“The underlying principles of sound investment should not alter from decade to decade, but the application of these principles must be adapted to significant changes in the financial mechanisms and climate.”
- Benjamin Graham
“There are two ways to find and keeping your edge in investing. The first is locating and assimilating the best data available and then making the most intelligent decisions about individual companies and how successful they might be. This is damn hard. The second is having an emotional edge over the markets. This means keeping your head on your shoulders during bull and bear markets. This is even harder.”
- Austen Wheeler
Gaining in Edge in Investing
It is inevitable that during bear markets and periods of underperformance – both of which we face today at Nintai – value investors question whether they still have the edge over the more general markets. At times like this, we try to remain focused like Lou Loomis (played by Bill Murray’s brother, Brian Doyle-Murray) at the end of Caddyshack, waiting for the ball to fall into the cup. While the sturm and drang of the bear market roar around us, we are trying to remain focused on what gives us the edge (over the long term) against the broader markets.
We agree with the quote above that we have three possible edges when competing in the investing world. First, we choose to be value investors over any other strategy. At Nintai, we believe this is our fundamental edge. Before I get into the second and third edges, I’d like to briefly describe what I mean by value investing and how Nintai thinks about it as an investment house.
Value Investing as an Edge
I break the definition of value investing into three schools of thought. The first one is very traditional, sticking to some of the earliest writings of Benjamin Graham. This tends to focus on such strategies as investing in “net-nets,” companies where the share price is less than its net current assets. This method takes cash and cash equivalents at 100% of value and discounts other assets (such as inventory or receivables) to perceived value at the point of liquidation. The “net-net” calculation is achieved by deducting total liabilities from the (adjusted) current assets. These types of investments were easier to find during the 1930s Depression-era stock markets but can still be found today on such sites as Gurufocus.com. The second school of thought focuses on the capitation of specific valuation metrics. Examples include not paying more than twelve times earnings or two times book value. While considered less restrictive than the “net-net” school, this form of investing has gotten harder as the economy has moved from capital-intensive to asset-light business models. This has driven valuation metrics higher and forced this investment strategy to focus less on technology or healthcare toward industries such as manufacturing or energy. Unfortunately, investors with such focus have missed opportunities over the past few decades in some of the highest market gainers. The last school is value investors who have acknowledged many changes in the economy and markets but remain focused on purchasing companies at a substantial discount to their estimated intrinsic value. These investors (and we count Nintai Investments in this class) have seen the acceptable range of valuation metrics expand with time. Still, they believe it must reflect evolving business models and economic changes.
The edge gained by value investing is quite simple. Determining a company's intrinsic value gives us a rough (I stress roughly!) estimate of how much we should pay to buy a piece of that business. By incorporating a margin of error into our purchase price, a portfolio of quality companies, purchased at a discount to their intrinsic value, can outperform the general markets in the long term.
Information and behaviors are the second and third ways to gain an edge. I intend to briefly discuss the information edge in this article and follow up with potential behavioral advantages in my next article.
Using Information as an Edge
An informational edge can be obtained in several ways. The first, and one with clear legal consequences, is achieved through non-public proprietary means. Until the SEC promulgated Rule FD (Fair Disclosure) in August 2000, many investors could obtain an information edge by receiving information that might not be available to other investors. Combined with illegal insider trading, this type of information edge was powerful and seriously skewed returns. Not surprisingly, there have been some well-known hedge fund managers whose returns had a mysterious reversion to the mean after Regulation FD went into effect.
Having said that (and that certainly is not an investment recommendation!), there are still ways to achieve an information edge on individual companies or specific industries. These include deep industry expertise, sources of scuttlebutt, and paid third-party research. All three of these require a lot of work or money to achieve (and equally important, maintain).
Industry Expertise: At Nintai, before opening Nintai Investments, our staff were healthcare consultants for over twenty years, working with industry c-suite and Boards on strategy, financial models, and corporate operations. Our staff developed a deep knowledge of industry trends, systems players, and technologies during that time. This expertise allows Nintai to understand better what potential investment opportunities exist in the marketplace. For instance. Our investment in Veeva (VEEV) was predicated on understanding the depth of the company’s reach within the biopharma industry, including sales, promotion, research & development, and document management. Understanding the company's role in such vital issues as integrating DDMAC reporting requirements, FDA privacy regulations, and cross-functional content management allowed us to understand the business case and valuation assumptions better. Does that guarantee a better-than-average investment return? Not necessarily, but we think it gives Nintai a slight advantage in valuing the investment.
Scuttlebutt[1]: Phil Fisher believed that industry scuttlebutt was a vital tool in value investing. He wrote:
“The business grapevine is a remarkable thing. It is amazing what an accurate picture of the relative points of strength and weakness of each company in an industry can be obtained from a representative cross-section of the opinions of those who in one way or another are concerned with any particular company.”
The challenge in utilizing scuttlebutt is that it must be accurate and it must be timely. (It goes without saying that it must also be non-proprietary in the sense of SEC regulatory requirements). It’s incredible how much scuttlebutt can be acquired simply by keeping your eyes and ears open and your mouth shut. Within Biopharma, for example, the website CafePharma has a host of information openly discussed by industry workers and researchers. Here you might find that a vital new product is receiving horrendous reviews from high-prescribing physicians. Conversely, you might read that a key management figure is rumored to leave the company for its chief competitor soon. Knowing where this information can be found while staying clear of Regulation FD issues can give an investor a leg up on critical information about a potential investment.
Third-Party Research/Thought Leaders: Many organizations or individuals that know a great deal about industries or companies either sell their product (third-party research parties) or post their research/thoughts/comments on blogs free of charge or websites behind paywalls. A tremendous amount of information can be obtained free of charge. For instance, within the Biopharma space, Derek Lowe’s blog “In The Pipeline” is a first-class discussion of research and development within the Biopharma industry, including information on specific drug classes, FDA filings, and new drug launches. Derek writes with remarkable clarity and from an inside-baseball view, being a drug researcher.
Keeping up to date on all three informational edges can be a full-time job. At Nintai, we spend roughly 30-35 hours weekly on the three. We generally talk to 8-10 thought leaders, read approximately 10-12 scuttlebutt/thought leader blogs and websites, and thumb through 5-10 research reports each week.
Conclusions
Succeeding at value investing isn’t easy. If it were, many more people would be doing it. Achieving an edge takes developing and implementing a set process that must be followed day after day, month after month, and year after year. You don’t have to be a rocket scientist or have a genius-level IQ to achieve success. In this article, I’ve discussed how information can be gathered and used to get a leg up on other investors. Finding the best sources, testing the facts of those sources, and understanding why those facts are essential to a potential (or existing) holding can make you a better investor. The challenge is having the discipline to achieve it. In my next article, I will discuss how gaining an informational edge can be easier in some ways that acquiring a behavioral edge. Getting our minds to work in a manner to be a better investors can sometimes mean fighting against tens of thousands of years of neurological evolution.
As always, I look forward to your thoughts and comments.
DISCLOSURE: As of publication, Nintai Investments LLC and Mr. Macpherson’s personal investment portfolio holds Veeva in their respective portfolio.
[1] The butt was a keg used to serve liquid to sailors in the 18 and 19th century Royal Navy. A scuttle was a hole in the butt to draw out the water. The term scuttlebutt came about as a description of the place where sailors would inevitably exchange news or rumors.
- Benjamin Graham
“There are two ways to find and keeping your edge in investing. The first is locating and assimilating the best data available and then making the most intelligent decisions about individual companies and how successful they might be. This is damn hard. The second is having an emotional edge over the markets. This means keeping your head on your shoulders during bull and bear markets. This is even harder.”
- Austen Wheeler
Gaining in Edge in Investing
It is inevitable that during bear markets and periods of underperformance – both of which we face today at Nintai – value investors question whether they still have the edge over the more general markets. At times like this, we try to remain focused like Lou Loomis (played by Bill Murray’s brother, Brian Doyle-Murray) at the end of Caddyshack, waiting for the ball to fall into the cup. While the sturm and drang of the bear market roar around us, we are trying to remain focused on what gives us the edge (over the long term) against the broader markets.
We agree with the quote above that we have three possible edges when competing in the investing world. First, we choose to be value investors over any other strategy. At Nintai, we believe this is our fundamental edge. Before I get into the second and third edges, I’d like to briefly describe what I mean by value investing and how Nintai thinks about it as an investment house.
Value Investing as an Edge
I break the definition of value investing into three schools of thought. The first one is very traditional, sticking to some of the earliest writings of Benjamin Graham. This tends to focus on such strategies as investing in “net-nets,” companies where the share price is less than its net current assets. This method takes cash and cash equivalents at 100% of value and discounts other assets (such as inventory or receivables) to perceived value at the point of liquidation. The “net-net” calculation is achieved by deducting total liabilities from the (adjusted) current assets. These types of investments were easier to find during the 1930s Depression-era stock markets but can still be found today on such sites as Gurufocus.com. The second school of thought focuses on the capitation of specific valuation metrics. Examples include not paying more than twelve times earnings or two times book value. While considered less restrictive than the “net-net” school, this form of investing has gotten harder as the economy has moved from capital-intensive to asset-light business models. This has driven valuation metrics higher and forced this investment strategy to focus less on technology or healthcare toward industries such as manufacturing or energy. Unfortunately, investors with such focus have missed opportunities over the past few decades in some of the highest market gainers. The last school is value investors who have acknowledged many changes in the economy and markets but remain focused on purchasing companies at a substantial discount to their estimated intrinsic value. These investors (and we count Nintai Investments in this class) have seen the acceptable range of valuation metrics expand with time. Still, they believe it must reflect evolving business models and economic changes.
The edge gained by value investing is quite simple. Determining a company's intrinsic value gives us a rough (I stress roughly!) estimate of how much we should pay to buy a piece of that business. By incorporating a margin of error into our purchase price, a portfolio of quality companies, purchased at a discount to their intrinsic value, can outperform the general markets in the long term.
Information and behaviors are the second and third ways to gain an edge. I intend to briefly discuss the information edge in this article and follow up with potential behavioral advantages in my next article.
Using Information as an Edge
An informational edge can be obtained in several ways. The first, and one with clear legal consequences, is achieved through non-public proprietary means. Until the SEC promulgated Rule FD (Fair Disclosure) in August 2000, many investors could obtain an information edge by receiving information that might not be available to other investors. Combined with illegal insider trading, this type of information edge was powerful and seriously skewed returns. Not surprisingly, there have been some well-known hedge fund managers whose returns had a mysterious reversion to the mean after Regulation FD went into effect.
Having said that (and that certainly is not an investment recommendation!), there are still ways to achieve an information edge on individual companies or specific industries. These include deep industry expertise, sources of scuttlebutt, and paid third-party research. All three of these require a lot of work or money to achieve (and equally important, maintain).
Industry Expertise: At Nintai, before opening Nintai Investments, our staff were healthcare consultants for over twenty years, working with industry c-suite and Boards on strategy, financial models, and corporate operations. Our staff developed a deep knowledge of industry trends, systems players, and technologies during that time. This expertise allows Nintai to understand better what potential investment opportunities exist in the marketplace. For instance. Our investment in Veeva (VEEV) was predicated on understanding the depth of the company’s reach within the biopharma industry, including sales, promotion, research & development, and document management. Understanding the company's role in such vital issues as integrating DDMAC reporting requirements, FDA privacy regulations, and cross-functional content management allowed us to understand the business case and valuation assumptions better. Does that guarantee a better-than-average investment return? Not necessarily, but we think it gives Nintai a slight advantage in valuing the investment.
Scuttlebutt[1]: Phil Fisher believed that industry scuttlebutt was a vital tool in value investing. He wrote:
“The business grapevine is a remarkable thing. It is amazing what an accurate picture of the relative points of strength and weakness of each company in an industry can be obtained from a representative cross-section of the opinions of those who in one way or another are concerned with any particular company.”
The challenge in utilizing scuttlebutt is that it must be accurate and it must be timely. (It goes without saying that it must also be non-proprietary in the sense of SEC regulatory requirements). It’s incredible how much scuttlebutt can be acquired simply by keeping your eyes and ears open and your mouth shut. Within Biopharma, for example, the website CafePharma has a host of information openly discussed by industry workers and researchers. Here you might find that a vital new product is receiving horrendous reviews from high-prescribing physicians. Conversely, you might read that a key management figure is rumored to leave the company for its chief competitor soon. Knowing where this information can be found while staying clear of Regulation FD issues can give an investor a leg up on critical information about a potential investment.
Third-Party Research/Thought Leaders: Many organizations or individuals that know a great deal about industries or companies either sell their product (third-party research parties) or post their research/thoughts/comments on blogs free of charge or websites behind paywalls. A tremendous amount of information can be obtained free of charge. For instance, within the Biopharma space, Derek Lowe’s blog “In The Pipeline” is a first-class discussion of research and development within the Biopharma industry, including information on specific drug classes, FDA filings, and new drug launches. Derek writes with remarkable clarity and from an inside-baseball view, being a drug researcher.
Keeping up to date on all three informational edges can be a full-time job. At Nintai, we spend roughly 30-35 hours weekly on the three. We generally talk to 8-10 thought leaders, read approximately 10-12 scuttlebutt/thought leader blogs and websites, and thumb through 5-10 research reports each week.
Conclusions
Succeeding at value investing isn’t easy. If it were, many more people would be doing it. Achieving an edge takes developing and implementing a set process that must be followed day after day, month after month, and year after year. You don’t have to be a rocket scientist or have a genius-level IQ to achieve success. In this article, I’ve discussed how information can be gathered and used to get a leg up on other investors. Finding the best sources, testing the facts of those sources, and understanding why those facts are essential to a potential (or existing) holding can make you a better investor. The challenge is having the discipline to achieve it. In my next article, I will discuss how gaining an informational edge can be easier in some ways that acquiring a behavioral edge. Getting our minds to work in a manner to be a better investors can sometimes mean fighting against tens of thousands of years of neurological evolution.
As always, I look forward to your thoughts and comments.
DISCLOSURE: As of publication, Nintai Investments LLC and Mr. Macpherson’s personal investment portfolio holds Veeva in their respective portfolio.
[1] The butt was a keg used to serve liquid to sailors in the 18 and 19th century Royal Navy. A scuttle was a hole in the butt to draw out the water. The term scuttlebutt came about as a description of the place where sailors would inevitably exchange news or rumors.
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