Gyan on Treadmill dated 12-Apr-2018
Thomas Gayner graduated from the University of Virginia in 1983 and started his career in accounting and began working at Price Waterhouse Coopers (PWC) as a Certified Public Accountant. Soon he moved out and after multiple transitions, has been working with Merkal Corporation since late eighties. Currently he holds the post of Chief Investment Officer in the company.
In this presentation Mr.Gayner discusses his evolution as a value investor.
Gayner started off as a quantitative analysts, looking a the numbers. However, as he gained experiences, he has added other qualitative aspects to his approach of identifying value.
The basic premise behind value investing is that if you buy a security at a price significantly below its intrinsic value, sooner or later, the price will catch up with the value. Gayner says that this premise is only the first step of 'spotting' value. Many a time, the price did not catch up with the value. So he moved to the next step of 'value creation'. In this way, he looks at progressive creation of value rather than a static picture of value.
Based on the above, he came up with a four point approach at identifying companies for investment.
The first thing he looks for is a 'Profitable business with a good return on capital and that do not use a lot of leverage to do it'. What does it mean?
He looks for companies with demonstrated capability to create profitability. According to him, continuous profitability is a sign that the company is doing something that its customer's value. There are two reasons why the company many not be making profits. One, the company may not be interested in making profits or two, it may not be good at making profits. Regarding the use of leverage, he has two interesting views, one financial and other ethical. Financially, the need to regularly pay 'Financial Charges' hangs like a Damocles sword over the business. In addition, the businessmen who use a lot of leverage may not have a lot of integrity, in other words, business men with integrity do not use a lot of leverage. (I am reminded of the character Coco Jacobsen in the book 'The Shipping Man', where he asks, 'Why should I use my own money to pay back my loan?' )
The second lens that he looks through is the management. He looks for character (integrity) and ability. One without the other is useless.
The third thing that he looks for is the 'reinvestment dynamics' of the business. He looks to see if the business model can be replicated successfully many times. As an example of a business that cannot be replicated, he talks about 'Gourmet' restaurant. Typically the food quality is dependent on the people staffing the restaurant. This model cannot be replicated. He looks for scalability and replicability in a business. A perfect business is one that earns very good returns on capital and reinvests it again and again thus compounding the investor's wealth.
The fourth criteria is price (valuation). This is where many people start and end their analysis. He looks for reasonable PE, PB ratios. When people look at price, they usually make two mistakes. One is that you pay too much for what the company is worth. Second, and the more costlier mistake, is that you 'think' that the stock is overvalued and wait for the price to come to reasonable level all the time the stock is compounding at a rapid rate and you are not able to invest.
The above approach of looking at price as the final criterion is in line with the thinking of Warren Buffett as discussed in this book.
Out of these four points, is there one that he thinks about more often? Yes, it is the third one, the 'Reinvestment Dynamics'. What is the growth potential of this company? Will it be able to sustain its growth? Will it be able to sustain its high ROIC? If you find some company with that characteristic, do not be a penny pincher.
Someone told Gayner that "The secret to success in investing is to last the first thirty years". This means that everything that happens in market will repeat all over. The bull market, the bubble, the correction, the depression, the recession... everything will repeat again and again. You will become successful only if you last thirty years and learn the right lessons from what is happening in the markets.
At the start of his career, as a value investor, Gayner used to look at stocks trading at 52 Week Lows to identify value opportunities. However, over a period of time, he has changed his approach and now looks at stocks trading at 52 Week Highs, to see what the market knows that he doesn't know and to identify potential compounders. If a stock intrigues him, he will invest a small amount in the stock just to have a position and learn more about the stock.
That is it. Pretty interesting talk.