Todays Right Side is going to be dedicated to the day-long meeting I had recently with Simon Caufield, Editor of True Value.
I had been meaning to meet Simon for some time. A few months of reading True Value had convinced me that we had a great deal in common. So while we were both in France on business recently, we agreed to meet up.
Now Simon and I come from different sides of the fence. I’ve trodden the traditional path… Masters degree in economics, a City career and all the professional exams and paraphernalia that goes with it.
Simon, on the other hand, founded and subsequently sold a successful IT management consultancy. His insights into investment come from personal experiences – and a passion for the work of Benjamin Graham – the Godfather of value investing.
Because of our different approach to valuing companies, we’ve got different ideas about how our portfolios should look. But our view of the City and how it works is exactly the same. Though we’ve taken very different paths – we’ve arrived more or less at the same place.
Perhaps I shouldn’t be so surprised – ultimately we’re both the same – we look after our own money and we want the best risk-adjusted long-term gains. We both had very firm ideas about how a private investors can best achieve those long terms gains.
Today I’d like to tell you about what we discussed. Because I really do think it goes to the heart of our concerns here at Right Side.
I’ll start with a subject we talked about at great length – the failings of fund managers…
Great companies don’t make for great stocks
The first thing I wanted to tackle Simon on is what he calls the biggest misconception in the City. And that is that great companies – businesses like Google, Amazon, or even Apple – rarely make great stocks.
How can that be?
Simon explained…
“I can tell as well as the next man that Apple is a great company… But I’m not looking for great companies. I want great stocks. Ones that are going to pay decent returns over the long run.”
The problem with the likes of Apple is that everyone knows they’re great. And investors pay up extraordinary premiums to get in on the action.
Simon made a point about the fund management industry that I know only too well from personal experience. Fund managers ‘have to buy’ overpriced businesses. If you’re managing a pension portfolio and you turn up to a meeting with the trustees, you don’t want to look like a chump.
Let’s say you don’t hold Apple in their portfolio because you think it’s overpriced. But if Apple has been doing well, the trustees are going to be furious. You’ll look like a prize chump!
That’s why you stuff the portfolio full of the popular companies. You won’t get any arguments from the trustees.
And if they crash? So what – everyone in the City holds the stock. You won’t be held responsible for the collective misconception of what that company is really worth.
Today that stock could be Apple, Amazon, or Google. In my day it was Enron, Marconi, or BT. These stocks got slaughtered during the dotcom bust-up.
That’s why you need to be very careful when it comes to buying into great companies.
Never Pay for Growth
The stocks I’ve just mentioned aren’t just fashionable – they are high growth. And as we just saw, the market is prepared to pay for it. But, YOU shouldn’t.
Benjamin Graham is the guy Warren Buffet bases his investment philosophy on. And ‘Graham never paid for growth’ says Simon.
But this concept is a bit alien to me. I’m certainly prepared to pay a bit more for a business that’s growing. Of course I don’t want to pay crazy multiples, but certainly anything up to 16 times earnings (normally I prefer to buy at less than 10) for a decent business is acceptable to me.
Simon’s response is typically analytical:
‘I think the key is to find businesses whose investment in growth is less than their cost of capital.’
Maybe I should explain what he means…
To get growth, you need to invest money. Growth costs – not just in physical premises, plant and equipment, but in personnel too. And you’ll need to shell out on Research & Development (R&D) if you want to stay ahead of the pack.
And that’s where the problem lies…
Take Apple whose iPhone is now the top-seller in the world. Not so long ago, Motorola held that position. Then came Nokia and Blackberry after that. Most of the profits you get from being number one go straight back into R&D to help you stay there. But even then you’re unlikely to keep your position over the long run.
If the R&D costs you more than your cost of capital, then why bother? It won’t deliver long-term shareholder value.
And I agree whole-heartedly with that. It all comes down to growth, barriers to entry and cost of capital. So Simon will pay for growth (sometimes) – it’s just that he won’t overpay.
‘Always buy ugly’ is his number one rule. If the City doesn’t want a stock and it’s deeply out of fashion, you’ll find Simon poring over its accounts.
And over the long-run, I know he’s right.
This really is one of the most significant ideas behind long-term successful investment.
And I mean that. Take my advice, download and print a copy of this report. Get yourself a cup of coffee and take fifteen minutes to have a good read and think about why buying ugly really could be the key to long-term performance.
And on Wednesday I’m going to fill you in on our discussion about gold. We both hold and there are some very good reasons for that.
Until Wednesday.
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