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Star Performers
There are some great investment minds out there.
It makes sense to stay as close to them as you can.
Think different!
Favorable
industry
outlook
Durable
competitive
advantages
High calibre
management
A price that
makes sense
Great investors outperform
the investment crowd by
thinking different.
Often the long-term
potential of their decisions
is not obvious for other
investors or they do not
have the nerve to follow
through.
Many times we wondered
“Why could anyone else
not see this?” but they
don’t or they disagree.
When we own portions of outstanding businesses with outstanding managements,
our favorite holding period is forever. – Warren Buffett.
Our strategy
Phase 1
First we bring
together the very
best ideas of the
great value investors
of our time.
Phase 2
Then we focus on
the companies with
a lot of growth
potential.
Phase 3
And if these
companies trade at
a price that makes
sense we buy.
We prefer to buy when the markets are way down
The father of the hedge fund was Alfred Winslow (A.W.) Jones. The true genius of the Jones model comes
from the insight to combine leverage and hedging. The hedge was provided by short positions.
We do not short stocks. But we do mitigate the risk of investing on margin by using options.
Our investment process
Ideas
• A good
amount of
time is spent
finding the
ideas and
opportunities,
e.g. by
reading the
reports of the
great value
investors of
our time.
Understanding
• Then we try to
get an
understanding
of the (future)
business
economics of
the company.
The business
description of
the 10K is a
great place to
start.
Risks
• Then we move
on to the risk
disclosure
section. These
are put
together by
management
and lawyers to
figure out
what can go
wrong with
the business.
Financials
• Finally we
move on to
the financial
statements
and footnotes.
We also read
trade articles
and other
publications
that are
relevant to
the business.
The better an investor knows a business, the better the ensuing investment decisions tend to be. Therefore, the
starting point is detailed fundamental analysis. The aim should be to get to know a business better than anyone
who is not an insider. There are few shortcuts and this process involves a meticulous review of all public
information, such as financial reports, as well as mining other independent sources. – Lawrence Cunningham
Companies we like
DeereDanoneHeineken
We look for companies with the power to
outperform competition for many years to come.
We try to avoid companies that do not comply with good citizenship values linked to human
rights, the environment, labor relations and anti-corruption. It’s much more fun to look for
companies that add good value to society. Disclaimer. The information in this presentation, is not
intended to be, nor does it constitute, investment advice and/or recommendations.
Our favorite books
The Intelligent Investor. Benjamin Graham.
Security Analysis. Graham & Dodd.
Common Stocks and Uncommon Profits. Philip A. Fisher.
Poor Charlie’s Almanack. Charles T. Munger.
Charlie Munger. The Complete Investor. Tren Griffin.
Margin of Safety. Seth Klarman.
The Clash of Cultures. John C. Bogle.
The Most Important Thing. Howard Marks.
Investing between the Lines. L.J. Rittenhouse.
Manias, Panics and Crashes. Kindleberger & Aliber.
Financial Shenanigans. Howard Schilit.
Creative Cash Flow Reporting. C.W. Mulford, E. E. Comiskey.
Irrational Exuberance. Robert J. Schiller.
The Essays of Warren Buffett. Lawrence A. Cunningham.
The Warren Buffett Way. Robert G. Hagstrom.
The Warren Buffett Portfolio. Robert G. Hagstrom.
Buffettology & The New Buffettology. M. Buffett, D. Clark.
Buffett beyond Value. Prem C. Jain.
Bull! The History of the Boom. Maggie Mahar.
You Can Be a Stock Market Genius. Joel Greenblatt.
The Little Book that beats The Market. Joel Greenblatt.
The Quest for Value. G. Bennett Stewart
Valuation. Tim Koller, Marc Goedhart, David Wessels
Warren Buffett’s Ground Rules. Jeremy C. Miller.
Inside the Investments of Warren Buffett. Twenty Cases. Yefei Lu.
Strategic Value Investing. S.M. Horan, R.R. Johnson, T.R. Robinson.
Capital. The Story of Long Term Investment Excellence. Charles D. Ellis.
Concentrated Investing. A C. Benello, M. van Biema, T. E. Carlisle
What works on Wall Street. James P. O’Shaughnessy.
The Origins of Political Order. Francis Fukuyama.
The Education of a Value Investor. Guy Spier.
One Up on Wall Street. Peter Lynch.
The Outsiders. William N. Thorndike.
The Dhandho Investor. Mohnish Pabrai.
100 Baggers. Christopher W. Mayer.
The John Deere Way. David Magee.
Stress Test. Timothy F. Geithner.
The Euro. Joseph E. Stiglitz
Good to Great. Jim Collins.
Dear Chairman. Jeff Gramm
To understand the investment style of Warren Buffett you can wait for Warren to
write a book or you can start reading the annual reports of Berkshire Hathaway.
“The Intelligent Investor” has
three ideas you really need:
• A stock is a piece of a business. Never
forget that you are buying a business
which has an underlying value based
on how much cash goes in and out.
• Chapter 8 on the Mr. Market analogy.
Wall Street is there to serve you, not
to instruct you. It quotes prices every
day that you can take or leave. There
are no “called strikes”.
• Chapter 20 on Margin of Safety. Make
sure that you are buying a business
for way less than you think it is
conservatively worth.
Our favorite quoteOur favorite quote
After you read “Art of Stock Picking” by Charlie Munger (just try to
understand his thinking on carrots and dessert), it would be a good idea
to listen to or read a transcript of “24 Standard Causes of Human
Misjudgment”, where Mr. Munger speaks about the framework for
decision making and the factors contributing to misjudgments.
A concentrated portfolio of
strong and predictable companies
acquired at a price that makes sense
will do the job.
Munger's3 Rules on How to
Become a SuccessfulInvestor.
• Munger's first rule is to
"carefullylook at what the
other great investors have
done”.
• Munger's second rule is to
pay close attention to
cannibal companies. Look
carefullyat the businesses
that are buying back huge
amounts of their stock.
• Munger's last rule is to
focus on spinoffs.
Successful investing is
about finding situations of
mispricing, or companies
selling below their true
worth. And spinoffs, when a
company divests one of its
divisions, are a great place
to dig for those situations.
Where is “the moat” and does the company has the ability to widen
“the moat”?
Is this company really providing an attractive value proposition for the
end customer?
In other words, what are the unique competitiveadvantages of the
company and is the company well positioned to exploit those
advantages for many years to come?
Does the company have pricing power (the ability to enjoy price
inelastic demand for their product) and the capacity to reinvest
(opportunities to deploy incremental capital at high rates)?
Does the company have favorable long-term prospects and what are
the drivers for long-term growth? Is there evidence that the short term
prospects are favorable as well (e.g. a solid order intake, backlog &
bidding pipeline).
Do I understand all the footnotes, especiallythose concerning the cash
flow statements. Same for vertical and horizontal analysis of the 10 year
financialsstatements and all the Howard Schilit shenanigans checks.
Does the company have a consistent operating history, strong cash
flows and consistent high return on capital?
Do we like the managementof the company? You want these people to
be brilliantbusiness (wo)men.
Does the company have a strong and solid balance sheet? Debt is the
most important thing to look for. The second most important thing to
look for is a significant cash position. And then don’t forget to check the
pension obligations.
Does management care about sustainability& ethical leadership and
does management have a track record of integrity and high
performance?Is management shareholder friendly and rational with its
capital?
Who are the main competitors (market leaders and challengers)? Do we
understand competition and who is going to win?
Are there disruptive industry forces to reckon with, e.g. technology
changes or new regulatory requirements? What is the catastrophy risk
of the business?
Do we understand the long-term business economics of the industry
and what is the current market share of the company? Where are we in
what’s called “the business cycle” and how is the temperature of the
stock market?
Will this company be around and doing well 25 years from now? Great
companies have great cultures. Do we really want to “own” this
business?
Is there any “insider trading” and/or are there “short sellers”? I always
check if Jim Chanos is “short” on the stock I intend to buy.
What is the value of the business and can it be purchased at a
significantdiscount to its value (marginof safety)?
The basicsOur checklist
It is fun to collect inanities (investing “mistakes”) because there’s never a shortage. The lessons learned from
these inanities are a crucial part of a well designed check list. You need a different checklist and different
mental models for different companies, industries and investment styles.
Our screening
Choosing individual stocks without any idea of what you’re looking for is like
running through a dynamite factory with a burning match. You may live, but you
are still an idiot. – Joel Greenblatt. Our “screener” is a quantitative strategy to pick
stocks. It’s actually a simple Joel Greenblatt kind of quantitative stock ranking
scheme. It uses Return on Capital and Price-to-Cash flow as inputs.
Return on Capital (ROC) is a core metric at The Value Firm®. An industry leading
ROC is a great indicator for excellent competitive advantages. Why don’t you
google “Calculating Return on Invested Capital” by Michael J. Mauboussin and read
it. But be careful. A solid investment decision definitely takes more than “just
what’s in the numbers”. You better read Mauboussin’s “Measuring the Moat” as
well.
Many people focus too much on the financial characteristics and those are really
the foundation and the starting point. The problem is that the numbers are telling
you about the past and you’re investing in the future (and that’s a Paul Lountzis
quote). So fundamental analysis is important, but not enough. You have to be
certain about the future cash flow streams of a company. Very certain. And that
can be achieved e.g. by studying industry trends, the regulatory environment,
disruptive technologies, the long-term competitive dynamics of an industry and
the durability of the competitive advantages.
There is more to it than “just
what’s in the numbers”.
Much more.
There is no mechanical formula to investing. You have to think of a lot of different things at once. It’s much more
about the balance between intellect, discipline and “what your tummy tells you”. Munger/Cundill.
An investor should act as though there is a lifetime
decision card with just 20 punches on it. – WB.
Our performance
Disclaimer. The performance data quoted herein represents
past performance and is not a guarantee of future results.
31 Dec ‘16 21,9 %
Remarks:
• If you want further details or do your own due diligence,just
send us an email: peter@thevaluefirm.com
• These are not actual fund performance or investors returns, but
returns based upon the companies own invested capital.
• Having a good track record is by no means a guarantee for future
results. Having no track record is even worse.
• During the first 5 years I leveraged up quite a bit and that’s
doable if you know how to hedge. But I don’t “leverage up” any
more and just might use a little bit of leverage. So you might
question the worth of the track record.
• Next update: when the financial statements2017 are approved:
Q3 2017.
Average annual return
since Q4 2011
Since 31 December 2013 we made
substiantialchanges to the portfolio.
We prefer not to share them,
because good investment ideas are
rare, valuable and subject to
competitive appropriation just as
good product or business acquisition
ideas are.
The financial markets are
inherently unstable
• More manias, panics and crashes
will plague us and more financial
crisis will occur.
• The financial markets will continue
to overreact, which offers
opportunity to the disciplined and
patient investor.
• History showed sudden declines of
50 % and more. If you can not
accept this brutal reality you better
stay out.
A value investor buys when
stocks are out-of-favor
• A stock is not just a ticker symbol. It
is an ownership in an actual
business. Investing is most
intelligent when it is most
businesslike.
• A shrewd value investor buys in a
bear market, when everybody else
is selling.
• Be very patient and “never
underestimate the value of doing
nothing” (Winnie the Pooh).
Munger calls this assiduity.
The historical stock market
return is 6 to 8 %
• The value of an investment is a
function of its present price. The
higher the price you pay, the lower
your return will be.
• If you buy stocks when the markets
are overvalued you will most
certainly underperform.
• Opportunities are usually found
where the flock doesn't fly. If you
want to pick stocks that outperform,
it typically requires departing from
the herd.
The basicsRemarks on Value Investing
Read 500 pages every day. That’s how knowledge works.
It builds up like compound interest.
History shows that Value Investing works in cycles. There will be periods when the returns
will be mediocre. But if you don’t believe in Value Investing, what do you believe in? - WB -
Our favorite quote
If you want to do better than the index then you have to engage in
active management with it’s costs, it’s uncertainty and the risk
that if you try to do better than the index you might do worse
than the index. So how are we going to beat the index? Well, by
doing a few things different and better.
• We look for very high quality companies that will be able to
outperform competition for many years to come. And if
these companies trade at a really attractive price we buy. But
we also look for investment opportunities in mergers, spin-
offs and takeovers.
• We will diversify our portfolio up to 25 - 30 stocks. We
believe this will yield the most cost-effective level of risk
reduction.
• We will use a dynamic hedging approach that aims to make it
possible to use a small amount of leverage without too
much risk.
How to beat the market
By periodically investing in a low-
cost index fund you can actually
outperform most investment
professionals.
Thomas J. O'Halloran, photographer
Professional investors have a long history of failing to beat
the market after accounting for their fees. Over the last
10 years it’s estimated that 83% of the mutual funds
underperformed. And worse over 20 years. It’s our guess
that less than 1% will outperform the index consistently
with more than 3%. Perhaps even less than 0.5%.
We believe the average investor (whether individual or
institutional) is much better off by periodically investing in
a low cost index fund. Now stop right here. Don’t look
any further. It’s probably the best “low-risk-solid-return”
proposition on the planet!
Our favorite quote
• Actually, there are many ways to value a company. You have to think about a
lot of things. In the Berkshire Hathaway 2017 annual meeting Warren Buffett
talked about the importance of the future interest rates. Most people don’t
get this right.
• We try to make a conservative estimate of the long-term business potential
of the company. If the company is too difficult to understand, and most of
them are, we skip the company and move on to the next.
• First we look at the storyline, i.e. the past, present and future of the
company. Obviously the most difficult and most important one is the latter.
We try to assess the industry outlook, the competitive dynamics, the
durability of the competitive advantages, the quality of the leadership team
and it’s strategy. And only then we move on to the numbers game: the
balance sheet, “owner earnings” and long term growth rate.
• And then we try to put a reasonable price tag on the business potential
(future cash flows) of the company. And that’s much more a matter of
experience (industry specific expertise) than the result of complex discounted
cash flow calculations (although you might argue that the ratios we use
actually result from DCFs). We prefer to think in terms of opportunity costs.
Don’t forget to read chapter 8 “The art of business
valuation” of Seth Klarman’s book “Margin of Safety”
once again. In case you forgot the subtitle of this book
“Risk-Averse Value Investing Strategies for the Thoughtful
Investor”. And that’s what Value Investing is all about:
a risk-averse approach.
How to value a company
Better be approximately right on your valuation than
precisely wrong on the future of the cash flow streams.
If you are going to use “growth” in your valuations, please watch Bruce Greenwald
on YouTube: “Value Investing and the Mis-measures of Modern Portfolio Theory”.
The basics
In a free-market economy, capital seeks the areas of highest return. Whenever a company develops a profitable
product or service, it doesn’t take long before competitive forces drive down its economic profits. Only
companies with an economic moat—a sustainable competitive advantage that allows a firm to earn above-
average returns on capital over a long period of time—are able to hold competitors at bay. Being patient and
buying wide-moat stocks when they become cheap is a compelling investment strategy.
Moats
MOAT DESCRIPTION
Customer Loyalty In some industries, customers strongly prefer certain brands. We like brands
with a lot of pricing power, like Deere and Coca-Cola.
Patents/Licenses/
Regulations
Patents, licenses and regulationsprevent competitionfrom entering into a
market and competing with the incumbent. E.g. VeriSign.
Network Effect Some products or services become more valuable when there are more
customers. Demand then becomes very sustainable and it is extremely difficult
for competitors to offer comparable products. E.g. Facebook.
Economies of
Scale
Some companies can produce at lower cost due to their greater scale (higher
volumes). New competitors will often have to incur large losses in order to
match the same level of pricing. E.g. Walmart.
Switching Cost Certain products or services can be every expensive for the customer to switch
to an alternative provider. This strong disincentive results in sustainable,
recurring demand. E.g. Oracle.
“If you gave me $100 billion and said, ‘Take away the soft drink leadership of Coca-Cola
in the world’, I’d give it back to you and say it can’t be done.” – Warren Buffett on
challenges one would face in trying to overcome the moat of Coca-Cola
Munger on “moats”.
The problem is that it’s relativelyeasy to identify a
company that is doing well. It’s much harder to look
into the future and determine if that company will
continue to do well. Identifyinga wide and durable
moat is a tough task and a task that's hardly an exact
science.
Our favorite quote
• During the first 5 years I used quite some leverage. And that can
be done if you know how to hedge the downside risks. In fact, it’s
quite lucrative.
• However, Howard Marks recently (2017) wrote that we are living
in a low-return high-risk world. I don’t think it’s very smart to use
leverage in a high risk world, despite the fact that you can hedge
the risks.
• But there are other reasons why I scaled down tremendously on
leverage. First of all, everybody makes mistakes now and then
and there is always the risk that you make a hedging mistake
during times of market turbulence.
• Secondly, I just don’t know what is going to happen to the hedges
if a cybersecurity incident hits one of these huge derivatives
trading platforms.
• And last, but not least, if you hedge like I do, you have to roll over
your hedges when they expire. Now, what happens when the
stock exchanges shut down in response to a panic? During the
panic of 1873 (by then nearly 10.000 businesses failed), there
was a 10-day closure followed the failure of Jay Cooke &
Company bank.
• The chances that these things will occur are indeed very small,
but if they do the result may be disastrous. So, ordinarily, debt
will be non-existent or small. It may be expanded to up to 10% of
invested assets when we are confident in the wisdom of so
expanding the use of debt.
Leverage
Initially successful with
annualized return of over
21% (after fees) in its
first year, 43% in the
second year and 41% in
the third year, in 1998 it
lost $4.6 billion in less
than four months
following the 1997 Asian
financial crisis and 1998
Russian financial crisis
requiring financial
intervention by the
Federal Reserve, with the
fund liquidating and
dissolving in early 2000.
And of course we have the hardly noticed bankruptcy
of this 600B USD AUM company of The Leverage
Brothers. Or was it Lehman Brothers? Anyhow.
Our favorite quote
Bull-markets are born on pessimism, grow on skepticism,
mature on optimism and die on euphoria.
The business cycle
Sir John Templeton
Crisis? What crisis? Just google “500 Years of Stock Panics”.
The cycle of manias and
panics results from the pro-
cyclicalchanges in the supply
of credit. You might want to
spend some time on
economicprinciples.org.
Seth Klarman once said: “The
stock market is the story of
cycles and of the human
behavior that is responsible
for overreactions in both
directions. I think markets will
never be efficient because of
human nature”.
The crash
of 2008
Euphoria
Optimism
Pessimism
Sceptisism
The basics
Warren Buffett had correctly identified by 1973 that the
shares of the Washington Post were selling for but a fraction
of the underlying business value represented by those shares.
The stock proceeded to relentlessly decline over the next two
years. Had Buffett worried, he might have not only failed to
add to his holdings but, conceivably, might also have panicked
or been forced out of his steadily dropping position.
Warren Buffett first bought shares of International Business
Machines in 2011, building a position worth nearly $11 billion
for Berkshire Hathaway. The stock has performed poorly since
then, leading many to question Buffett's investment decision.
Despite IBM's poor performance, Buffett has continued to add
to Berkshire's stake in IBM. In the first and second quarters of
2017 though Warren Buffett sold 30% of his IBM shares cites
big, strong competitors. "I don't value IBM the same way that I
did 6 years ago when I started buying... I've revalued it
somewhat downward,"
Don’t sell
• The chances that @ some point in time a stock will trade (substantially)
below the original purchase price are very high indeed. The biggest failure
an investor can make is to sell a stock because the price of the stock goes
down. If you are right on the long term business potential of the company a
stock decline is an opportunity to buy more.
• The second biggest failure is to sell a stock when the price of the stock goes
up. As long as the company remains a good company you better hold on to
the stock and profit even more in the long run as a result of the long term
business potential of the company.
But be very careful. In 2016 a few
great value investors bought more
stock of Valeantwhen the price
declined.That was not a very
thoughtful decision.
The basics
• A bear market is triggered when investors lose faith in the
market as a whole, decreasing the demand for stocks. This
tends to happen when the economy enters a recession,
unemployment is high and inflation is rising.
• Early in 2000, after nearly 13 years of a bull, millions of
investors were stunned when a serious downturn began in the
spring. Many of today's investors have lived through two fairly
nasty bears: a decline of 49% from 2000 to 2002 and a 57%
plunge from 2007 to 2009.
Beware of the bear
Like earthquakes,
bear markets are hard to predict.
Market Corrections
Market
peak
Bear
return
Duration
(months)
Bull begin
date
Bull
return
Duration
(months)
Crash of 1929 - Excessive leverage, irrational exuberance Sep 1929 -86% 33 Jul 1926 152% 38
1937 Fed Tightening = Premature policy tightening Mar 1937 -60% 63 Mar 1935 129% 24
Post WWII Crash - Post-wardemobilization,recession fears May 1946 -30% 37 Apr 1942 158% 50
Flash Crash of 1962 - Flash crash, Cuban Missile Crisis Dec 1961 -28% 7 Oct 1960 39% 14
Tech Crash of 1970 - Economic overheating,civil unrest Nov 1968 -36% 18 Oct 1962 103% 74
Stagflation- OPEC oil embargo Jan 1973 -48% 21 May 1970 74% 32
Volcker Tightening- Whip Inflation Now Nov 1980 -27% 21 Mar 1978 62% 33
1987 Crash - Program trading, overheating markets Aug 1987 -34% 3 Aug 1982 229% 61
Tech Bubble - Extreme valuations, .com boom/bust Mar 2000 -49% 31 Oct 1990 417% 115
Global Financial Crisis - Leverage/housing,Lehman collapse Oct 2007 -57% 17 Oct 2002 101% 61
Current Cycle Mar 2009 n.a. 100
Averages -45% 25 153% 54
July 2017 Source: FactSet, NBER, Robert Shiller, Standard & Poor’s, J.P. Morgan Asset Management
Investor psychology
You really need to read most of the books mentioned before. But it’s funny
though, that you will not learn the most important thing in investing from
the books, but from experience. And that’s investor psychology.
Most people don’t grab the concept of Value Investing, as simple as it is, at
all. But if you do, just remember that Value Investing is best learned through
extensive experience and mistakes.
“Investing is largely about
psychology. If you’re down a huge
amount, you’re not thinking
straight. If the markets do
something that completely
surprises you, you can be a deere
in the headlights”. (Seth Klarman).
“The elementary
part of psychology,
the psychology of
misjudgement, as I
call it, is a terribly
important thing to
learn. Terribly smart
people make totally
bonkers mistakes by
failing to pay heed
to it.” (Charlie
Munger).
The basicsTemperature of the markets
U.S. stock prices are "on the cheap side“. If rates were to spike, however, then the stock
market would be more expensive. If interest rates were 7 or 8 percent, then these [stock]
prices would look exceptionally high. Warren Buffetton CNBC. February 2017.
Jeff Ubben is not just talking about how expensive the market is, he is adjusting his plans
because of it. ValueAct will be returning $1.25 billion of capital to investors, because he
can’t find smart places to put it to work with current valuations.April 2017.
Bill Miller: “I don’t find the markets expensive either on an absolute basis or a relative
basis. On a relative basis (relative to other asset classes)the stock markets are (crazy)
cheap. If the Federal Reserve, as projected, moves rates higher only gradually, that would
be another check in the plus column for stocks. April 2017.
There is nothing immediately that’s scary. To take a two- or three-year perspective,I’m
concerned. Ray Dalio April 2017.
Joel Greenblattsaid that equity markets are in 80th percentile and 90th percentile of
expensiveness.May2017.
Paul Singer has a bleak outlook for Wall Street. "I'm Very Concerned About The Global
Economy"..."ballooningasset valuations and consumer debt pose even greater risks to
the economy than they did back in 2008." He has build a $5 billion rainy day fund in
preparation for what he describes as “all hell” to break out. May2017.
Jeremy Granthem can’t see interest rates rising a lot anytime soon (May 2017). I don’t
think this market is a true bubble about to blow up (August 2017).
Legendary investorJim Rogers predicts a market crash in the next few years, one that he
says will rival anything he has seen in his lifetime.“The bubble’s gonna come. Then it’s
going to collapse,and you should be very worried”. June 2017.
Bill Gross: “Don’t be mesmerized by the blue skies. The current market risk is the highest
since before the September 2008 collapse of Lehman Brothers.The return is gonna be
much lower and the risk much higher. It’s not an attractive situation. Insteadof “buying
low and selling high”, you’re buying high and crossing your fingers...”.June 2017.
James Montier believes the markets are behaving like the White Queen (June 2017). In
order to make sense of todays pricing you have to believe in six impossible things. Secular
stagnationin permanent and rates will stay low forever. The discount rates for equities
depends on cash rates. Growth rates and discount rates are independent.Corporates carry
out buybacks ad nauseum, raining EPS growth despite low economic growth. Corporate
cash piles make the world a safer place. The “Hell” scenario is the most probable outcome.
Put another way, Hell requires that stock prices have reached a “permanent high plateau”.
Investors need to tread carefully right now because market valuations are at "unusual
highs. In fact, the only times they have been higher were in 1929 and 2000. Both years saw
historic market crashes. Robert Schiller. June 2017.
‘We’ve never had QE like this before, we’ve never had unwinding like this before.
Obviously that should say something to you about the risk that might mean, because
we’ve never lived with it before.’ - Jamie Dimon. July 2017.
While Baupost doesn’t engage in the fool’s errand of attempting to predict the exact time
and date a market crash will occur, the value-based hedge funds does consider the macro
market environment and notes that the artificially tranquil environment that has put
markets to sleep has lasted “longer than we would have imagined.” July 2017.
David Tepper is rejecting fears that the market has become overvalued. Tepper sees a
combination of low interest rates and strong global growth as underpinning for stocks.
Rising interest rates would be considered a danger, but he said that increase would have
to be substantial before denting the market. August 2017
Leon Cooperman, the founder of hedge fund Omega Advisors, says a market correction
could start “very soon”. Cooperman, who’s known for his bullish stock picks, said any
number of events could prompt markets to fall. “North Korea, a disappointingearnings
report, anything…” September 2017.
Julian Robertson,a legendary hedge fund manager, thinks disaster will strike Wall Street if
the Federal Reserve doesn't keep raising interest rates. "We are creating a bubble" in the
stock market, Robertson said. September 2017.
Don’t try to time the markets. Invest consistently over time. And let the temperature of the markets be your guide
to decide if the time is right to be more aggressive or more conservative. When in doubt, choose the latter one.
The basics
• If you invested 10.000 USD in Amazon.Com in 1999 ten years later it
would be worth 1 million USD. Ever heard of Balchem? Since the end
of 1985 it has gained an average of 26,2% annually. That’s called “good
fortune”.
• If you invested in Kodak, Polaroid or Xerox, once all great and
successful companies, they either went bankrupt or needed to rise
from the ashes. That’s “bad luck”. And what about Enron, Worldcom
and Lehman Brothers!
• If you had invested $1,000 in each of just three companies back in the
1980s — Apple, Microsoft and M&T Bank — you would be a millionaire
today (1 March 2017).
• Your goal in investing isn’t to earn average returns. You want to do
better than average. Thus your thinking has to be better than that of
others - both more powerful and at a higher level. – Howard Marks.
• With time I learned that investing is not easy. In order to be an
effective investor one has to bet against the consensus and be right.
And it’s not easy to bet against the consensus and be right. – Ray Dalio.
It’s not easy
It can be very hard to really grasp the
long term potential of a business.
The memos from Howard Marks are great reads. One of his memos is entitled “It’s not easy”.
It elaborates on “second level thinking”. Google it and read it. And you might want to read the other memos as well.
“You don’t need the IQ in the
investment business. What you have to
be is aversive to standard stupidities. If
you keep these out, you don’t have to
be too smart”. Charles Munger.
Note from the author: You need both.
The basics
Did we ever mention that investing is hard work —
painstaking, relentless, and at times confounding?
Separating relevant signal from noise can be
especially difficult. Endless patience, great discipline,
and steely resolve are required. Nothing you do will
guarantee success, though you can tilt the odds
significantly in your favor by having the right
philosophy, mindset, process, team, clients, and
culture. Getting those six things right is just about
everything.
Complicating matters further, a successful investor
must possess a number of seemingly contradictory
qualities. These include the arrogance to act, and act
decisively, and the humility to know that you could
be wrong. The acuity, flexibility, and willingness to
change your mind when you realize you are wrong,
and the stubbornness to refuse to do so when you
remain justifiably confident in your thesis. The
conviction to concentrate your portfolio in your very
best ideas, and the common sense to nevertheless
diversify your holdings. A healthy skepticism, but not
blind contrarianism. A deep respect for the lessons of
history balanced by the knowledge that things
regularly happen that have never before occurred.
And, finally, the integrity to admit mistakes, the
fortitude to risk making more of them, and the
intellectual honesty not to confuse luck with skill.
- Seth Klarman
In fact, it’s hard work
Did we ever mention that
investing is hard work?
Successful long-term investing requires
unending hard work, great patience,
and strict discipline.
The basicsThink again (1)
Of course you want
to mimic Warren Buffett.
Right?
Takeaway 1.
You should read the Morningstar article entitled “Being like Buffett: Easy
to Say, Hard to Do” by John Rekenthaler. It says that while many mimic
Buffett’s investment approach, the collectiveresults stink. The 10-Year
return of Buffett-Style funds are 6.1%, underperformingthe Vanguard
Total Stock Market. That’s awful – not merely disappointing, not merely
bad, but terrible! It even argues that the Buffett approach doesn’t suit the
mutual fund format.
Takeaway 2.
Rupert Hargraves talks about the Buffett illusion. "Inside the Investments
of Warren Buffett: Twenty Cases“, a book by Yefei Lu, has convinced me
that it is impossiblefor most investors to achieve Buffett-likereturns. You
see, in most of the cases profiled in the book, Buffett had an edge over
ordinary investors. Whether it be via a personal relationshipwith the CEO,
a deal structured to yield a profit no matter what the outcome or personal
activist involvement,most of Buffett’s greatest investments have
produced outsized returns because he has been involved”.
Takeaway 3.
It’s not just “high returns” above the market. Peter Bernstein once said:
“The market is not an accommodatingmachine”. It will not go where you
want it to go just because you want it there to go. The S&P 500
compounded at a stunning rate of negative 1% from 2000 to 2010 (let that
sink in, a decade of negative returns from the U.S. equity market).
Takeaway 4.
It’s very interesting to read that Charlie Munger himself questions if it is wise to
“sell” the Buffett-Munger investment approach, e.g. as a fund or managed
account (Art of Investing by Munger). People expect results that never diverge
too much from a standard path except on the upside. In the short run, the
Buffett-Munger approach might lead to a bumpy ride and that’s just not what
feels comfortable. But in the long run, I would not try for anything else but the
Munger-Buffettapproach.
Takeaway 5.
Between 1980 and 2014, roughly 40% of all stocks in the Russell 3000 suffered
permanent 70% declines from their peak values. What’s more, over 320
companies were deleted from the Standard & Poor's 500 for distressed reasons
between 1980 and 2014. These figures show just how hard it is to pick winners.
A report published by Bank of America’s Research Investment Committee,
headed by fixed income strategist Martin Mauro earlier this week speculates
that an estimated 50% of S&P 500 companies could be replaced over the next
ten years. – Rupert Hargreaves. July 2017.
Warren Buffett once said: “I do
more reading and thinking and
make less impulse decisions
than most people in business”.
The basicsThink again (2)
Victor Niederhoffer, the hedge-fund manager who lost his entire $130
millionportfolio in the Thai stock market crash of 1997. In September
2008, Mr. Niederhoffer was forced to close two of his funds, including his
flagship, Matador. After his first hedge-fund blow-up in the 1980s, Mr.
Niederhoffer was forced to sell his silver and take out a mortgage on his
20,000-square-foot home in Weston, Conn., to stay afloat.
After attracting $9 billionworth of assets under management, Amaranth
Advisors energy trading strategy failed as it lost over $6 billionon natural
gas futures in 2006. Faced with faulty risk models and weak natural gas
prices due to mild winter conditions and a meek hurricane season, gas
prices did not rebound to the required level to generate profits for the
firm, and $5 billiondollars were lost within a single week.
In 2004, Bailey Coates Cromwell Fund event-driven, multistrategyfund
based in London was honored by Eurohedge as Best New Equity Fund. In
2005, the fund was laid low by a series of bad bets on the movements of
U.S. stocks, supposedly involvingthe shares of Morgan Stanley,
Cablevision Systems, Gateway computers and LaBranche (a trader on the
New York Stock Exchange). Poor decision making involving leveraged
trades chopped 20% off of a $1.3-billionportfolio in a matter of months.
Investors bolted for the doors and on June 20, 2005, the fund disolved.
The high-flyingCalifornia-basedhedge fund Marin Capital attracted $1.7
billion in capital and put it to work using credit arbitrage and convertible
arbitrage to make a large bet on GeneralMotors. When General Motors'
bonds were downgraded to junk status, the fund was crushed. On June 16,
2005, the fund's management sent a letter to shareholders informing
them that the fund would close due to a "lack of suitable investment
opportunities".
Aman Capital was set up in 2003 by top derivativestraders at UBS, the largest
bank in Europe. It was intended to become Singapore's "flagship"in the hedge
fund business, but leveraged trades in credit derivatives resulted in an
estimated loss of hundreds of millions of dollars. The fund had only $242
millionin assets remainingby March 2005. Investors continued to redeem
assets, and the fund closed its doors in June 2005, issuing a statement
published by London's Financial Times that "the fund is no longer trading".
In 2000, Julian Robertson's Tiger Management failed despite raising $6 billionin
assets. A value investor, Robertson placed big bets on stocks through a strategy
that involved buying what he believed to be the most promisingstocks in the
markets and short selling what he viewed as the worst stocks. This strategy hit
a brick wall during the bull market in technology. While Robertson shorted
overpriced tech stocks that offered nothing but inflated price to earnings ratios
and no sign of profits on the horizon, tech stocks continued to soar. Tiger
Management suffered massive losses and a man once viewed as hedge fund
royalty was unceremoniouslydethroned.
By most accounts, Atticus Global was a good fund that simply got whooped by
the 2008 financialcrisis. The hedge fund was founded by Tim Barakett in 1995
with less than $6 millionin hand and by 2007 was one of the largest hedge
funds in the world with $20 billion of assets under management. Barakett
managed to pull that rare and neat trick of providingmarket-beatingreturns
over a long time period until 2008, when the financialcrisis swept his feet out
from under him. After two years of losses, Barakett closed the fund in 2009.
Of course you want
to mimic Warren Buffett.
Right?
The basicsLessons learned
Nobody can tell you when a panic will occur. But it surely helps to have an idea
where we are in what’s called “the business cycle”. Everybody, and that includes
Warren Buffett and Seth Klarman, will make mistakes now and then.
We carefullytry to avoid the great academic insights like the Capital Asset Pricing
Model (CAPM), Black-Scholes, Beta and the weighted average cost of capital (WACC).
“Goodwill”is probably the most destructing accounting item ever created in history.
It’s tempting to use leverage, but it is a very risky proposition. You have to have
downside protection to prevent yourself from bankruptcy when adversity takes
over. And that means not only hedging against stock market volatility, but also
against currency fluctuations. You’re safer & better off without leverage.
The plethora of deeply entrenched biases and flawed evolutionary brain wiring makes
us prone to make plenty of mistakes. Most investors think they are rational, but
actually they are not. Our brains are extremely gullible and inconsistent decision
makers. “The mind itself is a confounded thing, woefullyill-suited to the task of
investing” – Guy Spier.
Most people have a herd mentality. What will set you apart is the ability to valuate
a business unaffected what other people think. Always do your own research!
We don’t use EBITDA or complex discounted cash flow analysis either. DCF is like the
Hubble Telescope. Move it an inch and you will end up studying a differentgalaxy.
Robert Robotti once said that DCF should be renamed the “Deliberate Certainty
Fabricating” model. I agree.
The important thing is to not get caught up in emotions. Knowing emotions exist
but not getting caught up and being cold, hard and calculatingon valuation –
that’s the secret.
It makes sense to study EVA®, MVA, SVA & CVA. Return on capital is an important
measure of business performance. But we are reluctant to use weighted average cost
of capital. Actually, we don’t use WACC at all.
Don’t try to time the markets. Invest consistently over time. And don’t spend too
much time on “the macro”. I try to limit my time on macro-economicissues to 5
minutes per decade. Max.
There is more to it than just “the financials”. You might want to analyze the operating
segments of a company and the competitiveenvironment in which these sub-
businesses are operating.
If smart people learn from their own mistakes while wise people learn from the
mistakes of others, the goal is to be both smart and wise. – Lawrence
Cunningham.
By far the best strategy, we think, is to buy a well diversifiedportfolio of strong and
predictable companies at a price that makes sense and hold on to these stocks as long
as the company remains a good company.
We do not trade commodities(like gold, sugar or beans), don’t buy stocks of
turnarounds and we also do not short individualstocks.
Remember, especiallyin a bull market, that the good times won’t roll on forever. We
should always invest as if the best is yet to come but the worst could be right around
the corner.
You might want to avoid “good” investment ideas. Why? Because most of the time
“good” is not good enough. Good is the enemy of great.
It takes many, many years to learn that there is still a lot to learn. If you think you
understand Buffett & Munger, think again.
A thorough understanding of accountancy, the language of the business, surely helps. There are some
great lectures on the web by Aswath Damodaran. E.g. look for Talks @ Google: “Valuation: Four
Lessons to Take Away” or “The Dark Side of Valuation: India Business Forum” on YouTube.
Intelligent Cloning
On 11 March 2017 I wrote an
article on “Intelligent Cloning”.
Just google “Latticework
Intelligent Cloning”. It
describes a methodology for
picking conservative stocks
from the portfolio’s of
successful investors and then
rank these stocks by a simple
Joel Greenblatt ranking system.
Disclaimer. The information in this presentation, is not intended to be,
nor does it constitute, investment advice and/or recommendations.
When What
2H 2016 Deere & Co (team Berkshire) @ 87 USD
Allison Transmission (Lou Simpson) @ 29 USD
1H 2017 Davita Inc. (team Berkshire) @ 65 USD
Verisign (team Berkshire) @ 83 USD
2H 2017
1H 2018
2H 2018
1H 2019
2H 2019
Warren Buffett made his initial fortune by tracking what top investors were
doing. In his biography, it is written Warren Buffett felt honored to borrow
ideas from any useful source. The “rationale” for cloning is an article entitled
“Imitation is the sincerest form of flattery” by Professors Gerald Martin and
John Puthenpurackal. Just google it.
So let’s have some fun and start implementing this approach. Of course there
are no guarantees that it will work, but I think it’s worth trying. The idea is to
invest once every 6 months the same amount of money, buy one or more
stocks and do that during the rest of your life. So buy the stock and hold it as
long as the company remains a good company.
Buffett once said that the best thing with stocks actually is to buy them
consistently over time. Of course it would have been much better if we
started this approach at the beginning of the bull market in 2009, but we give
it a try anyhow. And to sleep well let’s agree we start looking at the results
only after a 3 year holding period.
This is by no means a mechanical formula to investing.Both in deciding
which successfulinvestorsto followas in decidingin the end which stocks
to chooseI listen carefullyat what my tummy tells me.
If you try to “clone” the holdingsof Berkshire Hathaway,you should
realize that Berkshire Hathawayhas its limitationsin the universe of
stocks to choosefrom (only big caps).So cloningthem meanscloning
their limitations.Try to focus on small and midcap stocks.
The basicsFund Pitch Book
• The Value Firm BV is seeking to raise 15 to 20M EUR equity
investment for a fair share in the newly formed Fund Capital
Management BV for the launch of our Flagship Fund. The
strategic investor(s) must be willing to stay with the fund for
at least 15 years.
• The fund will be structured according to the original Buffett
partnerships. There is a Fund Pitch Book available with all
the necessary information, including a business proposal.
Just send me an e-mail: peter@thevaluefirm.com.
• Obviously it’s better to launch a new fund when the markets
are way down. It may take quite a while before more
favorable market conditions will be there. So that will be
one of the items that needs to be discussed.
Value Investing is so funny. Benjamin Graham once said that “It’s easy for us to tell you not to speculate.
The hard thing will be for you to follow this advice”. I’ll bet a crate of whiskey that 50 years from now
99,5% of us weren’t able to change their behavior and are still speculating. And I think that’s great!
The real secret to investing is that there is no secret to investing. Every important
aspect of value investing has been made available to the public many times over,
beginning with the first edition of Security Analysis.
Value investors should concentrate their holdings in their best ideas; if you can
tell a good investment from a bad one, you can also distinguish a great one from
a good one.
There is nothing esoteric about value investing. It is simply the process of
determiningthe value underlying a security and then buying it at a considerable
discount from that value. It is really that simple. The greatest challenge is
maintainingthe requisite patience and disciplineto buy only when prices are
attractive and to sell when they are not, avoiding the short-term performance
that engulfs most market participants. Value investing requires deep reservoirs of
patience and discipline.
When we look at value, we tend to look at it on a very conservative basis—not
making optimistic forecasts many years into the future, not assuming growth, not
assuming favorablecost savings, not assuming anything like that. Rather looking
at what is there right now, looking backwards and saying, is that the kind of thing
the company has been able to do repeatedly? Or is this a uniquely good year, and
is it unlikelyto be repeated? We tend to look at hard assets as much as possible.
Warren Buffett is right when he says you should invest as if the market is going to
be closed for the next five years. The fundamental principlesof value investing, if
they make sense to you, can allow you to survive and prosper when everyone
else is rudderless.
As Graham, Dodd and Buffett have all said, you should always remember that you
don’t have to swing at every pitch. You can wait for opportunities that fit your
criteria and if you don’t find them, patiently wait. Deciding not to panic is still a
decision.
Unlike speculators, who think of securities as pieces of paper that you trade,
value investors evaluate securities as fractional ownership of, or debt claims on,
real businesses.
Price is perhaps the single most important criterion in sound investment decision
making. Every security or asset is a “buy” at one price, a “hold” at a higher price,
and a “sell” at some still higher price.
Value investing is, in effect, predicated on the proposition that the efficient-
market hypothesis is frequently wrong.
Few are willingand able to devote sufficient time and effort to become value
investors, and only a fraction of those have the proper mind-set to succeed.
In a world in which most investors appear interested in figuringout how to make
money every second and chase the idea du jour, there’s also something
validatingabout the message that it’s okay to do nothing and wait for
opportunities to present themselves or to pay off.
The basicsMore thoughts...
• We look for companies with the power to
outperform for many years (decades). If such a
company trades at an attractive price we buy. We
also look for investment opportunities in mergers,
spin-offs, arbitrage and takeovers.
• At times we use a dynamic hedging approach that
aims to make it possible to use a sensible (small)
amount of leverage without too much risk.
• To succeed you have to read and study a lot, but
in the end it’s accumulated knowledge &
experience and the right temperament (discipline,
patience and controlling your emotions) that
matter most.
Contact us
Thank you. And do not hesitate to contact me.
Email: peter@thevaluefirm.com
The Value Firm B.V.
Mr. Peter Coenen
Pastelstraat 127
1339 JH Almere
The Netherlands
T: +31 6 230 44 767
E: peter@thevaluefirm.com
It’s much more fun to look for companies
that add “good value” to society.
Afterthoughts
• You don’t become a successful investor overnight. Forget it. Value investing is a lifelong journey of
learning, making mistakes and of course, if things go well, making profits. There is this great quote from
Chuck Akre: “Good judgement comes from experience. And experience comes from bad judgement”.
• To understand Warren Buffett you have to study and read a lot. But even more importantly is that you
learn to discipline the mind. Be greedy when others are fearful and be fearful when others are greedy is
easier said than done. Actually, it’s extremely hard to do.
• Only a few of us will be able to join the ranks of the great Value Investors. It’s my estimate that less than
0.2% of the professional Value Investors will consistently outperform a low cost index fund, like the
Vanguard S&P 500, with more than 3%. So think again if you really want to pursue a career in Value
Investing.
• Warren Buffett wrote in his 2017 letter to shareholders: “There are, of course, some skilled individuals
who are highly likely to outperform the S&P 500 over long stretches. In my lifetime, though, I’ve
identified – early on – only 10 or so professionals that I expected would accomplish this feat”. So think
again if you really want to pursue a career in value investing.
• Sometimes people ask me: “What’s your edge?”. Value investing, if practiced well, is the edge. And risk
management (which I consider as being part of value investing) if practiced well, is the edge. Can you be
sure that an investor with a great track record will continue to do well? No, you can not. Obviously he or
she has better chances to outperform than an investor without a great track record, but there is no such
thing as certainty in investing. Most people want to do better than the index without the risk of doing
worse. And I’m afraid that option is not available.
Once upon a time in Amsterdam one“Semper Augustus”bulb
was offered for sale at 10,000 guilders, a sum sufficientto
buy 10 small houses. Tradition contends that thousandsof
tulip-bulb speculatorswere ruined when the market
collapsed, taking the entire Dutch economy down with them.
Best advice ever...
Most of us are better off by
periodically investing in the Vanguard
S&P 500 index fund. And just leave it
there for the rest of your life. Let the
American industry do it’s job for you.
It's the best investment for everybody looking for the
least amount of worry.
And don’t forget that Howard Marks warns passive investors that with cap-
weighted indexes, index buyers have no discretion but to load up on stocks that
are already overweighted (and often pricey) and neglect those already
underweight. While passive investors protect against the risk of
underperforming, they also surrender the possibility of outperforming.
Disclosures
This presentation andthe information contained herein are for educational and informational purposes only anddo not constitute,
and should not be construed as, an offer to sell, or a solicitation of an offer to buy, any securities or related financial instruments.
Responses to any inquiry thatmay involve the rendering of personalized investment advice or effecting or attempting to effect
transactions in securities will not be made absent compliance with applicable laws or regulations (including broker dealer,investment
adviser or applicable agent or representative registration requirements), or applicable exemptions or exclusions therefrom. We do not
offer any services outside The Netherlands.
This presentation contains information and views as of the date indicated (31January 2017) and such information andviews are
subject to change without notice. The Value Firm® has no duty or obligation to update the informationcontained herein. Further, The
Value Firm® makes no representation, and it should not be assumed, that past investment performance is an indication of future
results. Moreover, wherever there is the potential for profit there is also the possibility of loss.
Certain information contained herein concerning economic trends and performance is based on or derived from informationprovided
by independentthird-party sources. The Value Firm® believes that such informationis accurate and that the sources from which it has
been obtained are reliable; however, it cannot guarantee the accuracy of such information and has not independently verified the
accuracy or completeness of such information or the assumptions on which such information is based. Moreover, independent third-
party sources cited in these materials are not making any representations or warranties regarding anyinformation attributed to them
and shall have no liability in connection with the use of such information in these materials.

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The Value Firm

  • 1. Star Performers There are some great investment minds out there. It makes sense to stay as close to them as you can.
  • 2. Think different! Favorable industry outlook Durable competitive advantages High calibre management A price that makes sense Great investors outperform the investment crowd by thinking different. Often the long-term potential of their decisions is not obvious for other investors or they do not have the nerve to follow through. Many times we wondered “Why could anyone else not see this?” but they don’t or they disagree. When we own portions of outstanding businesses with outstanding managements, our favorite holding period is forever. – Warren Buffett.
  • 3. Our strategy Phase 1 First we bring together the very best ideas of the great value investors of our time. Phase 2 Then we focus on the companies with a lot of growth potential. Phase 3 And if these companies trade at a price that makes sense we buy. We prefer to buy when the markets are way down The father of the hedge fund was Alfred Winslow (A.W.) Jones. The true genius of the Jones model comes from the insight to combine leverage and hedging. The hedge was provided by short positions. We do not short stocks. But we do mitigate the risk of investing on margin by using options.
  • 4. Our investment process Ideas • A good amount of time is spent finding the ideas and opportunities, e.g. by reading the reports of the great value investors of our time. Understanding • Then we try to get an understanding of the (future) business economics of the company. The business description of the 10K is a great place to start. Risks • Then we move on to the risk disclosure section. These are put together by management and lawyers to figure out what can go wrong with the business. Financials • Finally we move on to the financial statements and footnotes. We also read trade articles and other publications that are relevant to the business. The better an investor knows a business, the better the ensuing investment decisions tend to be. Therefore, the starting point is detailed fundamental analysis. The aim should be to get to know a business better than anyone who is not an insider. There are few shortcuts and this process involves a meticulous review of all public information, such as financial reports, as well as mining other independent sources. – Lawrence Cunningham
  • 5. Companies we like DeereDanoneHeineken We look for companies with the power to outperform competition for many years to come. We try to avoid companies that do not comply with good citizenship values linked to human rights, the environment, labor relations and anti-corruption. It’s much more fun to look for companies that add good value to society. Disclaimer. The information in this presentation, is not intended to be, nor does it constitute, investment advice and/or recommendations.
  • 6. Our favorite books The Intelligent Investor. Benjamin Graham. Security Analysis. Graham & Dodd. Common Stocks and Uncommon Profits. Philip A. Fisher. Poor Charlie’s Almanack. Charles T. Munger. Charlie Munger. The Complete Investor. Tren Griffin. Margin of Safety. Seth Klarman. The Clash of Cultures. John C. Bogle. The Most Important Thing. Howard Marks. Investing between the Lines. L.J. Rittenhouse. Manias, Panics and Crashes. Kindleberger & Aliber. Financial Shenanigans. Howard Schilit. Creative Cash Flow Reporting. C.W. Mulford, E. E. Comiskey. Irrational Exuberance. Robert J. Schiller. The Essays of Warren Buffett. Lawrence A. Cunningham. The Warren Buffett Way. Robert G. Hagstrom. The Warren Buffett Portfolio. Robert G. Hagstrom. Buffettology & The New Buffettology. M. Buffett, D. Clark. Buffett beyond Value. Prem C. Jain. Bull! The History of the Boom. Maggie Mahar. You Can Be a Stock Market Genius. Joel Greenblatt. The Little Book that beats The Market. Joel Greenblatt. The Quest for Value. G. Bennett Stewart Valuation. Tim Koller, Marc Goedhart, David Wessels Warren Buffett’s Ground Rules. Jeremy C. Miller. Inside the Investments of Warren Buffett. Twenty Cases. Yefei Lu. Strategic Value Investing. S.M. Horan, R.R. Johnson, T.R. Robinson. Capital. The Story of Long Term Investment Excellence. Charles D. Ellis. Concentrated Investing. A C. Benello, M. van Biema, T. E. Carlisle What works on Wall Street. James P. O’Shaughnessy. The Origins of Political Order. Francis Fukuyama. The Education of a Value Investor. Guy Spier. One Up on Wall Street. Peter Lynch. The Outsiders. William N. Thorndike. The Dhandho Investor. Mohnish Pabrai. 100 Baggers. Christopher W. Mayer. The John Deere Way. David Magee. Stress Test. Timothy F. Geithner. The Euro. Joseph E. Stiglitz Good to Great. Jim Collins. Dear Chairman. Jeff Gramm To understand the investment style of Warren Buffett you can wait for Warren to write a book or you can start reading the annual reports of Berkshire Hathaway. “The Intelligent Investor” has three ideas you really need: • A stock is a piece of a business. Never forget that you are buying a business which has an underlying value based on how much cash goes in and out. • Chapter 8 on the Mr. Market analogy. Wall Street is there to serve you, not to instruct you. It quotes prices every day that you can take or leave. There are no “called strikes”. • Chapter 20 on Margin of Safety. Make sure that you are buying a business for way less than you think it is conservatively worth.
  • 7. Our favorite quoteOur favorite quote After you read “Art of Stock Picking” by Charlie Munger (just try to understand his thinking on carrots and dessert), it would be a good idea to listen to or read a transcript of “24 Standard Causes of Human Misjudgment”, where Mr. Munger speaks about the framework for decision making and the factors contributing to misjudgments. A concentrated portfolio of strong and predictable companies acquired at a price that makes sense will do the job. Munger's3 Rules on How to Become a SuccessfulInvestor. • Munger's first rule is to "carefullylook at what the other great investors have done”. • Munger's second rule is to pay close attention to cannibal companies. Look carefullyat the businesses that are buying back huge amounts of their stock. • Munger's last rule is to focus on spinoffs. Successful investing is about finding situations of mispricing, or companies selling below their true worth. And spinoffs, when a company divests one of its divisions, are a great place to dig for those situations.
  • 8. Where is “the moat” and does the company has the ability to widen “the moat”? Is this company really providing an attractive value proposition for the end customer? In other words, what are the unique competitiveadvantages of the company and is the company well positioned to exploit those advantages for many years to come? Does the company have pricing power (the ability to enjoy price inelastic demand for their product) and the capacity to reinvest (opportunities to deploy incremental capital at high rates)? Does the company have favorable long-term prospects and what are the drivers for long-term growth? Is there evidence that the short term prospects are favorable as well (e.g. a solid order intake, backlog & bidding pipeline). Do I understand all the footnotes, especiallythose concerning the cash flow statements. Same for vertical and horizontal analysis of the 10 year financialsstatements and all the Howard Schilit shenanigans checks. Does the company have a consistent operating history, strong cash flows and consistent high return on capital? Do we like the managementof the company? You want these people to be brilliantbusiness (wo)men. Does the company have a strong and solid balance sheet? Debt is the most important thing to look for. The second most important thing to look for is a significant cash position. And then don’t forget to check the pension obligations. Does management care about sustainability& ethical leadership and does management have a track record of integrity and high performance?Is management shareholder friendly and rational with its capital? Who are the main competitors (market leaders and challengers)? Do we understand competition and who is going to win? Are there disruptive industry forces to reckon with, e.g. technology changes or new regulatory requirements? What is the catastrophy risk of the business? Do we understand the long-term business economics of the industry and what is the current market share of the company? Where are we in what’s called “the business cycle” and how is the temperature of the stock market? Will this company be around and doing well 25 years from now? Great companies have great cultures. Do we really want to “own” this business? Is there any “insider trading” and/or are there “short sellers”? I always check if Jim Chanos is “short” on the stock I intend to buy. What is the value of the business and can it be purchased at a significantdiscount to its value (marginof safety)? The basicsOur checklist It is fun to collect inanities (investing “mistakes”) because there’s never a shortage. The lessons learned from these inanities are a crucial part of a well designed check list. You need a different checklist and different mental models for different companies, industries and investment styles.
  • 9. Our screening Choosing individual stocks without any idea of what you’re looking for is like running through a dynamite factory with a burning match. You may live, but you are still an idiot. – Joel Greenblatt. Our “screener” is a quantitative strategy to pick stocks. It’s actually a simple Joel Greenblatt kind of quantitative stock ranking scheme. It uses Return on Capital and Price-to-Cash flow as inputs. Return on Capital (ROC) is a core metric at The Value Firm®. An industry leading ROC is a great indicator for excellent competitive advantages. Why don’t you google “Calculating Return on Invested Capital” by Michael J. Mauboussin and read it. But be careful. A solid investment decision definitely takes more than “just what’s in the numbers”. You better read Mauboussin’s “Measuring the Moat” as well. Many people focus too much on the financial characteristics and those are really the foundation and the starting point. The problem is that the numbers are telling you about the past and you’re investing in the future (and that’s a Paul Lountzis quote). So fundamental analysis is important, but not enough. You have to be certain about the future cash flow streams of a company. Very certain. And that can be achieved e.g. by studying industry trends, the regulatory environment, disruptive technologies, the long-term competitive dynamics of an industry and the durability of the competitive advantages. There is more to it than “just what’s in the numbers”. Much more. There is no mechanical formula to investing. You have to think of a lot of different things at once. It’s much more about the balance between intellect, discipline and “what your tummy tells you”. Munger/Cundill. An investor should act as though there is a lifetime decision card with just 20 punches on it. – WB.
  • 10. Our performance Disclaimer. The performance data quoted herein represents past performance and is not a guarantee of future results. 31 Dec ‘16 21,9 % Remarks: • If you want further details or do your own due diligence,just send us an email: peter@thevaluefirm.com • These are not actual fund performance or investors returns, but returns based upon the companies own invested capital. • Having a good track record is by no means a guarantee for future results. Having no track record is even worse. • During the first 5 years I leveraged up quite a bit and that’s doable if you know how to hedge. But I don’t “leverage up” any more and just might use a little bit of leverage. So you might question the worth of the track record. • Next update: when the financial statements2017 are approved: Q3 2017. Average annual return since Q4 2011 Since 31 December 2013 we made substiantialchanges to the portfolio. We prefer not to share them, because good investment ideas are rare, valuable and subject to competitive appropriation just as good product or business acquisition ideas are.
  • 11. The financial markets are inherently unstable • More manias, panics and crashes will plague us and more financial crisis will occur. • The financial markets will continue to overreact, which offers opportunity to the disciplined and patient investor. • History showed sudden declines of 50 % and more. If you can not accept this brutal reality you better stay out. A value investor buys when stocks are out-of-favor • A stock is not just a ticker symbol. It is an ownership in an actual business. Investing is most intelligent when it is most businesslike. • A shrewd value investor buys in a bear market, when everybody else is selling. • Be very patient and “never underestimate the value of doing nothing” (Winnie the Pooh). Munger calls this assiduity. The historical stock market return is 6 to 8 % • The value of an investment is a function of its present price. The higher the price you pay, the lower your return will be. • If you buy stocks when the markets are overvalued you will most certainly underperform. • Opportunities are usually found where the flock doesn't fly. If you want to pick stocks that outperform, it typically requires departing from the herd. The basicsRemarks on Value Investing Read 500 pages every day. That’s how knowledge works. It builds up like compound interest. History shows that Value Investing works in cycles. There will be periods when the returns will be mediocre. But if you don’t believe in Value Investing, what do you believe in? - WB -
  • 12. Our favorite quote If you want to do better than the index then you have to engage in active management with it’s costs, it’s uncertainty and the risk that if you try to do better than the index you might do worse than the index. So how are we going to beat the index? Well, by doing a few things different and better. • We look for very high quality companies that will be able to outperform competition for many years to come. And if these companies trade at a really attractive price we buy. But we also look for investment opportunities in mergers, spin- offs and takeovers. • We will diversify our portfolio up to 25 - 30 stocks. We believe this will yield the most cost-effective level of risk reduction. • We will use a dynamic hedging approach that aims to make it possible to use a small amount of leverage without too much risk. How to beat the market By periodically investing in a low- cost index fund you can actually outperform most investment professionals. Thomas J. O'Halloran, photographer Professional investors have a long history of failing to beat the market after accounting for their fees. Over the last 10 years it’s estimated that 83% of the mutual funds underperformed. And worse over 20 years. It’s our guess that less than 1% will outperform the index consistently with more than 3%. Perhaps even less than 0.5%. We believe the average investor (whether individual or institutional) is much better off by periodically investing in a low cost index fund. Now stop right here. Don’t look any further. It’s probably the best “low-risk-solid-return” proposition on the planet!
  • 13. Our favorite quote • Actually, there are many ways to value a company. You have to think about a lot of things. In the Berkshire Hathaway 2017 annual meeting Warren Buffett talked about the importance of the future interest rates. Most people don’t get this right. • We try to make a conservative estimate of the long-term business potential of the company. If the company is too difficult to understand, and most of them are, we skip the company and move on to the next. • First we look at the storyline, i.e. the past, present and future of the company. Obviously the most difficult and most important one is the latter. We try to assess the industry outlook, the competitive dynamics, the durability of the competitive advantages, the quality of the leadership team and it’s strategy. And only then we move on to the numbers game: the balance sheet, “owner earnings” and long term growth rate. • And then we try to put a reasonable price tag on the business potential (future cash flows) of the company. And that’s much more a matter of experience (industry specific expertise) than the result of complex discounted cash flow calculations (although you might argue that the ratios we use actually result from DCFs). We prefer to think in terms of opportunity costs. Don’t forget to read chapter 8 “The art of business valuation” of Seth Klarman’s book “Margin of Safety” once again. In case you forgot the subtitle of this book “Risk-Averse Value Investing Strategies for the Thoughtful Investor”. And that’s what Value Investing is all about: a risk-averse approach. How to value a company Better be approximately right on your valuation than precisely wrong on the future of the cash flow streams. If you are going to use “growth” in your valuations, please watch Bruce Greenwald on YouTube: “Value Investing and the Mis-measures of Modern Portfolio Theory”.
  • 14. The basics In a free-market economy, capital seeks the areas of highest return. Whenever a company develops a profitable product or service, it doesn’t take long before competitive forces drive down its economic profits. Only companies with an economic moat—a sustainable competitive advantage that allows a firm to earn above- average returns on capital over a long period of time—are able to hold competitors at bay. Being patient and buying wide-moat stocks when they become cheap is a compelling investment strategy. Moats MOAT DESCRIPTION Customer Loyalty In some industries, customers strongly prefer certain brands. We like brands with a lot of pricing power, like Deere and Coca-Cola. Patents/Licenses/ Regulations Patents, licenses and regulationsprevent competitionfrom entering into a market and competing with the incumbent. E.g. VeriSign. Network Effect Some products or services become more valuable when there are more customers. Demand then becomes very sustainable and it is extremely difficult for competitors to offer comparable products. E.g. Facebook. Economies of Scale Some companies can produce at lower cost due to their greater scale (higher volumes). New competitors will often have to incur large losses in order to match the same level of pricing. E.g. Walmart. Switching Cost Certain products or services can be every expensive for the customer to switch to an alternative provider. This strong disincentive results in sustainable, recurring demand. E.g. Oracle. “If you gave me $100 billion and said, ‘Take away the soft drink leadership of Coca-Cola in the world’, I’d give it back to you and say it can’t be done.” – Warren Buffett on challenges one would face in trying to overcome the moat of Coca-Cola Munger on “moats”. The problem is that it’s relativelyeasy to identify a company that is doing well. It’s much harder to look into the future and determine if that company will continue to do well. Identifyinga wide and durable moat is a tough task and a task that's hardly an exact science.
  • 15. Our favorite quote • During the first 5 years I used quite some leverage. And that can be done if you know how to hedge the downside risks. In fact, it’s quite lucrative. • However, Howard Marks recently (2017) wrote that we are living in a low-return high-risk world. I don’t think it’s very smart to use leverage in a high risk world, despite the fact that you can hedge the risks. • But there are other reasons why I scaled down tremendously on leverage. First of all, everybody makes mistakes now and then and there is always the risk that you make a hedging mistake during times of market turbulence. • Secondly, I just don’t know what is going to happen to the hedges if a cybersecurity incident hits one of these huge derivatives trading platforms. • And last, but not least, if you hedge like I do, you have to roll over your hedges when they expire. Now, what happens when the stock exchanges shut down in response to a panic? During the panic of 1873 (by then nearly 10.000 businesses failed), there was a 10-day closure followed the failure of Jay Cooke & Company bank. • The chances that these things will occur are indeed very small, but if they do the result may be disastrous. So, ordinarily, debt will be non-existent or small. It may be expanded to up to 10% of invested assets when we are confident in the wisdom of so expanding the use of debt. Leverage Initially successful with annualized return of over 21% (after fees) in its first year, 43% in the second year and 41% in the third year, in 1998 it lost $4.6 billion in less than four months following the 1997 Asian financial crisis and 1998 Russian financial crisis requiring financial intervention by the Federal Reserve, with the fund liquidating and dissolving in early 2000. And of course we have the hardly noticed bankruptcy of this 600B USD AUM company of The Leverage Brothers. Or was it Lehman Brothers? Anyhow.
  • 16. Our favorite quote Bull-markets are born on pessimism, grow on skepticism, mature on optimism and die on euphoria. The business cycle Sir John Templeton Crisis? What crisis? Just google “500 Years of Stock Panics”. The cycle of manias and panics results from the pro- cyclicalchanges in the supply of credit. You might want to spend some time on economicprinciples.org. Seth Klarman once said: “The stock market is the story of cycles and of the human behavior that is responsible for overreactions in both directions. I think markets will never be efficient because of human nature”. The crash of 2008 Euphoria Optimism Pessimism Sceptisism
  • 17. The basics Warren Buffett had correctly identified by 1973 that the shares of the Washington Post were selling for but a fraction of the underlying business value represented by those shares. The stock proceeded to relentlessly decline over the next two years. Had Buffett worried, he might have not only failed to add to his holdings but, conceivably, might also have panicked or been forced out of his steadily dropping position. Warren Buffett first bought shares of International Business Machines in 2011, building a position worth nearly $11 billion for Berkshire Hathaway. The stock has performed poorly since then, leading many to question Buffett's investment decision. Despite IBM's poor performance, Buffett has continued to add to Berkshire's stake in IBM. In the first and second quarters of 2017 though Warren Buffett sold 30% of his IBM shares cites big, strong competitors. "I don't value IBM the same way that I did 6 years ago when I started buying... I've revalued it somewhat downward," Don’t sell • The chances that @ some point in time a stock will trade (substantially) below the original purchase price are very high indeed. The biggest failure an investor can make is to sell a stock because the price of the stock goes down. If you are right on the long term business potential of the company a stock decline is an opportunity to buy more. • The second biggest failure is to sell a stock when the price of the stock goes up. As long as the company remains a good company you better hold on to the stock and profit even more in the long run as a result of the long term business potential of the company. But be very careful. In 2016 a few great value investors bought more stock of Valeantwhen the price declined.That was not a very thoughtful decision.
  • 18. The basics • A bear market is triggered when investors lose faith in the market as a whole, decreasing the demand for stocks. This tends to happen when the economy enters a recession, unemployment is high and inflation is rising. • Early in 2000, after nearly 13 years of a bull, millions of investors were stunned when a serious downturn began in the spring. Many of today's investors have lived through two fairly nasty bears: a decline of 49% from 2000 to 2002 and a 57% plunge from 2007 to 2009. Beware of the bear Like earthquakes, bear markets are hard to predict. Market Corrections Market peak Bear return Duration (months) Bull begin date Bull return Duration (months) Crash of 1929 - Excessive leverage, irrational exuberance Sep 1929 -86% 33 Jul 1926 152% 38 1937 Fed Tightening = Premature policy tightening Mar 1937 -60% 63 Mar 1935 129% 24 Post WWII Crash - Post-wardemobilization,recession fears May 1946 -30% 37 Apr 1942 158% 50 Flash Crash of 1962 - Flash crash, Cuban Missile Crisis Dec 1961 -28% 7 Oct 1960 39% 14 Tech Crash of 1970 - Economic overheating,civil unrest Nov 1968 -36% 18 Oct 1962 103% 74 Stagflation- OPEC oil embargo Jan 1973 -48% 21 May 1970 74% 32 Volcker Tightening- Whip Inflation Now Nov 1980 -27% 21 Mar 1978 62% 33 1987 Crash - Program trading, overheating markets Aug 1987 -34% 3 Aug 1982 229% 61 Tech Bubble - Extreme valuations, .com boom/bust Mar 2000 -49% 31 Oct 1990 417% 115 Global Financial Crisis - Leverage/housing,Lehman collapse Oct 2007 -57% 17 Oct 2002 101% 61 Current Cycle Mar 2009 n.a. 100 Averages -45% 25 153% 54 July 2017 Source: FactSet, NBER, Robert Shiller, Standard & Poor’s, J.P. Morgan Asset Management
  • 19. Investor psychology You really need to read most of the books mentioned before. But it’s funny though, that you will not learn the most important thing in investing from the books, but from experience. And that’s investor psychology. Most people don’t grab the concept of Value Investing, as simple as it is, at all. But if you do, just remember that Value Investing is best learned through extensive experience and mistakes. “Investing is largely about psychology. If you’re down a huge amount, you’re not thinking straight. If the markets do something that completely surprises you, you can be a deere in the headlights”. (Seth Klarman). “The elementary part of psychology, the psychology of misjudgement, as I call it, is a terribly important thing to learn. Terribly smart people make totally bonkers mistakes by failing to pay heed to it.” (Charlie Munger).
  • 20. The basicsTemperature of the markets U.S. stock prices are "on the cheap side“. If rates were to spike, however, then the stock market would be more expensive. If interest rates were 7 or 8 percent, then these [stock] prices would look exceptionally high. Warren Buffetton CNBC. February 2017. Jeff Ubben is not just talking about how expensive the market is, he is adjusting his plans because of it. ValueAct will be returning $1.25 billion of capital to investors, because he can’t find smart places to put it to work with current valuations.April 2017. Bill Miller: “I don’t find the markets expensive either on an absolute basis or a relative basis. On a relative basis (relative to other asset classes)the stock markets are (crazy) cheap. If the Federal Reserve, as projected, moves rates higher only gradually, that would be another check in the plus column for stocks. April 2017. There is nothing immediately that’s scary. To take a two- or three-year perspective,I’m concerned. Ray Dalio April 2017. Joel Greenblattsaid that equity markets are in 80th percentile and 90th percentile of expensiveness.May2017. Paul Singer has a bleak outlook for Wall Street. "I'm Very Concerned About The Global Economy"..."ballooningasset valuations and consumer debt pose even greater risks to the economy than they did back in 2008." He has build a $5 billion rainy day fund in preparation for what he describes as “all hell” to break out. May2017. Jeremy Granthem can’t see interest rates rising a lot anytime soon (May 2017). I don’t think this market is a true bubble about to blow up (August 2017). Legendary investorJim Rogers predicts a market crash in the next few years, one that he says will rival anything he has seen in his lifetime.“The bubble’s gonna come. Then it’s going to collapse,and you should be very worried”. June 2017. Bill Gross: “Don’t be mesmerized by the blue skies. The current market risk is the highest since before the September 2008 collapse of Lehman Brothers.The return is gonna be much lower and the risk much higher. It’s not an attractive situation. Insteadof “buying low and selling high”, you’re buying high and crossing your fingers...”.June 2017. James Montier believes the markets are behaving like the White Queen (June 2017). In order to make sense of todays pricing you have to believe in six impossible things. Secular stagnationin permanent and rates will stay low forever. The discount rates for equities depends on cash rates. Growth rates and discount rates are independent.Corporates carry out buybacks ad nauseum, raining EPS growth despite low economic growth. Corporate cash piles make the world a safer place. The “Hell” scenario is the most probable outcome. Put another way, Hell requires that stock prices have reached a “permanent high plateau”. Investors need to tread carefully right now because market valuations are at "unusual highs. In fact, the only times they have been higher were in 1929 and 2000. Both years saw historic market crashes. Robert Schiller. June 2017. ‘We’ve never had QE like this before, we’ve never had unwinding like this before. Obviously that should say something to you about the risk that might mean, because we’ve never lived with it before.’ - Jamie Dimon. July 2017. While Baupost doesn’t engage in the fool’s errand of attempting to predict the exact time and date a market crash will occur, the value-based hedge funds does consider the macro market environment and notes that the artificially tranquil environment that has put markets to sleep has lasted “longer than we would have imagined.” July 2017. David Tepper is rejecting fears that the market has become overvalued. Tepper sees a combination of low interest rates and strong global growth as underpinning for stocks. Rising interest rates would be considered a danger, but he said that increase would have to be substantial before denting the market. August 2017 Leon Cooperman, the founder of hedge fund Omega Advisors, says a market correction could start “very soon”. Cooperman, who’s known for his bullish stock picks, said any number of events could prompt markets to fall. “North Korea, a disappointingearnings report, anything…” September 2017. Julian Robertson,a legendary hedge fund manager, thinks disaster will strike Wall Street if the Federal Reserve doesn't keep raising interest rates. "We are creating a bubble" in the stock market, Robertson said. September 2017. Don’t try to time the markets. Invest consistently over time. And let the temperature of the markets be your guide to decide if the time is right to be more aggressive or more conservative. When in doubt, choose the latter one.
  • 21. The basics • If you invested 10.000 USD in Amazon.Com in 1999 ten years later it would be worth 1 million USD. Ever heard of Balchem? Since the end of 1985 it has gained an average of 26,2% annually. That’s called “good fortune”. • If you invested in Kodak, Polaroid or Xerox, once all great and successful companies, they either went bankrupt or needed to rise from the ashes. That’s “bad luck”. And what about Enron, Worldcom and Lehman Brothers! • If you had invested $1,000 in each of just three companies back in the 1980s — Apple, Microsoft and M&T Bank — you would be a millionaire today (1 March 2017). • Your goal in investing isn’t to earn average returns. You want to do better than average. Thus your thinking has to be better than that of others - both more powerful and at a higher level. – Howard Marks. • With time I learned that investing is not easy. In order to be an effective investor one has to bet against the consensus and be right. And it’s not easy to bet against the consensus and be right. – Ray Dalio. It’s not easy It can be very hard to really grasp the long term potential of a business. The memos from Howard Marks are great reads. One of his memos is entitled “It’s not easy”. It elaborates on “second level thinking”. Google it and read it. And you might want to read the other memos as well. “You don’t need the IQ in the investment business. What you have to be is aversive to standard stupidities. If you keep these out, you don’t have to be too smart”. Charles Munger. Note from the author: You need both.
  • 22. The basics Did we ever mention that investing is hard work — painstaking, relentless, and at times confounding? Separating relevant signal from noise can be especially difficult. Endless patience, great discipline, and steely resolve are required. Nothing you do will guarantee success, though you can tilt the odds significantly in your favor by having the right philosophy, mindset, process, team, clients, and culture. Getting those six things right is just about everything. Complicating matters further, a successful investor must possess a number of seemingly contradictory qualities. These include the arrogance to act, and act decisively, and the humility to know that you could be wrong. The acuity, flexibility, and willingness to change your mind when you realize you are wrong, and the stubbornness to refuse to do so when you remain justifiably confident in your thesis. The conviction to concentrate your portfolio in your very best ideas, and the common sense to nevertheless diversify your holdings. A healthy skepticism, but not blind contrarianism. A deep respect for the lessons of history balanced by the knowledge that things regularly happen that have never before occurred. And, finally, the integrity to admit mistakes, the fortitude to risk making more of them, and the intellectual honesty not to confuse luck with skill. - Seth Klarman In fact, it’s hard work Did we ever mention that investing is hard work? Successful long-term investing requires unending hard work, great patience, and strict discipline.
  • 23. The basicsThink again (1) Of course you want to mimic Warren Buffett. Right? Takeaway 1. You should read the Morningstar article entitled “Being like Buffett: Easy to Say, Hard to Do” by John Rekenthaler. It says that while many mimic Buffett’s investment approach, the collectiveresults stink. The 10-Year return of Buffett-Style funds are 6.1%, underperformingthe Vanguard Total Stock Market. That’s awful – not merely disappointing, not merely bad, but terrible! It even argues that the Buffett approach doesn’t suit the mutual fund format. Takeaway 2. Rupert Hargraves talks about the Buffett illusion. "Inside the Investments of Warren Buffett: Twenty Cases“, a book by Yefei Lu, has convinced me that it is impossiblefor most investors to achieve Buffett-likereturns. You see, in most of the cases profiled in the book, Buffett had an edge over ordinary investors. Whether it be via a personal relationshipwith the CEO, a deal structured to yield a profit no matter what the outcome or personal activist involvement,most of Buffett’s greatest investments have produced outsized returns because he has been involved”. Takeaway 3. It’s not just “high returns” above the market. Peter Bernstein once said: “The market is not an accommodatingmachine”. It will not go where you want it to go just because you want it there to go. The S&P 500 compounded at a stunning rate of negative 1% from 2000 to 2010 (let that sink in, a decade of negative returns from the U.S. equity market). Takeaway 4. It’s very interesting to read that Charlie Munger himself questions if it is wise to “sell” the Buffett-Munger investment approach, e.g. as a fund or managed account (Art of Investing by Munger). People expect results that never diverge too much from a standard path except on the upside. In the short run, the Buffett-Munger approach might lead to a bumpy ride and that’s just not what feels comfortable. But in the long run, I would not try for anything else but the Munger-Buffettapproach. Takeaway 5. Between 1980 and 2014, roughly 40% of all stocks in the Russell 3000 suffered permanent 70% declines from their peak values. What’s more, over 320 companies were deleted from the Standard & Poor's 500 for distressed reasons between 1980 and 2014. These figures show just how hard it is to pick winners. A report published by Bank of America’s Research Investment Committee, headed by fixed income strategist Martin Mauro earlier this week speculates that an estimated 50% of S&P 500 companies could be replaced over the next ten years. – Rupert Hargreaves. July 2017. Warren Buffett once said: “I do more reading and thinking and make less impulse decisions than most people in business”.
  • 24. The basicsThink again (2) Victor Niederhoffer, the hedge-fund manager who lost his entire $130 millionportfolio in the Thai stock market crash of 1997. In September 2008, Mr. Niederhoffer was forced to close two of his funds, including his flagship, Matador. After his first hedge-fund blow-up in the 1980s, Mr. Niederhoffer was forced to sell his silver and take out a mortgage on his 20,000-square-foot home in Weston, Conn., to stay afloat. After attracting $9 billionworth of assets under management, Amaranth Advisors energy trading strategy failed as it lost over $6 billionon natural gas futures in 2006. Faced with faulty risk models and weak natural gas prices due to mild winter conditions and a meek hurricane season, gas prices did not rebound to the required level to generate profits for the firm, and $5 billiondollars were lost within a single week. In 2004, Bailey Coates Cromwell Fund event-driven, multistrategyfund based in London was honored by Eurohedge as Best New Equity Fund. In 2005, the fund was laid low by a series of bad bets on the movements of U.S. stocks, supposedly involvingthe shares of Morgan Stanley, Cablevision Systems, Gateway computers and LaBranche (a trader on the New York Stock Exchange). Poor decision making involving leveraged trades chopped 20% off of a $1.3-billionportfolio in a matter of months. Investors bolted for the doors and on June 20, 2005, the fund disolved. The high-flyingCalifornia-basedhedge fund Marin Capital attracted $1.7 billion in capital and put it to work using credit arbitrage and convertible arbitrage to make a large bet on GeneralMotors. When General Motors' bonds were downgraded to junk status, the fund was crushed. On June 16, 2005, the fund's management sent a letter to shareholders informing them that the fund would close due to a "lack of suitable investment opportunities". Aman Capital was set up in 2003 by top derivativestraders at UBS, the largest bank in Europe. It was intended to become Singapore's "flagship"in the hedge fund business, but leveraged trades in credit derivatives resulted in an estimated loss of hundreds of millions of dollars. The fund had only $242 millionin assets remainingby March 2005. Investors continued to redeem assets, and the fund closed its doors in June 2005, issuing a statement published by London's Financial Times that "the fund is no longer trading". In 2000, Julian Robertson's Tiger Management failed despite raising $6 billionin assets. A value investor, Robertson placed big bets on stocks through a strategy that involved buying what he believed to be the most promisingstocks in the markets and short selling what he viewed as the worst stocks. This strategy hit a brick wall during the bull market in technology. While Robertson shorted overpriced tech stocks that offered nothing but inflated price to earnings ratios and no sign of profits on the horizon, tech stocks continued to soar. Tiger Management suffered massive losses and a man once viewed as hedge fund royalty was unceremoniouslydethroned. By most accounts, Atticus Global was a good fund that simply got whooped by the 2008 financialcrisis. The hedge fund was founded by Tim Barakett in 1995 with less than $6 millionin hand and by 2007 was one of the largest hedge funds in the world with $20 billion of assets under management. Barakett managed to pull that rare and neat trick of providingmarket-beatingreturns over a long time period until 2008, when the financialcrisis swept his feet out from under him. After two years of losses, Barakett closed the fund in 2009. Of course you want to mimic Warren Buffett. Right?
  • 25. The basicsLessons learned Nobody can tell you when a panic will occur. But it surely helps to have an idea where we are in what’s called “the business cycle”. Everybody, and that includes Warren Buffett and Seth Klarman, will make mistakes now and then. We carefullytry to avoid the great academic insights like the Capital Asset Pricing Model (CAPM), Black-Scholes, Beta and the weighted average cost of capital (WACC). “Goodwill”is probably the most destructing accounting item ever created in history. It’s tempting to use leverage, but it is a very risky proposition. You have to have downside protection to prevent yourself from bankruptcy when adversity takes over. And that means not only hedging against stock market volatility, but also against currency fluctuations. You’re safer & better off without leverage. The plethora of deeply entrenched biases and flawed evolutionary brain wiring makes us prone to make plenty of mistakes. Most investors think they are rational, but actually they are not. Our brains are extremely gullible and inconsistent decision makers. “The mind itself is a confounded thing, woefullyill-suited to the task of investing” – Guy Spier. Most people have a herd mentality. What will set you apart is the ability to valuate a business unaffected what other people think. Always do your own research! We don’t use EBITDA or complex discounted cash flow analysis either. DCF is like the Hubble Telescope. Move it an inch and you will end up studying a differentgalaxy. Robert Robotti once said that DCF should be renamed the “Deliberate Certainty Fabricating” model. I agree. The important thing is to not get caught up in emotions. Knowing emotions exist but not getting caught up and being cold, hard and calculatingon valuation – that’s the secret. It makes sense to study EVA®, MVA, SVA & CVA. Return on capital is an important measure of business performance. But we are reluctant to use weighted average cost of capital. Actually, we don’t use WACC at all. Don’t try to time the markets. Invest consistently over time. And don’t spend too much time on “the macro”. I try to limit my time on macro-economicissues to 5 minutes per decade. Max. There is more to it than just “the financials”. You might want to analyze the operating segments of a company and the competitiveenvironment in which these sub- businesses are operating. If smart people learn from their own mistakes while wise people learn from the mistakes of others, the goal is to be both smart and wise. – Lawrence Cunningham. By far the best strategy, we think, is to buy a well diversifiedportfolio of strong and predictable companies at a price that makes sense and hold on to these stocks as long as the company remains a good company. We do not trade commodities(like gold, sugar or beans), don’t buy stocks of turnarounds and we also do not short individualstocks. Remember, especiallyin a bull market, that the good times won’t roll on forever. We should always invest as if the best is yet to come but the worst could be right around the corner. You might want to avoid “good” investment ideas. Why? Because most of the time “good” is not good enough. Good is the enemy of great. It takes many, many years to learn that there is still a lot to learn. If you think you understand Buffett & Munger, think again. A thorough understanding of accountancy, the language of the business, surely helps. There are some great lectures on the web by Aswath Damodaran. E.g. look for Talks @ Google: “Valuation: Four Lessons to Take Away” or “The Dark Side of Valuation: India Business Forum” on YouTube.
  • 26. Intelligent Cloning On 11 March 2017 I wrote an article on “Intelligent Cloning”. Just google “Latticework Intelligent Cloning”. It describes a methodology for picking conservative stocks from the portfolio’s of successful investors and then rank these stocks by a simple Joel Greenblatt ranking system. Disclaimer. The information in this presentation, is not intended to be, nor does it constitute, investment advice and/or recommendations. When What 2H 2016 Deere & Co (team Berkshire) @ 87 USD Allison Transmission (Lou Simpson) @ 29 USD 1H 2017 Davita Inc. (team Berkshire) @ 65 USD Verisign (team Berkshire) @ 83 USD 2H 2017 1H 2018 2H 2018 1H 2019 2H 2019 Warren Buffett made his initial fortune by tracking what top investors were doing. In his biography, it is written Warren Buffett felt honored to borrow ideas from any useful source. The “rationale” for cloning is an article entitled “Imitation is the sincerest form of flattery” by Professors Gerald Martin and John Puthenpurackal. Just google it. So let’s have some fun and start implementing this approach. Of course there are no guarantees that it will work, but I think it’s worth trying. The idea is to invest once every 6 months the same amount of money, buy one or more stocks and do that during the rest of your life. So buy the stock and hold it as long as the company remains a good company. Buffett once said that the best thing with stocks actually is to buy them consistently over time. Of course it would have been much better if we started this approach at the beginning of the bull market in 2009, but we give it a try anyhow. And to sleep well let’s agree we start looking at the results only after a 3 year holding period. This is by no means a mechanical formula to investing.Both in deciding which successfulinvestorsto followas in decidingin the end which stocks to chooseI listen carefullyat what my tummy tells me. If you try to “clone” the holdingsof Berkshire Hathaway,you should realize that Berkshire Hathawayhas its limitationsin the universe of stocks to choosefrom (only big caps).So cloningthem meanscloning their limitations.Try to focus on small and midcap stocks.
  • 27. The basicsFund Pitch Book • The Value Firm BV is seeking to raise 15 to 20M EUR equity investment for a fair share in the newly formed Fund Capital Management BV for the launch of our Flagship Fund. The strategic investor(s) must be willing to stay with the fund for at least 15 years. • The fund will be structured according to the original Buffett partnerships. There is a Fund Pitch Book available with all the necessary information, including a business proposal. Just send me an e-mail: peter@thevaluefirm.com. • Obviously it’s better to launch a new fund when the markets are way down. It may take quite a while before more favorable market conditions will be there. So that will be one of the items that needs to be discussed. Value Investing is so funny. Benjamin Graham once said that “It’s easy for us to tell you not to speculate. The hard thing will be for you to follow this advice”. I’ll bet a crate of whiskey that 50 years from now 99,5% of us weren’t able to change their behavior and are still speculating. And I think that’s great!
  • 28. The real secret to investing is that there is no secret to investing. Every important aspect of value investing has been made available to the public many times over, beginning with the first edition of Security Analysis. Value investors should concentrate their holdings in their best ideas; if you can tell a good investment from a bad one, you can also distinguish a great one from a good one. There is nothing esoteric about value investing. It is simply the process of determiningthe value underlying a security and then buying it at a considerable discount from that value. It is really that simple. The greatest challenge is maintainingthe requisite patience and disciplineto buy only when prices are attractive and to sell when they are not, avoiding the short-term performance that engulfs most market participants. Value investing requires deep reservoirs of patience and discipline. When we look at value, we tend to look at it on a very conservative basis—not making optimistic forecasts many years into the future, not assuming growth, not assuming favorablecost savings, not assuming anything like that. Rather looking at what is there right now, looking backwards and saying, is that the kind of thing the company has been able to do repeatedly? Or is this a uniquely good year, and is it unlikelyto be repeated? We tend to look at hard assets as much as possible. Warren Buffett is right when he says you should invest as if the market is going to be closed for the next five years. The fundamental principlesof value investing, if they make sense to you, can allow you to survive and prosper when everyone else is rudderless. As Graham, Dodd and Buffett have all said, you should always remember that you don’t have to swing at every pitch. You can wait for opportunities that fit your criteria and if you don’t find them, patiently wait. Deciding not to panic is still a decision. Unlike speculators, who think of securities as pieces of paper that you trade, value investors evaluate securities as fractional ownership of, or debt claims on, real businesses. Price is perhaps the single most important criterion in sound investment decision making. Every security or asset is a “buy” at one price, a “hold” at a higher price, and a “sell” at some still higher price. Value investing is, in effect, predicated on the proposition that the efficient- market hypothesis is frequently wrong. Few are willingand able to devote sufficient time and effort to become value investors, and only a fraction of those have the proper mind-set to succeed. In a world in which most investors appear interested in figuringout how to make money every second and chase the idea du jour, there’s also something validatingabout the message that it’s okay to do nothing and wait for opportunities to present themselves or to pay off. The basicsMore thoughts...
  • 29. • We look for companies with the power to outperform for many years (decades). If such a company trades at an attractive price we buy. We also look for investment opportunities in mergers, spin-offs, arbitrage and takeovers. • At times we use a dynamic hedging approach that aims to make it possible to use a sensible (small) amount of leverage without too much risk. • To succeed you have to read and study a lot, but in the end it’s accumulated knowledge & experience and the right temperament (discipline, patience and controlling your emotions) that matter most. Contact us Thank you. And do not hesitate to contact me. Email: peter@thevaluefirm.com The Value Firm B.V. Mr. Peter Coenen Pastelstraat 127 1339 JH Almere The Netherlands T: +31 6 230 44 767 E: peter@thevaluefirm.com It’s much more fun to look for companies that add “good value” to society.
  • 30. Afterthoughts • You don’t become a successful investor overnight. Forget it. Value investing is a lifelong journey of learning, making mistakes and of course, if things go well, making profits. There is this great quote from Chuck Akre: “Good judgement comes from experience. And experience comes from bad judgement”. • To understand Warren Buffett you have to study and read a lot. But even more importantly is that you learn to discipline the mind. Be greedy when others are fearful and be fearful when others are greedy is easier said than done. Actually, it’s extremely hard to do. • Only a few of us will be able to join the ranks of the great Value Investors. It’s my estimate that less than 0.2% of the professional Value Investors will consistently outperform a low cost index fund, like the Vanguard S&P 500, with more than 3%. So think again if you really want to pursue a career in Value Investing. • Warren Buffett wrote in his 2017 letter to shareholders: “There are, of course, some skilled individuals who are highly likely to outperform the S&P 500 over long stretches. In my lifetime, though, I’ve identified – early on – only 10 or so professionals that I expected would accomplish this feat”. So think again if you really want to pursue a career in value investing. • Sometimes people ask me: “What’s your edge?”. Value investing, if practiced well, is the edge. And risk management (which I consider as being part of value investing) if practiced well, is the edge. Can you be sure that an investor with a great track record will continue to do well? No, you can not. Obviously he or she has better chances to outperform than an investor without a great track record, but there is no such thing as certainty in investing. Most people want to do better than the index without the risk of doing worse. And I’m afraid that option is not available. Once upon a time in Amsterdam one“Semper Augustus”bulb was offered for sale at 10,000 guilders, a sum sufficientto buy 10 small houses. Tradition contends that thousandsof tulip-bulb speculatorswere ruined when the market collapsed, taking the entire Dutch economy down with them.
  • 31. Best advice ever... Most of us are better off by periodically investing in the Vanguard S&P 500 index fund. And just leave it there for the rest of your life. Let the American industry do it’s job for you. It's the best investment for everybody looking for the least amount of worry. And don’t forget that Howard Marks warns passive investors that with cap- weighted indexes, index buyers have no discretion but to load up on stocks that are already overweighted (and often pricey) and neglect those already underweight. While passive investors protect against the risk of underperforming, they also surrender the possibility of outperforming.
  • 32. Disclosures This presentation andthe information contained herein are for educational and informational purposes only anddo not constitute, and should not be construed as, an offer to sell, or a solicitation of an offer to buy, any securities or related financial instruments. Responses to any inquiry thatmay involve the rendering of personalized investment advice or effecting or attempting to effect transactions in securities will not be made absent compliance with applicable laws or regulations (including broker dealer,investment adviser or applicable agent or representative registration requirements), or applicable exemptions or exclusions therefrom. We do not offer any services outside The Netherlands. This presentation contains information and views as of the date indicated (31January 2017) and such information andviews are subject to change without notice. The Value Firm® has no duty or obligation to update the informationcontained herein. Further, The Value Firm® makes no representation, and it should not be assumed, that past investment performance is an indication of future results. Moreover, wherever there is the potential for profit there is also the possibility of loss. Certain information contained herein concerning economic trends and performance is based on or derived from informationprovided by independentthird-party sources. The Value Firm® believes that such informationis accurate and that the sources from which it has been obtained are reliable; however, it cannot guarantee the accuracy of such information and has not independently verified the accuracy or completeness of such information or the assumptions on which such information is based. Moreover, independent third- party sources cited in these materials are not making any representations or warranties regarding anyinformation attributed to them and shall have no liability in connection with the use of such information in these materials.