Interview with John Huber – Part 2

John Huber Basehit Investing Interview


You can read Part 1 of this interview here.


Dev: As a long-term investor, how should one control oneself to not to panic? Also, when should one panic (say, panic to buy more when markets falls a lot)?

John: This just comes from maintaining a discipline about your investment philosophy.
I think it’s helpful to keep in mind that stocks aren’t trading vehicles, but pieces of real businesses. And if you’re buying a business that produces x amount of cash flow, the lower the price, the better.
As Buffett says, whether it’s stocks or socks, we like buying merchandise when it’s marked down.


Dev: I am a conservative investor who focuses a lot more on Return of Capital than on just return on capital. Though every individual’s risk and investing profile is different, do you think that focusing on mistake-reduction is what investors should focus on? Or lets say that just like in the game of Tennis, its best to first work towards reducing unforced errors. Does it help in winning the game of investing too?
John: Absolutely. I think the vast majority of investment mistakes come from “stretching” too far for upside potential at the expense of downside risk.
The tennis analogy is a good one—amateur tennis players win matches not by making the most forehand winners, but by making the fewest mistakes. Just hit the ball over the net. In investing, it’s very difficult to make up for losses. So keeping a relentless focus on preventing losses has always been at the core of my investment approach.
To use one more sports analogy—focus on base hits, not home runs.


Dev: As an investor, hardest thing about investing is to find a balance between 1) riding out periods temporarily unfavorable to your views and 2) realizing your views are wrong and moving on. How should an investor maintain that balance?
John: This varies case by case, but certainly you have to be honest with yourself. If you’ve made a mistake (which all investors do, and will continue to do), you should be honest in your assessment, sell the stock, and move on.
Of course, the market is volatile so sometimes general market conditions take all stocks lower, and this volatility might have nothing to do with the intrinsic value of stocks in your portfolio.
So company specific situations should be differentiated from general market volatility.


Dev: In his book Thinking, Fast and Slow, Daniel Kahneman talks about two approaches to thinking. System-1 (which is fast, instinctive and emotional) and System-2 (which is slow, effortful and calculating). How can an investor make use of these two systems to invest? At the face of it, System-2 seems like a better choice. But are there any market situations, where thinking in System-1 mode can work wonders for long-term investors?
John: I’m not very familiar with Kahneman’s work, although I’m familiar with his ideas you referenced.
I think generally speaking, my style of investing falls very much in category #2. Thinking logically, rationally, and patiently has always been beneficial to me.


Dev: Do you think lack of preparedness is what causes most investors to miss out on wealth creation opportunities in stock markets? (Both mental as well as financial preparedness)
John: I think that has a lot to do with it. But I think the biggest reason investors probably fall short of what they hope to achieve is lack of discipline (selling during downturns, and buying when outlooks are more optimistic). Generally, investors need to do the opposite to do well over time.
For people with full-time jobs and excess earnings, building wealth is a very simple formula.

Spend less than you earn, and invest in a basket of good businesses (or a broad index fund) over long periods of time.

In America especially, earnings of S&P 500 companies will be much higher 10 and 20 years from now, dividends will be two or three times the levels they are now collectively, and stocks will be much higher.
Dollar cost averaging works – as long as you’re not buying into bubble-level valuations (like 2000). Try to buy stocks when they are down, save more than you earn, and you can’t help but become wealthy over a working lifetime.


Dev: How do you manage your own money? Funds? Direct Stocks? How do you go about it?
John: I invest in stocks. Saber’s strategy is to buy well-managed businesses with stable competitive positions, predictable cash flow, and high returns on capital. I try to invest in these high quality compounders when they are priced well below my estimate of their fair value (or the value a private owner would pay for the entire business).
Because of my standard of looking for both high quality and discounted price, I tend to only invest in a small group of stocks at any given time.
I feel that owning a few things that I understand very well is much less risky than owning a lot of things that I don’t know so well.


Dev: What is your advise for those who are just starting their investing journey?
John: Read about value investing – specially Warren Buffett. I think the simple logic of value investing makes intuitive sense, and it works over long periods of time.
I think investors who don’t have time to manage their own money should invest in index funds, or possibly with an investment manager who uses a straightforward value investing approach, but the best way to learn is through practice.
Those who want to learn to manage their own investments should get in the habit of reading a lot. Study Warren Buffett’s letters, and begin reading company annual reports. Knowledge is cumulative, and it’s possible to do well in investing with the right approach combined with the right temperament.


Dev: For most common investors, it’s suggested that they should Dollar-Cost Average through mutual funds. Not trade much in individual stocks. Buy some shares directly here and there. Tell me what is wrong about this that these people fail to understand?
John: I believe this is good advice generally, but I would say that instead of mutual funds, I would prefer most investors using simple, low-cost index funds (ETFs). These are similar to funds in that they are diversified with hundreds of stocks, but different in that they are passively managed (they are designed to match the performance of an index, such as the S&P 500 in the US).
The costs of these index funds are much lower than the cost of actively managed funds. Of course, a good investment manager can outperform the index over time, but these managers are rare and it’s often easier to focus on just putting money into one or two diversified passively managed index funds.
Dollar cost averaging simply means putting more money to work over time, and I think this is a good approach for working people because they are steadily getting more money each month from their paycheck. Some months will be making purchases at higher prices, but some months will be at lower prices.
This mechanical method is helpful because—if one sticks to it—can help you be disciplined when bear markets (and fear of stocks) come around again. That is the time to buy as much as possible.


Dev: As someone who spends his day in midst of financial data and news, how do you filter out what is good and what is not to get to your daily reading list? How to become a good consumer of financial content?
John: I generally stick to my routine. I get up each day at 5am, read the Wall Street Journal (and sometimes a few other papers), and then (after spending an hour helping my family/kids get ready for the day) I begin working on whatever research project I have going on at the current time.
I don’t pay much attention at all to mainstream media (CNBC, Bloomberg, etc…). I spend most of my time reading primary materials (company reports, industry reports, trade magazines, etc…). I also make phone calls to people to learn more about businesses, but most of my time is spent reading. So I pretty much stay away from mainstream business media.


Dev: What is your daily reading list?
John: Wall Street Journal, Economist are daily reads (Economist comes each week, but I read a few articles each day).
I also read NY Times, Financial Timesand a few other papers, but not necessarily daily.
But most of my time is spent reading about companies through books, annual reports, industry research, etc… this varies from day to day, but each day involves a lot of reading.


Dev: 5 quotes that should be framed and put on every investor’s desk?

John:
  • There are two rules of investing: #1: Don’t lose money. #2: Don’t forget rule #1. – Warren Buffett
  • I will tell you how to become rich: Be fearful when others are greedy, and be greedy when others are fearful. – Warren Buffett
  • An investment in knowledge pays the best interest. – Ben Franklin
  • Just practice diligently and you will do very well. – Johann Sebastian Bach
  • And the one thing that all those winner bettors in the whole history of people who’ve beaten the pari-mutuel system have is quite simple. They bet very seldom. – Charlie Munger
  • It’s not given to human beings to have such talent that they can just know everything about everything all the time. But it is given to human beings who work hard at it – who look and sift the world for a mispriced bet – that they can occasionally find one. – Charlie Munger (an extension from the previous quote).

Dev: 5 books that everyone looking to become better investor must read. Atleast one each from domains of building processes, psychology and financial analysis.

John:

Dev: Lastly, I know this might sound funny, but how to find a company like Google, Apple, Tesla, Berkshire, etc. early on. And more importantly, how to have the conviction to stay with them?
John: This one is tough. We should all be so fortunate to find one of these in a lifetime, but most of us won’t. The good news is, you don’t need to find the next Google or Microsoft to become a very good investor over time.
I’m not sure there is a specific way to describe how one could locate such an investment.
It’s part preparation, paying attention, working very hard, and learning about a variety of companies.
But to find an investment of the kind you mentioned, it’s also part luck – being in the right place at the right time.
If you find such a great business, it takes discipline and foresight to stick with it through periods of seemingly overvaluation and short-term underperformance.
It’s hard to specifically set out to find such an investment. I think focusing on working a specific investment process is a better approach. Look for base hits, and maybe one day you’ll come across a home run idea.

Ben Graham made 20% per year buying bargains, and then happened across GEICO, which made him very wealthy. He had many base hits, and one home run. But the home run wasn’t necessary to produce.


Dev: That’s all from my side John. I thank you for answering my questions. It was wonderful to have you share your insights.

John: Thanks Dev.




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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…