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FEMALE SPEAKER: Welcome everybody
to this TechTalk on Monday afternoon.
Thank you very much for coming, and we
are very happy to host today John Mihaljevic.
He the author of a very popular book, "The Manual of Ideas,"
which introduces you to a framework of finding, analyzing
research, and implementing the best value investing ideas.
And among his great accomplishments,
John is also a member of the Value Investors,
and the Value Investors Club.
It's a community for top money managers,
and he also won the prize for best investment
idea in that club.
There could be many other great words said about John,
but you came here to listen to him.
So welcome, and the floor is yours.
JOHN MIHALJEVIC: Thanks.
Well, thank you so much, [? Anna, ?]
for the overly generous introduction.
I also want to thank [? Sirabat ?] in the Bay Area
office for the invitation, which I was very excited to receive.
And it's such a pleasure to be here at Google.
I don't think I could have made it here if applying for a job,
so this is kind of my entree, if you will.
I want to talk about idea generation,
and specifically from an investment angle,
so how to find great investment ideas.
And I put "secret" in quotation marks
here because there really is no secret.
But I'm glad so many came to hear the talk.
How do we really think about investing?
And it has a lot to do with how we view the stock market.
Because when it comes to investing in public companies,
you are transacting in a global stock market.
It's very liquid, you can buy and sell at any time.
And I think there's just a lot of confusion
out there as to what the stock market really is, and there
are also very many approaches.
And it's actually in the interest
of the financial community and Wall Street
to make it seem very complicated,
so that you will just give your money to them
and think that they're doing such a great job for you
that they deserve to get paid a lot of money.
When in reality, it isn't that complicated.
The stock market is a beauty contest,
that's really a criticism that economist John Maynard
Keynes levied on the stock market, or on Wall Street.
And it's really this idea that a lot of investors, and even
professional investors, will choose companies
based on what they think other people will
think of those companies.
So everybody's kind of trying to play a guessing game, where
basically you're picking the prettiest face,
or the prettiest company-- but it's not
the one you think is the prettiest,
it's the one you think others will think is the prettiest.
And of course, as Keynes said in this quote,
you can take that to the third degree, and the fourth degree,
and so on, and so on, and it becomes very self-referential.
And because a lot of people invest this way,
this is how the stock market might act in the short term.
It's very unpredictable, everybody
trying to out-guess everybody else.
But that's really not how you can
be successful in the long term.
And by viewing the stock market as a parimutuel betting system,
we're getting a little bit closer to the essence of it.
Because really it's not about guessing the prettiest face,
or the best company, or what others will think--
because if there is a company out there like Google,
that game becomes pretty easy.
What becomes harder is calibrating that judgment
versus what you have to pay to actually buy
that company in the stock market.
So as Warren Buffett's partner Charlie Munger says here
in this quote, sometimes it's just really easy
to see which horse is most likely to win a race,
but that horse will have odds that are maybe
three to two, that pay three to two,
and some other horse that doesn't look as fast
may have odds of 100 to one.
And then it becomes much more difficult,
because probabilistically, the best horse
isn't going to win 100% of the time.
What if the horse that has the odds of 100 to one
can win 5% of the time, or 10% of the time?
It may actually be the better investment-- or the better bet,
in this case.
And this quote from Warren Buffett
kind of fits that paradigm.
He says, we simply attempt to be fearful
when others are greedy, and greedy when others are fearful.
And that really speaks to those odds.
Because if you have everybody in the world believing
that a company will go bankrupt, the odds on it
may be so great that if it just doesn't go bankrupt--
it may still be a mediocre company--
you could actually do very well.
And then finally we really get to the essence of the stock
market, and it's just a conduit to ownership.
So Google would be a great company
whether it's publicly traded or not.
It would still have the cash flow it has,
it would still have the customers that it has.
And so you don't need the stock market
to make a Google valuable, or any other company.
And so it's basically just a place
to buy and sell stock in companies.
And what is stock?
The legal definition tells you that it's just
a partial ownership of a corporation.
That's really what you're buying when you invest in a stock.
And it may not seem that way because it's
so easy to transact online.
You're just looking at a stock ticker,
and it's easy to forget that what you're really buying
is ownership of a real life business.
And so you'll hear of all kinds of different strategies,
or you'll hear of people trying to invest based on charts.
They'll look at different bands and try
to guess when the stock is breaking out or not.
But that's basically removing yourself
from the essence of what a stock really is.
And when you do that, your chances of success
go down dramatically.
Because let's say you do invest based on a chart,
and you lose all your money.
There's no recourse.
You can say, well, the chart looked good,
and in every other case when that happened,
the stock did go up.
Well, there's no connection between that
and what a stock is legally.
Legally, it's ownership of a business.
And so if you invest in a company, and you're right,
you can in the worst case take the recourse
and acquire a majority of the stock,
kick out the board of directors, put in your own directors,
your own management team, and take
full ownership of that company.
So there you are getting to the essence of what a stock really
is.
And if you invest based on that essence,
you'll be much more successful, because you're just
as close to the truth as can possibly be.
I want to talk a little bit about the mindset
that you need to have to be a successful investor.
So a lot of investors will think this way,
kind of the small fish mindset.
Let's say I have $100,000 to invest.
Here's a bunch of companies, and their stock price
is their market value.
Market value simply is what it would take at the current stock
price to buy the whole company.
And if you have the small fish mindset,
you might just say, well, $100,000
buys a few thousand shares of any of these companies.
And my $100,000 is insignificant,
s so it really doesn't move the needle on these companies,
or the market is a whole.
And the reason it's the wrong mindset to adopt
is because just because your portfolio may be small,
your role in the market is not insignificant.
Because the market is supposed to function efficiently
because even small investors think
about how well is company A going
to do, how much do I have to pay to buy
it, et cetera, et cetera.
So you really need to think about not the scale
of your portfolio, but the scale of the companies
you're investing in.
And so here's kind of the mindset to be, which is really,
I think, what successful investors adopt,
no matter how much money they're investing.
And it's the same table as before,
but we're just showing it in a different way.
By the way, this is about 10 years old,
some of these numbers, so it's changed quite a bit.
But what I'm trying to illustrate
here is when you look at it this way,
you suddenly realize, wow, I can either buy all of Toyota
for $99 billion.
Or for the same amount of money, actually a little bit of less,
I can buy all of these companies on the left.
And that's 100% of them.
So you can either own all of Toyota,
or you can own all of Ford, GM, and the other companies.
And you may still decide that owning all of Toyota
is the smarter investment, but at least you'll
be aware what that decision implies.
You're no longer on this slide, where you're thinking,
oh, well, I can buy a few thousand shares of Toyota
or some other company, and it's kind of all the same thing.
So here you're realizing what you're really doing.
And that mentality, to really think of investing as an owner,
I think is very much in line with the legal essence
of stocks.
So here's a very busy chart, and we're not
going to get through all of it, but there
are few points I'd like to make here.
So one is all the way on the left you see idea generation.
And there's so many different ways
to find potential investment ideas.
You may hear it from friends, on message boards, read
about a company in the newspaper.
You could do a quantitative stock screen,
searching for the cheapest companies based on some metric.
So idea generation generally is the easy part.
And we can overload ourselves with ideas.
There's actually about 10,000 publicly traded companies
in North America alone, and probably
20,000 to 30,000 companies worldwide.
So there's a ton of companies to choose from.
So where successful investors really generate their success--
or as they call it in the industry,
their alpha or edge-- is really in assessing the investment
opportunities.
So I could give everyone the same potential company
to invest in, and someone will say, wow, that's great,
I want to buy.
Someone will say, no way.
And that's really that decision.
If you can get that decision right,
you're going to be successful.
So given what we know now about the right mentality
to think of a business as an owner, and would
I want to buy the whole company if I could,
let's walk through this a little bit.
So a company will usually have real assets,
especially if it's kind of an old school
company that maybe has factories.
Let's take a General Motors.
They've got factories, they've got
all kinds of tangible assets.
You would want to ask whether this company, at the stock
price it is today, is trading for more than it would
take to recreate it from scratch.
And you're not going to be able to recreate the company exactly
the same from scratch, but the idea
is how much capital would it take to recreate the earnings
flow and the basic business of a company.
So if it's selling for a lot more in the stock market,
you're not going to buy that stock.
Because what that's saying is there's
an incentive for a competitor to come in,
because they can recreate that same company for less
money than the stock price implies.
So if the company in the stock market is worth $2 billion,
and you could recreate that business for $1 billion,
there's an incentive for someone with a lot of money
to come in, create that company for $1 billion,
take it public immediately, and then basically sell the stock
for $2 billion in the market.
So that's where we're going to basically eliminate the company
from consideration if it's trading above its replacement
cost.
Now if it's below, then we go to the other extreme,
which is liquidation value.
And what is liquidation value?
It basically means what is this company worth dead today?
So if you were to shut down the business,
or sell it, and liquidate all the assets,
how much money would you have left over?
And if a company is selling below that,
that's usually a low number, but sometimes
companies actually do sell below that.
I'll give you an example.
When the shipping industry-- these big ocean tankers that
transport crude oil around the world, and so forth.
When that industry is doing badly,
it's doing generally so badly that no one wants
to own these stocks, and they will sell, on occasion,
for less than the scrap value of the metal used
to build the ships.
So you could buy those stocks for less than the scrap value.
And then, generally, management of these companies, the CEO,
they'll say, oh, the turnaround will come next quarter.
OK, maybe in a year.
But after two or three years, they'll
start selling the ships for scrap themselves.
And if they do that, and the stock
is trading for less than scrap, you're
actually going to make money, even though the business looks
like it's going under.
So that's another easy one.
You would take control of the company,
you would liquidate it, you'd make money.
Now beyond that-- those are kind of the two bounds, the upper
and lower bounds-- you get into where
you're looking at actual earning power of the company.
And this is where most companies end up,
unless we're in a 2008 financial crisis-type scenario, where
there were a lot of companies selling
for less than their liquidation value.
And what you would look at here is
how much is this company actually earning,
and how much do I have to pay in the stock market
to acquire the whole business?
And there's no right or wrong answer.
So you would basically decide, well, what kind of return
is good enough for my savings?
If a company's earning $1 billion a year,
and it takes $10 billion to buy it in the stock market,
that's a 10% a year return.
And then maybe you want to know, well,
are those earnings growing over time?
So my 10% in year one will be 11%, and then 12%,
and so forth.
Or are the earnings declining?
In which case you'll want a higher initial percentage
yield.
So maybe even if the earnings are going to decline,
well, if you can acquire it for two times current earnings,
that means you're making 50% return just based on--
and we have the mindset of a capital allocator and owner
here, no longer just pieces of paper and stocks.
If you can buy the whole company and in one year
get half your money back in earnings,
you're probably going to be fine,
even if those earnings are going down slowly over time.
Because within two to three years,
you've got all your money back, and then whatever
comes after that is just gravy.
So here you're making a decision whether the earnings yield--
that's the earnings before interest and tax--
and these are some technical terms here,
but I'm telling you the essence of what's
on here-- if those earnings divided by what the company's
worth in the market exceed whatever return you require--
because you're going to look at your alternatives, right?
You can put money in a CD, you can buy a bond,
you can do all kinds of things.
If that exceeds your return, you move on here.
If it doesn't, you eliminate this particular company
from consideration.
And now what we're talking about here
is we're looking at the business itself now.
Forget the stock market.
We just want to know how good is this company.
And because we're dealing with money here,
we want the company to make as much money as possible
in earnings or cash flow relative to the capital it
takes to build that company.
So if I need to have a factory that costs me $1 billion,
and that factory is then going to throw off $10 million a year
in profit, that's probably not good enough.
Because that's a 1% return, and a factory is no CD,
it's not a safe investment, and so forth.
So you really want to know how good is the business.
Google, for example, doesn't take a whole lot of capital,
and it throws off a lot of free cash flow
relative to that capital, so that's
why it's a great business.
And that's the kind of business you
want to be in, because when you buy a stock,
they're not actually going to pay you out all their earnings
every year.
Now if they just took their earnings and paid them out,
you may not even care how good of a business
it is, because you're getting those earnings.
Like I mentioned, if you're buying a company
with a 50% earnings yield, and they paid everything out,
you got your money back in a little over two years,
and that's fine.
But because most companies will actually retain those earnings
in the business, you care very much about when
they retain those earnings.
They're going to invest them in their business,
and what is the return on that capital?
Some companies pay dividends, so that's
a portion of the earnings, usually.
They won't pay out their whole earnings,
they'll pay out half, if you're lucky.
So there you may care a little bit less,
because you are getting some cash back.
But where you're not basically getting cash back,
you want to know what kind of return
is this company getting on the cash that
stays in the business.
And if it's a great business, like Google, the problem
actually becomes that it's very hard to reinvest that cash,
because the business doesn't require a lot of capital.
So take one year's worth of free cash flow for Google.
If it could be reinvested in the business
at the kinds of returns that Google is currently
getting on its capital, that would be phenomenal.
But because it's not a capital-intensive business,
that free cash flow just kind of builds up on the balance sheet,
and over time there's tens and tens
of billions of cash on the balance sheet.
So if we like the quality of the business,
as measured by the earnings divided by the capital employed
in the business, then it's a good potential opportunity.
And it still doesn't mean that it's a great investment.
But you've kind of eliminated all the obvious candidates
that are just not good enough.
And then once you're here, it becomes really more of an art,
which company you are going to invest in versus another.
And we're going to get into some of that here.
So here are some value-oriented investment approaches.
You might have heard of value investing and growth investing.
So growth investing, usually it's
kind of the other mindset, or just the mindset
of which company is going to grow the fastest
and that's where I want to invest.
But you're not really thinking, well,
what if everyone else thinks it's
going to grow the fastest as you're super expensive.
You may not make any money.
If they have any kind of disappointment,
like they missed a quarter by a penny,
the stock can be down 20% in a day,
because there was just no value there.
So we want to buy things that are more valuable than what
we're paying for them in the stock market.
And some of the well-known approaches in this area--
there's the Benjamin Graham style, deep value.
And I start with that because Benjamin Graham wrote the book
on value investing.
It's called "The Intelligent Investor."
And the style is today called deep value
because you focus mostly on the assets--
like I mentioned a shipping company
with their ships and the scrap value.
That would be deep value, if you can
buy something for less than the assets.
Question?
AUDIENCE: Yeah, I have a question.
How would you find [INAUDIBLE]?
JOHN MIHALJEVIC: Correct.
So really what you're going to look at
is the financial statements of a company,
and that's where we get kind of into the language of investing,
which is really accounting.
So every company will have a line item on their balance
sheet called property, plant, and equipment.
And for a shipping company, that's
where their ships might be.
For a hotel company that owns hotels,
that's where their hotels would be.
And then they may have a footnote in their annual report
that actually lists out the ships.
It won't necessarily tell you the market value
of those ships, but it might tell
you what they're carried on on the books,
and how much they've depreciated so far, and some detail.
But you're going to have to dig a little bit deeper
if you want to know the market value of specific ships,
or specific real estate, or something like that.
AUDIENCE: John, can you repeat the question?
JOHN MIHALJEVIC: Yeah.
The question was, how do you actually
find companies that maybe have those ships
and trade for less than that.
So you could use a quantitative stock screener
that looks for companies that have market
value less than tangible book value.
And tangible book value is once you
satisfy all the liabilities-- like the debt-- what's
left over for the shareholders, using this accounting
language-- which is standardized,
but it's not really correct in an economic sense.
But you can use it for screening,
and then you have to do your own research to decide, well,
the book value may be high, but that's not actually
if I wanted to sell the ships, so you take it down and do
that kind of analysis.
Now Joel Greenblatt is a very successful investor.
He's written a book called "The Little Book That Beats
the Market," where he talks about this magic formula.
It's essentially a way to screen for companies that, according
to my previous schematic, would be
in that green portion at the end,
and then you can invest in them.
And it looks at two factors.
One is the high earnings yield, how cheap is a business.
And the other is the high return on capital,
how good is a business.
And historically, just a mechanical screen
of those companies that rank highly on those two metrics
has outperformed the S&P 500 by several percentage
points a year.
And over time, due to compounding, that just
is a huge number.
Then we have what I call here Carl Icahn-style,
sum-of-the-parts investing.
You may have heard of Carl Icahn,
or these activist investors, who will buy a big chunk
of a company-- maybe 10%-- and then try to tell the company
what to do so that the stock would be worth more, or go up.
And usually what they look for is
where you have a company that has different parts to it,
and if you add up the value of all the parts,
it's materially above what the whole company
is trading for in the stock markets today.
And that can happen quite often, because maybe a company has
a core business, and that's what investors are focused on,
and they value the company based on that.
But then there may be something else
that they own that's totally unrelated-- like some big piece
of real estate, or some other business.
And then there are some other approaches,
what I call jockey stocks, which is really
companies that are run by a great jockey.
It's again the horse racing kind of analogy,
where you have a CEO who is not just great at running
the business, but also great at what he does with the cash
that the business generates.
Because once the cash is there, there are a lot of options.
And you can destroy a lot of value is a company,
or create a lot of value, based on what you do with the cash.
So it's especially relevant for companies
that have a ton of cash on their balance sheet.
You might make an acquisition, you
could overpay for another business,
just because you fear you're going
to miss out on the next trend.
And you take that hard earned cash
and you could basically waste it.
Or if your stock price gets low--
let's say there's a financial crisis and the stock gets hit,
and it's trading way below what it's
worth-- the company could actually take the cash hoard
and buy its own stock in the stock market,
and create huge value.
Because if it's just sitting there,
the cash is maybe earning 0%, 1%, 2%.
But if you're buying your own stock at yields of 10% or more,
you're going to create huge value.
So I want to maybe get into a couple of these
quickly, and then take questions.
But these are basically these buckets we just talked about.
And I'm not a huge fan of buckets,
because once you get into that, then
it becomes a little bit more mechanical.
You find a company, and all of a sudden you're
thinking, well, what bucket does it fit in?
And how do I have to analyze it?
When really it should just be common sense.
You should just take a company, imagine
you own the whole thing, and think like an owner,
basically, from scratch.
But nonetheless, let's just touch on some
of the key features of some of these types of companies.
So these deeper value companies where
you're buying maybe some factory-type business
for less than it would cost to create the factory,
these are generally hated stocks.
And if you look at it historically,
people have overreacted on the negative, generally.
So this guy, Jeroen Bos, he's a successful investor
who just invests in these hated companies.
So he says it's kind of contradictory
that you buy what no one else wants, and then you outperform.
And it just takes a certain mindset
to be comfortable doing that, because everyone around you
will say, oh, you are not very smart.
And imagine if an investment doesn't work out,
you're really going to not feel very smart.
Because everyone was telling you all along, and then that's
what happened.
So even when people start off like this,
they can't sustain it for very long.
Because after a while they just think, you know what?
It's too hard, and I can handle it,
so I'm going to move on to one of the more comfortable
approaches, where you buy great companies,
and you pay more for them, but at least no one's
going to tell you that you're making an obvious mistake.
But then, they actually do outperform.
And it's kind of the reward for the discomfort, if you will.
These are some takeaways that I basically have in the book
related to this chapter on deep value.
And I'll just kind of highlight the first one,
which is we start with the price of the stock.
So when you talk to Jeroen Bos, or one
of the other investors who focus on these kinds of companies,
the first thing they'll talk about is wow, this is so cheap.
And then after two minutes, you ask them, well,
what does the company do?
So they really just care that it's really cheap,
kind of the bargain basement pricing.
And here's an example of a company
that somebody presented at one of the online conferences
we've hosted for investors.
And the basic thesis here-- this is a tire manufacturer in Korea
that has a few different types of stock,
so it gets a little complicated.
But basically, you can invest in this company
in a few different ways, and the basic way-- the common stock--
is cheap.
But then there's another way, through the preferred stock,
where you're getting this exact same thing 50% cheaper
than other people are paying for the other thing.
And the other thing they're paying more,
basically because it's a little bit more well-known, or has
more trading going on.
So sometimes people will care about liquidity a lot
in a stock.
Oh, can I buy $10 million of this in one day,
or does it trade very little?
When actually, how much it trades
has nothing to do with how much it's worth.
I mean, if you own a house it trades zero,
and it's still worth whatever it's worth.
So the preferreds trade at a big discount to the common,
and that's just an example of a deep value investment.
AUDIENCE: John, can you go back to the previous slide?
JOHN MIHALJEVIC: Sure.
AUDIENCE: One quick question.
On point number two, you said no voting rights,
but confer some economic benefits.
Can you explain that point?
JOHN MIHALJEVIC: Sure.
So depending on the class of stock,
the voting rights may be a little bit different,
which just means do you get to decide
who is on the board of directors, and so forth.
And companies do that for different reasons.
Actually, Google has, I think, two or now
three classes of stock.
And the purpose there is really to make sure
that the founders retain operating control
of the company, and can make the decisions that
are needed for the future.
Because you wouldn't necessarily want an outside investor
to come in and buy up enough shares
to get voting control of a company, and then do something
that may move the stock in the short term,
but may destroy value in the long term.
So one way to do that is to sell non-voting stock, or shares
that have fewer votes, to public investors,
so that they can never gain a majority of the vote.
And these preferreds have no voting rights,
but this is a Korean tire manufacturer.
Even if you're buying the stock that has voting rights,
there's no practical difference, because you're not
going to be able to influence it in any way, either way.
So the voting rights are not worth very much,
but you're getting the same economic benefits.
So if the common shareholders get $1 dividend,
you'll get $1 dividend, but you're paying half the price
for the preferred stock.
Sum-of-the-parts, there are many examples of this kind
of-- Yeah?
AUDIENCE: [INAUDIBLE].
JOHN MIHALJEVIC: Yeah, that's a great question.
And actually they can stay cheaper for a very long time.
Sometimes a company may, if the company's smart, or cares
about the value, they may actually
buy that preferred stock themselves,
because it's so much cheaper than the other stock.
They could sell the other stock in the market,
and then use the money to buy back the preferred.
But absent that, you're right, the disparity could continue.
But would you rather buy the one at 50% discount,
and maybe it stays at a discount, maybe not.
The discount could get wider, but I think probabilistically,
you're much better off buying it at a discount.
And it turns out that over time, they
do tend to work out, because some large shareholders would
move in, and they'll just kind of start putting pressure
on the management to eliminate this disparity.
AUDIENCE: [INAUDIBLE].
JOHN MIHALJEVIC: Absolutely.
And sometimes preferred stock-- or often-- it's
a better security because it ranks ahead of the common.
In case of bankruptcy, it may have certain preferences.
But because a lot of investors are so focused on liquidity,
meaning being able to-- if I decide tomorrow,
I want to dump this stock-- being
able to dump it in one day, versus taking a week
to sell it slowly.
They put such a premium on that, that the preferred-- even
though it's a better security-- may trade at a big discount
to the common.
And to a long-term investor that makes no sense.
So you can buy that preferred slowly, you can sell it slowly,
and over time you're going to make more money.
There are some examples of sum-of-the-parts are
so obvious, they're at very large companies.
So there was a couple years ago, Vodafone,
which is a big mobile phone carrier based in the UK,
owned a large stake in Verizon Wireless in the US.
And Verizon Wireless publicly traded so just
that the value of that stake was so great
that the rest of Vodafone was being valued extremely cheaply.
But investors didn't see care to see it for a while,
and it's hard to predict these things,
but usually it works out, and then
after a couple of years, all of a sudden it worked out,
and you actually make a great return.
Even though you didn't quite know when
that disparity would be removed.
And so, sometimes it makes sense to analyze the different parts
of a company separately, and then sum up all those values
to decide what is this business really worth.
And I'll just make a kind of a side comment here.
So whether you're adding up different parts,
or just using an earnings yield, or what have you,
you really need to know-- or basically
have an estimate that you believe in--
that a company's worth before you can even
think about investing in it.
Because if you don't know what you think a business is worth,
then there's no basis to make an investment decision.
And I think that's often forgotten.
Sometimes you'll just hear someone say, oh, you
should buy Apple stock, because they're
going to come up with a new iPhone.
And there's no reference in that sentence to how much
you have to pay for Apple.
Could be $100 billion, could be $200 billion.
So maybe the fact that they're coming out with a new product
is already reflected in that market value--
and actually if the new product is not
quite as great, the stock goes down.
So you really need to think about what
is this business worth in the stock market,
and what do I value it at.
If I had the money, how much would
I want to pay for that company to own all of it,
and just make money off the cash flow of the company.
And here's just kind of a classic example
of sum-of-the-parts.
Where you have this little company in India where
they got $50 million cash, they have a big plot
of land near Mumbai airport, and both of those things
together are already worth more than
what the whole company's trading for in the stock market.
So you're actually getting the business, whatever
it is that they do-- which is an exhibition and IT parks
business-- you're getting that for free.
And that may or may not be a good deal,
but at least you found something that looks kind of interesting.
Because if they sold that land, or gave back that cash
to the shareholders, you get your investment right back,
and you own this business.
So that's an interesting type of set up,
and that would fit into sum-of-the-parts category.
I'll just touch very briefly on magic formula,
and then we'll open it up for questions.
Here we were talking about the two factors screening,
looking for cheap stocks and good companies.
Alon Bochman is an investor who focuses on that.
And an interesting finding is that if you gave people
the lists of those companies that rank highly on those two
factors and told them, well, now that you have these companies,
choose the best ones-- or now, use
your own judgments to choose which ones
you want to invest in.
What they found is actually, when people choose their own,
they do worse than the mechanical screen does.
And it's interesting but it's also kind of intuitive,
because there we go back to the discomfort of owning
hated businesses.
If they're that's cheap, they're usually
companies that have fallen a little bit on hard times.
And when you're looking at that list,
you're going to want to eliminate any company that
doesn't feel quite right.
But they're priced so cheaply that they'll actually
outperform.
And so I'll end it there.
There's one more approach discussed in the slide deck
that we're going to skip over now,
but it deals with the quality of the management team.
And the point that I just want to kind of leave
with all of you is, there's no secret,
there's no magic to this.
And the only way to do well in the long term
is to find businesses where you feel like you're
comfortable with it, and it's cheap enough
in the stock market that you feel like the return
you're getting from the business itself
is going to make it worthwhile.
Ben Graham, who wrote that original book on investing,
he said in the short term, the stock market
is a voting machine.
And in the long term, it's a weighing machine.
So in the short term, there's the beauty contest,
there's all this noise out there.
And when you turn on CNBC, they're
always talking about this quarter, or today even,
or tomorrow, what's going to happen.
That's just noise.
There's no signal there.
But in the long term, there's that mystery.
So how do you go from a voting machine to a weighing machine?
But I guess over time, the earnings of the business
come in, and people settle down, whatever
emotion they had on that day dissipates.
When there was the oil spill in the Gulf of Mexico,
BP's stock got killed, because they
were operating that well that had the spill.
And that was the voting machine, right?
People were saying BP is going bankrupt.
And then as people start to think, well,
what are the scenarios?
How much could they have to pay?
And even in the worst case scenario,
if they had to pay $20 billion to clean up this oil spill,
they'd still be undervalued because the stock has gone down
so much.
And over time, the stock went back up,
because people realized what BP was actually worth.
So with that, I will open it up to any questions.
Yeah?
AUDIENCE: So you always have to be ahead of the market
price, which is representative of the current prediction
that other people have made and according to [INAUDIBLE].
So if you want to find some investment opportunity that
is worthwhile, you have to make a better prediction
than all those [INAUDIBLE].
So you have to find one where others
have made a bad prediction.
This requires [INAUDIBLE], so is it
feasible for a small scale investor who's
going [INAUDIBLE] profit from it to actually be worth the time
[INAUDIBLE].
JOHN MIHALJEVIC: Yeah, that's a great question.
So the stock price does reflect the opinion of the market.
And just to be technical, it's not the actual stock price,
it's the market capitalization.
So it's stock price times number of shares outstanding.
And it'll have a prediction built in,
but you don't need to outsmart the market on the prediction
necessarily, because you can just
decide what you're comfortable with.
So if the company's earning $1 billion in free cash flow,
or net income per year, and it's selling for $10 billion,
that's a 10% yield.
And you can say, well, I'm comfortable with that.
Because again, we're getting back
to the legal essence of a stock.
It's part ownership of the company.
You're not actually betting-- there was that marketplace that
got shot down online, where you could back
from different things, maybe even things
like that-- how many iPhones are going to get sold,
and if they sold above a certain number,
you could actually get paid.
Well, that's not what stocks are.
Stocks are just ownership in the business.
So if you're fine with 10%, and you're fine
with it growing very slowly, you're going to make money.
The market may expect it to grow faster,
but that's not going to take away your 10% yield.
It does get dangerous when you're
buying very expensive stocks, because there
your yield from the business is so low that you really
are betting on something great happening.
And that's where outsmarting the market
becomes much more important.
But if you're just sticking with things
that you're totally comfortable with,
you don't need to worry very much
about what the market is predicting.
Yeah?
JOHN MIHALJEVIC: What are the top three to five positions
in your personal portfolio?
[LAUGHTER]
I'm not going to get into it, just because that
can age fairly rapidly.
Although I do view myself as a long-term investor,
but circumstances can change, and I
don't want to make any recommendations here.
And you shouldn't accept recommendations from anyone
really, because they're not going to necessarily tell you
when they sell the stock that they told you to buy.
And also, we talked about the discomfort
of owning stocks that go down.
And generally, I want to only buy a stock
where I am excited if it goes down 50%,
because then I can buy even more.
And if you have that mindset, you're
going to be a lot pickier.
Because usually when a stock goes down 50%,
you're really scared.
You're thinking this is going to zero.
So you need to just know what you think a company's worth,
and then be comfortable with the downside.
So you really need to do your own work, would be my--
AUDIENCE: John-- since you're a value investor,
would you say that you don't invest
in areas like biotech, where the company's not public yet,
and there's no revenue?
JOHN MIHALJEVIC: Yeah, that's right.
And a biotech company could be worth a lot,
even if it has no revenue, but that's
beyond my capacity to judge.
And Warren Buffett once said, you
need to know your circle of competence.
But what's even more important is to stay within it.
So it can be small, but if you stay within that,
you'll do well.
And if you venture outside of it,
like would be my case with a biotech company,
or many other companies-- and it's OK to say,
I don't know enough.
Actually, that's what I would say with most companies
in the stock market.
To use a baseball analogy again from Buffett,
it's a no-strike called game.
So you don't need to swing at every idea that comes your way.
The only thing that matters is the companies that you do
buy, you're right on.
And even there, you're not going to be right on every one.
So stay within your circle of competence
and you'll do much better than if you venture outside of that.
Maybe go to San Francisco?
AUDIENCE: Yeah, I have a quick question.
Thank you for a great presentation, and a great book.
In the book, you mention about using American Association
of Individual Investors' data to be able to [INAUDIBLE] for some
of these buckets.
I wonder if you have recommendations
on how one uses raw data in countries outside the US.
So I know you're based in Europe.
How does one do that in Europe, or any of the other countries,
if you have recommendations?
JOHN MIHALJEVIC: Yeah, that's a great question.
The data that exists for the US stock market
is a lot more robust than what's available
out there for Europe or other markets.
So if you're looking at companies listed on the New
York Stock Exchange, or NASDAQ-- even foreign companies--
you can screen for those very cheaply.
The subscription you mentioned is about $300 a year,
and then the databases that will do a good job on Europe
and the rest of the world may cost $20,000 or $30,000 a year.
So if you want to go the low-cost route,
there's really no great solution for Europe or Asia.
You may just end up relying a lot more
on the primary documents, and doing the work yourself.
Which of course makes it hard to screen across many companies.
You'll be kind of be digging one by one,
unless you're willing to pay quite a bit of money.
AUDIENCE: I know you run a very well-respected newsletter, also
by the same name "Manual of Ideas."
I wonder, how do you go about looking for these companies?
You obviously don't go one at a time.
Do you use a database, or is this names
that show up through looking at [INAUDIBLE] equivalent
in foreign countries?
JOHN MIHALJEVIC: Yeah, so we have developed
a few different idea generation methods over time,
and we do have an internal database that's
kind of fills in some of the holes
that exist in some of the more widely available databases.
So we'll use that, and then we'll
use some of the more serendipitous ways
of generating ideas, like you mentioned,
some of the filings by well-known investors,
and looking at what they own in Europe.
So that's really what we do is we've built that internally
over time.
But if you want something off the shelf,
it's probably going to be fairly pricey to cover
Europe and Asia.
AUDIENCE: So would you say that for an individual investor
the lowest-cost option after the databases available in the US
would be to subscribe to a newsletter like yours,
and that would be something that's
the lowest-cost next available option?
JOHN MIHALJEVIC: I'm not really sure about the lowest-cost
option.
If you're looking to screen mechanically,
the "Manual of Ideas" really won't be the right tool,
because we don't allow you to screen on our whole database.
We actually select ideas and present them each month.
So I'm not sure what service you would
want to go with for screening.
AUDIENCE: Thanks, that's a great response, though,
that's a good idea, thank you so much.
I have one follow-up question, but maybe I
can come back after lunch again.
JOHN MIHALJEVIC: There's one--
AUDIENCE: There's time for one more question from the room.
AUDIENCE: I wanted to ask if there's
a danger in picking stocks that are very public,
and many people might be buying as fanboys,
and I want to take an example, and not just there's Google
and there's Microsoft, which have a somewhat similar market
cap.
But the price earnings ratio of Microsoft is twice more,
so technically Microsoft makes twice more money than Google.
And is there a reason that Google, just because hey,
Google is cool, they do everything well,
is going to attract a lot of attention
and people are going to think oh, they are going to be great.
And the Microsoft people don't believe it,
even though it's making all that money.
Is it a good idea just to collect it
as an issue or something?
Or is it just the long term [INAUDIBLE]?
JOHN MIHALJEVIC: So that's a great question,
and it kind of goes back to the parimutuel
betting system nature of--
AUDIENCE: John, could you repeat the question?
JOHN MIHALJEVIC: The question is really Microsoft versus Google
as potential investment.
The questioner says that Microsoft,
because basically half the price of Google is measured by PE,
and whether that makes Microsoft the better investment.
And it's very hard for me to judge,
so it's really impossible to say.
But it is true that, as you say, the market
is making a judgment that Google will
do much better in the future than Microsoft.
Otherwise, you would want to buy Microsoft,
because you're getting twice the *** for your buck, in a way.
So just to kind of illuminate that with some sample numbers.
Basically Google and Microsoft were the same market value.
Microsoft right now, the way they're valued,
is making twice as much money as Google.
Now in absolute terms it's not true
because Google has a bigger market value, and so forth.
And that's just a judgment that every investor needs to make,
but as I said earlier, you can actually
just look at other things if you're not
comfortable making that judgment.
And generally, that's not an extreme situation.
Usually you'll find much more extreme situations
than that, where Research In Motion is trading
at 1% of the valuation of Google.
And something that extreme can be also more rewarding,
if you are a little bit right in some aspect.
Microsoft and Google, the judgment
becomes pretty difficult to make,
and it also may depend on your time horizon and other things.
AUDIENCE: John, we won't hate you if you said Microsoft here.
JOHN MIHALJEVIC: Sorry, say it again.
AUDIENCE: I said you could say Microsoft
if you really believe it.
We wouldn't blame you for saying that here.
JOHN MIHALJEVIC: Well, I don't believe it,
but I'm not sure I'd say if I did.
AUDIENCE: Can I ask one more question John?
JOHN MIHALJEVIC: Sure.
AUDIENCE: When you follow so many different investors who
are of all different sizes, in terms of how much capital they
manage and how popularly known outside the value investing
circles.
Who would you rate as the top two or three investors,
not just from a performance point of view,
but people you look up to, and look forward
to reading their shareholder letters,
and who have really meaningful insights that are not popularly
known otherwise.
JOHN MIHALJEVIC: Well, there are a lot of investors I admire.
If you want people who are really not well-known,
they're actually in this slide deck.
Phil Ordway is somebody I have a little bit later.
He manages a fund and does just extremely good work.
He's kind of an up-and-coming fund manager,
but I think will do very well.
And then there are fund managers that are kind of not
as well-known as Warren Buffett, but I'd
say Bruce Berkowitz or David Einhorn,
definitely among the folks I respect the most.
There's actually a list of investors in the book
as well, if you want to look at it.
And we kind of update the list for our monthly edition
all the time.
So we want to track people that have had good track records,
and that we know do very good work on the companies they
invest in.
AUDIENCE: Are there specific point managers or shareholder
letters you look forward to?
JOHN MIHALJEVIC: Well, it's sometimes hard
to get on some of these lists, because they
manage private partnerships and are not
allowed to mail those letters out widely.
But Phil Ordway has a letter, as does Michael Shearn.
Seth Klarman's letter is great, it's sometimes hard to get.
And there are probably a number of other guys on that list
that we could email around maybe.
AUDIENCE: Thank you.
AUDIENCE: OK, so thank you very much [INAUDIBLE].
JOHN MIHALJEVIC: Thank you.