need to know. You don’t need to know the area under the curve. Remember that quadratic equation and integral calculus and the area under the curve? Whoever cared what was under the damn curve? But you had to study this. You don’t need this in the stock market. All you must know is that it’ll always be scary, there will always be something to worry about. You must forget all about it. Cut it all out and own good companies or own turnarounds. Study them and you’ll do well.

The following are excerpts of the Q&A session:

Monroe Karmin: When managing a portfolio, do you pay attention to the activities of Congress and the regulators?

Lynch: I spend zero time thinking about what’s happening down here in Washington, and I spend only a little time thinking about what’s going on in Russia or China. I just deal with facts. When the economy’s going down, when economy’s going the wrong way, I can deal with that. But this whole healthcare reform bill drove a lot of drug stocks down to low levels. I could say to myself, “60% of Johnson & Johnson’s earnings are outside the United States.” Their pharmaceutical drug business is all patented and nothing’s coming off patent. They only have 5% of sales from one product, which is Tylenol, which is already an over-the-counter drug and it’s growing overseas. Why has this stock gone from $58 to $36? These companies are already dealing in Japan and overseas. They already have the government controlling pharmaceutical prices. They’ve dealt with them. I deal with facts. They might, this year – I thought it was likely they’d have a bill passed on healthcare. It didn’t happen. It drove the stocks down, but I think the stocks would have rebounded anyway even if the healthcare bill had passed. I don’t deal with what’s happening in Congress or what’s going to happen in the future. I just deal with what’s happening in the economy and what’s happening in the companies I call.

Karmin: How useful is the financial reporting in the general daily press to you? And how useful should it be to investors in general?

Lynch: It has improved dramatically not just in the press but also company reporting. Ten years ago, companies didn’t have interim balance sheets. I’d imagine they only gave their balance sheet to you annually. Now they share it quarterly. They report inventories, receivables, and other useful information. In the major newspapers, they even show types of funds. There are around 2,500 companies in the New York Stock Exchange. There are over 5,000 different mutual funds, twice as many mutual funds as stocks. At least in the paper, they explain something about the fund.

If you own auto stocks, you shouldn’t be reading the financial part of the newspaper. Many local newspapers devote a whole four pages on automobiles weekly. They talk about new models and offer opinions about automobiles. If you own auto stocks, that’s the part of the newspaper automobile stock owners should look at.

You shouldn’t be calling your broker four times a day to get stock quotes. It doesn’t work. Getting up in the morning to see how your stock did yesterday is not useful, either. All this stuff is just a waste of time. If you’re adding up how much your stocks are worth, it’s an absolute waste of time. You should be looking at the company when you get the quarterly reports.

If you were in the retailing industry or if you were in the restaurant industry, you would have seen companies like Taco Bell, McDonald’s, and Toys “R” Us. You would have seen all these companies do terrifically well. You would have seen Bombay and Radio Shack and its Tandy. You would have seen Radio Shack roll across the country until there were 25 Radio Shacks in every major city. You said there’s not much room for them to grow, but they had a great 20-year run. That’s what you’re dealing with. You’re not dealing with the minutiae of today. You’re dealing with what this company is doing two years, three years, four years, five years from now. If you’re dealing with a cyclical and business is turning around, you wait for signs that business is slowing down. When you see it, you move on to something else.

Karmin: Are you concerned about the volatility in the financial markets today? Do you think something needs to be done to reduce it?

Lynch: I love volatility. I remember the market went down dramatically in 1972. Taco Bell went from $14 to $1. It had no debt. It never closed a restaurant. I started buying at $7, but I kept on it and it went to $1. It was the largest position in Magellan in 1978 when Pepsi-Cola bought it out at $42. It would have gone to $400 if Pepsi hadn’t bought it out. Volatility is terrific. These calls are important. I don’t think the market going up 80 points one day and down 80 the next is a good thing for the public. But I think all these callers and all these other things to keep the volatility down each day is important, but the market is going to go up and down.

Human nature hasn’t changed a lot in 25,000 years. Some event will come out of left field and the market will go down or the market will go up. Volatility will occur, and the markets will continue to have these ups and downs. That presents a great opportunity if people can understand what they own. If they don’t understand what they own, they can own mutual funds and keep adding to their mutual funds. Basic corporate profits have grown about 8% per year historically. Corporate profits double about every nine years. The stock market ought to double about every nine years, too. The market is about 3,800 today. I’m convinced the next 3,800 points will be up. It won’t be down. After that – the next 500 or 600 points – I don’t know which way they’ll go. The market ought to double in the next eight or nine years and double again in the eight or nine years after that because profits will go up 8%, then stocks will fall. That’s all there is to it.

Karmin: We’re in the month of October. Beware of the month of October, the witching month of the stock market. What do you see as the outlook for this month? And when do you think the Dow will hit 4,000?

Lynch: October’s always been a special month. In 1987, I was convinced the market was not in trouble and I didn’t worry about things. Carolyn and I planned this great golf vacation to Ireland. We planned to visit one course and stay at a little house and visit another and go all along the west coast of Ireland and play golf. We left on a Thursday night. The market went down 55 points that day, which was not too good. The next day, we got to Ireland. Because of the time difference, we had completed our day. I got back to the hotel and called in. The market had gone down 112 on Friday. I said to Carolyn, “I think if the market goes down on Monday, we’re going to have to go back.” We stayed there for the weekend, and on Monday, the market went down 508 points. My fund went from around $12 billion to around $8 billion. That gets your attention – two working days. I said by the end of this week, I’d have no fund.

There wasn’t a lot I could do. Here it was Monday, because the market didn’t open – by 12:00 in Ireland it was still 7:00 in New York. We did spend that day, and we played around and golfed more, and then we went somewhere instead to watch the market deteriorate. I did return home. There was nothing I could do about it. But I think my shareholders thought differently. They called up and asked, “Well, what’s Lynch doing?” They said, “He’s on the sixth hole. He’s even par now, but he’s in a trap. This could be a triple bogey here. This could be a big inning.” I don’t think that’s exactly what shareholders wanted to hear, but it’s not like I could do something about this damn thing. So, I came back home and suffered with everybody else. I was consistent. When I ran Magellan, in 13 years the market went down nine times. Every time the market went down, Magellan went down. I was nine for nine.

Here’s another one of these numbers you must write down: If you put $1,000 in a stock, all you can lose is $1,000. I’ve done that several times. But if you’re right, you make $5,000, $10,000, $20,000. In this business, you don’t have to be right one out of two times. You can be right one out of four. A lot of the times you’re right, you know the company’s doing well, you know they’re doing a great job, and you add to it or at least you don’t sell it, which is a tragedy. You can make more money on the upside. I just roll those out. I will now flip a coin to tell you whether the market will go to 4,000 this year or next year. Heads means it goes up, but it’s a two-headed coin. I flipped the coin and the market will go up in the next year. That’s it. That’s all I ever know about the stock market.

Karmin: As you can imagine, we have many questions about where people should put their money. I’ll divide it into two parts, and you can address it. This questioner intends to put $1,000 yearly into their four-year-old daughter’s education fund. Where should it be invested? The other question covers everybody else: What are some of your current market favorites and why?

Lynch: On the first one – and this is important whether you’re investing for a four-year-old, a 14-year-old, or a 74-year-old – you must ask, “What am I going to do when the market goes down?” I’ve had audiences like this, and I’ve asked, “How many people in the room are short-term investors?” I’ve never had anybody raise their hand. Everybody in the world is a long-term investor until the market goes down. I remember 1990, a scarier year than 1987. In 1987, the market just fell. You call up companies, and they say, “Our business is terrific. We’re about to announce a stock buyback. We’re already buying back stock. Business is great, and we can’t figure this out.” But 1990 was different. Iraq invaded Kuwait. You had the banking system on the ropes, I mean close. You call up a company and they say their business was slowing down.

We sent 500,000 troops to Saudi, and we’re about to fight what people thought was the fourth largest army in the world. Some said they were the toughest army in the world. This was going to be a terrible war, and we ought to sit them out. Remember the big theory? A lot of people in this city said we ought to wait them out. We’d still be waiting for them in 120 degrees, about 500,000 people. I think Bush made an incredibly brave decision on the information he was getting to go in there and knock them out or we’d still be there. But that was an ugly time, and that was scary. Some people learned from 1987 and they stood throughout that and said, “I’m confident about the next 5, 10, 15 years in this country,” and they hung in there.

If you want to buy a small growth fund or a balanced fund that’s part bonds and part stocks and you put so much money in, then you should put more in every year. You’ll be pleased in 10, 20, or 30 years. Stocks will beat the hell out of money markets. They’ll beat the hell out of bonds. Think of it this way: Great corporations like McDonald’s, Marriott, or any other will never get together and say, “We’re doing well. Why don’t we raise the coupon on our bonds? Those bond holders have been loyal. We’ve been given 8%. Why don’t we raise it to 9%?” Companies like Automatic Data Processing – it does payrolls, an amazing prosaic company, 32 years of higher earnings, 32 years of double-digit earnings growth. We’ve had recessions. We’ve had wars. We’ve had changes in Congress, changes in the Supreme Court, but it’s had 32 years of up earnings. That’s what you’re relying on; Johnson & Johnson has 30 years of up earnings, General Parts 42 years of up earnings, Emerson Electric 38 years of up earnings. You don’t see companies like this in other parts of the world. That’s what you buy when you buy a fund. You buy a bunch of good companies.

As for the stocks, the financial area has been attractive. Stocks like Chemical, or Traveler’s, or Citicorp, or Bank of Austin, Fannie Mae, Freddie Mac, these stocks have all come down. Their businesses are terrific. They’ve improved their balance sheets. They’re selling at multiples half or 1/3 lower than the general market. We have a chance for the cyclicals for the first time in a long time – the steels, papers, aluminums, chemicals. It’s their turn to come to the plate. We seem to have an economy recovering in Latin America. Brazil is turning around. These are facts, again. Things are improving in India. Europe had the worst recession since the Depression. There are 18 million people out of work in Western Europe right now, and the economy is starting to slowly turn. Japan has bottomed. I think you’ll see demand.

Commodity prices look attractive. Aluminum prices reached a 30-year low. Ingot has almost doubled. You’ll see the same thing with linerboard. We’ll see a good time for cyclical stocks, and I think the auto stocks are also extremely cheap at four or five times earnings. These are not extraordinary times. Housing is affordable. It’s not as affordable as it was two years ago, but on a 20-year basis, housing is affordable. Automobiles are affordable. Consumer durables are affordable.

We hear about job growth. In the recession, we lost 1.8 million jobs, and now we’ve added 5.8 million, 4.5 million in the last 19 months. We lost 1.8 million and we’ve added 5.8 million back. We’re 4 million to the good. The tough part of it is we dropped about 600,000 manufacturing jobs and we only brought back 100,000 manufacturing jobs. But there are a lot more people working, and I think that trend will continue. This is key. This is what you hear from the press. This is what you hear from TV. In the decade of the 1980s, the 500 largest companies eliminated 3 million jobs, but there were 2.1 million businesses started in the 1980s. If they just have 10 people each, that’s 21 million jobs. It’s an incredible job machine we have in America.

That’s what happened in the 1980s. These 2.1 million businesses created all the jobs. In the decade of the 1990s, the top 500 companies will eliminate another 3 million jobs, and all you ever hear about is company X lays off 5,000 people in Hartford, and company Y lays off 5,000 people in Rochester. Somebody doesn’t buy a sofa in Scottsdale, Arizona because they read about layoffs in the Northeast. That’s the nature. These companies must make these layoffs to stay competitive. That’s our business. We’ve had, in the last 2.5 years, 1,750 companies become public. They raised over $100 billion. There are only 2,500 companies on the New York Stock Exchange. They’ll put the capital they raised into research and development. They’ll put it into more plants and more efficient equipment. This is a fantastic thing for these companies. I think the situation is excellent.

The banking system today has more investments on the left side of the balance sheet. We’re talking about the governments they own, the mortgage-backed securities they own, then they have loans for the first time ever since 1951. They’re only making 50, 20, 30 basis points and they said, “We’ll have to make loans.” The banking system has the highest equity-to-assets in 45 years. The banking system is ready to go. There’s lots of liquidity to run. I don’t know why some people are so depressed about people getting hired all the time. I can’t quite figure this out. I’ve never met a banker or anybody in business that likes recession. I’ve yet to find these people.

Karmin: Speaking of banks, are you concerned about banks being allowed to offer mutual funds and the confusion that creates among investors over whether bank deposits are insured or not? Are you concerned about the whole question of deregulation?

Lynch: I think it’s positive that banks will be allowed to sell mutual funds because they’ll probably sell a lot of Fidelity mutual funds. That’s important. No, but seriously, I think it’s important that people understand when they own a bond fund that bonds can go up and down. Bonds are just about as volatile as stocks. If they own a 30-year bond fund, then you can lose 25%, 30% of your money fast even if they’re government bonds. People must understand this.

There’s an incredible rate of illiteracy in our public. All they ever hear about is what happened today to Bristol-Myers going up $2 or $3, what happened to Dow Jones. They don’t get to learn anything about America. People near retirement are given, say, $450,000 as early retirement. They have no experience. They don’t know what a bond is. They don’t know what stocks are. They must make decisions in 30 or 60 days, or they’ll have a big tax consequence. These people have no experience learning about the stock market. It’s a tragedy. I think anything we can do to educate the public, if you can convince people, if they understand the volatility of the stock market – I’m not saying anybody should buy a stock. I’m just saying if you purchase a stock, you must do certain things. If you’re not ready to do those things, you should keep your money in the bank. Keep your money in a money market fund.

Some people don’t do their homework, they don’t have the stomach for it. They should stay out. They’re not doing anybody any good by taking half their life savings and putting it in the stock market. They’ve been lucky enough to save $50,000 or $60,000 to send their kids to college, and one is going to start in a year. They’re going to take all that money and put it in an equity mutual fund with a one-year horizon. That’s doing no one any good. The SEC is working hard on explaining to people the nature of these products. If they understand them, they’ll do better with it. The more information, the merrier.

Fidelity is launching a major study on retirement. It will be out by the end of this year. We’ll do it over 1,600 people, over 300 experts. We’ll do a major study and explain to people the nature of retirement and how they can best understand how they should invest their assets. We won’t mention Fidelity – maybe subliminally! We’re trying to help. There’s been an incredible push by the SEC to do this, and I think it’s a positive element.

Karmin: A couple of questions about that. What do you think of the SEC’s proposal to require mutual funds to adapt a quantitative ratings scale for riskiness? Also, what effect do you feel the new shareholder rights proposals for more open disclosure and communication are having on companies and the market?

Lynch: I’m not too familiar with the SEC proposal. Concerning the new shareholder rights proposals, I think you must be careful crossing the bridge on how much we get involved in managing companies. There should be a disclosure about people getting paid and a disclosure on how many shares they own. But I don’t think we should decide whether they should make this acquisition or whether they should expand this plant. When you get too involved in running a company, it’s complex. A lot of great companies have made a lot of decisions you haven’t heard about because they decided not to do something, so the best decision they didn’t do is to not do something. If they’re under all this pressure from shareholders of what to do and what not to do, they’ll take their eye off the ball and won’t be able to run the business. The companies that do well look out five, six, or seven years. Some of the decisions they make might not be the right thing for the next year, but they are the right thing for years later. The more we concentrate on what they’re doing and we keep commenting on it as outsiders, it’s going to be run by an enormous committee and we’ll get committee results. I don’t think that’ll help anybody. But disclosure of relevant facts like how many options people have, whether the options are at the market, and what they’re paid – I think that’s important.

Comments in a letter by the Chief Executive in the annual report are fairly new. It is a valuable piece of information. You don’t realize these companies spend a lot of time on this letter. It’s a serious document, and it’s helpful to shareholders. Quarterly shareholder reports are excellent. Also, everybody in America can contact a company. Access is not limited to Fidelity and Platinum and Dreyfus. If you own 100 shares, you can call a company, and somebody will talk to you about it. People don’t take advantage of that. These companies are willing to talk.

On these quantitative and qualitative risk ratings, I think if it could be done, I think it might be possible. I’m a little confused about it. I’m not that current on it. But I think people should understand that certain stock funds, emerging growth funds, small cap funds, and investment companies with $50 million of sales are more volatile than when you’re buying major quality blue chip growth companies. Also, long-term bonds are more viable than medium-term bonds, which are more volatile than one-year bonds. These are things that should be explained to people. People should get a menu like you get at Howard Johnson’s.

Karmin: Several people in the audience asked how you view Fannie Mae’s stocks and options today.

Lynch: I’d include Freddie Mac in that, too. Both companies have great businesses. People study chess. This would not be a good game to study for the stock market. In chess, an outstanding player beats a good player 1,000 times in a row. Everything’s in front of you. All the moves are known. It’s all technique. However, in poker and bridge, there are many uncertainties. You can play a hand exactly right and lose. You can say, “Well, I played it right. If I do it again, over a night, over a month….” That’s not the stock market. The stock market is closer to poker than to any other game, and I think that’s the important thing to know.

Fannie Mae has been like a 27-card stud poker game. Cards keep getting turned over. We were not doing so well in Houston – this was 10 to 12 years ago – with these 5% downs that a lot of people had in mortgages. People moved there for jobs. They brought their spouses along. The job left. They had no ties to those communities and they left. It was the same in Oklahoma or in Alaska. When that card turned over, it was ugly. They were losing $1 million a day. That was easy to remember. That wasn’t too pleasant. They finally figured out we have a good business. We’re extremely low cost. If we can match our liabilities and assets, make a small spread even when we have low cost, we can have a pretty good business. Then a card would turn over like when real estate prices started to go down in California. They started to go down in the Northeast. Then you’d say, “Oh, I better keep checking to see what foreclosures were like.” If you keep watching the story, every year you get a chance to buy this again. Something will come up. People are worried rates would go down. Stocks went down because rates went down. Now that interest rates are going up, the stocks are going down because interest rates are going up. Freddie Mac and Fannie Mae are still doing great, and I think they’ll be terrific stocks. They won’t quadruple, but they’re about 25% undervalued now. They’d be good stocks to own for five years.

Karmin: This next question is from a fellow with a real problem. He says if the real secret of your success is following your daughters to the shopping mall for stock tips, what do we bachelors do?

Lynch: I think one of the reasons people get so depressed is they get away from children. On the weekends they read all these magazines, they need the newspapers, and they’d become economists and get so depressed. They’re bullish if they take that lunch to work on Monday. You need to rent a 12-year-old on the weekend. They don’t know about the problem of the ozone layer disappearing and all these terrible things we think of all the time and we get so depressed about. They don’t know about how second basemen and shortstops get paid $4 million and they can’t throw to first base on a bounce. You need to find a 12-year-old and rent him for the weekend and follow this boy or girl around and see where they’re shopping.

Our kids love Body Shop. I bought it, and I think it will be a good stock. Our oldest daughter, Mary, likes Ann Taylor. She had to dress up to go to work when she was working a summer in a consulting firm. She thought Ann Taylor’s prices were good and the quality was good, and it was a great stock pick. My wife, Carolyn, is an extremely good shopper. She almost got a black belt in shopping. Because of the children, she didn’t quite finish that, but she’s a good shopper. She’s given me some great tips, too. I think either you must use your spouse, or you must go out on your own.

Once the biggest position in my fund was Hanes, which owned L’eggs. It was a huge stock. Consolidated Foods eventually bought it. Hanes had a monopoly on L’eggs, and L’eggs is a big company. I knew somebody would come along with a new product. Kayser-Roth introduced “No Nonsense.” I was worried this “No Nonsense” thing was better, and I couldn’t quite figure out what was going on. I went to the supermarket and bought 62 pairs of “No Nonsense.” I bought different colors, different shapes. They must have wondered what house I came from. I brought them into the office and passed that to anybody, male or female, who wanted one of these things. Just take them all and tell me how it is. They came about in about three weeks and said it’s not as good. That’s what research is. That’s all it was. I held on to Hanes, and the stock was a huge stock. That’s what it’s about.

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