The GuruFocus Interview That Never Was
October 4, 2016
I have been due for a re-introduction to the 17 Mile blog/’project’ and I thought the invitation to do an interview with GuruFocus provided a good opportunity for a re-introduction and review. However – after submitting my answers to the interview I was informed that GuruFocus would only post the interview if I used my real name. No worries – it was a good opportunity to codify my thoughts, and the interview that never was is provided below…
GuruFocus: How and why did you get started investing? What is your background?
17 Mile: Before getting started, just a quick disclaimer that the views and information I provide are for informational purposes only; are not meant as investment advice; are subject to change without notice of any kind; do not constitute an offer of products or services with regard to any fund, investment scheme, or pooled investment; nor do they in any way, shape or form represent the views of my employer. With that out of the way…
I grew up 110% focused on sports, and was only modestly interested in political and economic-related topics by the time I entered college. And to be honest, it took until junior year for me to really get serious about my post-collegiate future.
I switched from a Political Science concentration to Public Administration my junior year in order to add a full suite of Finance classes to my schedule without extending my time in school. Fall semester Accounting 101 was my first Finance class, which for some reason led me to Google who Warren Buffett was! The first paper I read on Buffett outlined his “value-oriented” investment strategy that entailed determining what a business was worth and buying with a margin of safety. I was instantly hooked; and by the following spring I was building DCF valuation models alongside an intensive self-study of Benjamin Graham’s Security Analysis. My DCF work centered on Washington Mutual in May 2008 – an interesting time…
In the wake of Lehman Brothers I gathered a tiny base of capital from friends and family to launch a value-oriented strategy. With the market depressed and my investment hero telling the world to “Buy American. I Am.”, I believed my timing was next to perfect. But into the March 2009 bottom I was down almost 50%, giving me my first taste of the psychological side of investing. By April 2009 I was back above water and decided to return the money before moving into the real world.
From May 2009 thru March 2011 I worked as a regional bank credit analyst before taking a job at a registered investment advisor. My role at the RIA has evolved from that of a junior-level generalist equity analyst responsible for covering existing portfolio names and generating new ideas, to that of a senior-level generalist + quasi CIO responsible for broad investment strategy development & implementation and portfolio management + member of a firm-level corporate strategy team.
Very early on I learned and embraced the fact that the ultimate investment strategy is the Berkshire Hathaway model: a wholly owned business or set of businesses that form a platform for further acquisitions while generating a perpetual stream of cash for public equity investments. Now of course Buffett has taken this model to untouchable levels of intricacy, but the basic model is beyond brilliant, as it removes the inherent strains on fixed-AUM portfolio management. The principle underlying the model is the “builder” principle. All of the great wealth creators over time are builders first, financial engineers second (if at all): Buffett, the Koch brothers, Masayoshi Son, Charlie Ergen, etc.
I attempted to launch my own version of this model when I worked as a credit analyst, sending a buyout proposal to the CEO of one of the bank’s clients in late 2010 upon learning he was looking for a company-friendly exit strategy. Sadly, I never heard back. But this is an extremely long ‘game’, and the Berkshire model remains my ultimate long-term professional goal.
Including the initial foray into the market in December 2008, thru mid-2014 I spent approximately 5.5 years ‘finding myself’ as an investor outside of the ‘plain vanilla’ RIA world. This period of time culminated with the June 2014 launch of 17 Mile, a blog that I have since used to publicly document my personal investment process broadly, and my decision making process managing two personal investment strategies specifically (“17 Mile” and “17 Mile Global Equity”).
“17 Mile” – started June 15, 2016 – is a highly aggressive value-oriented, event-driven absolute return strategy designed for no more than 5-10% of a total portfolio. The benchmark/goal is simple: double in value as quickly as possible. A tough market + too much exposure + myriad trading conflicts collided in early 2016 to bring down this strategy (from a performance standpoint), and I was forced to restructure my thought process. While incredibly painful and embarrassing, it was the best thing that could have happened, given that I have 4-5 decades remaining in my career.
While there are numerous lessons to be had from the last 2+ years of managing the “17 Mile” strategy, first and foremost was the inappropriate mixing of goals: I took the highly aggressive portion of my total investment portfolio and tried to hold that out as a model of my core investment style, which is far less aggressive and very long-term oriented.
“17 Mile Global Equity” – started May 1, 2016 – is simply the “17 Mile” strategy ex. the use of leverage, and with strict portfolio management rules. My personal goal is to beat the DWCFT by 5% per annum over all trailing periods greater than 3 years, net of hypothetical fees (a 1% management fee and a 15% performance, net of a 6% hurdle, for the sake of comparison to hedge fund strategies that are reported net of fees).
GF: Describe your investing strategy and portfolio organization. Where do you get your investing ideas from?
17M: I do not know the exact statistic, but the average stock fluctuates something like 50% from low to high over any given 12-month period. Even if not precisely accurate, the guiding principle is that an enormous number of opportunities arise over 12-18 months; and if one is extraordinarily passionate, analytically intense and psychologically cold-blooded, I believe this framework renders Warren Buffett’s “20 Punch Card” philosophy moot for the “enterprising investor”. So in simple summary, outside of my buy & hold retirement accounts – which are run via the Berkshire model (cash goes in every month, so there is no need to dance in and out of opportunities) – I look for relatively high quality businesses that are temporarily out of favor with attractive 18-36 month risk/reward profiles.
There are not enough adjectives in the English language to describe how incorrect it is to draw a distinction between “growth” and “value” investing…yet we all do it! Amazon (NASDAQ: AMZN) trading at 50% of a fair value that is comprised of 95% future growth opportunities is no different than Transocean (NYSE: RIG) trading at 50% of a fair value comprised of 100% cold-stacked Ultra Deepwater rig net PP&E. Point is – if there is a moderate to extreme amount of pessimism surrounding a company, industry or sector, there is a good chance I will take a look regardless of the ‘growth’ or ‘value’ orientation.
There are two types of entry points into these 18-36 month set-ups. (1) The classic “Dogs of the Dow” strategy where a beaten down stock that has missed 2-4 straight quarters of earnings is so low/cheap that it has no choice but to rally 50%+. This strategy is a pain, as it often requires one to endure months of stock price ‘bleeding’ resulting from “premature accumulation” (to quote Bruce Berkowitz). I am getting better at managing these set-ups, but still have plenty to learn.
Quick example: Cummins (NYSE: CMI) was down almost 40% in 2015 alongside declines in the Brazil and US truck markets, but is up over 45% YTD in 2016 despite at best ‘firming’ fundamentals.
(2) An “entry catalyst” into an attractively valued business with strong fundamental momentum, where the “entry catalyst” has a rubber band effect over a well-defined duration. While the rubber band may not snap back sooner than a stock price purchased under the “Dogs of the Dow” strategy, the downside is typically very well defined, allowing for out-sized positioning.
Quick example: Charter Communications (NASDAQ: CHTR) declined 10-20% in early- to mid-2015 once the Comcast/Time Warner Cable deal fell thru as the market began to price in deal-related complexity of a Charter-for-TWC bid. The stock traded down to below $170, and standalone fair value was conservatively circa $200. A true win-win investment set-up, as a TWC deal break would provide deal ‘relief’, while a TWC deal was a long-term fair value game-changer. The stock now trades for almost $270.
In my “17 Mile Global Equity” strategy I maintain ten positions at minimum; go no higher than 10% on initial position size; and do not let positions grow to more than 15% of the portfolio.
My primary idea generation source is reading physical newspapers. Not on a phone or tablet – but actually getting ink on my hands. I maintain a “Scratch Notes” page on my blog that I use to catalogue my notes on pertinent articles – which ironically I never really go back and review, but the actual process of taking notes helps immensely to ingrain what I read.
While heresy in Warren Buffett land, I also read a mountain of ‘Street’ research every week, as it allows me access to untold multiples of information that I otherwise would not be privy to. I do not really care about ‘Street’ conclusions, I just want information and a sense of how bullish or bearish the market is on a particular company/industry/sector.
Lastly, the combination of the blog and Twitter has allowed me to develop a solid investment network from which I derive a reasonably steady stream of ideas and analysis. It is tough to balance the powerful network effect of “Finance Twitter” with the need to shut off the ‘machines’ in order to focus, read and think quietly in a room; but if balance can be achieved, it is enormously valuable, in my opinion.
GF: What drew you to that specific strategy?
17M: Very early on in my career I was drawn to Dan Loeb’s event-driven style. And while it may simply appear that I am cloning him by saying I have an event-driven investment ‘personality’, in my experience it is extremely difficult to mimic an investment style/strategy that I am intrinsically uncomfortable with.
Over the years I have honed my ‘personality’ via my own experiences and learning/drawing from other investors. Specifically, David Tepper’s trading ‘touch’ around true deep value situations, and Stan Druckenmiller’s ability to go big when the odds are overwhelmingly in your favor.
GF: What books or other investors changed the way you think, inspired you, or mentored you? What is the most important lesson learned from them? What investors do you follow today?
17M: Early on I read anything and everything I could find on Dan Loeb, David Einhorn and Bill Ackman, in addition to every single Warren Buffett letter (BPL and BRK) multiple times over.
The single greatest lesson I learned from my early readings was to become my own investor. The investment process is intensely personal – and in my opinion there is likely no single greater danger in the investment business than NOT listening to one’s self.
GF: How long will you hold a stock and why? How long does it take to know if you are right or wrong on a stock?
17M: 100% depends on the strategy and the performance incentives in place. At my day job I manage 30-40 stock portfolios populated with high quality businesses that I want to let compound their intrinsic value over 10-20 years; while in my highly aggressive “17 Mile” strategy I will sell a stock that is up 15-20% in a month if the stock begins to ‘behave’ like it wants to decline.
It takes months/quarters/years to know if you are wrong on the fundamental thesis; but if you are in tune with a stock’s ‘behavior’ – a big if, as most fundamentally-oriented investors actively shun chart watching – you can know very, very quickly.
GF: How has your investing approach changed over the years?
17M: I have simultaneously become more patient with highly attractive investment set-ups and more impatient with poorly ‘behaving’ stocks.
GF: Name some of the things that you do or believe that other investors do not
17M: There is almost no such thing as an original thought in today’s day and age of rapid fire information flow; but I would venture to say that among traditional “value-oriented” investors I am one of the few that believe this ‘game’ is 70% portfolio management, 30% stock selection.
It has been said about George Soros that he was only moderately better than his peers, if at all, in his analysis of situations; but what set him apart was his ability to cut his losses and go big when the odds were in his favor. My investment ‘personality’ leans in this direction, so my bias is toward the importance of portfolio management.
GF: What are some of your favorite companies, brands, or even CEOs? What do you think are some of the most well run companies?
17M: Those questions are best answered with the portfolio I would put together were I unable to touch it for the next forty years (roughly in order of position sizing): Visa/Mastercard, Wells Fargo, Berkshire Hathaway, ExxonMobil, Deere, United Technologies, Mondelez, Pepsi, McDonalds, Johnson & Johnson, General Dynamics, and General Electric.
GF: Do you use any stock screeners? What are some efficient methods to find undervalued businesses apart from screeners?
17M: No. Read and develop an investment network.
GF: Name some of the traits that a company must have for you to invest in, such as dividends. What does a high quality company look like to you and what does a bad investment look like? Talk about what the ideal company to invest in would look like, even if it does not exist.
17M: A simple business with high returns on capital and multi-decade secular growth potential; multi-decade track record of industry-leading returns on capital; robust earnings power hidden by a ‘bad’ segment; ‘hidden’ assets; presence of a long-term oriented, operationally focused activist investor; presence of an owner-operator with an exemplary track record.
A high quality company is one that has a materially better than average probability of generating its current (high) return on capital – within a reasonable band – 10+ years from today.
I am actually a pretty bearishly oriented investor – and while I do not actively ‘short’ stocks with real money, I play a short seller on paper and thus have a wide swath of what I consider to be ‘bad’ investments in mind at all times…
Frauds and fads are most likely the worst investments over time; but I do not really troll in that arena, so I cannot speak intelligently about them. My ‘bad’ investment focus tends to focus on where market sentiment toward a company/industry/sector is out of control on the upside.
Nike (NYSE: NKE) is a great example of a ‘compounder’ that everyone and their brother was extrapolating top-line growth + margin expansion + share shrink into infinity over the last several years. This extrapolation resulted in increasing justification for premium PE application to EPS figures with multiple layers of embedded double counting. Admittedly I am a stickler for ‘clean’ valuation work – as I believe the investment business is too uncertain to simply apply valuation multiples pulled out of the air (though many would say that the uncertainty is precisely why one should not be overly precise in their valuation work, citing Munger’s quote that he “…has never seen Buffett do a DCF…”) – but this type of extrapolation and sloppy valuation work is nails on a chalk board to me. Nike is a fantastic brand/business with a very high probability of possessing its current ROIC 10+ years from now; but shareholders likely face multiple (many?) years of stock price underperformance from current levels, in my opinion.
Amazon (NASDAQ: AMZN) is a great example of the ideal company: a high ROIC business that can deploy capital well in excess of annual earnings power over many years. And while Visa and Mastercard possess better core businesses than AMZN, the economics of their industry do not allow for reinvestment of earnings power…hence V/MA shareholders must ‘suffer’ with a 10% growth rate + 80% annual payout.
But while AMZN shareholders likely possess a greater runway for business value growth over the next 10-20 years than do V/MA shareholders, I believe the sentiment toward AMZN’s business prospects is quite literally out of control at present. Yes, looking out 20 years current shareholders will likely do just fine – but looking out 1-3 years, I see nothing but potential disappointment for the AMZN stock price as the Company continues to build out its Retail distribution network and Public Cloud infrastructure. I believe the near-daily enthusiasm around AAPL’s seemingly impenetrable stock price in September 2012 is a very, very, very good template for navigating current AMZN sentiment.
GF: What kind of checklist do you use when investing? Do you have a specific approach, structure, process that you use?
17M: Outside of the normal due diligence process of reading anything and everything I can on a situation/company/industry/sector I do not. I cannot reiterate enough how an investment set-up must fit your investment ‘personality’ and hit you over the head like a ton of bricks. For me, checklists tend to obfuscate the ‘ton of bricks’ conclusion I am seeking.
GF: Before making an investment, what kind of research do you do and where do you go for the information? Do you talk to management?
17M: Again, the standard due diligence process of company filings, presentations, transcripts, ‘Street’ notes, and talking to other investors more knowledgeable about the situation/company/industry/sector than myself is pretty straightforward. Though I am constantly striving to hone the day-to-day process, make it more efficient, cover a wider swath of companies, etc.; but that just comes with time and effort.
GF: How do you go about valuing a stock and how do you decide how you are going to value a specific stock?
17M: Amazon is a good example. I use a 5-year DCF model to value Amazon Retail and an industry comp price/sales multiple on 2017 sales to value Amazon Web Services. In the DCF model I assume 20% top-line growth and a 22.5x terminal PE on year 6 NOPAT.
GF: What kind of bargains are you finding in this market? Do you have any favorite sector or avoid certain areas, and why?
17M: The market as a whole is hellaciously overvalued based on historical valuation metrics; but there are pockets of moderate to extreme pessimism in some moderately good businesses. For lack of a better descriptor the Specialty Pharmaceutical industry is setting up quite nicely for a big post-election “Dogs of the Dow” run, in my opinion. Stable to growing cash flows are cheap due to the regulatory/pricing overhang, and once we get thru the election and year-end tax loss selling the rebound could be swift beginning 1/1/17 (perhaps even by mid-December the buying begins due to the mechanics of getting losses off the books before year end). I have a decent allocation to this area at present, but am ramping up my coverage into the likely year-end selling.
The Media space is near and dear to my heart, as it has an abundant near-, medium- and long-term M&A ‘event’ potential, highly skilled owner-operators with decades of well-documented success, and now almost 24 months of pessimism baked into stock prices. Perhaps tax loss selling provides a bit of pressure into year-end, but I believe downside from current levels is extremely limited. My paper trade long/short pair would be long FOXA/short AMZN J
GF: How do you feel about the market today? Do you see it as overvalued? What concerns you the most?
17M: As stated in the previous answer, based on historical valuation metrics the market is extremely overvalued. However, a very good case can be made that historical valuation metrics are not applicable due to aggregate tax policy and interest rates. So perhaps the market is only modestly overvalued. Regardless – as long as the US economy avoids recession, downside should be limited to no more than 20%.
From a medium-term standpoint the market is in very, very good shape. The post-February rebound exhibited all of the typical signs of the beginning of a cyclical bull market rally; but if there was any doubt – which I had an abundance of, unfortunately – the post-Brexit market behavior emphatically confirmed the cyclical bull market.
Short-term the market is working off excess optimism – but for those looking at this weakness as the start of a new cyclical down leg I would point to the new all-time highs in the NYSE equity-only advance/decline line.
GF: What are some books that you are reading now? What is the most important lesson learned from your favorite one?
17M: To be honest I do not read many books, as daily company due diligence, my job responsibilities, writing and networking take up an enormous amount of time; and I am actually trying to cut back even more in order to achieve better balance. However, I am slowly working thru “Good for the Money” and “More Money Than God”, with the latter containing fantastic overviews of Paul Tudor Jones and Stan Druckenmiller’s respective investment styles.
GF: Any advice to a new value investor? What should they know and what habits should they develop before they start?
17M: Start investing real money ASAP; read a lot; and do not coattail other investors at the expense of developing your own investment ‘personality’.
GF: What are your some of your favorite value investing resources or tools? Are there any investors that you piggyback or coattail?
17M: The Wall Street Journal and Financial Times are my favorite resources/tools.
Coattailing in its purest form – simply buying because another investor owns a stock – is a horrific practice.
ValueAct Capital, Trian Partners and Pershing Square (yes I said it) are three of the better long-term oriented, operationally focused activist funds out there that can materially change the fundamental business outlook of a company.
For deep value/special situation idea generation, Appaloosa (David Tepper) is a fund to pay attention to. Again – an idea has to fit your own investment ‘eye’, but at bare minimum their involvement can materially change the risk/reward profile of a situation.
GF: Describe some of the biggest mistakes you have made value investing. What are your three worst investments? What did you learn and how do you avoid those mistakes today?
17M: My biggest mistake (or set of mistakes) came from late 2015 into early 2016. I am a contrarian at heart and love the physical act of going against the market by buying into a stock price that is declining for what I believe to be uneconomic reasons; but in late 2015 and into early 2016 I bought far too aggressively into the WMB/ETE deal-related debacle against a horrific market backdrop. In my aggressive “17 Mile” strategy I put myself in a position where I could not survive a worst-case scenario, which led me to commit the ultimate investment sin: making myself ‘path dependent’ to the point where I let short-term volatility permanently impair long-term capital.
There is nothing wrong with being aggressive as long as appropriate risk management protocols are in place. But you have to respect the market backdrop. Quite literally anything can happen in a weak market. In this limited space, that is the key lesson from the WMB/ETE situation.
GF: How do you manage the mental aspect of investing when it comes to the ups, downs, crashes, corrections, and fluctuations?
17M: Staying diversified and taking a multi-decade view across my total investment life. Within the “17 Mile Global Equity” strategy, modest position sizing and diversification give me great comfort in riding out market volatility; while within the “17 Mile” strategy staying on top of market conditions and cutting off losers as quickly as possible allows me to navigate market volatility.
GF: If you’d like to share, how have the last five to ten years been for you investing wise?
17M: I would say mixed success. I have a lot to prove going forward.