“There is the great line that to finish first you must first finish. To do that, you have to stay on the road. You have to have guardrails that prevent you from driving into the woods. Another phrase is you can’t see the forest through the trees. To confuse the hell out of you all, I’m going to mix metaphors. You won’t finish first if you drive off the road into a bunch of trees. That’s bad. Really bad. So make sure you stay on the road and make sure you don’t mix metaphors. Screwing up either of these never ends well.”
- Steven Harcourt
One of the things I think most underestimated is that successful investors have strict value-based guidelines. That doesn’t mean their investment criteria is necessarily strict (though it might be). It means the tools they use to help structure their strategy are strict. An analogy might be driving on the highway. The guardrails play a vital role of keeping you on the road and headed for your destination. These guardrails are immovable. How fast you drive, whether you pass someone or not, or what type of gasoline you use is entirely up to you and dependent upon your time to destination, the weather, or even how you are feeling that day.
Many great value investors have their own guardrails. Some of these include margin of safety, or staying within your circle of competence. Whatever it might be, most investors will find that a similar structural framework will help guide them in reaching their investment destination. At a recent conference, I struck up a conversation with a very successful value investor who has outperformed the markets for roughly three quarters of any 5-year rolling period between 1980 - 2016. When I asked him the secret to his success he said there are two things to always bear in mind.
Never Stray From Your Framework
This individual has four key theses that he says guides him and his firm in everything from asset allocation to investment selection to business operations. He says he developed these over time to reflect his strengths and weaknesses. These four values are non-negotiable from his and his organization’s standpoint. He refers to them as his foundational guide posts. In the conversation he went on to say:
“These four guide posts corral our thinking, our operations, and our decision making. Having something that maps out your path and gently reminds you (and sometimes NOT so gently) to stay on the straight and narrow has been a big part of our success. We have a lot of flexibility at our firm – from our investment style mandate to our work-from-home-policy. But every one of those flexible policies can be traced back to the four values. Those never change and are never negotiable. They are our guiding light”.
Trace All Your Decisions Back to Your Guidelines
The second item for this investor was the fact that all of his company’s strategy, operations, and decision processes flow from his four theses. As a professional money manager, I’ve tried to build everything about Nintai Investments LLC around my own guidelines. When I started the firm, the Board and I decided there were two sets of theses (or guardrails) that would drive the business. The first set centered around the type of company I wanted to work for and offer to my employees, investment partners, Board of Directors, and greater community where we live and work. I’ve touched on those previously, so I will pass on any discussion specific to these. The second group of guidelines helps create a structure around our investment philosophy, portfolio selection, and capital deployment. Everything we do in portfolio management can be traced back to these guidelines – our stress on high returns on capital, low or no debt, deep competitive moat, and purchasing with a considerable margin of safety.
Nintai’s Guidelines: GPS (More than Roadside Assistance)
After our first Board meeting, it was brought up that it might be helpful to create an acronym for our investment guidelines - something pithy that could make it easy to remember. After considerable time (and a not so inconsiderable amount of libations) we developed the acronym GPS. Not only does it automatically make one think of guidance and direction, the letters also happened to represent the three guiding values in our investment policies.
To most GPS means Global Positioning Service. It is a satellite-based system created by the United States government (and now greatly enhanced by both private and international government efforts) to assist in defining one’s location speedily and accurately. At Nintai Investments, GPS is an acronym for the three major pillars in our investment process. First, we seek companies with a systems or platform-based approach to their customer. We look for companies that seek to embed themselves within their customers operations and/or marketplace. We like to see the company have an agnostic approach to technology. This allows for sales in new product niches or adjacent markets regardless of the legacy technology applications or systems. This assures (G)rowth. Next, we try to find companies that earn high returns on capital - considerably higher than their weighted average cost of capital - and then hold on to them for extended periods. When we can find managers who are outstanding allocators of capital – and give them a long stretch of time to produce – this gives us our best chance at long-term (P)rofitability. Finally we look for companies with a high conversion of revenue into free cash and no debt. Companies with such strength on their balance sheet and statement of cash flows have great strategic flexibility (particularly in down markets). They are rarely forced to make poor capital allocation decisions that can permanently impair our customers’ capital. This assures (S)afety.
We see this three-legged guideline approach to our investment process as a means to sleep well at night regardless of market conditions. Additionally, the broader role of the GPS acronym gives our investment partners a simple - yet effective - tool to remember how Nintai structures its investment decisions.
No matter how long you’ve been in the investment management business, times of market highs or severe drawdowns can distract you very quickly from your investment strategy and processes. Knowing your guidelines and building your investment processes around them can help you stay focused in times of real market stress. The ability to go back and draw on your core values and apply them quickly and easily can make or break your investment returns over the long term. Spending some time drafting up your investment guidelines then mapping your investment processes against them can be a great tool to better understand how you might react in times of crisis. In these days of Twitter announced (and canceled) tariffs, Federal Reserve policy reversals, and potential economic conflicts, it can’t hurt to have something that anchors your emotions and investment decisions.