December was a busy month for me and the books. I read three books during those 31 days — all investing related — and thought it would be a good time to jot down some thoughts I had on each book. I’m not sure if I should be impressed with reading three books in one month, or disappointed in my lack of a social life. Regardless, December was extremely productive. The books — read in order — are: 100 Baggers: Stocks That Return 100-1 and How To Find Them, The Outsiders, and Dhando Investor. For each book I’ll provide a review on what I learned as well as what I took from it to apply to my own investing philosophy and strategy.
100 Baggers: Growth Really Matters
As the name suggests, this book is all about finding those public companies that returned 100-to-1 for their investors (read: an extremely difficult task). The stocks that were studied in the book did just that in less than a decade. If you were lucky enough to pick one or three of these such companies you’d be well off today, to say the least. So how did these stocks return 100-to-1? Growth, growth and more growth. Along with consistently high growth, each of the companies highlighted excelled at returning capital at high rates over an extended period of time. Combine these two qualities and you have the ingredients needed to become a 100-to-1.
The Takeaway: Narratives Matter More Than Screens
Here’s the conundrum — as value investors, we are constantly on the search for deep discounts. We want to find companies trading for far less than what we think they’re worth, and we want to make sure we’re buying them as cheap as we can. To accomplish this, many value investors rely heavily on quantitative metrics to filter for such ideas. Screens such as low EV/EBITDA, low P/E and low P/S allow the value investor to focus their time on a subset of companies that pass through this quantitative screen. That’s the main benefit of doing a screen like that — it is a huge time-saver. Unfortunately there is a glaring problem with this way of idea sourcing.
Thinking about this notion of quantitative screening a little deeper, we start to understand the inherent flaws. Because screening saves so much time, many investors run the exact same screens, ensuring that the amount of eyeballs viewing the same list of companies is extremely high. So although investors that screen based on fairly cheap quantitative metrics claim they are fishing in smaller ponds, the fact remains that the perimeter of the pond is filled with other investors looking for the same fish. For those that don’t fish, you won’t fully appreciate the frustration in this analogy. When a fisherman finds a hot spot where all the fish are, they don’t go telling everyone, and they certainly don’t want others finding out about it. Quantitative value screens are air-horns to investors on where the fish are. Sure you might find some bargains, but you won’t be fishing alone.
Value screeners didn’t find Amazon, they didn’t find Monster Beverage and they didn’t find Facebook. I’m not completely discounting screeners. I use them all the time. What I am advocating for is a looser net. There are fantastic businesses that fall through the cracks of traditional value metric screeners. In order to find these you need to cast wider. I’ve seen an inverse correlation between the specificity of my screeners and my growth as an investor.
The Outsiders: Never Underestimate The Jockey
I’m ashamed it took me this long to read The Outsiders. It instantly became one of the most powerful books I’ve ever read. In fact, I got it for Christmas and finished it the day after. Without giving the main details away, I’ll share the crux of the book: $10,000 invested with these seven CEO’s would be worth over $1.5M 25 years later. This far out-paces the S&P and the “legend” Jack Welch by multiples. How were they able to accomplish this? Radically different thinking and tremendous capital allocation.
The CEO’s of these companies weren’t Harvard MBA’s, they didn’t go through grooming periods under prestigious executives — they were radically different leaders. From the CEO of Washington Post to the CEO of General Dynamics each CEO possessed an intense desire to return capital back to its shareholders. How did they do this? Refusing to offer dividends, aggressively buying back shares and radically reducing operating costs. How can one apply this to their own investing strategy?
Takeaway: Invest in the Best (Jockeys)
The best thing about us as investors is that we have the opportunity to find these tremendous jockey’s and back the truck up alongside them. Being able to find these types of jockey’s is extremely hard, and if one commits themselves to it, will find a lot of frustration with little success to show. The flip-side of that is just as good — if you do find one of these iconoclast leaders and innovators, all one has to do (easier said than done) is have conviction to bet big. Jockeys increase in value as the size of the company gets smaller. This makes sense intuitively. The larger an entity or organization gets, the harder it is for those at the top to have the same ripple effect. Sure there are your exceptions (Steve Jobs with Apple) — but for the most part, larger companies aren’t particularly dependent on their executives. Warren Buffett likes to chime, “invest in businesses so strong that a monkey could run them, because eventually one will.” Smaller companies don’t have that same luxury. The smaller you go, the more important management becomes.
Dhando Investor: Heads I Win, Tails I Don’t Lose Much!
Mohnish Pabrai is the managing partner of Pabrai Funds, but more famously known for spending big bucks to break bread with Buffett himself. Pabrai hails from India and was transformed by the ways of Buffett, Munger and compounding interest that he sold his technology business to become a full-time investor. The Dhando Investor lays a foundation for taking low-risk, high uncertainty bets that are positively skewed in your favor (i.e., positive asymmetry). Mohnish outlines this philosophy by thumbing through numerous examples of successful Indian entrepreneurs, such as the Patel family and their motels. Throughout the book Mohnish claims that individual investors can reap these same asymmetric risk-reward profiles by investing in companies that have the potential to generate loads of free cash flow + trading at a low multiple to that cash flow or earnings.
Takeaway: Uncertainty Doesn’t Equal Risk
The largest takeaway wasn’t the quantitative examples Pabrai gave of his investments, nor was it the metrics he used to find these companies — it was the mental framework. Looking at the investing world through the lens of low-risk, high uncertainty opened my eyes to companies that — on the surface — seemed extremely risky, but ended up being positively asymmetric. As value investors we want to look for high uncertainty bets with low risk — companies that are priced for extinction but might have some good operations left. Uncertainty has to do with the future of the business; risk has to do with the price you pay for the business. You want to find investments where: Heads you win, tails you don’t lose much!
Like I mentioned earlier in the post, December was quite the month for reading. I am now on the hunt for other great works of literature to fill my time in January and February. If you have a fantastic book that you just finished, or know of an author I might like based on what you read, please leave a reference down in the comments section. I just finished The Richest Man In Babylon and will probably try to finish Jordan Peterson’s latest book before the end of the month. Here’s to reading more books this year than last year!