I get a lot of emails asking the same question: just exactly
what kind of investor are you? The simple answer is: I'm the kind
of investor who likes to buy a consistently profitable company at
a low EV/EBITDA.
I've stuck fairly close to that approach. And, yet, that's
sometimes caused me to be clearly in value territory and
sometimes caused me to get emails asking if I'm really a value
investor at all. The fact that I'll happily buy a company with
negative tangible book value still shocks some true Grahamites.
I'll get to the idea in a minute - the very simple and very good
idea - of buying consistently profitable companies at low
EV/EBITDA ratios. First, I'd like to tackle the issue of
investment style. Can you have a clear style of your own - and
yet sometimes appear to be a value investor, sometimes a quality
investor, sometimes a contrarian investor, sometimes a net-net
In my experience, you can.
once said that all investing is value investing. And most
quantitative attempts to shove Buffett into a style box conclude
he is a high-quality investor rather than a low price investor.
Since he is a buy-and-hold investor, his portfolio is full of
stocks that are no longer cheap. A wonderful blog called "Value
and Opportunity" - it's one of my absolute favorites, you should
be reading it - demonstrated this quite clearly in this post.
I get a lot of emails from people who are confused about what
kind of investor I am. It depends on which articles of mine
they've read first and which they've read most recently. First
impressions are hard to shake. And for some readers my
"establishing character moment" was a micro cap - like
George Risk (
Ark Restaurants (
- two stocks I own now.
Others "met" me in print when I was writing about Japanese
net-nets. Or when I was writing GuruFocus's Ben Graham Net-Net
Newsletter. They naturally think of me as a net-net investor.
Someone who will buy any stock so long as it is cheap.
Then there was the time I bought
Barnes & Noble (
. If you read that article, you probably thought I was a
Finally, if you've been reading my articles for a really, really
long time - like way back in early 2009 - you'll remember me
owning stocks like
and IMS Health. These never qualified as value stocks on a
price-to-book basis. About the only justification a value
investor could find for buying them was a low
So what kind of investor am I? Do I simply change styles from
I have changed as an investor. But I haven't changed much - if at
all - since the 2008 crash. What has changed is where the
In 2009, a lot of stocks were cheap. I bought the stocks I liked
best. They were stocks like Omnicom and IMS Health and Berkshire.
Some of them were quite big. My usual diet is pretty micro cap
heavy. But if big cap stocks sell at low prices, I'm willing to
buy them too. Usually, they don't. In early 2009, some did and I
Am I a value investor?
Am I a micro cap investor?
Am I a domestic investor or a foreign investor?
Well, right now, I own two stocks: George Risk and Ark
Restaurants. They are both American stocks. They are both micro
cap stocks. And - on an EV/EBITDA basis - they both qualify as
So we could say I'm a U.S. micro cap value investor. I think
I've used this analogy before, so forgive the repeat. Here's my
idea on "investing styles." I don't think you can look at any
investor's portfolio at a single moment in time - and you
certainly can't look at just one position - and say what their
style is. That doesn't mean they don't have a style.
Basically, I think two investors - with different styles - can
own the same stock at the same time, for different reasons.
And I think a stock can fit more than one style.
The analogy I trotted out before - and am bringing out again - is
an author's style. One of the best known works of George Orwell
is "Animal Farm." It's a fairy tale. Yes, it's also an allegory.
And, yes, it's also a political book. But it's undeniably written
as a fairy tale. One of Charles Dickens's best knows works is "A
Christmas Carol." It's a ghost story.
Now, if you sat down each night for a year and read a fairy tale
a day and near the end of that year you picked up "Animal Farm" -
I think you'd find the flavor of that book kind of odd. Likewise,
if you read a ghost story a day for a year and near the end of
that year you picked up "A Christmas Carol" - I think it would
jump out at you as distinctive.
Well, that happens in investing all the time. Net-nets are a
great example. Everyone has an idea of what the net-net genre is
like - just as we've all got an exemplary fairy tale or ghost
story in mind - and a lot of what net-net investors come across
out there in the investing wilds match that image you've got in
But a lot doesn't.
There are many different flavors of net-nets. And some net-nets
are every bit as genre busting as "Animal Farm" or "A Christmas
Carol." They tick all the boxes that cause them to qualify as a
net-net. But they have other attributes that we'd consider odd.
Most net-nets are money losers - or at least lousy businesses.
However, there are actually a few net-nets (in fact, quite a few
in Japan) that earn money every year. Many net-nets face
technological change, legal problems, etc. Some seem perfectly
normal. Some - like
- are in businesses that have been around a long-time and will be
around a long-time. There is almost no risk of technological
Most net-nets are micro caps. But every so often something like
Ingram Micro (
ventures into net-net territory.
You can see this clearly if you follow blogs - like Oddball
Stocks and Whopper Investments - that cover net-nets. There are
some genre busting net-nets out there.
I think this happens with all stock genres. I just think it gets
noticed with net-nets because they have a clear technical
definition. Something either is or is not a net-net. If it is a
net-net and it has been profitable for 12 straight years, that's
strange and we notice it because we can't deny it's a net-net but
it just tastes wrong to us. It tastes too good to be a net-net.
Well, I think that happens with a lot of stock genres that have
squishier defining lines. And I think investors like
operate in those spaces.
What works in investing?
Studies show momentum works - but I know nothing about that. So
let's leave momentum aside. What else works in investing?
I can think of three things: quality, safety, and cheapness.
For me, these are the three corners of the stock style map. Most
stocks probably end up somewhere in the middle of that triangle.
A few are extreme examples that end up totally at one end. The
classic net-net tends to be an extreme example. A net-net is
cheap but it's not much else. It's usually not very safe or very
good. It's just cheap.
Cheapness is easy to define quantitatively. Academics like - or
liked, there may be some change over time here - the
price-to-book ratio. I'm not a big fan of price-to-book. I've
always thought enterprise value to EBITDA made much more sense.
First of all, only tangible book ever made sense to me. And,
secondly, price-to-book always included a rather unfortunate
leverage aspect. I'm not saying that an unleveraged stock that
trades below its tangible book value isn't cheap. I am, however,
saying that while EBITDA always matters - I'm not sure book value
does. In fact, I'm sure in many cases it does not.
For example, here are three stocks I think look kind of
interesting right now:
Weight Watchers (
John Wiley (
Dun & Bradstreet (
I think cash flow ratios show them for what they are - a bit
cheap on a leveraged (FCF basis) but just reasonably priced on an
unleveraged (EV/EBITDA) basis. I think price-to-book ratios for
these - and frankly, any stock with substantial internally
generated economic goodwill - is meaningless. And that's kind of
important because some of
's favorite stocks (Coca-Cola, Moody's, Gillette, etc.) are
stocks where price-to-book is meaningless.
I mentioned that I own two American micro caps right now: George
Risk and Ark Restaurants. In neither case would I ever make a
decision to buy, sell, or hold those stocks using book value as a
With some other stocks -
DreamWorks Animation (
International Speedway (
Berkshire Hathaway (
- I would use price-to-(tangible)-book as a reference point. But
that is only because in each case I believe the company has some
value not shown on the books. In other words, I'd be willing to
use price-to-book precisely because I think I know it's wrong.
This is a big problem in defining value investing. Some value
investors will tend to have high - possibly even "no meaningful
figure" - price-to-book ratio portfolios. Meanwhile, some other
value investors may have high EV/EBITDA portfolios but low
price-to-book portfolios. These are the guys who focus on asset
I think it's value investing either way. I believe in something
called asset-earnings equivalence. Physics has mass-energy
equivalence. And I believe business has asset-earnings
equivalence. I think that unless you really believe in
asset-earnings equivalence you'll be baffled by half the
investment universe. If you don't make asset-earnings equivalence
the foundation of all your thinking when you analyze businesses -
you're going to end up stuck entirely in an earnings value
mindset or an asset value mindset. And you'll think what the
other guy is doing isn't real value investing.
Finally, I think there's a third part to the story. The two
things that matter most are assets and earnings. We can measure
them both in value. But to do that we need to think in terms of
time. We want durable assets. We want stable and recurring
earnings. We want the future to be as good as the past - or
This is where the DCF usually comes in. I don't believe you need
to use discounted cash flows to figure out whether or not to buy
a stock. And I'm sure you are better off not using discounted
I've always found DCFs to be indeterminate. They lay out the
equation exactly as it must be. By definition, no one can argue
with a DCF. But they hinge on precisely those things that could
turn out either way. If your assumptions are correct, the value
is correct. But the assumptions can reasonably vary and in either
That part is key. It separates most DCFs from something like a
price-to-tangible-book approach to DreamWorks, Carnival,
International Speedway, and Berkshire Hathaway. In those cases, I
can't know the correct price-to-book ratio (because I don't know
the "normal" return on tangible equity going forward) but I can
determine the likely direction of my error.
At a price-to-book ratio of 1, the likelihood of undervaluing any
of those companies - DreamWorks, Carnival, International
Speedway, and Berkshire Hathaway - is much higher than the
likelihood of overvaluing them. So I can't come up with a number.
But I can determine an action. If they trade below book, I'm
justified in buying them.
There is a cheat here. And I think it's the one
uses. Buffett just bought Heinz. Yes, he lent some money as part
of the deal. But he still bought half the company - and while the
preferred is part of the story, there's no getting around the
fact he paid a high overall price for Heinz. Buffett said:
"We hope to own Heinz 100 years from now...If you own great
brands and you take care of them, they're terrific assets."
Here, the margin of safety is non-numerical. The business is
inherently safe. But he has no margin for error. If he is wrong
in his assessment of Heinz's future, there is no discount to
absorb the blow.
You have to be completely certain about a business's future to
pay a price like Warren Buffett did for Heinz.
I think most purchase decisions are better restated in these
terms than presented as an intrinsic value. If I was certain of
this business's future I would pay "x." I am certain this
business is better than most businesses and most businesses trade
for "x" times EBITDA - therefore, I can pay...
I think that kind of approach makes more sense in the real world
than a DCF does. And it's that approach - of trying to find an
above average business at a below average price - that I've used
when picking stocks.
Back to Buffett, and some simple arithmetic. If you were
completely certain of a business's future from now until the end
of time you could pay 12 times EBITDA.
That price - without using leverage - will tend to get you an
after-tax earnings yield greater than 4%. Historically, public
companies (if we use the Dow as a proxy) have been able to grow
around 6% a year. If you were a true buy-and-hold forever
investor buying a business with zero future uncertainty you could
pay 12 times EBITDA and still make 10% a year.
That's the definition of a pure "safety" investor in stocks. It
would be someone who only bought a business like Heinz.
I've never been able to do that. And I've never had much success
as a pure "cheapness" investor either.
Where I have had success is buying the highest quality net-nets
and highest quality low EV/EBITDA stocks I could find. What would
you call this? Value at a reasonable quality investor?
I don't have a word for it. But I know it works.
There are many measures of quality and safety. My preferred
metric is simply the number of losses going back as far as
possible in the company's history.
In other words, if you ever find a company trading at five times
EBITDA with 20 straight years of profits - you have my permission
to buy it sight unseen. A basket of ten such stocks will always
work out. Of course, in the U.S., there's probably only about ten
such stocks at any one moment in time.
Those criteria are probably a little too tough. But you can
generate a list of 100 to 200 stocks - at almost any time in the
U.S. - simply by limiting your shopping list to stocks with ten
straight years of profits trading at less than eight times
I think most investors would benefit from that simple blending of
genres - good enough and cheap enough.
A cheap business is one that trades for a low EV/EBITDA. A good
business is one that tends to always make money.
That's a simple definition of good and cheap. But in my
experience, it works much better than trying to maximize the
goodness (at any price) or cheapness (at any quality) of the
stocks you buy.
I don't have a name for buying an above average business at a
below average price. And considering how quickly dogma can attach
to a name - I'm not real eager to slap a label on the approach.
But if you want to know whether I'm a value investor or not - all
I can say is:
Is buying an above average business at a below average price
If so, I'm a value investor. If not, I'm not sure what I am. But
I'm sure I like it better than when I knew I was a value
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