Wednesday, February 19, 2014

Peter Thiel and His Version of Moats: Durability

"More important than being the first mover is being the last mover. You have to be durable. In this one particular at least, business is like chess. Grandmaster José Raúl Capablanca put it well: to succeed, "you must study the endgame before everything else"."
Have you ever tried to philosophize on what would be the end-game of a company? Try to play it backwards.

Wednesday, February 12, 2014

Graham & Doddsville: Lee Ainslie Interviewed + Post Holdings Investment Case

This issue was nice, indeed. I decided to share it because Lee makes interesting points on his firm and its investment philosophy. I don't agree with everything he said, although I share most of his thought. So, here are a couple quotes from the interview:
"What truly made Tiger a special place was that you were surrounded by so many individuals who were not only very talented and dedicated investors, but also just really nice people." 
This reminds me of the "brilliant jerk" topic as Seth Klarman has already put it. When we work in such a small company, we need to get along - the team has to be your second family.

"We all had different pockets of knowledge about investing, not only in terms of sectors and industries, but also different ways of looking at and thinking about stocks. We spent a lot of time comparing notes and playing devil's advocate to each other, and so the collective talent of the team ended up being a great benefit to my investing education.(...) We believe that having responsibility for both longs and shorts sharpens analytical judgement and helps a team build a more complete understanding of a particular industry. In my experience, people that are solely focused on shorts tend to become extreme pessimists." 
This quote yields two interesting comments: (i) team complementarity might be the definitive edge to perspective/learning and (ii) the insertion of the contra case when an investment idea is provided might enlighten blind spots on the long thesis.
"We have tried to develop a culture where we have a group of people who view themselves as peers, who are not afraid to challenge one another, who enjoy working together and who are driven by common goals and values."
That one is interesting. It caught my eye the values since in the asset management business this is not common ground. Also, it becomes clear by this statement that Maverick's associates have to be vulnerable - it's part of their learning culture.
"There's a certain trade-off with having very narrow expertise. If one focuses on just a very small number of names they can develop a deep understanding of certain companies but may lose perspective of how that opportunity set compares to a broader universe.(...) Today, we generally hold about four investment positions per investment professional. At most hedge funds, this ratio seems to average somewhere between 10 and 20. This gives us a significant advantage in terms of the quantity and depth of our due diligence behind each investment decision and how familiar we are with the companies in which we invest. (...)"
Definitely, working on few names wouldn't give an analyst perspective/the broad picture. At the same time, who said the analyst would focus solely on the one company? When studying a company, one should compare it to others. While trying to understand the market structure and the value chain - which should be part of the due diligence process - the analyst will eventually stumble upon other companies which might be future competitors (upstream/downstream/consolidation strategic movements), giving the analyst the broader picture. The deal is: for that kind of due diligence, one needs TIME. And this is the scarcest asset we have and damn, it's hard to allocate it well.

Another tidbit is how envy I am as a Brazilian investor when looking to the tiny Brazilian investment universe.
"The most important components we gauge [in candidates] include competitiveness, mental flexibility and emotional consistency - that last trait is surprisingly important. This is a very stressful business. We are all human, and we all make mistakes. How one responds to those mistakes and whether someone can keep a level head and make thoughtful decision is critical. Conversely, how does one respond to a few big wins? With some folks, early success leads to inflated confidence that may slow the recognition of a mistake."
That is sharp. Psychology plays a big role in the investment business. When you buy a stock you are implicitly stating that the guy who sold it to you is dumber than you. At the same time, you know you might be wrong, but you believe the odds are in your favor. It's an eternal humbleness x arrogance duel. Also, resilience - not like the common physical athletes have, but mind resilience - is key to sobriety.
"So while we place great emphasis on valuation in our investment decisions, valuation alone should never the driver of either a long or a short investment. (...) As investors, it is critical that we have a strong understanding of the quality and the objectives of every management team in which we invest."
Avoid value traps. Moreover, check formal and informal incentives. Businesses don't run alone, they're run by real people. Don't trust numbers at face value - there are a lot of assumptions embedded and perhaps some dark incentives. Capital does not allocate itself.
"(...) when we evaluate a management team, we're much more focused on analyzing past decisions and actions than simply reviewing their responses to our questions."
This is key. Generally executives are aligned with stock prices, so they don't necessarily have to be uttermost upfront. I'm not saying they lie, what I'm saying is that they are in a conflict of interest. In order to avoid this kind of situation, ask for what happened in the past in the type of situation you are trying to analyze. You shall gather a way better answer.

After reading the full interview, don't miss the Post Holdings investment case on page 50. The company is run by Stiritz (79), who ran Purina and was profiled in The Outsiders book, having compounded at a 20% return over 19 years, ultimately repurchasing 60% of total outstanding shares! You should also take a look at his last annual report.