Dr. Michael Burry is the founder of Scion Capital. He was recently made famous with the general public as a character in the movie adaptation of Michael Lewis’ book The Big Short, but even before then he was famous in investing circles for his astute investing during times like the financial crisis of 2007. Michael Burry is portrayed in the movie by Christian Bale. The real Michael Burry started out as a part time investor and blogger and built his reputation and AUM with great results and original thinking. He is a physician by training and has diagnosed himself as having Asperger’s Syndrome. Burry is particularly interesting for investors in that he has adapted value investing principles to his personality, skills and nature. Like Charlie Munger did many years before, Burry found new ways for value investing to evolve beyond using the system to find “cigar butt” stocks. Burry’s approach indicates that value investing can work for technology and other stocks that people like Warren Buffet may invest in if circle of competence exists and the holding period is not as long that used by someone like Warren Buffett. Technology changes too much to adopt the same holding period as Munger and Buffett. What is Burry doing today? “Michael Burry is still managing a hedge fund named Scion and is still critical of the way the financial system is being run, but now he’s more interested in water than real estate” wrote the author of a New York magazine article who interviewed him in late 2015. Burry’s story demonstrates several important things. Most importantly, the power of being rational and the power of fundamental bottoms up research. It also demonstrates the huge value that permanent capital provides to a rational money manager since as Keynes once said: Markets can remain irrational longer than you can remain solvent. Even as rational as Burry is, it took courage to make and to hold on to the investments that made him famous. Being right, but too early, is indistinguishable from being wrong.
- “My weapon of choice as a stock picker is research; it’s critical for me to understand a company’s value before laying down a dime. I really had no choice in this matter, for when I first happened upon the writings of Benjamin Graham, I felt as if I was born to play the role of value investor.” “Investors in the habit of overturning the most stones will find the most success.” “The late 90s almost forced me to identify myself as a value investor, because I thought what everybody else was doing was insane.” Burry has not completely adopted the ideas of Warren Buffett or Ben Graham and has instead developed his own approach that remains true to the fundamental bedrock of value investing. Burry’s example illustrates how it is possible to follow the value investing system and yet have your own unique style. Again, he is at his core a value investor. Burry makes clear in this set of quotes that he treats shares of stock as a partial ownership of a real business and that understanding any business requires research. You must genuinely understand of the underlying business. A share of stock is not a piece of paper to be traded like a baseball card. The movie version of The Big Short conveys that the style of Burry has a lot more stress associated with it than a Buffett approach, but for Burry it has worked out well financially.
- “All my stock picking is 100% based on the concept of a margin of safety, as introduced to the world in the book “Security Analysis,” which Graham co-authored with David Dodd. By now I have my own version of their techniques, but the net is that I want to protect my downside to prevent permanent loss of capital. Specific, known catalysts are not necessary. Sheer, outrageous value is enough.” “My firm opinion is that the best hedge is buying an appropriately safe and cheap stock.” “It is a tenet of my investment style that, on the subject of common stock investment, maximizing the upside means first and foremost minimizing the downside.” Burry reveals in these statements that he keeps the core value investing faith by always using a “margin of safety” approach. When Burry says: “Lost dollars are simply harder to replace than gained dollars are to lose” it is another way of saying what Warren Buffett has said many times: “The first rule of investing is: don’t lose money; the second rule is don’t forget Rule No. 1.” Joel Greenblatt agrees: “Look down, not up, when making your initial investment decision. If you don’t lose money, most of the remaining alternatives are good ones.” Seth Klarman writes in his book of the same name: “A margin of safety is achieved when securities are purchased at prices sufficiently below underlying value to allow for human error, bad luck, or extreme volatility in a complex, unpredictable and rapidly changing world.” An investor who purchases shares in a business at a price that reflects a margin of safety can make a mistake and still do well financially. When Burry refers to “catalysts” he is talking about the events that I wrote about in my post on Mario Gabelli, who has said: “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.” Burry, Buffett, Greenblatt, Klarman, Gabelli all think about margin of safety first. It is not an optional part of value investing.
- “I try to buy shares of unpopular companies when they look like road kill, and sell them when they’ve been polished up a bit.” “Fully aware that wonderful businesses make wonderful investments only at wonderful prices, I will continue to seek out the bargains amid the refuse.” The third bedrock value investing principle is: Mr. Market is your servant and not your master. Howard Marks makes the same point Burry is making about the necessity of sometime being contrarian: “It is our job as contrarians to catch falling knives, hopefully with care and skill. That’s why the concept of intrinsic value is so important. If we hold a view of value that enables us to buy when everyone else is selling – and if our view turns out to be right – that’s the route to the greatest rewards earned with the least risk…. To achieve superior investment results, your insight into value has to be superior. Thus you must learn things others don’t, see things differently or do a better job of analyzing them – ideally all three.” Adopting the popular viewpoint will not result in market out-performance if the popular forecast is also right. Some roadkill is really roadkill, and some refuse is really refuse. Finding an out-of-favor business selling at a substantial bargain and then waiting is the name of the value investing game. It is easier to say than do.
- “If you are going to be a great investor, you have to fit the style to who you are. At one point I recognized that Warren Buffett, though he had every advantage in learning from Ben Graham, did not copy Ben Graham, but rather set out on his own path, and ran money his way, by his own rules.… I also immediately internalized the idea that no school could teach someone how to be a great investor. If it were true, it’d be the most popular school in the world, with an impossibly high tuition. So it must not be true.” “Ick investing means taking a special analytical interest in stocks that inspire a first reaction of ‘ick.’ I tend to become interested in stocks that by their very names or circumstances inspire unwillingness – and an ‘ick’ accompanied by a wrinkle of the nose on the part of most investors to delve any further.” In his book The Big Short Michael Lewis describes Burry’s view: “The lesson of Buffett is, to succeed in a spectacular fashion you have to be spectacularly unusual.” The movie version of The Big Short certainly portrays Burry as a very usual character due to his Asperger’s syndrome. Burry believes he has an advantage in the investing process since Asperger’s allows him to be more rational/less emotional. There will be times when Mr. Market will offer up shares in a business at a price that reflects a substantial margin of safety, and to find that bargain wise investors try to find something that is out-of-fashion. Burry believes there is no better place to look for something that is out-of-fashion than the “ick” category.
- “I prefer to look at specific investments within the inefficient parts of the market.” “The bulk of opportunities remain in undervalued, smaller, more illiquid situations that often represent average or slightly above-average businesses.” “In essence, the stock market represents three separate categories of business. They are, adjusted for inflation, those with shrinking intrinsic value, those with approximately stable intrinsic value, and those with steadily growing intrinsic value. The preference, always, would be to buy a long-term franchise at a substantial discount from growing intrinsic value.” Markets are often efficient but that does not mean that they are always efficient. If you work hard at the research side of investing and are diligent Burry believes that bargains can be found. The bargains may not always be found within your circle of competence and may not be available for very, long but if you are aggressive and willing to act quickly Burry believes there are big opportunities for an investor.
- “It is Buffett, not Graham that espouses low turnover. Graham actually set targets: 50% gain or 2 years. That actually ensures rather high turnover.” The actual Ben Graham quote from an interview is: “If a stock hasn’t met your objective by the end of the second calendar year from the time of purchase, sell it regardless of price.” This statement by Graham is not consistent with Warren Buffett’s view of the world, but it is perfectly acceptable for a value investor to do as long as the holding period is not so short that it falls within the definition of speculation. Burry feels comfortable buying stocks and other assets that Buffett would avoid. Both approaches are still value investing.
- “Credit-default swaps remedied the problem of open-ended risk for me. If I bought a credit-default swap, my downside was defined and certain, and the upside was many multiples of it.” Burry is describing a classic example of positive optionality that I discussed in my post on Nassim Taleb: “Optionality is the property of asymmetric upside (preferably unlimited) with correspondingly limited downside (preferably tiny).” If you can buy positive optionality at a bargain price that investment can be very valuable. It is of course possible to overpay for optionality.
- “A Scion portfolio will be a concentrated portfolio.” “The Fund maintains a high degree of concentration – typically 15-25 stocks, or even less. Some or all of these stocks may be relatively illiquid.” “I like to hold 12 to 18 stocks diversified among various depressed industries, and tend to be fully invested.” Burry is what Charlie Munger calls a “focus investor” since he concentrates his bets. For Burry, owning a small number of stocks in “various depressed industries” is enough diversification. This means he does not buy a dozen health care stocks. In other words, Burry diversifies based on categories.
- “One hedges when one is unsure. I do not seek out investments of which I am unsure.” It is always wise to have what Charlie Munger calls a “too hard” pile and avoid investment about which you are unsure. But this approach is especially important if an investor has as few as 12 stocks in their investment portfolio like Burry. One way to make peace with this approach and avoid hyperactive investor syndrome is to realize that you can be a successful investor by making only one of two sound decisions a year. Joel Greenblatt says: “Even finding one good opportunity a month is far more than you should need or want.”
- “How do I determine the discount? I usually focus on free cash flow and enterprise value (market capitalization less cash plus debt). I will screen through large numbers of companies by looking at the enterprise value/EBITDA ratio, though the ratio I am willing to accept tends to vary with the industry and its position in the economic cycle. If a stock passes this loose screen, I’ll then look harder to determine a more specific price and value for the company. I also invest in rare birds — asset plays and, to a lesser extent, arbitrage opportunities and companies selling at less than two-thirds of net value (net working capital less liabilities). I’ll happily mix in the types of companies favored by Warren Buffett — those with a sustainable competitive advantage, as demonstrated by longstanding and stable high returns on invested capital — if they become available at good prices.” Burry is not like Buffett in every way and not like Graham either. Burry shows how it is possible to follow the value investing system and yet have your own unique style. But he is still a value investor since he buys at a price that reflects a margin of safety, does not make Mr. Market his master and treats shares of stock as a partial ownership of a real business. Burry’s style is opportunistic and fits with who is he is. You are not Michael Burry and neither am I. Most everyone is far better off investing in a low cost portfolio of diversified index funds.
- “Volatility does not determine risk.” “I certainly view volatility as my friend. Volatility is on sale because 99% of the institutions out there are doing their best to avoid it.” “I will always choose the dollar bill carrying a wildly fluctuating discount rather than the dollar bill selling for a quite stable premium.” Michael Mauboussin has a wonderful description of volatility that I like a lot.
“A lot of value investors shun concepts such as volatility, or standard deviation, as a measure of risk — and I’m sympathetic to that point of view. That said, the notion of risk is very time-dependent. For very short periods of time, volatility is a pretty good way to think about risk. I have kids in college and I have to write a check for their tuition, so volatility is a very important concept for me. I want to minimize my volatility so I can make sure I can write that check. Or if you go out to an options desk and say, “Options traders, we’re taking away your measure of implied volatility,” they would actually be very much hamstrung. But if you take a long-term point of view, which most value investors do, then that idea of volatility melts away and, in fact, volatility becomes your friend. Risk then becomes the loss of permanent capital. You can bring these under the same tent by thinking about the temporal dimension.”
- “Innovation, especially in America, is continuing at a breakneck pace, even in areas facing substantial political or regulatory headwinds.” Anyone involved in a real business or an occupation like medicine can see the pace of innovation in increasing not decreasing. That people are not buying as much capital equipment like machine tools is not evidence that innovation has slowed. That software is replacing capital goods is obvious to anyone paying attention to the real economy. Innovation is racing ahead, but not all innovation is profitable. A simple way to think about disruption is to say that it happens when one business is able to harm or eliminate the competitive advantage of another business. It’s that simple. Disruption happens when a business creates innovation which reduces the competitive advantage of rival businesses. Innovation both creates and destroys competitive advantage and therefore profit. Consumers always benefit from innovation. Producers only sometimes benefit from innovation depending on whether the innovation creates or harms a moat.
Ben Graham interview in Medical Economics “The Simplest Way to Select Bargain Stocks” September 1976. Ben Graham interview in Medical Economics “The Simplest Way to Select Bargain Stocks” September 1976. http://blog.alphaarchitect.com/wp-content/uploads/2011/04/Simple-and-Easy-Approach-Medical-Economics-Graham-1976.pdf
60 Minutes Interview with Burry https://www.youtube.com/watch?v=blq-1pLGKwc
Bloomberg Profile: http://www.hulu.com/watch/333216
Vanity Fair Profile: http://www.vanityfair.com/news/2010/04/wall-street-excerpt-201004
New York Magazine: http://nymag.com/daily/intelligencer/2015/12/big-short-genius-says-another-crisis-is-coming.html