Leon Cooperman is the founder of the multi-billion dollar hedge fund Omega Advisors. Cooperman founded the firm after a 25 year career at Goldman Sachs where he was a partner and served as chairman and CEO of Goldman Sachs Asset Management. His biography is extensive. The fund’s approach to investing is described as: “We are a value-based, catalyst driven investor, focused on a variant perception of company fundamentals. Our disciplined, fundamental approach to company analysis allows us to estimate a company’s business value and compare it to market value. Once the investment decision has been made, we determine the appropriate exposure/sizing in the context of prudent risk control and liquidity of the investment.”
1. “We are trying to look for the straw hats in the winter. In the winter, people don’t buy straw hats, so they’re on sale.”
“We’re looking for things that are mispriced, where opportunity for achieving excess returns exists.”
The primary job of any value investor is to find assets that are sufficiently mispriced so they can be bought at enough of a bargain that the purchase price provides a margin of safety. When Mr. Market is greedy about owning more hats, don’t buy hats. When Mr. Market is fearful about owning hats, it can be a good time to buy hats. The “best time to buy straw hats is in the winter” principle is simple, but actually following it is hard. John Kenneth Galbraith said once that “The conventional view serves to protect us from the painful job of thinking” and this is often applicable to investing. Seneca adds: “When a mind is impressionable and has none too firm a hold on what is right, it must be rescued from the crowd: it is so easy for it to go over to the majority.” It is mathematically the case that you can’t outperform a crowd by following it. It is also the case that always avoiding what is popular is folly. The goal is to sometimes be contrarian and to be right when doing so. That requires work and thinking. Cooperman has also said: “With an average IQ, a strong work ethic and a heavy dose of good luck, you can go very far.” And “The harder I worked, the luckier I got.” If you don’t want to work and think, buy a low cost index fund.
2. “[In July 2008.] To some degree, I feel like a kid in a candy store.”
2008 was the last time in recent memory when were loads of assets in many asset classes available for purchase at a substantial discount to their intrinsic value. Many great value investors had cash to buy assets that year because that cash was a residual of there being few bargains when the market was euphoric. It may look like people with cash in 2008 successfully timed the market turn around, but in fact they kept their focus on the prices of individual stocks. A value investor fundamentally works from the bottom up when making investment decisions and that means starting from the fundamentals of the specific business.
When a value investor like Warren Buffett says: “I felt like an oversexed guy on a desert island. I didn’t find anything to buy,” it is a time like 1973. Just a year later Buffett was saying: “This is the time to start investing.” A fundamental difference between value investors and many other investors is that value investors say things like “this stock is attractively priced” rather than “I think the market will go up soon.”
3. “I am very knowledgeable and cognizant of what the S&P represents; [in 2015] it’s an index of 500 companies, on an average they are growing about 5 percent a year, they yield about 2 percent, they trade a little under three times their book value. They have got 35 or 36 percent of debt in their capital structure and for those financial statistics you pay on an average today about 16.5–17 times earnings. So, I look for, as a value investor, I am looking for either more growth at a lower multiple, I am looking for more asset value or more yield. Some combination that says, ‘Buy me,’ and my team and I spend all day long, 7 days a week, 24/7 trying to look for things that are mispriced to the market.”
“As a value investor, I’m looking for more, but for less. I‘m looking for more growth at a lower multiple. I‘m looking for more yield versus what I can get from the S&P. Or, I’m looking for more asset value.”
“About 95% of publicly traded companies have two values. One is the auction market value, which is the price you and I would pay for one hundred shares of a company. The other is the so called private market value, which is the price a strategic or financial investor would pay for the entire business.”
Leon Cooperman is explaining that what you pay (price) is not always what you get (value). You need to look very hard and be very patient as well. When you see the opportunity you must also act quickly and aggressively. Few investors have the temperament to do this since they panic when the crowd is fearful. “Inverting” your emotions in an opposite direction from the crowd is not an easy thing to do. Most everyone is better served by sticking to a low cost diversified portfolio of index funds.
4. “We’re very confident in the companies we own because they incorporate a margin for error.”
He is referring here to the margin of safety principle of value investing. If you buy at a substantial discount to intrinsic or private market value you can make a mistake and still do just fine. And if things work out better than you thought you get an additional bonus. Cooperman points out: “We have a very narrow assignment, and that’s to know the companies we know better than anyone else and own the right companies.” You can’t do the former without the latter since to understand the stock you must understand the business. Since risk comes from not knowing what you are doing, know what you are doing when doing. It’s that simple.
5. “I look for a stock in the public market that is selling at a significant discount to private market value where I can identify catalysts for a potential change.”
This approach is similar to Mario Gabelli, who I have profiled previously. Gabelli places so much importance on catalysts that his firm actually filed for a trademark on the phrase (Private Market Value with a Catalyst™). For example, a catalyst exist if an investor believes that a business selling at a discount also possesses a possible value accelerant that the market does not recognize. This catalyst approach is a tweak on value investing that is optional. Some investors seek an catalyst and some don’t. Bruce Greenwald and his co-author’s write:
“There are two kinds of catalysts: specific and environmental. Specific catalysts are those changes, either anticipated or recently occurring, that alter the prospects of a particular company. The grimly labeled ‘death watch’ stocks are attractive to investors who believe that the departure of the CEO or a large shareholder will allow the company, once freed from restraints, either to improve its performance or to restructure itself, including here selling the whole thing. … Other company-specific catalysts include all types of financial or operational restructurings, such as the spin-off of a division or a significant repurchase of shares, a change in management, and investments in new business developments….In many instances, the environment in question is the government, in its legislative, administrative, and regulatory roles. Even in the most free market of countries, governments cast enormous shadows over the economy and the companies operating within it…. Other environmental catalysts emerge as the consequences of disruptive shifts in technology that facilitate the reorganization of whole industries. The most unavoidable one in our time is the Internet…”
6. “We’re a value-oriented, research-driven firm that buys undervalued stocks, shorts overvalued ones, and participates in selected overseas debt and equity markets. May not be an exciting approach, but it works.”
Boring “get rich slow” approaches attract fewer competitors which is helpful in the competitive world of investing. Investing where the competition is dumb, misinformed and lazy is an excellent way to boost financial returns. The good news here is that get rich quick type people these are who you are competing against. If other investors and traders were not muppets sometimes, value investing would not work. Turning their dysfunctional behavior into profit is your opportunity.
7. “If you don‘t have the free cash flow, you don‘t have anything.”
The only unforgivable sin is to run out of cash. Charlie Munger points out that “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.” On another occasion Charlie Munger added: “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.”
8. “A lot of companies Warren Buffett owns would not be considered value in the classical sense. A company can be growing at an extremely high rate but happens to be trading at a very reasonable multiple.”
“[You want] a business that has a moat around it, where it’s competitively insulated to some large degree.”
What Leon Cooperman is referring to here is that Warren Buffett, with the help of Charlie Munger, was able to evolve his value investing style when Ben Graham style cigar butts companies trading at less than liquidation value disappeared after the Great Depression. In other words, Buffett and investors like Cooperman began to look for quality as an element in the bargain that creates the margin of safety. In the second quote Cooperman is talking about one particularly key elements in the quality of any business which is a moat. Without a sustainable competitive advantage (a moat) competition among suppliers will cause price to drop to a point where there is no long term industry profit greater than the cost of capital. Greater supply kills value. So you want some aspect of the business that puts a limit on supply and the duration of that limit on supply is a key part of what defines the value of the moat.
9. “Analysts tend to be cheerleaders for corporate repurchase programs. In my view, these programs only make sense under one condition – the company is buying back shares that are significantly undervalued. Most management teams have demonstrated the total inability to understand what their businesses are worth. They‘re buying back shares when the stock is up, and have no courage to buy when the stock is down.”
This view is very consistent with both Warren Buffett and Henry Singleton. Businesses buying shares back when prices are high instead of low is driven by short-term investing myopia. Company management has the same opportunity as any investor to do the reverse, which is to buy low instead of high. The best time to be buying back shares are times like 2008 when Mr. Market was fearful.
10. “What the wise man does in the beginning, the fool does in the end.”
It is easy to get caught up in the movement of a herd. And it is easiest of all to follow the herd when it is close to the end of a cycle. Even the wisest investors can fall victim to crowd folly. The basic underlying force at work is that people rarely make decisions independently. Fear of missing out (FOMO) and laziness make people follow the lead of other people and that process can snowball. Or not. And it will continue until it doesn’t.
11. “There are roughly speaking 10,000 mutual funds that are happy to manage your funds for 1% or less. And roughly 10,000 hedge funds that have the chutzpah to ask for 2 and 20. If clients are going to pay 2 and 20, they have a right to expect more. You’re always on the balls of your feet.”
“If you are paying somebody two and 20, as opposed to 1%, you basically have the right to expect more from that person.”
Since it is possible to invest based on what John Bogle calls the ‘low fee hypothesis’, if you are paying hedge fund style fees or even 1% just for assets allocation or stock picking you have a right to expect outperformance. One thing you should definitely do if you decide to seek that outperformance is write down actual performance. With an actual pen and paper. Force yourself to consider your real world after fee results. I have several friends who did this and not are index fund investors. Always consider that you may not want to be a member of any fund that will have you as a member. The number of investors profiled in this blog that will not take you on as an investor is huge.
12. “I think it was my discovery of Teleydne and its extraordinary CEO Henry E. Singleton. In my opinion Dr. Singleton was one of the greatest managers in the annals of modern business history. No less an authority than Warren Buffett called Dr. Singleton “the best operating manager and capital deployer in American business.” Dr. Singleton started buying up his company’s own shares and from 1972 to 1984 he tendered eight times and reduced his share count by some 90%. His ability to buy his stock cheaply and correctly and time the short and long-term troughs is truly extraordinary.”
Cooperman can claim lot of credit for discovering the investing and business genius of Henry Singleton, who I’ve previously profiled here. Charlie Munger has interesting things to say about Singleton that I can’t say better:
“We respect Henry Singleton for a very simple reason: He was a genius. Henry Singleton never took an aptitude test where he didn’t score an 800 and leave early. He was a major mathematical genius. Even when he was an old man, he could play chess blindfolded, at just below the Grand Master level. He had an awesome intellect, well into the top 1/1,000 of one percent. This was an extreme analytic. Of course, he did create a conglomerate because it was legally allowed at the time. He did it the way everybody else was doing it, he did it better, and he made a lot of money. When they ran out of favor, the stock went way down, he bought it all back for less than it was worth.
Of course, he died a very wealthy man. He was a totally rational human being in things like finance. What I found interesting about Henry Singleton, which has interesting educational implications, is that in watching both Henry and Warren invest and operate at the same time, we had two great windows of opportunity to examine human nature. Henry was very rational. He was quite similar to Berkshire in some ways. Henry never issued a stock option. He had certain commonalities with Warren that were just logical outcomes. What was interesting to me was how much smarter Warren was at investing money than Henry. Henry was born a lot smarter, but Warren had thought about investments a lot longer. Warren just ran rings around Henry as an investor even though Henry was a genius, and Warren was a mere almost-genius.”
Notes:
Bloomberg: http://www.bloomberg.com/news/articles/2012-06-28/cooperman-says-earning-13-in-stocks-takes-average-iq-
CNBC: http://www.cnbc.com/id/101823194
Interview: http://www.valueinvestorinsight.com/Nov_06Trial.PDF
Interview: http://wagsome1.rssing.com/chan-1906771/all_p22.html
Graham and Doddsville: http://www8.gsb.columbia.edu/rtfiles/Heilbrunn/Graham%20%20Doddsville%20-%20Issue%2014%20-%20Fall%202011.pdf
Graham and Doddsville: http://www.grahamanddoddsville.net/wordpress/Files/Gurus/Leon%20Cooperman/cooperman.pdf
Business Insider: http://www.businessinsider.com/leon-cooperman-observations-on-life-hedge-funds-and-the-investment-outlook-2012-9?op=1
2015 Daily Journal Meeting http://www.forbes.com/sites/phildemuth/2015/04/27/charlie-mungers-2015-daily-journal-annual-meeting-part-4/
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