This guest post documenting Guy Spier advice for investors was written by Henry Jackson. Henry is a private investor based out of New York. Article image (creative commons) by Richter Frank-Jurgen.
Guy Spier has run the Aquamarine Fund for 20 years, racking up a stellar record of market beating returns. Given his enormous success, many value investors want to find out exactly how he’s doing it.
One place to look is in Spier’s book, The Education of a Value Investor. Unfortunately for would be Spier-ites, on the first page Guy Spier tells his readers that this story is not an investment how-to guide but rather a story of personal journey. The book is an honest account of his personal evolution from Gordon Gekko wannabe to Guy Spier successful value investor/fund manager. So, despite the excellent read, value investors are left with a lingering question: How exactly does Guy Spier earn such fantastic returns?
Guy Spier’s Starting Point
After reading The Education of a Value Investor, I still wanted a Guy Spier investment how-to guide. And, despite lacking in-depth discussion of how he invests, Guy’s book provided a logical place to start. It served as an investment checklist designed to evaluate your thinking processes before performing any stock analysis.
Spier is a large proponent of using checklists in investing. In Guy’s November 17, 2017 interview with Beyond Quant, Guy stated,
“Investment checklists don’t substitute for an indication of how to analyze, or how to look for investments. It cannot be a substitute. The checklist, the way I understand it, is simply, oh, I’m about to make this investment and I need to go back and remember every single mistake that I or some investor that I know has made. It’s not foolproof. It’s not a substitute for thought, creative search and analysis. It’s just a way to try and filter through some mistakes and reduce the error rate. We know that we don’t have to reduce the error rate by much to have a substantial impact on performance.”
Guy has proven his assertion that the use of checklists has had an outstanding impact on his investment performance. From September 1997 thru the end of 2015, Guy’s Aquamarine Fund has compounded at a rate of 8.9% annually versus 6.2% annually for the S&P 500. The fund’s total return since inception thru the end of 2015 was 376.4% versus 202.4% for the S&P 500. These figures are net of fees and therefore, are actual returns.
Guy Spier on Finding Investment Candidates
I am a value investor like Guy, but not all value investor calculate the intrinsic value of a company in the same manner. I personally favor Ben Graham’s Net Current Asset Value (NCAV) method, while Warren Buffett favors the Discount Cash Flow (DCF) method, and others compare some source of value to Enterprise Value. The list goes on. All value investors have to have a screening process or tool to whittle down the large universe of stocks available. Guy uses stock screens to assist him in his homework, and he’s open to investments from around the world. In his interview with Beyond Quant, he had this to say about the process,
“I do run stock screens, using Capital IQ, which is a phenomenal piece of software. And I have about 30 or 40 saved screens and I go into them from time to time. Some of them I use infrequently; some of them more frequently. But I think saved screens or screening is a great place to see just what comes out. However, I try not to screen in particular geographies. So, if I am slicing through all 30,000 publicly traded companies in Capital IQ, then I try to do the first slice across. Maybe it will bring up a company in Mongolia or Oman. I think that is kind of part of learning and part of the being open to serendipity.”
Screening indiscriminately around the globe has the potential to dig up exceptional bargains not found in your home country. It seems that all the best value investors have branched out beyond their borders. Whether Buffett or Templeton the best picks are often found internationally.
But even stock screening tools have their limitations. Guy continues,
“I try not to rely on accounting information in the screen. There are numbers which are much harder to fudge like shares outstanding, or sales and those numbers are better to screen for, I think, as they’re closer to the underlying reality. We should remember that a company’s accounts are just a map, it’s not the territory. But some numbers like EBITDA or earnings are open to enormous fudge factors. Whereas sales are a lot more difficult to fudge; the number of shares outstanding is the number of shares outstanding, for example.”
EBITDA manipulation was at the center of WorldCom’s multi-billion dollar accounting fraud in 2002. Evidence shows that EBITDA is a useful screening tool that produces above average return but investors must dig deep into the numbers and business to avoid issues.
Small Cap? Large Cap? Guy Spier, Doesn’t It Matter?
Cigar-butt type of companies are usually small, out of favor stocks that (if the numbers are right), might have one more good puff in them and therefore can yield a profit. Ben Graham was the dean of this type of investing and Warren Buffett’s early investment partnership specialized in these type of companies. As Buffett’s capital to invest grew into tens of millions of dollars, it became impossible to deploy large amounts of capital in small cigar-butt type of companies. Buffett moved on to large cap companies that could be purchased at a discount to future cash flows.
Luckily, Guy’s Aquamarine Fund has only $160 million in AUM and he has stated he will invest in any size company. Guy shared his thoughts on this in his Beyond Quant interview,
“I’m not trying to stick to one or the other. I’m trying to intelligently choose between the one and the other. I think it’s probably a lot easier to get a sense of understanding of the large cap known stocks and so that’s an easier, safer place to go to. But given the right amount of knowledge, risk-reward, or understanding of moat, then I’d like to believe that I can decide whether or not to go to what you call “unknown” small cap companies.”
Guy does not limit his investing to just small caps or just large caps. While his fund has $160 million under management, it’s still not as small as most individual value investing portfolios which often total less than $10 million, and one has to assume that he would be using even better strategies if he was managing his own money. Net nets or Ultra stocks, for example, provide much better returns than the large caps he’s buying. Net nets often produce returns 15% above the market return, or 25% compounded, and Ultra stocks provide very similar returns.
Still, the amount of money Guy’s fund has under management affords him the opportunity to invest where opportunities for profit exist. Although he does seem to be wedded exclusively to stock investing. In a July 10th, 2017 interview entitled “An Interview with Famed Value Investor Guy Spier,” Guy states,
“I can invest in anything most of the time. I’m invested in the equities and securities of publicly-created companies because I think that offers the best risk reward. Debt securities are lovely but you’re not going to get a significant reward out of them. You might get a few percentage points better than the bond rate. In equities, you can double and triple your money if you’re in the right places. That’s where the risk reward is really good.”
The focus of my personal investing is toward stocks trading at a discount to NCAV and I obtain my picks from www.netnethunter.com. I’m not comfortable with having as broad focus as Guy. Having specialized knowledge is a competitive advantage in the world of finance. Stocks trading at a discount to NCAV is my personal niche and I’m comfortable evaluating those type of companies.
In the Broad Quant interview he talks further about investing and performance,
“If I were to stay with the kinds of large cap companies I have right now, I don’t think that would impact performance. And I haven’t done the analysis recently, but I think that more than fifty percent of the performance of Aquamarine Funds has actually come from the larger cap ideas which would imply that there wouldn’t be such a drag on performance if the fund was larger. At some point, how many steaks can a man eat and would I be happy if I was running three times the amount of money to what I have now and the management. Quite probably not.”
Guy, like Buffett, looks at stock ownership as a long term commitment. Guy is not just buying a piece of paper or an entry in a broker’s ledger. Guy is committed to finding businesses that he can own for decades. Guy will periodically alter this commitment as certain macroeconomic conditions or fluctuations of a business cycle within an industry, will not yield companies that can be held for decades. Guy discussed what his fallback position is in the Beyond Quant interview,
“In an environment where I can’t find those things, I’d buy businesses which you would call maybe three to five year trades. I would argue that perhaps the U.S. banking sector is a three to five year trade and is a valid place to be, I guess. I would also tell you that the nature of compounding is such that or the nature of discount is such that if I’ve bought something which I think is fifty percent undervalued, and it doesn’t go up, or doesn’t respond within a five year period. Now my compounding is really going to suffer in a certain way. If I don’t get a significant move in the stock within five years or say seven years at the outset, or at the outer limits, then in a certain way the investment has not worked out because it’s simply very hard to deliver good compounding numbers when you’re waiting that long for a result that time will kill you. So, I think that my horizon is let’s say three to seven years.”
Guy’s “three to seven” year time horizon is instrumental in limiting the effect of possible long term value traps while simultaneously allowing for his investment to become profitable. This is the same approach that Evan Bleker takes with his own holdings.
The Guy Spier Olympics: On Your Mark. Get Ready. Get Set. Do Nothing!
Buffett has spoken at great lengths on finding businesses that have a defensive moat. Investopedia’s definition of a moat is a business that has the ability to maintain competitive advantages over its competitors to protect its long-term profits and market share from competing firms.
In the age of creative destruction with internet companies disrupting old industry, Guy’s perspective on moats is standard large cap value doctrine. In his interview with Beyond Quant,
“The moats that are unaffected, say floor coverings is one, household paints is another. So, in floor coverings we have two companies: Mohawk which is publicly traded. And inside Berkshire, we have Shaw Industries. Similarly, with paints, outside Berkshire Hathaway, we have Sherwin-Williams. Those are two businesses that are not going to be disrupted by the Internet. Doesn’t matter what kind of robots or virtual reality we have, people are going to want to paint their walls and cover their floors. But those moats which haven’t changed become extraordinarily highly valued because there’s fewer and fewer places for people to find moats. Many, many companies have had their moats probably at least marginally narrowed, if not a lot worse than that. And so, I would tell you it’s become a lot harder.”
Finding firms with strong competitive advantages is important for fund managers, even those managing comparatively smaller portfolios such as Guy Spier. Guy seems to have made the same shift towards large growing companies that Buffett did when he couldn’t find net nets. The result, as deep value investors know, is lower returns.
But, what should an investor do if there are not any candidates that fits their investment criteria? Do we lower our standards just to invest? Guy stated his opinion on the matter in a October 12th, 2014 interview he gave titled, A Dozen Things I’ve Learned from Guy Spier about Value Investing,
“All-too-often we feel like we are forced to make a decision. Warren Buffett has often said that, unlike baseball, there are no “called strikes” in investing. That is a truism, but the point is that too many of us act like it is not true. When you are a professional, there is a whole system of oversight that is constantly saying, “What have you done for me lately! Or in baseball terminology, “Swing you fool! Most of the time the answers are not to invest and to do nothing.”
I agree. At times most (if not all) value investors have felt a need to “do something” and fell victim to the dreaded value trap. At The Broken Leg Investment Letter, for example, we hold our picks for a minimum of 12 months, since investments need time to work out. Guy continues in his July 10th, 2017 interview, An Interview with Famed Value Investor Guy Spier,
“The biggest danger we have as value investors is that we fall into value traps. I used to get very excited when I looked at small-cap companies and I’d see that they were trading at some ridiculous multiple of earnings. The value trap was where the management and the board of directors are using the company as a retirement plan. The company is small enough and they control enough of the shares that they’re sucking an enormous amount of the value, that has been created in the company, out as direct payments to management. In theory, the management can be removed and you could release all that value and pay somebody a lot less money to do the same job. In practice, it’s impossible to remove the management.”
We’ve seen a lot of this as deep value investors, as well, which is why we included a check against this in our Core7 Scorecard on Net Net Hunter. It’s important to buy into situations with reasonably honest management and avoid vampire-like management who suck the cash out of a company.
Guy Spier Does His Homework Before Meeting Management
But it’s also important to know the effect that management have on an investor’s perceptions, as Guy Spier discusses in “The Education of a Value Investor”:
“Close contact with management is more detrimental to my investment returns. CEOs tend to be skilled salespeople and have a gift for making the listener feel optimistic about the company’s prospects. Knowing my own rational limitations, I’d prefer not to expose myself to this potentially distorting influence.”
Have you ever heard of a CEO who isn’t bullish on his company? We haven’t. Guy’s awareness of potentially distorting influences is part of his process in filtering noise. From Beyond Quant,
“I’m trying to create around me a flow of valuable information and valuable idea streams. I think that more than anything else, what I’ve discovered is relationships with other smart human beings, who have good filters, who are not throwing a lot of noise at me, but who have a sense of who I am and what I’m looking for and who know what signal is and what noise is are likely to send me signals rather than noise, which does not necessarily mean that they’re sending me stock ideas.”
Guy altered his position on meeting with management and realized he could make it an important part of his business analysis, provided he performed some important prerequisites. From Beyond Quant,
“I do think it’s appropriate to talk to management. The key is when you do it. I think that a careful study of the company or the industry and the personalities in it has to come before we reach out and talk to management. So, it’s all based on the first idea to enter your mind because those ideas tend to stick hardest. And so I want to form my impressions of the company from materials that were less likely to bias me like the written 10-Ks and 10-Qs and other more formalistic documents, before moving on to other kinds of less more biased documents that are more likely to influence me.”
Guy’s change of heart in respect to speaking with management might have come about due to his experience with Horsehead Holdings (ZINC). In an article by private investor Eric Jorgensen entitled, How Horsehead Holdings Made Me Look Like a Horse’s Ass, Horsehead Holdings was a company that contracted with manufacturers to cart away scraps of zinc. Horsehead would take the zinc and refine it. The moat was the contracts Horsehead Holdings had with the companies. As it turned out, the company borrowed a ton of money to update an obsolete plant and required more money to get the plant operational and in the black. They carried the plant on their balance sheet at close to a million dollars when it was actually worth zero. Guy (and Mohnish Pabrai) purchased the stock at $10 per share and it ultimately traded close to zero after the bankruptcy. Here’s what Guy Spier had to say on the issue in his Beyond Quant interview,
“I now have the dubious privilege of being able to say that I’ve invested in a company that went bankrupt! It’s not something I enjoy at all. I do think that if I had been closer to the management, in the case of Horsehead, I may have been able to see what was coming better.”
Guy continues in the same interview,
“Don’t meet management in order to take dictation from them. Meet with them in order to observe them in their environment and see what other things one can glean, after all those other things are done.”
In other words proper study prior to meeting management will prevent the investor from being charmed into a rosy viewpoint of an otherwise poor investment.
Guy Spier’s Advice: Don’t Get Caught Short
The heroes of the 2008 housing bubble were investors such as John Paulson, Mike Burry and Andrew Lahde. Their investing exploits were chronicled in the book, The Greatest Trade Ever. These men made billions shorting the housing bubble and now with the current Bitcoin bubble, there is a great deal of discussion on how to short bubbles.
It can be problematic when shorting a bubble or stock as the market continues to climb higher. Remember the stock market maxim, “the market can stay irrational longer than you can remain solvent.” From the 25iq.com interview, Guy explained his thoughts on shorting,
“The fund has not shorted a stock since the 2002 to 2003 time frame. At that time I did short three stocks, on which I broke even on two and made money on one of them. The experience taught me that I was not going to be using short selling going forward for a slew of reasons. The first is the straightforward logic of the matter. The trend of the market is up, not down. Shorting stocks puts you against that trend and thus makes it more difficult to make money. Second, the mathematics of shorting, when you short something and it goes against you, it becomes a bigger and bigger part of your portfolio, thus creating increasing risk as things go against you, making it an unbalanced and unstable thing to manage. By contrast, when you go long something and it goes against you, it becomes a smaller and smaller proportion of the portfolio, thus reducing its impact on the portfolio.”
The statement, “[D]o not go against the trend. Let the trend be your friend,” is drilled into the head of stock or currency traders. Deep value investors often buy stocks that end up dropping after purchase before eventually doubling or tripling in value. Remember, it’s impossible to pick the bottom. Still, some value investors claim that they can avoid exposing their portfolios to large losses by riding the upward trend of the market. While this may be viable, short selling definitely isn’t.
Standing With Guy Spier on the Shoulders of Giants
In The Education of a Value Investor, Guy talks at length about Mohnish Pabrai, Charlie Munger and Warren Buffett. Guy respects these men, not just for their investment prowess but more importantly, how they conduct themselves as good human beings. Guy Spier’s comments on his interaction with Mohnish Pabrai is particularly interesting. From the 25iq.com interview,
“Mohnish Pabrai taught me to be a cloner. In the academic world, plagiarism is a sin. In business, copying other people’s best ideas is a virtue, and it is no different in investing. In the same way that if I wanted to improve my chess, I would study the moves of the grandmasters. If I want to improve my investing, I need to study the moves of the great investors.”
Too many small investors want to look brilliant rather than just follow what works so they can make large investing profits. There are well worn paths to massive wealth creation that are known and easy to put into practice. It’s ironic, then, that so few people start down these near-sure-things or, if they do, they get easily sidetracked with speculations such as housing, Tesla stock, or the latest dotcom darling.
Munger has the same viewpoint, so it’s no surprise that Guy Spier has a great affinity for Charlie Munger. Guy states,
“Somebody was asking him about some investment path (I think was venture capital) and he just looked at him and said, “Look, that’s an insider’s game. I’ll never win at that insider’s game unless I work 20 years to be an insider.” He just doesn’t plan things where insiders can win against outsiders. He doesn’t feel any sense of remorse or envy over the money venture capitalists are making. He’s waiting for those opportunities where he can say, “I’m an outsider but I’ll do fine in this.”
And that’s really what you have to do. Look for games that you can play and win at. This very likely does not mean falling into the Warren Buffett trap, trying to be the next Buffett. We recognize our limitations, so have wholeheartedly embraced deep value. We recommend you take a long look at your own limitations, as well.
Guy modeled Aquamarine’s fee structure after Buffett’s original Investment partnership but also learned that modeling someone is different from blindly following their every move. Guy says,
“I’ve had my head handed to me in certain circumstances because I was overly respectful of the moods of other value investors. In a certain way the Berkshire meeting this year was quite hard for me because I didn’t own shares of IBM but I had this idea I could put Warren Buffett on such a pedestal where I thought he has got to be right about this. I’m not willing to earn it myself because I don’t really see it. But I know he’s going to prove everyone, all of the doubters, wrong. Then I come to this meeting and discover he’s pretty much sold most of his IBM because he woke up and did make mistakes. He felt like he wasn’t so sure about the future of IBM. I discovered that Warren Buffett is fallible and that’s very, very hard for me. At the same time, I have this sort of idiotic idea that Charlie and Warren read newspapers, therefore, I should read newspapers. And that may work for them but I need to work out what works for me.”
So, don’t plan on drinking Cherry Coke instead of water, like Buffett does. The greats, such as Guy Spier, have a lot to say about investing, but that does not mean you have to live or invest the exact way they do.
Guy Spier is a phenomenal investor and like his mentors, he’s a wonderful human being. Guy left the hustle and bustle of the New York investing scene to set up shop in Zurich, Switzerland. This move assisted him in his continuing pursuit of processes that will not only show up on the bottom line of his balance sheet, but the bottom line of his life and relationships with others. One thing stood out to me when Guy Spier discussed his assessment of Deere and Company. Guy commented in his interview with doughroller.net,
“Companies like Deere & Company are in the business of organizing the farming supply chain. Thus, participating in the earnings of agricultural land and helping agricultural yields and the returns to farmers improve. The fact that they’re in a position to make and sell equipment to the farmer means they’re in an ongoing financial relationship with the farmer and in a position to propose all sorts of other solutions to the farmer. You want to be in the things that humanity can’t do without.”
Guy’s humility shines through in the above statement and to quote Guy one more time, from 25iq.com,
"I’m just trying to get it right, 55% of the time or get it slightly better 55% of the time.”
Guy, you’re doing a fine job.
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