Pairing a post about Bill Miller with a post about Mohnish Pabrai is useful since it contrasts the investment thesis of Miller with someone else who is a self-professed “cloner” of Warren Buffett and Charlie Munger. In other words, how Bill Miller’s investing thesis differs from the value investing orthodoxy is useful to consider.
1. “In the complex adaptive system that is the stock market … there will be dominant narratives that most everyone agrees with and that seem to provide pat explanations for what has happened and predict what’s likely to happen. … we don’t make forecasts and conform portfolios to those forecasts.” Bill Miller compiled an amazing investing record for 15 consecutive years. And after a few years of underperformance Miller is again outperforming the market. People I know who know Miller have tremendous respect for him. Any analysis of his performance must answer the question: What went wrong starting in 2006? I will try to do that with the first four quotations. I may be wrong about what happened, but it is clear that something was off-kilter.
2. “The crisis was the biggest mistake we made — not understanding the systemic nature of what was happening. … We had it completely wrong.” The problem with this statement is that it contradicts the statement in the first quotation (“we don’t make forecasts”). Miller’s years of working with complex adaptive systems arguably should have led him to conclude that understanding “the systematic nature of the crisis” was not possible. The best investing systems available to a “know something” active investor put this sort of systemic understanding in the “too hard” pile.
3. “Our portfolio contains a mix of businesses, some of which we believe are cyclically mis-priced, and some of which we believe are secularly mis-priced.” Other value investors in this blog series do not try to predict secular changes in technology stocks since it is “too hard.” as an example of his different approach, Miller’s Kodak investment required that he understand how fast Kodak’s moat would disappear and whether a team of mostly chemical engineers would create a new moat in a digital age. Applying a moat-based analysis to technology companies is absolutely the right approach, but doing so and generating alpha is a task that most other value investors avoid. In short, Miller did not put Kodak in the “too hard” pile.
4. “It seemed like we needed a 12-step program to cure us of our addiction to buying beaten-up stocks.” The massive size of Miller’s portfolio going into the financial crisis may have caused confirmation bias to interfere with sound judgment on the margin. Putting that amount of money to work is a very hard problem if you are not investing like Warren Buffett with a more orthodox style. Like Ruane, Miller perhaps should have limited the size of his fund. Miller may be performing better today because his fund is smaller.
5. “If it’s in the papers, it’s in the price. The market does reflect the available information, as the professors tell us. But just as the funhouse mirrors don’t always accurately reflect your weight, the markets don’t always accurately reflect that information. Usually they are too pessimistic when it is bad, and too optimistic when it is good.”
6. “Most people are not wired to sell what’s going up and buy what’s going down. It hurts…. Stocks, markets, and money managers’ performance are subject to the tendency of things to swing to their opposites. Those swings can have wide arcs, and unsustainable trends can sometimes persist beyond the ability of one to endure. That is why most investors are out of stocks at the bottom–they are tired of losing money–and fully invested at the top–they believe their good performance will persist.” Disciplined value investors can arbitrage the bipolar behavior of Mr. Market.
7. “We practice the Taoist wei wu wei, the ‘doing not doing’ as regards our portfolio, otherwise known as creative non action. We are mostly inert when it comes to shuffling the portfolio around, with turnover that has averaged in the 15 to 20% range, implying holding periods of more than 5 years. Many funds have turnover in excess of 100% per year, as they constantly react to events or try to take advantage of short term price moves. We usually do neither. We believe successful investing involves anticipating change, not reacting to it.”
8. “[Value traps happen'] when you get down toward the lower end of these valuations, value people find them attractive. The trap comes in when there’s a secular change, where the fundamental economics of the business are changing or the industry is changing, and the market is slowly incorporating that into the stock price. So that would be the case over the last several years with newspapers. They are a good example of where historical valuation metrics aren’t working.”
9. “When we think about the future of the world we always have in mind where it would be if it continues to move as we see it moving now. We do not realize that it does not move in a straight line and that its direction changes constantly.” Quoting Ludwig Wittgenstein.
10. “Your profit is the difference between your average purchase price and your average selling price. Bernard Baruch [a great investor in the 1920s] said nobody buys at the bottom and sells at the top except liars. Your stock will go down after you buy it, and it will go up after you sell it. Being willing to lower your average cost [by buying more when a stock drops] is a great strategy. But it’s difficult.”
11. “What you are trying to do as an investor is that you are trying to exploit the fact that [fewer] things will happen than can happen. So you are trying to figure out how that probability distribution works and stay in the middle of what will happen.”
12. “Anyone can get lucky for a short period of time. But consistent outperformance over long periods is probably evidence of skill.”
1. “There is just one way to invest – buy assets for less than they are worth and sell them at full price. It is not ‘my approach.’ I lifted it from Graham, Munger and Buffett.” I talk a lot about the value of index funds only because for nearly all people it is the right approach. But nearly all is not all. Pabrai in this quotation is referring to what Warren Buffet calls a “know-something investor” who can outperform an index fund. Only 2-5% of people can actually do this and the odds that you are one of those people are therefore small (which will not stop most people from trying).
2. “The best thing for an [know-nothing] individual investor to do is to invest in index funds. Charlie Munger [once said] ’If you consistently spend less than you earn and invest it in index funds, dollar-cost average,’ because you’re putting in money every paycheck…’in, 20, 30, or 40 years, you can’t help but be rich. It’s just bound to happen.’…any individual investor, if they just put away 5%, 10%, 15% of their income every month, and they just bought into the low-cost index funds, and just two or three of them, to split it amongst them–you’re done. Only “know-something” investors (or people who desire to “know something”) absolutely need to know what follows.
3. “As long as humans vacillate between fear and greed, there will be mispriced assets. Some will be priced too low and some will be priced too high.” Markets that are often efficient are not always efficient. Much of the ability of a small number of know-something investor to earn alpha comes from people who think that they know something but do not.
4. “If you study any number of entrepreneurs… what you’ll find is that they have repeatedly made bets which are low-risk bets, which have high-return possibilities. So they’re not going high risk, high return. They’re going low risk, high return.” Pabrai is referring to “optionality” which I discussed in a previous blog post. The “know-something” investor seeks out optionality especially in an environment where uncertainty is high. Pabrai adds: “it’s all about participating in coin tosses where: Heads I win; tails, I don’t lose too much.” Advisors too often tell investors to dial-up risk when the investors should instead dial-up optionality.
5. “I’m a better businessman because I’m an investor. … My experiences as a businessman have very direct, long-term positive impacts on me as an investor, because when I’m looking at an investment, I now look at it like the way I looked at my first business…the first thing I’m looking at is, how can I lose money on this?… The upsides will take care of themselves. It’s the downsides that one needs to worry about… the crossover between entrepreneurship in investing, and value investing especially, is protecting your downside.”
6. “The ideal scenario is to buy a good business at a cheap price. That’s very hard to always do. If we can’t find enough of those, we go to buying fair businesses at cheap prices.”
7. “If you talk to Michael Porter, he would give you five books on what is meant by, you know, strategy and competitive advantage and durable competitive advantage. If you talk to Warren and Charlie, they would just say it’s a moat. And they’d break it down to one word. But basically it’s the ability of a business to have some type of an enduring competitive advantage that allows it to earn a better-than-average rate of return over an extended period of time. And so some businesses have narrow moats. Some have broad moats. Some have moats that are deep but get filled up pretty quickly. So what you want is a business that has a deep moat with lots of piranha in it and that’s getting deeper by the day.”
8. “Moats are critically important. They are usually critical to the ability to generate future cash flows. Even if one invests with a time horizon of 2-3 years, the moat is quite important. The value of the business after 2-3 years is a function of the future cash it is expected to generate beyond that point. All I’m trying to do is buy a business for 1/2 (or less) than its intrinsic value 2-3 years out. In some cases intrinsic value grows dramatically over time. That’s ideal. But even if intrinsic value does not change much over time, if you buy at 50 cents and sell at 90 cents in 2-3 years, the return on invested capital is very acceptable. If you’re buying and holding forever, you need very durable moats). In that case you must have increasing intrinsic values over time. Regardless of your initial intrinsic value discount, eventually your return will mirror the annualized increase/decrease in intrinsic value.”
9. “The durability of technology moats is many times an oxymoron.” Pabrai has been in the technology business himself as a business person and know that predicting the future in technology is a very hard problem. Of course, if you have optionality, uncertainty can be your friend as it is for the wise venture capitalist.
10. “When you are long on a stock, as it goes down in price, the position is going against you and it becomes a smaller portion of your portfolio. In shorting, it is the other way around: if the short goes against you, it is going to become a larger position of your portfolio. When you short a stock, your loss potential is infinite; the maximum you can gain is double your value. So why will you take a bet where the maximum upside is a double and the maximum downside bankruptcy?”
11. “Investing is a peculiar business. The larger one gets, the worse one is likely to do. So this is a field where the individual investor has a huge leg up on the professionals and large investors.”
12. “The main thing that makes Warren Buffett Warren Buffett is that he is a learning machine who has worked really hard for [decades] and is continuously learning every day.”