Reblog: Bill Nygren: Value Investing Principles and Approach

Bill Nygren is a fund manager at Oakmark Funds. He is also Chief Investment Officer for U.S. Equities at Harris Associates. He’s particularly well-known for being a value investor who doesn’t fear the technology sector.

This post summarises key takeaways from his talk at Google in December 2017. While he reinforces many core value investing principles, he also challenges us to think differently.

The difference between gambling and investing

A value investor recognizes there are different ways she can put capital at risk and the difference between gambling (negative expected value) and investing in stocks (positive expected value)

Buying stocks like you would buy groceries

Bill observed the way his mother shopped for groceries by buying more of something that was on sale and deferring her purchase of something that wasn’t yet on sale

Smart money is not always smart

He spent two years as a research analyst at Northwestern Mutual Life where he pitched ideas of companies that he found were trading below their asset values. However, the portfolio managers chose not to buy such stocks until after they were recommended by 2-3 Wall Street analysts, by which time the price had moved to above asset values.

Investing in technology stocks, avoiding hindsight bias and trusting the process

An Oakmark analyst pitched Bill Netflix in 2010 when it was valued at $15 / share, a fraction of HBO on a per subscriber basis. Bill passed on the stock and it subsequently went up to $200 in Dec 2017.

However, he does not classify passing on Netflix in 2010 as a mistake. Here’s why.

At the time, Bill spoke to industry experts who said Netflix was incredibly risky due to several reasons:

Competitors like HBO spent several times on programming and could “squash Netflix whenever they wanted to”
Netflix only had one blockbuster show at the time, House of Cards, which they would likely lose to an established network when it went up for rebid
Their programming costs were likely to increase dramatically when content partners realized their rate of subscriber growth

When the potential rewards aren’t commensurate with the risks determined by your process irrespective of what the stock (asset) has done in the meantime, trust your process.

On a related note, if you don’t own bitcoin, read this.

Having humility

In early 2017 Bill’s Oakmark bought Netflix for the first time after an analyst presented the stock as:

A Netflix subscription costs $10 / month compared to $15 / month for HBO, Spotify, and others. However, customers rated Netflix as more valuable than the other subscriptions. i.e. Netflix could charge $15 / month and it would then be trading at 13x earnings

By growing its subscriber base at 25% annually and putting $8B / year into programming, they now had a moat that would be incredibly hard to attack

A successful investor is humble enough to change his mind when considering changed facts from different perspectives

Your cheese will always be moved

20 years ago buying low PE, low PB was enough to generate alpha. Today computers are smarter at combining these characteristics with growth metrics.

What a value investor did 20 years ago won’t work today. What works today won’t work 20 years from now

His focus, therefore, is on identifying companies where there are non-operating assets that can generate earnings in the future and therefore will be missed by algorithms. Think about how your investing framework is evolving.

Sphere of competence – prudence or excuse?

The idea that technology is out of your sphere of competence because it changes so fast is outdated because all sectors are changing rapidly. Predicting Intel’s growth five years from now is no riskier than predicting P&G over the same period.

How likely is it that Google / Facebook / Youtube growth in India will leave the print and broadcasting businesses unchanged over the next 5-10 years?

Sometimes, value hides in plain sight

Post-2008, most banks were trading at much lower than their book values, many for good reason. Oakmark started buying banks at the time most people predicted Armageddon for bank stocks.

The risk was that banks would get over-regulated like Utilities which traded at 2x book value. At the same time, banks were in the process of repurchasing shares automatically increasing book value. The potential downside was limited which made them value buys.

Which sectors don’t get talked about in India these day? Or better yet, only get talked about negatively?

Deciding when to sell

When buying, Oakmark predicts seven years of operating earnings taking capital requirements into account and assuming similar valuations. They revisit the 7-year projection each year, and as long as the growth trajectory continues to be strong, they don’t mind holding stocks that have risen sharply

On their sell decisions: “We look to sell stocks trading at above 90% of fair value after buying them at 2/3rd (67%) of fair value”

There is a difference between deciding to add a new stock to your portfolio versus reviewing one that’s already in there. Defining your process leads to better decision-making

The crowd’s often right – get rid of losers early

When a stock falls 20% after you’ve bought, the typical value investor response is to buy more of it. Bill believes in doubling the scrutiny of the stock when it falls to understand if there was something you missed the first time because the stock might be falling for a good reason.

Before averaging down, study your track record to determine how often was that a winning strategy

Broadening your value investing horizon

Value investing discussions tend to be about “the usual suspects”. Reading about Warren Buffett tends to be like comfort food for value investors, even though you already know what made him successful after the first 2-3 books.

Bill has found it useful to read books by varying investors, hedge fund managers like Paul Tudor Jones, George Soros, Michael Steinhardt instead of reading “the 15th book on Warren Buffett detailing his breakfast habits”.