The Discipline of Buy and Sell Decisions - Mark Mobius

The Discipline of Buy and Sell Decisions

2013/03/28

The thought of giving up a once-treasured possession can be an emotional exercise for anyone, even if the object of affection has outlived its use. As investors, we can find it difficult to sell a once-favored holding — even more difficult than the decision to purchase it. But sometimes, you just have to let go.

I’ve often been asked about my team’s process, not only in selecting potential opportunities, but also when and how we determine a particular holding may not be worth keeping in a portfolio and bears replacing with something we deem to be a better opportunity. Emotion simply can’t play a role in our decisions. Instead, we pair bottom-up, rigorous research with step-by-step analysis, first identifying potential bargains within a dataset of more than 25,000 securities, then conducting deep quantitative and qualitative analysis to assess each company’s long-term value potential. Our quantitative analysis includes five-year historical audited financial statements and five-year forecasts based on projected future normalised earnings, cash flow, or asset value potential. Qualitative analysis covers understanding of the company’s business, management quality, ownership structure, corporate governance and commitment to creating shareholder value. That includes an understanding of who owns and controls the company, how it operates, and in what markets. As you can see, our research approach is extensive.

As I’ve said time and again, we firmly believe an on-the-ground presence is necessary to provide local, first-hand understanding of investment opportunities. Our Templeton Emerging Markets team currently numbers 53 investment professionals spread across 18 global offices and visits as many companies as we can—approximately 1,500-2,000 per year— to tour facilities and conduct management interviews. I personally travel more than 250 days a year.

Deal Breakers

Our ongoing fundamental research drives all buy and sell decisions. Our analysts set a target price for particular stocks based on the intersection of their research and our overall investment philosophy. We review all our holdings regularly to ensure our analyst recommendations are as up-to-date as possible and accurately reflect changes in company fundamentals. As value managers, we seek to invest in companies that are trading at a discount compared to our five-year valuation projections, and we adhere to a strict sell discipline based on valuation thresholds. Any one of the following triggers may cause us to sell stocks:

• The current security price exceeds our estimation of full value

• We believe significantly greater value potential exists in another security

• A fundamental change occurs at a company to alter our forecasts

One of our deal breakers includes unhealthy corporate governance. Corporate governance is a very, very important issue to us; we want to ensure the interests of shareholders are being addressed. So the first things we look for are a strong culture and ethical conduct.

Getting into the guts of governance means we conduct analysis of ownership structures, the management team’s track record, the company’s corporate governance history and its commitment to creating shareholder value. We look for managers who know the business well and have experience in a given field. We track management’s ability to cope with a rapidly changing business environment, and evaluate whether the risks a company takes seem rational and have the potential to be properly rewarded.

Understanding risk is core to our process. A dedicated Performance Analysis and Investment Risk Group (PAIR) team regularly examines our portfolios and analyses the risks.

Collaboration is critical, so the members of our investment teams communicate on a daily basis. We also hold weekly peer reviews in which we examine company weightings, valuations and price targets to ensure a portfolio is managed in accordance with its investment objectives. In addition, the Templeton Emerging Markets Group holds semi-annual meetings to evaluate investment methodology and portfolio performance, optimization of resources, and to discuss portfolio-related themes such as company-specific issues, country-related issues and global industry trends.

Volatility and Valuation

Emerging markets have traditionally been volatile and can be dominated by retail investor flows and sentiment changes, but we seek to use this volatility to identify potential bargains. We believe strong growth prospects in many emerging markets aren’t always recognized in equity valuations, and can lag those of developed markets by a considerable margin. As such, select companies or sectors in our portfolios may not perform as we’d like in a given month or year, but we are long-term investors, not short-term traders and we abide by our sell discipline.

Sometimes a falling market tide will drop even the soundest of ships, and that’s when bargains can be born. But there are times when stocks are priced cheaply because they are distressed. We may invest if we believe these sorts of companies can turn things around, given some time. Even good companies can fall on temporary hard times.

We think the best indicator of whether a stock is a good value or has completely lost its luster (what one might call “a value trap”, or fallen but still expensive relative to its intrinsic value) boils down to growth. If we don’t see any future growth potential, a company isn’t worth investing in; but if it’s inexpensive and earnings projections look good then there can be a case to invest. Of course, when a particular stock market is rapidly rising, it can be harder to find individual values. If a stock approaches what we deem to be fair value, we may consider reducing a position.

For all our stock-specific analysis, I should add that we do also examine macroeconomic factors in a particular country that support our investment themes, but don’t tend to be more bullish on one country or region than another, since we focus on individual companies. We believe there are great companies in all countries around the world, and that most markets have at least some attractive stocks.

We have maintained the same investment strategy for more than 25 years, and don’t expect to change. Our team inherited the same investment philosophy and methodology from our founder, Sir John Templeton, who summed up his thinking well with these words: “To buy when others are despondently selling and to sell when others are buying requires the greatest fortitude and pays the greatest ultimate rewards.”

Warren Buffett's 'Professor' Teaches 12 Steps To Financial Success

Warren Buffett's 'Professor' Teaches 12 Steps To Financial Success

Brazil’s richest citizen, Jorge Paulo Lemann, may not be a household name–yet. But the brands he controls are already quite familiar to consumers around the world. With his partners, Lemann runs the makers of Budweiser beer, the Whopper and soon even Heinz ketchup.

Lemann made international headlines when he partnered with Warren Buffet in the largest deal in the food industry’s history, the $23 billion acquisition of Heinz.  Buffet is excited to partner with Lemann, “this is my kind of deal and my kind of partner… I want to learn more about Brazil and Jorge [Paulo Lemann] is a great professor,” said the Oracle of Omaha to Brazilian Magazine EXAME.

In a speech to students in 2011 organized by Jorge Paulo Lemann’s foundation, Estudar, which provides merit-based scholarships to young Brazilians willing to study in universities like Harvard, the intensely private and media-shy billionaire, worth $17.8 billion, revealed 12 principles that guided him to achieve financial success:

1. Dream Big.

“I always say, to have a big dream requires the same effort as having a small dream. Dream big!”

“Maybe I was accepted to Harvard only because of my tennis skills since I definitively had no great academic achievements. I was 17 and only thought about surfing and playing tennis. I had almost never left Rio de Janeiro and had never been to the United States. Suddenly, I was at Harvard, that place so full of ideas. In my freshman year, I was forced to read Plato and Socrates. I was learning things I had never even heard before. Up to that point my biggest dreams were to surf bigger waves or win a tennis championship.”

 2. Choose partners well.

“The three short years I spent at Harvard, where I lived with excellent people, taught me not only that I must know how to choose my partners but also that choosing excellent partners is a skill you can learn. Obviously, when you spend time with the best, you learn how to choose among them.”

Lemann knows the importance of being among the best. He was chair of the Latin American Advisory Board of the NYSE and in the 1990s was nominated to the board of razor maker Gillette, where he met Warren Buffett.

At Banco Garantia, Lemann worked with Marcel Herrmann Telles, who started as a trainee at Garantia, and Carlos Alberto Sicupira, whom he had met while surfing in Rio de Janeiro. The trio became inseparable and have been acting together in every major transaction ever since.

3. Develop your own long term vision.

“In our bank Garantia we [Lemann, Sicupira and Telles] developed the basic ideas that are part of every single business we engage in. Some of the decisions we made, such as leaving financial companies and buying industrial/commercial companies, [like Burger King and AB Inbev, Budweiser makers] were based on the vision we set up 20 years ago.”

What you do today will cause effects in years to come. Don’t limit yourself to make decisions only focused on the short term. Good ideas have a bigger effect than any temporary fact.

4. Always try to get better. You can always improve.

“You have to be always trying to do something better, or improve yourself all the time.”

Does it sound a bit overwhelming? Well, maybe that’s why you need to focus on the three first principles. It is going to be much easier to get in the habit of constant improvement if you have a big dream, are surrounded by the right people and have a long term vision.

5. Develop your own method to achieve the results you want.

“Look at the four or five essential points of any issue. I’ve always tried to nail questions down to what is essential. Most of our companies have a maximum of five goals and employees working for us also have 5 personal objectives.”

“I developed a system for choosing new classes [at Harvard]. I interviewed former students and professors before signing up for any classes. I also found out that previous exams were available in the library. Soon, I realized that professors usually repeat their questions. This methodology allowed me to know exactly what I would learn before signing up for any class.  It also helped me to change my status from one of the students with the worst grades to a top student while taking six or seven classes per semester instead of only four as most of my peers. I graduated when I was only 20 and was on the dean’s list.”

6. Simple is always better than complicated. Be careful with too much theory.

Einstein once said: “If you can’t explain it to a six year old, you don’t understand it yourself.”

Not only look for simplicity but learn how to explain anything in a simple manner.

7.  Ethical behavior is the best long-term strategy.

“I have learned that the ethics of the so-called markets can be different from what we learn at school. In day-to-day life you have stimulus to behave unethically, but in the long term it always pays off to be ethical.”

“There are some basic principles that are embedded in every company I have a stake in.”

8. Meritocracy  

Those who perform the best must be those who are best rewarded.

9. Ownership: It is fundamental to have partners. Always work with people who are also owners.

Talent retention is one of the hottest topics among corporations of all sizes, from startup to multinationals. I believe principles eight and nine go together. The bottom line is: you want to be surrounded by the best. However, the best must also be willing to be with you as well. To keep the best close to him, Lemann imitated Goldman Sachs’ method of rewarding the most brilliant executives at bank Garantia with stock shares.

10.  Take risks.

“A lot of people study too much, but to do the exceptional you need to take risks.”

“You need to do more than only study. When I was on vacation from Harvard, I would go back to Brazil and enjoyed my summer break playing tennis and surfing. I was always looking for the biggest wave.”

“Every two or three years there would be a storm and some huge waves would show up on Copacabana beach. We were used to surfing only 3- or 4 meter-high waves, but those were at least three times higher. My friends knew it was almost impossible for me to surf such huge waves, but I decided I would do it. I went for it and experienced the maximum adrenaline ever; I felt blood running fast all through my body.”

“For me that was enough. It was dangerous, too dangerous. I mention this story because I think that in life it is important to take some risks. In college we usually don’t learn how to measure risks, we only learn theoretically, but in general college teaches you not to take risks. However, in life, you have to risk.”

Some other of my favorite quotes about risk:

He who risks and fails can be forgiven. He who never risks and never fails is a failure in his whole being. – Paul Tillich

If you are not willing to risk the unusual, you will have to settle for the ordinary. – Jim Rohn

It seems to be a law of nature, inflexible and inexorable, that those who will not risk cannot win. – John Paul Jones

 11. Know thyself.

Focus on what you do best. Focus on your main strengths.

Do you have the opportunity to do what you do best every day? Don’t let your natural talents go untapped. Each one of us has a unique combination of personal traits and capabilities. Do not spend more time building up your weakness or finding shortcuts. Instead, develop you strengths.

Don’t try to be everything for everyone. The only way to achieve excellence is to spend most part of your day doing what you do best.

12. Get your hands dirty

“The best way to learn anything is by doing it.”

Lemann concluded his speech reaffirming the importance of being among the best and said, “I am ready to help, on one way or another, anyone who was accepted to Harvard.”

The stock market and economy are two very different animals

The stock market and economy are two very different animals

from blog of abnormal returns March 15th, 2013

I think one of the hardest things for novice investors to grasp is the idea that the economy and stock market are two very different animals. In fact I start a chapter on Equities in my book Abnormal Returns: Winning Strategies from the Frontlines of the Investment Blogosphere with the title: “The Stock Market is Not the Economy.” There is ample data to show that a negative relationship exists between economic growth and equity market returns. What this relationship omits is valuation. Starting valuations have a big role in future returns, not economic growth.

This theme about the perceived disconnect between the stock market and economy has been touched on by a number of writers this past week.* Josh Brown at The Reformed Broker post-debate on the link between the two had this to say:

It’s a difficult concept to grasp when you’re trained to look for narratives and storylines as most journalists are. Steve is a very good economic reporter and brings a wealth of information to the viewers each time he’s on. I was simply trying to make the point that the Greek stock market had risen by 30% last year despite a contracting economy while in Shanghai stocks were down all year as the Chinese economy grew by 7%. Thus, the Economy ≠ the Stock Market.

Barry Ritholtz writing at the Washington Post has an article arguing not only does economic have a limited role in investor decision making but so do political machinations as well. Barry also notes the importance of valuation on decision making as well.

Most folks seem surprised when I tell them the sequester will have “little or no” impact on markets. The correlation between how markets perform relative to economic events is actually quite weak…Indeed, the correlation between economic noise and how equity markets perform has been wildly overemphasized.

To quote Warren Buffett: “If you knew what was going to happen in the economy, you still wouldn’t necessarily know what was going to happen in the stock market.”

Peter Coy at Businessweek does not one feedback mechanism between the stock market and the economy. One that the Fed is hoping will happen sooner rather than later.

The stock market’s importance is more symbolic than economic. Only a handful of companies use it to raise money in a typical year, and most families have more wealth in real estate than in stocks. What higher stock prices do is signal to CEOs that investors want them to put their money to work. Farmer argues that rising stock prices may yet rouse dormant animal spirits and get the economy going again. If that’s so, then the Fed’s strategy will have worked.

Although not directly related to the earlier discussion I thought this piece by François Sicart at AlphaNow was interesting in that it delineates the differences between the goals of the entrepreneur and the stock market investor. They have very different outlooks and one shouldn’t approach stock market investing with the same attitude entrepreneurs bring to the table.

The primary goal of an entrepreneur is to create a fortune, in part by taking significant risk when necessary and when the potential return warrants it. The goal of an investment manager is to protect a patrimony against (or through) economic, political, or financial crises – as well as against the loss of purchasing power due to inflation. With the right discipline, this patrimony should also grow over time.

But the successful entrepreneur and the successful investment manager have different skill sets and instincts. Good judgment demands that one should not attempt to practice in the other’s field of excellence.

We want to believe the stock market and economy are inextricably linked. That is what the financial news industry is built upon. The economic indicator announcement is a staple of business TV. Maybe that is yet another good reason to go on a “news diet.”

*Although one could argue like Joe Weisenthal at Money Game does that the stock market has been moving in lockstep with initial weekly unemployment claims over the past six years.