Today, I’ll be answering a question from a reader and addressing the question, How do I describe myself as an investor? This question provides an opportunity to delve into what I mean by being an “eclectic value investor with a slight touch of dogmatism.” It’s a comprehensive look at our investment philosophy and approach.
Every investor is unique. How would you describe yourself? Are you a quality investor? A quality investor with a value tilt? A value investor…?
I think of myself as an eclectic value investor with a slight touch of dogmatism.
Let’s start with the eclectic part.
Our portfolio doesn’t look like a traditional value portfolio – it doesn’t fit neatly into a quadrant of any box. Undervalued companies come in different sizes, and not all of them are located in the US. We own companies all over the developed world.
Not all undervalued companies look “in your face” statistically cheap (something you’d expect to see in a “by the book” value portfolio). Some of them are even considered to be growth stocks and thus trade at growth multiples.
But our portfolio is definitely constructed using the values of value investing – each company is valued with the same care as if we were buying the whole business and demanding a margin of safety. In other words, we only buy stocks when we believe they are undervalued.
What is the difference between cheapness and undervaluation?
Statistical cheapness is often easy to see: A company that trades at 7 times last year’s earnings is considered cheap, but it may or may not be undervalued. Though it may appear to be cheap based on rear-view-mirror earnings, it won’t be cheap if its earnings collapse in the future.
Also, undervaluation can come from different sources, and growth is one of them. There is value in growth – I’ve written about that in my essay called “Growth and Value Demagogues.” As David Einhorn put it, “The opposite of value is not growth, but anti-value.”
The US stock market is the largest and most liquid market in the world, but it is not the only market. We are not trying to be the Indiana Jones of value investing; I don’t want to visit companies in countries where I would need to be accompanied by armed-to-the-teeth bodyguards. However, there are plenty of developed countries with the rule of law where companies follow Western accounting conventions.
The Touch of Dogmatism
Where does the touch of dogmatism come in?
Your investment process should bring out the best in you and play to your strengths. It should fit your personality. It should amplify your strengths and reduce the impacts of your weaknesses.
Investing is a very different endeavor from other professions. Let’s contrast it with being an orthopedic surgeon. You are an orthopedic surgeon, and you discover that, for whatever reason, your success rate for surgeries on right knees is much higher than for left knees. There is, however, very little you can do with this knowledge. It is going to be impossible for you to build a practice solely focused on right knees.
However, if you’re an investor, you have more flexibility. At IMA, we only need a portfolio of 25–30 stocks. There are thousands of stocks out there in the developed world. After careful observation of my past decisions (something every investor should do), I found that I have the worst IQ and EQ when it comes to retail stocks. They are my “left knees.” But this is the beauty of investing – we can build a portfolio that does not include retail stocks. Therefore, being mindful and deliberate and figuring out what your “left knees” are is essential. Focusing on “right knees” is what every investor should do. Well, at least, this is what we do.
Let me give you this example. I have tremendous respect for Seth Klarman of Baupost. However, I look at his holdings, see a lot of single-drug biopharmaceutical companies and scratch my head. Seth has done extremely well with these types of stocks, but I don’t understand them. And that is absolutely fine. My IQ is very low in this area. Today I have enough self-confidence in myself to put these stocks into the “too difficult” category.
Here is another very real example.
I was at a conference where two of my good friends (people I deeply admire, who do thorough and brilliant research) presented ideas that looked wonderful. As I was listening to them pitching their stock ideas, I remembered that both companies have very opaque accounting due to the nature of their business. I had looked at both companies before. Simplicity and clarity of financials is a must for me. I passed on both stocks. I’m sure they will both turn out to be good investments for my friends.
Why did I pass on these opportunities?
If the Almighty issued a guarantee that these companies would never encounter turbulent times, I’d buy them. But investments don’t come with guarantees. My EQ is low when I deal with businesses that have complex, opaque accounting.
It is important to understand that it is not just your EQ at the time of purchase that should be considered but during the whole arc of ownership – in both good and bad times. It is paramount to be dogmatic – to carefully study your EQ and IQ weaknesses and then keep them from affecting your portfolio. As Charlie Munger remarked, “All I want to know is where I’m going to die so I’ll never go there.”
This brings me to quality. Through painful experiences, I found that my EQ is the highest when we own high-quality businesses. There is nothing wrong with owning low-quality businesses; some investors are very good at doing that. I don’t look at my desire to own high-quality businesses run by good management as a badge of honor; it’s just the strategy that fits my EQ and IQ. Again, trying to play to my strengths.
The liquidity offered by the stock market is both a feature and a bug. It is a feature because we can enter and exit stocks in seconds at a low transaction cost. However, it is also a bug, because it encourages promiscuity, lack of seriousness, and hasty (half-baked) decisions. Another way to describe being dogmatic is that we are disciplined, process-driven, and know our limitations.
Our job is to be patient and say “no” thousands of times to new opportunities and say “yes” just a few times a year. These words are worth repeating – there are thousands of stocks out there, and we only need 25-30.
Key takeaways
- As an eclectic value investor, your portfolio doesn’t fit neatly into traditional value categories, including companies of various sizes and from different countries, some even considered growth stocks.
- The core principle of your eclectic value investor approach is to buy undervalued companies, which differs from mere statistical cheapness and can include value in growth.
- Your “touch of dogmatism” involves recognizing and avoiding your investment weaknesses (like retail stocks or companies with opaque accounting) to focus on your strengths.
- Quality is a key factor in your eclectic value investor strategy, as you’ve found your emotional intelligence (EQ) is highest when owning high-quality businesses run by good management.
- As an eclectic value investor, you emphasize patience, discipline, and a process-driven approach, saying “no” to thousands of opportunities to find the 25-30 stocks that fit your portfolio criteria.
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