This outstanding article on John Templeton was written by Guest Writer Tobias Meier.
If you had to choose one dinner companion, who would it be?
If you're like most people then you'd choose someone like Richard Branson, or Steven Tyler of Aerosmith. Either of these folks would be a sound choice, but you'd also be passing up on one of the most insightful people you could ever meet, John Templeton.
John Templeton, Sir John Templeton to you, is considered one of the greatest investors of all time. He's also one of the pioneers of value investing, a true contrarian and was investing globally before anybody ever dared.
Over several decades and market cycles, depressions, wars and frenzies, Templeton has stood his ground as a gifted investor. Through it all he showed the intelligence, energy, discipline and courage needed to be extraordinary. From 1954 to Templeton's retirement in 1992, the Templeton Growth Fund returned a 16% CAGR after fees, one of the best records in investing history.
While John Templeton retired over 25 years ago, deep value investors today should still listen up. His principles of thought and action are as relevant today as they were at the beginning of the Second World War, when it all started for Templeton.
1. Value Investing is a Lifestyle
Many deep value investors know that Templeton considered himself a bargain hunter, wanting to purchase a stock for a price that was significantly below intrinsic value. But few realize just how deep this characteristic ran. Templeton also applied his bargain hunter mentality to everyday life.
As a young couple, Templeton and his wife made a commitment to save and invest 50% of their income. They took great pride in shopping around for the best bargains. When they first moved to New York, they managed to furnish their first apartment for 25 dollars. After the couple moved in and had kids, it was reported that John Templeton would follow around the members of his family turning off lights to save electricity.
Templeton never abandoned this frugal lifestyle. This ethic eventually afforded him the chance to buy a Rolls Royce but of course by that time, as a billionaire, he thought he could finally afford to.
2. Embrace Maximum Pessimism
According to Templeton, the best time to buy stocks is when public sentiment is the most pessimistic, when 99% of all people have given up. Likewise, at any given time, there are usually certain markets, industries and stocks that are especially unpopular.
In 1939, at the early stages of Hitlers Blitzkrieg and after a decade of economic problems, the sentiment was pessimistic indeed. If ever the world seemed to be coming to an end, this had to be the time – it seemed that the devil himself was attacking Europe.
At this point, Templeton made a bold move: He purchased all US stocks trading below 1 dollar, 104 in total – with borrowed money. He was sure that while the general sentiment at that time was very negative, the war was actually going to fuel the economy. Templeton knew though, that not all of his stocks would work out. In fact, 37 were already in bankruptcy. That’s why he diversified heavily. Throughout his career. John Templeton was always a proponent of extensive diversification. He acknowledged that no matter how careful he was, not every idea would turn out the way he thought it would. Templeton believed that unless you are right 100% of the time, you have to diversify.
In the next few years, the original $10 000 investment turned into $40 000, with an average holding period of 4 years. Ironically, Templeton's stocks delivered above-average returns precisely because they were for the most part troubled businesses. In 1939, Templeton had anticipated that once the United States would be drawn into the war, the government would come up with a wartime tax on excess profits, like they had done in the past. This tax would hurt the profitable companies more than Templeton's bargain basement stocks, where there was usually not much to tax anyway. This turned out to be one of many instances where Templeton had done his homework just a little better than the average investor, saw what others didn’t see, made a sound decision and had the courage to act.
Decades ago, Templeton already understood perfectly what many aspiring value investors today have a hard time accepting: in order for financial assets to be offered at the most attractive bargain prices, usually, there has to be something wrong with them – a broken leg – at least in the perception of the public. Guidelines like buy low and sell high or buy below liquidation value sound super easy in theory, but once people actually see a list of cheap stocks or markets, they tend to feel uncomfortable.
3. Search Worldwide
John Templeton is often considered to be one of the pioneers of global investing. While other investors of his generation were hesitant to invest anywhere but in their home country, it was only common sense for Templeton not to restrict himself to the US markets.
Firstly, he didn’t just want bargains, he wanted to buy the very best bargains around. By investing globally, Templeton had a much bigger pool of stocks to choose from. Secondly, he wanted to take advantage of maximum pessimism – not just every 20 years or so, but on an ongoing basis. Looking at several countries, it was almost certain that some would be viewed more pessimistically than others. As a bonus, Templeton could enhance diversification across different markets.
"It seems to be common sense that if you are going to search for these unusually good bargains, you wouldn’t just search in Canada. If you search just in Canada, you will find some, or if you search just in the United States, you will find some. But why not search everywhere? That’s what we’ve been doing for forty years; we search anywhere in the world" - John Templeton (speaking in 1979)
In the 1950s, Templeton started to invest in Japan. What drew him to the country was the combination of low P/E ratios – an average of 4, whereas the US stood at 19.5 - and high growth rates, which where 2.5 times higher than in the United States. In hindsight, it seems obvious that this was a good move. But at that time, there seemed to be something wrong with Japan. There was negative sentiment in the air. The Japanese have lost the war. All they can do is copy. There’s not enough information. Too much volatility. There are capital controls. What about different accounting rules? Negative biases like these were the reason why valuations were so low, despite the remarkable Japanese economic miracle.
Templeton was a quantitative bottom-up investor first and foremost. Unlike another investor like Jim Rogers, who often like to buy everything they can get their hands on once they have found a cheap market, Templeton would try to buy the best bargains within that market. Japan was just the hunting ground in the 50s and 60s - he would then search that market for the best bargains. Oftentimes, he found smaller, less known companies to be better bargains than large-cap household names.
John Templeton would never invest in countries solely because valuations were low. He also tried to avoid countries with unfriendly investment conditions. He avoided two things in particular: socialism and inflation. Templeton believed in free enterprise, unburdened by too much government control and regulation.
Templeton's first priority had always been low valuation - but if he could buy growth as well, without paying up for it, all the better. He wanted the clearest mismatch between price and value, but wasn’t overly concerned with distinctions like value investing vs. growth investing. When comparing two stocks, Templeton would sometimes be content to buy the slightly more expensive one in terms of valuation metrics like P/E, if, according to a conservative assessment, it showed better growth prospects. However, according to Templeton, one shouldn’t extrapolate extremely rapid growth into the future. Usually it's unsustainable. Templeton would use different valuation metrics, weight two options against each other and purchase what he considered to be the better bargain. Like Ben Graham's Simple Way strategy, P/E was his favourite metric, but other concepts like liquidation value could play a role, too.
He also used these relative value judgements to determine when to sell. Like many value investors, Templeton spent some time thinking about selling strategies. The best answer for when to sell he came up with was to sell when you have found a much better bargain to replace it.
4. It’s All in Your Head
John Templeton considered his strongest talent to be judgement – and so did others when they talked about him. He could assess the totality of a situation and determine the key factors without spending too much time on the details. With self-confidence and courage, he would then act on his insight.
While the ability to get to the essence of things is probably to a large extent something a person will either possess or not, it still seems crucial for an investor to remind himself of what’s important and what isn’t when researching an investment idea, for example by sticking to a checklist of proven key factors and ignoring everything else and thereby turning off the internal chatter, so to speak.
One of John Templeton's favourite topics was what he called thought control. He would train himself to think in a focused, productive and positive way. Like every other activity, Templeton believed that you could train your thoughts to be the way you want them to be. With a high level of awareness and self-discipline, it should be possible to fill your mind with nothing but good, productive, thoughts and constantly weed out whatever negative or unproductive thought pops up. "And the more you work at it, the easier it gets," Templeton said.
5. Keep Your Distance
When Templeton started out as a professional money manager, he set up shop in New York at first, where he had easier access to information and could easily build a client base and a web of personal contacts. However, he never really felt at home in New York. As soon as his business was established and going well, he was ready to set up a lifestyle that suited him personally.
In 1968, Templeton moved from New York to the Bahamas. The performance record of the Templeton Growth Fund became even better when he managed it from the Caribbean. Templeton always stressed the fact that if you want your performance to be better than average, you have to do something different from what other money managers are doing. He found that by living in the Caribbean, far away from the hectic Wall Street crowd, it was much easier to maintain the detachment necessary to be a contrarian.
Instead of being around salespeople and chasing hot tips every day, Templeton would spend time around relaxed people who were there on vacation, oftentimes successful and financially literate individuals themselves. Even if there were discussions about markets, or investments, they were still in an easy-going bunch of people in a very laid back environment.
Templeton liked to go the beach for an hour or so daily, where he would sit, read and reflect in solitude. These concentrated retreats in his favourite surroundings were often surprisingly productive. With nothing but sand and ocean around him, he couldn’t help but think in worldwide terms.
It is certainly no coincidence that many of the most successful value investors choose not to take domicile in New York, but set up a lifestyle that suits them and protects them from unwanted influences - Warren Buffett being the most famous example. Oftentimes, successful investors enjoy relatively unpretentious and quiet lifestyles. Rather than buying things to impress others, they are well attuned to what they really want out of life. After all, how can you expect to discover intrinsic value in the market, if all you care about in everyday life are high price tags and popularity contests?
Being far away from Wall Street, John Templeton was certainly able to cope with the common behavioural traps that investors face. Nassim Taleb, the author of The Black Swan, wrote that knowing about cognitive biases is not enough. To some extent, you will still fall prey to them. You have to get around them.
In other words, you have to avoid situations in which they occur – for example by adopting rules in your investment process. John Templeton, operating on a very high awareness level, probably thought similarly about the influences he was being exposed to in New York. Even if he knew he was being exposed to noise, short-termism and braggery, he could only truly rise above irrelevant chatter if he cut it off completely. By moving to the Bahamas, he took care of that as best as he possibly could.
6. Valuation Matters
In 1979, Businessweek published a cover with the Title The Death of Equities after a decade of the stock market going sideways. Due to high inflation, real returns were devastating. Stocks had fallen out of favour, while real assets like commodities and real estate where popular instead. At that time, pension funds won permission to quit stocks and bonds for real assets. John Templeton saw this as a sign that the point of maximum pessimism was close. The last holdouts in stocks were ready to sell and were leaving the market.
In addition to that, Templeton looked at valuation levels. What he found excited him. The Dow Jones was at a P/E ratio of 6.8x – the lowest level in recorded history up to that point. Templeton didn’t limit his research to the P/E ratio, but also looked at other valuation metrics like Price-to-Book, Price-to-Cashflow and EV/EBITDA, which were also at very attractive levels. Click here for insight into the highest performing deep value strategies.
John Templeton particularly liked to assess stocks based on their Price to Replacement Value of the firm's assets or business. Whereas the Price-to-Book Value level had been even lower after the crash of 1929, the Price-to-Replacement Value ratio told a different story: Because of runaway inflation, replacement costs of assets were estimated to be 70 percent higher than Book Values – contrast that to 1932, when replacement values where actually about 20 percent below stated Book Values due to deflation at that time. Therefore, according to John Templeton's calculations, the Dow Jones price level was at an incredible all-time low, just 59% of replacement cost.
Templeton always considered multiple valuation metrics because he knew that one ratio would never tell the whole story.
During a television appearance in 1982, in the midst of the death of equities pessimism, John Templeton made a contrarian prediction: There would come a great bull market with the Dow reaching 3'000 over the next 10 years – nearly a fourfold increase. Templeton went on to explain why: Assuming long-term average growth rates of 7 percent and inflation staying in the neighbourhood of 7 percent, profits would increase 14 percent nominally per year. This alone could almost account for a rise to 3'000. However, if the P/E ratio was to get closer to its long-term average of 14, starting from this low a level, 3'000 didn’t seem that far-fetched anymore.
People thought he had sunstroke from the tropical Bahamian sun, but the prediction turned out to be almost frighteningly accurate. The Dow reached 3'000 points in 1991 and, once again, Templeton seemed like a genius.
It is important to note what kind of a prediction Templeton actually made. He didn’t try to predict where the market was heading in the next few months. Low valuations can get even lower, after all. Valuation levels are not a market timing tool but they have certain predictive power over, say, a 10-year period.
7. Learn From History
In 1999, in the midst of the internet bubble, Lauren Templeton, great niece of John Templeton, visited her famous relative on the Bahamas. She asked him whether he had been buying any technology stocks lately.
John Templeton smiled and went on to talk about major financial bubbles throughout history – from the Dutch tulip mania in the 1630s to 20th century bubbles. He pointed out that one element was often present in these frenzies: some new-era item or industry that seemed to be changing the world and therefore defying the old rules of valuation. Many of these new inventions actually did change the world – the railroad, the automobile, the airplane, the internet. Yet, many investors lost money trying to participate.
In the beginning stages, many players rush into the new field, creating fierce competition, resulting in few survivors. For every Amazon, there are dozens of WorldComs. At the same time, these new companies are often bid higher and higher, reflecting the overflowing optimism that surrounds them. At some point, people wake up to the fact that their assumptions were unrealistic, fuelled by greed and rationalized by wishful thinking. They expected too much too soon. Valuations start to sink and investors who were hoping to get rich fast actually lose money.
By studying the history of markets, you can’t help but notice that cycles of boom and bust come and go. Strangely enough though, most investors tend to extrapolate present conditions far ahead into the future. Times will change and the future won’t unfold exactly the way we think it will. Assuming mean reversion is usually a wise bet.
8. Going Short
Don’t go short… until you see the whites of their eyes.
Christmas 1999, somewhere in America:
Lauren Templeton's father receives a fax from Uncle John. It contains a list of NASDAQ stocks which John Templeton recommends to sell short. Selling short means betting that the stock will decline in price by borrowing it and immediately selling it. Later, the short seller buys the stock back (hopefully at a lower price) and returns the shares to the lender. The most an investor can make in a short sell is 100 percent – the potential loss is unlimited. This accounts for why short selling is a somewhat dangerous activity.
Many value investors had started to go short in the nineties, only to see stock prices to climb even higher. It was like stepping in front of a speeding truck on a highway – it's going too fast to dodge and you’re going to get crushed – and then some. The economist Keynes famously stated that the market could "stay irrational longer than you can stay solvent." Even if you're right, if investors don't realize it and keep pushing the stock price higher then you could still go broke.
John Templeton, contemplating this problem, flipped his maximum pessimism concept on its head and saw the point of maximum optimism coming closer. Besides the absurd valuation levels, with some tech companies being valued on the basis of how many engineers with PhDs they had on their payroll, Templeton considered other factors, too. He was particularly interested in insider transactions following IPOs. At initial public offerings, where shares are sold to the public, insiders often get rewarded for their contributions with substantial stakes in the company. However, there’s usually a lockup period after the IPO, where insiders can’t trade their shares. In 1999 and 2000, there was tremendous IPO activity with stocks being valued at lofty levels. Templeton felt confident that in many instances, insiders would start to sell immediately after the lockup period, acting as catalysts to initiate heavy selling. Templeton researched lockup expirations. He concentrated on the stocks that had increased at least three times in price since the IPO and sold them short a few days before the lockups expired. He bet 185 million dollars in total. Templeton, aware of the dangers of short selling, was quick to cover losses at predetermined points, should some positions move against him. He let winners run much more, but had set rules for that, too.
Another indicator that increased Templeton's confidence was the notion of there being no more buyers, the inverse of the scenario of the last seller selling at the point of maximum pessimism. That came about on March 10, 2000, when the NASDAQ hit a new all-time high of 5 132. On the same day, the Wall Street Journal ran an article stating that conservative investors were starting to believe in tech stocks and were abandoning their old-fashioned methods. And you couldn’t blame them, because this time, it really WAS different, right?
The NASDAQ started its descent. From a high of 5 132 it tumbled down to $3 321, a 35% drop in just over a month before recovering a few points only to continue its downward slide to $2 407 by the end of the year. Its bottom came on October 4th, 2002, at a low of $1 140. Many investors had their life savings completely wiped out – the tech bubble had truly burst leaving behind nothing but broken (pipe) dreams.
As for John Templeton, he made 90 million dollars shorting the tech bubble over the course of 2000 – sometimes, the old ways are still best, after all.
9. Life is Not About What You Get
Ironically, like most other great investors, John Templeton never cared too much about the materialistic benefits of money – he immersed himself in philanthropy instead, where he could put his money to good use. He loved the process of investing, where money happened to be the yardstick.
As a young man, Templeton set out to reach the highest level of success as an investor. He didn’t shy away from the hard work necessary to get there - on the contrary, he embraced it with his characteristic positive attitude, because he knew that the difficulty in getting there is what made it great.
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