Mario Gabelli is the founder of the money-management firm GAMCO Investors, Inc. Bloomberg writes: “His investment methodology combines the pioneers of value-oriented investing and the iconic boss of Berkshire Hathaway Inc.”
1. “We’re not buying a piece of paper when we buy stock, we’re buying a business.”
“Think like an owner.”
A security represents a partial share in an actual business. When you are buying that business you should understand it. This first bedrock principle of value investing is a simple but often ignored idea. What you are buying is not a piece of paper that should be traded as if it were a baseball card. I can’t believe I have to say this, but let’s be clear since some people have made contrary assertions: The fact that Ben Graham invested in a lot of businesses does not mean he was an index investor. He actually understood each business that he bought through research. How much a given value investor diversifies is a personal choice, but understanding and researching each company as well as applying the other bedrock principles is not optional if you want to be a value investor. An index fund that is tweaked to consider a value “factor” is not Ben Graham-style value investing. Buying a factor-driven indexed fund is one choice, but it isn’t value investing but rather index-based investing with a value factor.
2. “What you do is identify a company in the public markets that is selling below a channel called ‘intrinsic private market value.’”
“We define Private Market Value (PMV) as the value an informed industrialist would pay to purchase assets with similar characteristics. We measure PMV by scrutinizing on- and off-balance sheet assets and liabilities and free cash flow. As a reference check, we examine valuations and transactions in the public domain. Our investment objective is to achieve an annual return of 10% above inflation for our clients.”
“That gives you a margin of safety, and help protect the downside by providing a cushion, because it is selling at a significant discount to “private market value.”
“You approach stocks as if they were pieces of a business you want to buy at a discount.” “Why am I buying it? Because I have a margin of safety.”
“Value investing works because it is founded on the notion of buying something for less than it is worth.”
Invest in an asset only if you have a “margin of safety” is the second of four bedrock principles of Ben Graham-style value investing. When you buy assets with a margin of safety you can make a mistake and still do fine as an investor. As Mario Gabelli puts it: “The value investor has the best of both worlds: upside potential and the comfort of owning a business with a margin of safety.” Mario is a big fan of Warren Buffett who advises investors to: “Have the purchase price be so attractive that even a mediocre sale gives good results.” This is another simple idea that many people want to look beyond for some other “trick.” There is no trick. If you buy dollars for 70 cents it is harder to lose money. Those opportunities won’t happen very often, so most of the time a value investor does nothing. Most people can’t stand doing nothing most of the time so they are not candidates to be successful value investors.
3. “Markets fluctuate.”
“Mr. Market gives you opportunities to buy above and below intrinsic value.”
That Mr. Market should be your servant and not your master is the third of four bedrock principles of Ben Graham-style value investing. Mr. Market is a bipolar maniac rather than a perfectly informed rational agent. Prices in markets will inevitably move rapidly and unpredictably up and down. Markets are far from wise in the short term. This is obvious to a child of ten. Warren Buffett writes: “Ben’s Mr. Market allegory may seem out-of-date in today’s investment world, in which most professionals and academicians talk of efficient markets, dynamic hedging and betas. Their interest in such matters is understandable, since techniques shrouded in mystery clearly have value to the purveyor of investment advice. After all, what witch doctor has ever achieved fame and fortune by simply advising ‘Take two aspirins'”?
4. “Quality is quality, and just because Mr. Market allows you to buy a share of a company well below its intrinsic value, doesn’t change the underlying value.”
Price is what you pay and value is what you get. Price and value are often different because Mr. Market is not wise and the prices he offers to buyers and sellers gyrates wildly in the short term. Those prices are sometimes higher and sometimes lower than intrinsic value. Value investors believe that you should not try to predict those short term gyrations. As an example, it is unlikely that value of a business that drops 10% in price in a single day has actually dropped in value by 10% . What has changed is the market price, which is set in the short term by a herd of highly emotional and psychologically challenged people. Some people will never understand that price and value can be different and as a result will never understand value investing. That’s OK. It happens all the time. You either understand value investing or you don’t.
5. “Our investment process centers on the application of principles first articulated in 1934 by the founders of modern securities analysis, Benjamin Graham and David Dodd, in their seminal work Security Analysis (1934). To this, we add what Warren Buffett contributed to the field of investing: the notion of valuing a business’s franchise and taking a substantial stake in portfolio companies.”
“Value investing, the way I define it, is finding a good business run by smart people, at a reasonably good price relative to its values today and five or more years from now.”
Value investing is a get rich slow approach. Gains will be lumpy and during a bull markets there will be underperformance relative to an index. This explains why value investing is less popular than it should be. Mario Gabelli is saying that he has taken the Graham approach and in and terms of his own style evolved in it the way Warren Buffett and Charlie Munger did when it ceased to be possible to buy “cigar butt” businesses trading at less than liquidation value (these cigar butt opportunities disappeared after a significant period had passed after the Great Depression).
6. “What would be the element [the catalyst] that would help narrow the spread between private market value and the stock price? A catalyst may take many forms and can be an industry or company-specific event. Catalysts can be a regulatory change, industry consolidation, a repurchase of shares, a sale or spin-off of a division, or a change in management.”
In using the term “catalyst” Mario Gabelli has created a way to describe the idea that one can look for secular and other changes that may increase or decrease value. A catalyst represents extra potential upside in the view of the person doing the analysis. This is another tweak on value investing that has been adopted by some value investors but not others.
7. “When the informed industrialist is evaluating a business for purchase, he or she is not going to put a lot of weight on stated book value. What that informed industrialist wants to know is: How much cash is this business throwing off today and how much is he going to have to invest in this business to sustain or grow this stream of cash in the future.”
From time to time, some people lose track of the importance of cash. These people forget that the only unforgivable sin in business is to run out of cash. Charlie Munger said once: “There are worse situations than drowning in cash and sitting, sitting, sitting. I remember when I wasn’t awash in cash —and I don’t want to go back.” Liberty’s Greg Maffei said to me once during a period of market euphoria in the 1990’s: “cash will again be king.” Markets are cyclical and he was surely right. Of course, you can’t time precisely when this will happen.
8. “We believe free cash flow, defined as earnings before interest, taxes and depreciation (EBITD), or a slight variation, EBITDA, both minus the capital expenditures necessary to grow the business, is the best barometer of a company’s value. Just as growth-stock investors will pay a higher price-to-earnings ratio for higher earnings growth, private-market-value investors will pay a higher multiple of cash flow for faster cash-flow growth.”
The key words in this statement are: “minus the capital expenditures necessary to grow the business.” Charlie Munger points out: “There are two kinds of businesses: The first earns 12%, and you can take it out at the end of the year. The second earns 12%, but all the excess cash must be reinvested — there’s never any cash. It reminds me of the guy who looks at all of his equipment and says, ‘There’s all of my profit.’ We hate that kind of business. Mario Gabelli also says: “We believe that an average management running an above average franchise will do an above average job. An above average management running a lousy franchise will do a lousy job.” For more about what Mario Gabelli looks for in a business see: http://gabelli.com/news/articles/gakraut.html
9. “We don’t have to swing at everything.”
Some business can’t be valued with any reasonable degree of certainty. One great beauty of investing is that you can simply put that decision in the “too hard pile” and move on. There are no “called strikes” in investing. Stated differently, there is no premium for hyperactivity in investing. In fact, there is a penalty. By being patient, but aggressive when the time is right, the investor can “swing big” just when the situation is most advantageous and the odds are substantially in their favor.
10. “If you understand a business, buying the business has less risk.”
As Warren Buffett points out, risk comes from not knowing what you are doing. Risk is not a number and certainly risk is not a number that defines volatility. Volatility is certainly “a” risk but it is not the only risk. Charlie Munger points out: “Using [a stock’s] volatility as a measure of risk is nuts. Risk to us is 1) the risk of permanent loss of capital, or 2) the risk of inadequate return. Some great businesses have very volatile returns – for example, See’s [a very profitable candy company owned by Berkshire] usually loses money in two quarters of each year – and some terrible businesses can have steady results.”
11. “When things look bleak there’s a great opportunity for everyone.”
The best opportunity to buy a mispriced snow shovel is usually in a month like August not in the middle of winter. Similarly, the best time to buy financial assets is when other investors are fearful. Much of the profit in investing and business is made in downturns. The trick is to have cash to invest at such times. The best investors have cash at such times since it is a residual of not being able to find enough securities and others assets to buy during the euphoric part of the business cycle. If you stay focused on buying assets at a margin of safety to intrinsic value, the cash will naturally tend to be available for investing when a period of market euphoria ends and bargains appear.
12. “Always keep your portfolio and your risk at your own individual comfortable sleeping point.”
Different people have different emotional temperaments. If you are having trouble sleeping because of your level of investment risk, you have too much risk in your portfolio. The famous investor Jesse Livermore said once: “If you can’t sleep at night because of your stock market position, then you have gone too far. If this is the case, then sell your position down to the sleeping level.” Mario Gabelli adds: “if you hold certain cash-generating companies and you buy at a reasonable price, you’re going to make more than you will in Treasury bills. The mistake is not staying focused on that.” “If I’m an individual investor and I have $100,000 I want to invest in the next five to 10 years, I’d have no problem doing what Warren Buffet recommends — buy an S&P 500 index fund. You’re going to earn 5 percent to 7 percent over the next 10 years. The 10-year government bond is yielding only 2.3 percent, so you could earn five percentage points higher.”
Notes:
Gabelli on Value Investing http://www.gabelli.com/news/articles/reg-selby_123099.html
Graham & Doddsville – Columbia Business School https://www8.gsb.columbia.edu/sites/valueinvesting/files/files/Graham%20%20Doddsville%20-%20Issue%2013%20-%20Fall%202011%20-%20v2.pdf
2002 Gabelli talk: http://www.gabelli.com/news/mario_times022502.html
Investment Gurus: A Road Map to Wealth from the World’s Best Money Managers by Peter J. Tanous http://www.amazon.com/Investment-Gurus-Wealth-Managers-Selection/dp/0132607204
Value Investing: A Conversation with Mario Gabelli http://blogs.cfainstitute.org/insideinvesting/2013/02/16/a-conversation-with-mario-gabelli/
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