Notes on Brian Gaines of Springhouse Capital Management

Brian Gaines is an investor who runs an investment firm known as Springhouse Capital Management. His background includes experience in distressed debt on the banking side and also on an investment basis. His firm was founded in 2002 with seed capital from Joel Greenblatt who wrote You Can Be a Stock Market Genius and The Little Book That Still Beats the Market. Brian’s initial agreement with Joel Greenblatt allowed him to focus solely on investment research and to outsource all other aspects of the role to Gotham Capital. He has once said his view’s with Gotham Capital are well aligned and that they both look for “great ideas and focus on how you can get hurt.” My reason for writing about Brian is mostly personal interest which was sparked by reading two interviews’ he has completed in the past one was with Manual of Ideas in September 2009 and the other with Value Investor Insight in May 2006.

In short, his investment philosophy focuses on asymmetric investment opportunities where upside needs to be 50% while downside needs to be in the range of 20%. If a stock has 50% upside and 50% downside, why not just flip a coin and save the transaction fees. He has mentioned that he doesn’t believe in limiting himself to value or growth stories as upside can come from many different avenues. Brian likes to avoid situations where stocks are well covered, well known and where the bets you end up making are on whether the business is getting moderately better or staying better for a period of time. He has highlighted that this has generally driven him to invest in small-caps to micro caps but will still invest in large caps if an opportunity presents itself. His mandate seems to be all about being opportunistic, adaptable and flexible. I think he’s doing a lot of things right.

When evaluating a company he’s pursued the usual avenues that are required ie) reading 10-K’s/10-Q’s, speaking with management, reading transcripts and studying competitors. Brian also likes to look for differences between competitors, what each is pursuing and why it could be a good opportunity for the company. Multiples that he likes focus on include enterprise value over EBITDA less capital expenditure. Furthermore, he also likes to see returns on invested capital of at least 20% or ideally in excess of 30%. In a future post I’ll comb through his 13-F filing which updates his holdings each quarter.

Brian adheres to a concentrated portfolio management style where the top 10 positions can often make up 80% of his portfolio. As Howard Marks says “you can’t take the same actions as everyone else and expect to outperform.” To outperform any sort of passive investment portfolio you need to invest in assets that aren’t in that portfolio and you also need to weight them differently. In the manual of ideas interview he says “I know concentrated investing is out of style today as some high profile investors have had tough times, but it seems more appropriate than ever to wait for great situations and take oversized positions.” I think these words are as true as they were when he said them back in September 2009.

The most common theme from I had caught from his interviews was that managing emotions and impacts from market movements is a big challenge. If the market’s perception on an investment changes by +/- 50% it’s uncommon not to feel at least some pleasure or pain. In particular, losses tend to impact our egos more because having something then losing it is painful, especially if it’s not our choice. It’s been commonly quoted that that losses are twice as powerful as equivalent gains. Perhaps there is some logic to his 50% upside and 20% downside requirement for an investment.

His investment philosophy just seems very sound to me. Invests where there is little professional competition. Limit investments to what you can understand. Do the work yourself and be a perpetual student. Bet heavily when an opportunity arises. One that that was absent that some investors have tended to focus on lately is he doesn’t require catalysts to unlock value. Brian mentioned that often if there is a catalyst you have to pay for it. If an event is that clear to you why isn’t it clear to everyone else? Another element I think that was valuable within the interviews was how investors often draw circular conclusions from data or are impacted by halo effects. If a company is “bad” it doesn’t necessarily mean an investment is “bad.”

I’ll close with a brief quote from Brian Gaines he was asked about key lessons from working with Gotham Capital. “Don’t limit yourself in where you look for cheap stocks. Don’t be paralyzed by the fear of making a mistake. Understand the best opportunities usually carry more perceived risks, and distinguish carefully between the risks that matter most and those you can live with.”

Sources:

http://www.valueinvestorinsight.com/May2006Trial.PDF

https://www.manualofideas.com/members/pmr200909.pdf

http://csinvesting.org/wp-content/uploads/2016/02/THE-SEARCH-PROCESS.pdf

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Notes on Brian Gaines of Springhouse Capital Management

The Global View With Mohnish Pabrai And Guy Spier

Here are my notes from a recent interview on ET NOW with Mohnish Pabrai and Guy Spier. Link here for people who are looking to watch the full interview.

Discussion in the interview begins with the hosts concerns on how far the market has moved and if that is a concern for either of the guests. Pabrai doesn’t think those are really important data points to follow and that they can be more distracting rather than helpful. He recommends focusing on business fundamentals and limiting your opportunity set to companies you are able to understand well. If the market moves substantially higher or lower it isn’t really going to impact a valuation of individual business. Often the incentives of people discussing broader market movements are not aligned for the reader or viewer. They are often looking to get your attention for advertisement revenue, page views or likes. What people think will happen next quarter or next year on a macro basis just isn’t all that useful in my view.

The host then dug into the duo’s views on Trump. Spier started discussion with highlighting how it’s both difficult interpret political information and to also understand how markets will react. In the United States if you knew what trumps policies were going to be it would still have been difficult to understand all the second and third order impacts it would have on markets. One change to policy has implications in many places where people don’t initially think of but can still be important. Trump had recently tore up the Trans-Pacific Partnership and many people who are pro-trade were very outraged and really concerned about the direction the government was going. It turned out there was a very valuable silver lining because as a result of the USA removing itself as a trade leader of the world it opened an opportunity for others like China and India to lead. So to re-hash, optics were quite bad but resulted in a valuable rebalancing of power among the economic powerhouses of the world.

This followed with the ongoing passive vs active management discussion which appears to re-surface daily. Pabrai highlighted that for most people index funds are a great way to go. He agreed with Buffett’s recent writing on the topic as well. When you pay more in fees either to people who help you allocate the capital or from additional middlemen you will simply earn less of the underlying asset returns. The basic formula to be very wealthy is to save early in your life time, continue saving over a lifetime and continue to dollar cost average.  It’s a shame that some active managers make money off their investors rather than with them. I’m all for high fees where performance justifies it. Perhaps that means only using active managers where the competition is weak or non-existent. You need to play in games where it’s easy to win. Where are the forced sellers in investing?

The host then asks Pabrai and Spier if they focus on looking for 3-4 baggers in today’s environment or do they focus on a margin of safety for each investment. Pabrai says that if Spier tells him an idea that isn’t at least a 5x it would be waste of time. Pabrai uses an analogy from a Miller Beer commercial where the taste is great but the beer is less filling. Ie) good benefits but less cost. In investing you try to find similar situations where the potential is high and that you also have a built in margin of safety. For an investor to be successful at this they should look to limit risks of capital loss and retain high optionality. What this typically looks like for an investor is long period of inaction and studying followed by brief periods of activity when a mispricing occurs.

Next up was the automotive sector in India given Pabrai & Spier has made similar investments outside of the country. Pabrai said he had only purchased Fiat-Chrysler because of its very undemanding valuation at a P/E 1x in 2019 and that he hasn’t been able to find similar opportunities elsewhere. If Pabrai was an investor today in India he would spend all of his time on small publicly listed businesses and keep tearing them apart and trying to understand it all. What about airlines in India? There are some notable similarities and differences about the sector in India. The major difference was that fuel costs represent a higher proportion of total costs compared to the USA. Since oil isn’t very likely to move higher above $50-60/bbl a major component of costs for the sector are going to be relatively capped. Frackers have become the new swing producer in the world. Overall, the airlines in India aren’t as cheap and don’t have a similar opportunity in his view. That said they both discussed how the opportunity set is much larger in India than in developed markets. There are ~4,000 publicly traded businesses and over 90% of them aren’t covered well by sell-side analysts. This results in a wider dispersion of returns. That is what you want if you believe you have good judgement and an edge over your competitors. There is more of a chance for your head to get cut off but also to outperform meaningfully.

How do you evaluate commodity companies? Spier says to always focus on companies with the lowest cost of production as this increases odds that they will survive through the cycle. If this relative advantage is in place then you have an implied margin of safety. P/E’s of 1x are possible to find but only if you believe you can find them. Below a $100 million in market capitalization is a great place to start looking for these opportunities.

Pabrai then begins to talk about how patient Munger really is. He read Barron’s magazine for ~50 years and in most cases each issue had at least about 10 investment recommendations which means he read over ~26,000 recommendations without acting once. Then an opportunity presented itself with an obscure auto parts company which he made a $10 million investment. Based on Pabrai’s twitter account the company is Tenneco. The investment turns into $80-$90 million and Li-Lu turns it into even more. What Pabrai thinks you can learn from this is that you need extreme patience, like really just be able to watch the paint dry and keep looking for anomalies. If you study ~4,000 businesses in India for the next few years and eventually make 3-4 bets you are likely to end up with way more money than you can consume. Spier says there are two types of bears some that chase all the salmon in the stream while others just wait on shore ready to strike at what falls into their lap.

Then discussion about the insurance sector comes up, was there a similar opportunity in India? Spier talked about how he would really want to be comfortable understanding the management teams and their actions for a long period of time before he would invest money in the sector. It would only be clear over a long cycle which teams are taking appropriate risks and are well managed. Pabrai thinks the better question is “Where are the no brainer investments in India?” The insurance sector has grown at a very high rate over the past few years in India and as a result investor focus seems to already be on the sector. Pabrai thinks there could be opportunities looking back over time but they just aren’t that clear to him today. Up next was the technology sector which includes companies like Infosys. Pabrai thinks they could be reasonable investments but they don’t fall into the category of no brainers. He thinks changes to regulations make it too hard to tell where the company will be in 5 or 10 years’ time. There are also some headwinds as Trump is exploring changing the H1 Visa program and in some ways these technology companies are abusing the regulations. He thinks optimal policy in the United States would be to retain the best talent in the country. If the United States wants to be very competitive long term one lever they can pull is to dramatically increase the amount of immigrants they allow into the country from today’s 65-80 thousand cap today and make it up to half a million. If these individuals are well educated, and able to contribute it could do wonders for the economy there. Pabrai thinks the American government should tighten regulations and limit what could be done elsewhere. Other places in the world such as Canada are working on building similar hubs to service US businesses, the example he used was Vancouver, Canada.

The conversation closed with the two guests highlighting again of the world of opportunity in India for investing and that competition in Western Europe and USA is just disproportionately higher.

If you are looking to learn more about Mohnish Pabrai or Guy Spier i’d recommend both of their books. Click here to purchase The Dhandho Investor  and The Education of a Value Investor: My Transformative Quest for Wealth, Wisdom, and Enlightenment

Hope this helps, let me know if you have any feedback or commentary

The Global View With Mohnish Pabrai And Guy Spier

Notes From Nate Tobik’s interview on Planet Microcap Podcast

Notes From Nate Tobik’s interview on Planet Microcap Podcast

https://planetmicrocap.podbean.com/e/ep-37-banking-sector-and-investing-books-with-nate-tobik-founderceo-completebankdatacom-and-author-oddballstockscom/

I made some brief notes on a recent podcast Nate Tobik had on the Planet Microcap Podcast. Nate runs the “oddballstocks.com” blog which I love to read and he also runs “completebankdata.com”. I’ve enjoyed his writing for some time and hope you find some value in the notes below.

Nate’s background is in computer science but has managed to self-learn the most important things in investing. He highlighted he hasn’t taken formal economics, finance or banking course but from what I may have read elsewhere has completed 1 or 2 levels of the CFA program. He also mentioned that his investing style has evolved over time and at points in time included a focus on spinoffs, net nets and compounders.

Later on he recommended the investment classics. I can’t recall which books if any he recommended but when I think of investment classics I think of Security Analysis, Common Stocks and Uncommon Profits and You Can Be a Stock Market Genius. Books should be re-read in an attempt to absorb what you may not have understood the first read or what may not have initially spoken to you. Shane at Farnam Street also recommends this and is also a big fan of the Feynman Technique. I agree with both of them, the more active of a reader you are the more you have the potential to retain and understand. Without retention or understanding what’s the point of reading anyways. Writing about what have read could be helpful as well.

Then Nate and the host get into his views on banks. This was one of my favorite parts of the interview. To start they discuss how accounting for banks is quite different compared to industrial or brick and mortar businesses. In simple terms banks take deposits and loan proceeds to businesses and individuals at a higher rate. Since US disclosure requirements are very standardized it’s very easy to compare particular details from each bank. One of the unique aspects of a bank is that it can give you specific regional exposure and the exposure that you do obtain is driven by the success of small businesses in the area. Let’s say you are looking for exposure to central Omaha, it just might be possible. Banks are leveraged institutions so it is important that the managers have good skill and/or systems in place to manage risk and lend prudently. The majority of the businesses in the world are private and as a result banks are one of the few ways to obtain indirect exposure to these assets. When evaluating a bank you want Net Interest Margins (NIM) to be positive and relatively low non-interest expenses compared to revenue (Efficiency Ratio). A 1% return on assets is a good anchor to keep in mind when evaluating the quality of a bank’s assets. Take the ROA * Assets / Equity to arrive at an ROE. Return on Equity target of ~10% is reasonable in Nate’s view. If banks have a significant amount of assets from businesses this may be a good sign because commercial deposits usually require little to no interest which results in an attractive funding base. The next higher cost accounts are chequing and then savings accounts for individuals. In today’s low rate environment banks that do not understand how to lend prudently have made very long term loans and results in significant yield curve risk. Overall, Nate recommends that people own a basket of banks rather than just one “perfect” bank.

On screening – He likes it and uses various tools to help him screen. Nate stated that everyone uses a screen of some sort to find ideas whether it’s a news article, podcasts, Wikipedia or Bloomberg machine. Nate likes when people he admires as an investor already own a stock despite the potential risks of confirmation bias and group think. He thinks watch lists are misused by investors at times because only few investors need to be invested at all times. Taking a more patient view and attempting to evaluate how a business has changed is probably more worth the effort in my view.

Nate’s favorite “dead money” stock idea is Hanover Foods. It’s a frozen food supplier to grocers and other businesses. They trade at 0.3x book value and a low single digit multiple of current earnings. Management has paid itself lavishly for a long period of time while there are also some issues with the controlling family. Despite the very high compensation book value is still growing and the business is still profitable. They already own a jet and he doesn’t think compensation can go substantially higher than today. He thinks it’s a reasonably good investment but the enemy of this type of investment is boredom. You just have to wait. No other way to approach it.

To close the conversation ended with Nate saying that when you know the least, is typically when you think you know the most. It’s over time that many people see how little they used to know and they begin to expand their understanding how truly little they understand today. Keep reading, thinking and trying to figure it all out.

 

Notes From Nate Tobik’s interview on Planet Microcap Podcast

Markel Q4/16 Conference Call Excerpt

“First, we earned 13% on our equity investments during the year, which exceeded the S&P 500 return of 12% by 100 basis points. More important than any one year though is the longer-term record. With the 2016 results on the books, we now enjoy a 27-year record of excellent equity investment returns with that 100-basis-point advantage in place for 27 years now.”

  • Over 27 years 100 basis points is quite a big difference but I bet most people would underestimate the power compounding can have on an investment. Using a 10% vs 11% return over 27 years results in a 28% difference in the ending sum. Small changes add up to very big things. I recently watched a Chuck Akre interview on Wealthfront in which he highlighted his own focus on investing in businesses which have an ability to reinvest free cash and capitalize on internal tax efficient compounding opportunities.
Markel Q4/16 Conference Call Excerpt

Jeff Ptak

In Late 2016, Jeff Ptak of Morningstar was recently interviewed by Patrick O’Shaugnessy to talk about Active investment management. I enjoyed the conversation and thought Patrick had a number of good questions. If you are interested in learning more about Jeff you can find some of his additional work which is published on the Morningstar website here. These are my notes from the podcast hopefully these are of some help to you. If you have any feedback please send my way.

  1. When evaluating investment products never overlook the associated fees. Choose low cost over high cost in most cases. Passive ETF’s and mutual funds have been winning market share over the past few years owing to increasing investor allocation to lower cost products. As a result you have seen mutual fund fees drop from large investment managers such as RBC Asset Management, and Investors Group.
  2. Look for investment managers who have low portfolio turnover. High portfolio turnover implies more of your own capital will be paid in fees all else equal. In my view, managers who don’t trade often have higher conviction when they do trade and are potentially doing more in depth research when allocating capital. Perhaps they are looking for the right opportunity each time they allocate rather than just today’s opportunity.
  3. Look for investment managers who are meaningfully invested in the products themselves. Alignment in incentives between any Principal and Agent is required for an agreement to work. If anyone is aware on how to find out easily how much a manager owns of a particular mutual fund I would be interested in seeing the data.

A few investment managers Jeff highlighted as strong included Sequioa, Capital Research Group and Dodge & Cox. While investment managers who he thinks have more structural problems includes Third Avenue which has faced some issues with generational transfer to the new group of managers and a blow up on its Focused Credit Fund.

The most interesting investment manager he’s worked with was PrimeCap Management, who is led by Theo Kolokotrones and Joel Fried. Jeff mentioned he really enjoyed the conversation between these two and noticed a stark difference in the amount of time they were willing to spend explaining their business and how they think about it. Theo/Joel discussed culture, generational transfer, capacity to invest, how they teach new analysts and optimizing incentives for employees. One unique aspect at PrimeCap appeared to be how analysts get to run a small component of the actual portfolio which was utilized to better incentivize analysts. A short excerpt on the company’s investment philosophy is pasted below.

“Four key principles guide PRIMECAP Management Company’s approach to investment selection: commitment to fundamental research, long-term investment horizon, emphasis on individual decision-making, and focus on value.

First, PRIMECAP Management Company is committed to fundamental research. The primary objective of its research is to develop opinions independent of Wall Street and to understand the companies it follows as well as any industry analyst. The firm looks for stocks where it believes the underlying company’s long-term fundamentals will evolve significantly better than the current Wall Street consensus or valuation suggests. This can be a function of greater expectations it has for new products, new markets, new management, restructuring, a structural shift in demand or supply, or other changes in industry dynamics. The firm’s research involves interacting directly with the companies it is reviewing as well as their competitors, suppliers, and customers.

Second, PRIMECAP Management Company takes a long-term perspective. The firm looks for stocks that it believes will outperform the market over a three- to five-year time horizon. Portfolio managers strive to recognize values early and patiently wait for the market to reach a similar conclusion. Often, the search begins with companies and industries that are currently out of favor among investors. Consequently, PRIMECAP Management Company’s investment ideas are frequently early. However, if the firm believes that the long-term thesis is intact, conviction derived through its research efforts gives portfolio managers the fortitude to stay the course when the near-term fundamentals are challenging.

Third, PRIMECAP Management Company emphasizes individual decision-making. The firm shuns “group think” and committees whenever possible and relies on individual decision-making in its investment process. The firm believes that individuals, not committees, generate the best investment ideas.

Fourth, PRIMECAP Management Company believes the key to successful investment decisions rests in correctly appraising the relationship between the fundamental value of a company and the market price of its stock. In its judgment, a stock has the potential to be a good investment only if it is purchased at the right price.”

The conversation of hedge funds and their associated fees also came up. If you already make 2% on AUM why would you really care about the 20%. Well I think if you are an emerging hedge fund the 20% on relatively small AUM can keep you focused on delivering returns. In a best case scenario, this would engage an investment manager to think about the market opportunity they have to access and would hopefully drive them towards limiting AUM growth.

That’s all folks. If you’ve read something good lately send me a note or drop a link in the comments. Thanks for the time.

Jeff Ptak