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Interview with John Huber – Part 1

John Huber Basehit Investing
John Huber is portfolio manager at Saber Capital Management and author of the popular investing blog Base Hit Investing. In his own words, his investment style (which is amazingly methodical) is influenced by Warren Buffett, Ben Graham, Walter Schloss and Joel Greenblatt.
 
I have become a big fan of his writing and thought process, ever since I came across his blog and strongly recommend it to anyone interested in following a structured approach towards investing and improving as a rational thinker.
 
I thank John for agreeing to get interviewed for Stable Investor.
 
So lets get straight to the interview now…



Dev: Hi John. Tell me something about your investment journey. How did you get to where you are?

John: I’ve always loved investing. My father was an engineer by trade, but was very active in the stock market (investing his savings) and by extension, I became interested in stocks.
 
But I came to the world of investment management unconventionally. I began my career in real estate, and I established a few small partnerships with family members and friends to begin buying undervalued income producing property. We bought residential properties as well as small multi-family properties.
About ten years ago, I began studying the work of Warren Buffett. Like many value investors, the simple logic of value investing really resonated with me right from the start.
 
I began studying Buffett’s letters, and reading various Buffett biographies. I set a goal early on to establish a partnership that was similar to the partnership Buffett set up in his early days.
 
After a number of years, I was fortunate to build up enough capital to support my living expenses while also seeding my investment firm. Saber Capital Management was established in 2013 as a way for outside investors to invest alongside me. Saber runs separate managed accounts, so clients get the transparency and liquidity of their own brokerage account. Our goal is to compound capital over the long run by making concentrated investments in well-managed, high quality businesses at attractive prices.
 
Dev: I know you focus a lot on having a process-oriented approach towards investing. How should one go about creating and refining one’s investment process?
John: It’s a great question. I think developing an investment philosophy is very important.
 
There are many different investment approaches out there — even within the value investing category. I think it’s important to first identify an investment program that will work (value investing — or buying stocks for less than what they are worth) works over time.
 
But I also think it’s important to understand your own personality, your own skill sets, and your own circle of competence.
Look at Benjamin Graham and Charlie Munger as an example. An approach that worked for Ben Graham was a completely different approach that ended up working for Charlie Munger, yet both were fantastically successful. But they both had different skill sets and preferences.
Graham loved numbers, he loved the mathematical aspect of investing. He thought of a portfolio like an underwriter would think of the insurance business—buying stocks for less than their net asset values worked collectively as a group over time, but any one individual situation was difficult to predict (just like insuring 1000 automobile policies with a given set of underwriting criteria would lead to very predictable results—although on a case by case basis it would be very difficult to predict which driver would end up making claims). So Graham’s preference for these investment tenets led him to manage a diversified portfolio of value stocks.
On the other hand, Charlie Munger became fascinated by great businesses. He wanted to own companies that could compound at high rates of return over long periods of time. He loved thinking about the intangible qualities of great businesses.

He once asked an associate to write up an investment thesis on Allergan, and when the associate came back with a list of Graham-esque metrics, Munger told him to forget the numbers and research why the company had such an advantage over its competition.

He was interested in brands, pricing power, predictability of earnings, high returns on capital — things that produced growth and compounding value over time.
Both Graham and Munger were enormously successful in their partnerships—both producing around 20% annually over the period they managed money, but both did so in very different ways.

Neither were right or wrong in their approach, but both managed money according to their personalities.
I think if you first identify what works in investing, and then you tailor it to what you like and what you understand, you’ll do well over time.
Along with value principles, discipline, and patience, perhaps Polonius has some good words of advice when it comes to setting up an investment process when he told his son Laertes in Hamlet: “To thine own self be true”.
 
 
Dev: How to generate new investment ideas and more importantly, how to filter those Ideas?
John: I used to do a lot of screens and other mechanical methods to generate ideas, but I find the best way to look for good investments is just to read as much as possible, build watchlists of good companies that you feel you can understand, and then patiently wait for opportunities to buy stocks on that watchlist. Inevitably, if you have a list of 50 or so businesses, there are almost always opportunities on at least a few of them to make an attractive purchase of an undervalued stock.
So most of my time is spent reading about companies and trying to always increase my understanding of the companies I follow, while also slowly expanding my circle of competence.
 
I read a lot of company annual reports, but I have also found a lot of value reading books about businesses, or books about general industries. I also read numerous newspapers, and the Economist.
Often, investment ideas come from situations that occur within companies on my watchlist that I already know well. Other times I read about a special situation or corporate event in the news that might offer an interesting investment idea.
 
So while my method isn’t scientific, my routine is quite replicable, and it basically involves a lot of reading and thinking. I would say that it is an approach that helps me always be tuned in to a variety of interesting situations where opportunities often pop up. But most importantly, it’s an approach that helps me continually learn, and I enjoy that aspect of investing.
Dev: Do you believe in importance of having an investment checklist?
John: I do think having a checklist can be a very valuable exercise. I’ve discussed checklist items before, but I’ve also adapted this point of view in recent years as well.
 
While I consider various checklist items when evaluating a business, I have found that because each investment situation is so different, that unlike flying an airplane that requires the same multi-point checklist before each flight, each investment is like a snowflake—it is unique and not exactly like any other investment.
 
So while I’m 100% sure that studying case studies is a valuable exercise (especially investment failures of great investors — something Mohnish Pabrai discusses which is a great idea), I’m not sure that a single checklist will be suitable for each investment idea. 

Studying why Dexter Shoe was a bad investment is a very valuable exercise. But the lessons learned from that case study might not transfer directly to another investment situation with its own unique set of variables.
So I don’t have a practice of running a bullet point mechanical checklist, although I think that might work for other investors and it’s certainly not a bad idea.
 
Instead, I choose to try and locate investments with very few variables that are required for the investment to be a success. I try to identify those variables, and then evaluate them over time as the investment plays out.
I think studying case studies probably helps you build a mental database of checklist items, so maybe indirectly we all have checklists as investors, but I choose to focus on each individual investment as its own situation with its own set of variables, and I try to reduce risk as much as possible by locating ideas with very things that can go wrong. The lower the hurdle, the better I like it.
 
Note – John has agreed to share a checklist which he prepared few years back. Below is the snapshot of the checklist. Though he doesn’t strictly follow the checklist approach anymore (as discussed above too), it can still be a great starting point for those who are setting out to build their own checklists. You can read about it in detail here.

Dev: It’s very easy to say that investors should only invest when value on offer is blindingly more than the price that needs to be paid. But how does one implement that in reality? Being greedy when others are not, is actually quite difficult to do.
John: As I said before, each individual investment is different, so there isn’t necessarily an exact approach that can be implemented with each stock being evaluated.
 
But I think the first thing is to stick to businesses that you can understand. This is widely discussed, and highly touted, but I think it still might actually be under-appreciated. 
 
Reducing unforced errors in investing goes a long way to producing great results over time. And reducing mistakes comes from sticking to what you know, and picking your spots.
 
I think patience is a real virtue in investing, and over the course of time, there will be a number of opportunities to buy good businesses at prices that are clearly well below their intrinsic value. The key is to have a list of companies you know very well, and then just wait for one of them to fall significantly below your range of estimated values. Easier said than done, but being patient is very key.
 
It is also a necessity in investing to have a calm demeanor and a contrarian attitude in general — the market is often correct, so being a contrarian for contrarian’s sake alone isn’t rational, but you must be able to be detached from the crowd so that in times of general market panic, you are willing to buy stocks even when the near term outlook is bleak. This is also easier said than done, but it helps if you have a long-term view of stocks, and stick to owning good businesses that you understand well.
One other thing to point out—I’ve read the average NYSE stock fluctuates by 80% annually (meaning the 52 week high is 80% above the 52 week low for the average NYSE stock). This holds true across every index, and every country (probably much more pronounced in many countries than it is in the US).

Note – Check out a similar analysis on Indian markets here.

So stock prices are very volatile. There is no way that the average company’s intrinsic value fluctuates this much on an annual basis.

So this of course means that stock prices fluctuate much more dramatically than true values do, giving investors an opportunity.
And since these statistics refer to annual levels, it means that there are a lot of opportunities each year in the stock market to buy undervalued merchandise.
 
Dev: Joel Greenblatt (of Magic Formula fame) once said, “My largest positions are not the ones I think I’m going to make the most money from. My largest positions are the ones I don’t think I’m going to lose money in.” What are your thoughts on this?
John: I completely agree with this. In fact, my largest position right now is Berkshire Hathaway, which became my largest position in February (I wrote a post recently outlining my thoughts on Berkshire).

The stock doesn’t have tremendous upside as its capital base is so large now, but it has—in my opinion—virtually no chance of any permanent downside.
 
These are my very favorite investment ideas because they allow you to put a lot of capital to work with no risk, and I’ve found that often the market “corrects” itself sooner, meaning that sometimes 2 or 3 year return potentials occur in a year or less, simply because of general market volatility.
 
1) Don’t lose money.
 
2) Don’t forget rule number 1.
 
Trying to stick to companies you understand and sticking to businesses that are growing value over time helps reduce risk.

I think keeping a relentless focus on capital preservation is the best way to produce great results over time.
 
Dev: Another of Greenblatt’s idea has been to focus on the Key Variables of an Investment. He mentioned once that he might be average when it comes to the valuation exercise. But was above average at putting the information in context, remembering the big picture, and being able to pinpoint what factors really matter to an investment. How does an investor focus on what really matters?
John: I agree with Joel on this point as well. I think many investors get lost in the weeds — they become too focused on their models, their excel spreadsheets, or trying to predict what margins will be in 2019, etc.

I think gaining an understanding of the big picture is usually the most important objective when looking at a stock.
 
The big picture often means identifying the most important drivers of value in a business.
These value drivers could be things like cost advantages (Wells Fargo gathers deposits cheaper than just about every other bank), network effects (the more people that use Visa’s network, the more valuable it becomes), supply chain management (Amazon), economies of scale (Walmart’s leverage over suppliers), sometimes brands are very valuable assets (Nike, or even Apple for example), and sometimes it could be the management team that is just executing a business model well or is very adept at allocating capital (Berkshire Hathaway is an obvious example, but there are many companies that owe large portions of their success to the management team).
 
Many of these things can’t be measured by simply looking at the financial statements, so it helps to identify these things and keep them in mind when analyzing businesses, because often these big picture items continue to be the reasons for the company’s success going forward.
To be continued…
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