“One of the most demanding times is when you underperform. Whether it’s an individual stock that drops by 30% in one day or the entire portfolio grinding down month after month, stress can reach an intolerable level. Nobody said this would be easy. I always think these are times to really review your process. Is there something you are missing? Are there inputs that might give slightly different or better insights? I also see this time as a teaching moment for my clients. Do they understand why I am underperforming? Am I explaining it well enough. Most importantly, do I understand why I’m underperforming?
- Ted Regina, PhD
One of the most overlooked sections in great value investing writing is Chapter 2 in Benjamin Graham and David Dodd’s classic “Security Analysis[1]”. Entitled “Fundamental Elements in the Problem of Analysis. Quantitative and Qualitative Factors”, the chapter is filled with insights on both an investor’s approach and views on data/information about possible investments. I think many investors prefer Graham’s “Intelligent Investor” because of its length (575 vs. 733 pages) and Warren Buffett’s very vocal support of Chapters 8 (“The Investor and Market Fluctuations”) and 20 (“Margin of Safety as the Central Concept of Investment”).
During times of underperformance I generally turn to the investment classics to clear my head of the worries, doubts, and emotions that come with it. And boy have I been reading a lot over the past quarter. Nintai and Dorfman Value holdings Novo Nordisk (NVO) down -36.4% YTD, Hargreaves Lansdown (HRGLF) down -38.4% YTD, Manhattan Associates (MANH) down -24.5% YTD, and T Rowe Price (TROW) down -11.6% YTD. Just a solid wall of red across the board.
Returns like this can make you question your investment process[2]. The pressure can get immense to tweak the system or make hasty changes to try to stop the losses. I know I’ve spent many days listening to quarterly earnings calls, reading through 10-Qs, and talking to customers of our holdings. But I think one of the more important things is to go back to Chapter 2 in Security Analysis and re-read it after taking a deep breath (and maybe pouring yourself a wee dram if that kind of thing works for you).
In this chapter, Graham and Dodd start out by discussing four fundamental elements necessary to answering this question: should security (S) be bought, sold, or held at this price (P) at this time (T) and by this individual (I)?
(S) The Security
Here Graham and Dodd look to answer three questions. First is defining the business. Do we understand how it makes its profits? Second, what is the price of the security? Are the terms offered going to provide us with an adequate return? Last, define the security itself. Where do we stand as share holders or debt holders? I would add one additional item - corporate financial statements. Investors should know these to an in-depth degree for each of their holdings.
(P) Price
Price is what you pay, value is what you get. How many times have we heard this phrase (far too many times in my view)? Graham and Dodd point out the danger of paying the wrong price is equal to buying the wrong issue. They end this section by saying, “…the new-era theory of investment left price out of the reckoning, and that this omission was productive of most disastrous consequences.” I couldn’t agree more. Which is what makes such significant price drops in my holdings so painful.
(T) Time[3]
Graham and Dodd point out that an investment can look vastly different depending on the time. Tech stocks certainly looked different in March, 1999 versus March, 2002. It’s important that your models work in most settings - such as 1999 or 2002 - and can adapt to new information. The authors state, “security analysis, as a study, must necessarily concern itself as much as possible with principles and methods which are valid at all times – or, at least, under all ordinary conditions.” Being able to adapt with the times is essential.
(I) The Individual
Before any investment is made, it should be assured it meets the investment criteria of the potential holder. I have been remarkably fortunate in having investment partners that have extremely long time horizons (such as the Nintai Charitable Trust) or individual investors with great patience. It is during periods like right now - when underperformance is a very real concern - that you find whether your investors’ needs are aligned with your investment approach.
Breath in Patience, Breath out….Profanity?
I’m not a real proponent of checklists. I understand their value to some – just ask any airline passenger flying with a captain who hasn’t done his pre-flight checklist. In general I’ve found that a structured process is better for me than the list. With the latter, too many times I became focused on one particular item at the expense of several others. Process looks at the process more holistically while the checklist is driven by data. I generally look for a process that keeps emotions in check allowing for a more integrated and objective look at the data. An old friend of mine said that problems begin when you don’t let the profanity out. This is what makes Security Analysis’ Chapter 2 so vital. In its own way it allows investors to expunge the fear and terror as they watch their investments drop in price (along with a steady stream of epithets).
Conclusions
Every investor will go through a dramatic period of underperformance in his/her career. It’s just a question of whose turn it is to be - as John Dorfman and I say– “in the barrel”. It’s safe to say the past 30 days it’s been this humbled writer’s turn to go over the falls. It isn’t very pleasant for me as an investment advisor and even less fun for my investors. The key is to avoid making any hasty decisions that assure locking in bad decisions through uncontrolled emotions. Each time I read Chapter 2 it allows me to reel these in and get back to basics. By answering Graham and Dodd’s question, I can feel comfortable the smartest move might be to do nothing at all.
As always I look forward to your thoughts and comments.
Disclosure: Nintai Charitable Trust is long NVO, HRGLF, MANH and TROW, as are some individual accounts at Dorfman Value Investments.
[1] “Security Analysis”, Sixth Edition, Benjamin Graham and David L. Dodd, McGraw Hill, 2009
[2] We can take heart in the fact 60% of all funds that outperformed their bogey over a 15-year period (1998-2013) underperformed in 7 of those years. See here for more information.
[3] Graham and Dodd are addressing more “timing” than “time”. Utilizing time as risk mitigation is an entirely separate concept deserving it’s own article.
- Ted Regina, PhD
One of the most overlooked sections in great value investing writing is Chapter 2 in Benjamin Graham and David Dodd’s classic “Security Analysis[1]”. Entitled “Fundamental Elements in the Problem of Analysis. Quantitative and Qualitative Factors”, the chapter is filled with insights on both an investor’s approach and views on data/information about possible investments. I think many investors prefer Graham’s “Intelligent Investor” because of its length (575 vs. 733 pages) and Warren Buffett’s very vocal support of Chapters 8 (“The Investor and Market Fluctuations”) and 20 (“Margin of Safety as the Central Concept of Investment”).
During times of underperformance I generally turn to the investment classics to clear my head of the worries, doubts, and emotions that come with it. And boy have I been reading a lot over the past quarter. Nintai and Dorfman Value holdings Novo Nordisk (NVO) down -36.4% YTD, Hargreaves Lansdown (HRGLF) down -38.4% YTD, Manhattan Associates (MANH) down -24.5% YTD, and T Rowe Price (TROW) down -11.6% YTD. Just a solid wall of red across the board.
Returns like this can make you question your investment process[2]. The pressure can get immense to tweak the system or make hasty changes to try to stop the losses. I know I’ve spent many days listening to quarterly earnings calls, reading through 10-Qs, and talking to customers of our holdings. But I think one of the more important things is to go back to Chapter 2 in Security Analysis and re-read it after taking a deep breath (and maybe pouring yourself a wee dram if that kind of thing works for you).
In this chapter, Graham and Dodd start out by discussing four fundamental elements necessary to answering this question: should security (S) be bought, sold, or held at this price (P) at this time (T) and by this individual (I)?
(S) The Security
Here Graham and Dodd look to answer three questions. First is defining the business. Do we understand how it makes its profits? Second, what is the price of the security? Are the terms offered going to provide us with an adequate return? Last, define the security itself. Where do we stand as share holders or debt holders? I would add one additional item - corporate financial statements. Investors should know these to an in-depth degree for each of their holdings.
(P) Price
Price is what you pay, value is what you get. How many times have we heard this phrase (far too many times in my view)? Graham and Dodd point out the danger of paying the wrong price is equal to buying the wrong issue. They end this section by saying, “…the new-era theory of investment left price out of the reckoning, and that this omission was productive of most disastrous consequences.” I couldn’t agree more. Which is what makes such significant price drops in my holdings so painful.
(T) Time[3]
Graham and Dodd point out that an investment can look vastly different depending on the time. Tech stocks certainly looked different in March, 1999 versus March, 2002. It’s important that your models work in most settings - such as 1999 or 2002 - and can adapt to new information. The authors state, “security analysis, as a study, must necessarily concern itself as much as possible with principles and methods which are valid at all times – or, at least, under all ordinary conditions.” Being able to adapt with the times is essential.
(I) The Individual
Before any investment is made, it should be assured it meets the investment criteria of the potential holder. I have been remarkably fortunate in having investment partners that have extremely long time horizons (such as the Nintai Charitable Trust) or individual investors with great patience. It is during periods like right now - when underperformance is a very real concern - that you find whether your investors’ needs are aligned with your investment approach.
Breath in Patience, Breath out….Profanity?
I’m not a real proponent of checklists. I understand their value to some – just ask any airline passenger flying with a captain who hasn’t done his pre-flight checklist. In general I’ve found that a structured process is better for me than the list. With the latter, too many times I became focused on one particular item at the expense of several others. Process looks at the process more holistically while the checklist is driven by data. I generally look for a process that keeps emotions in check allowing for a more integrated and objective look at the data. An old friend of mine said that problems begin when you don’t let the profanity out. This is what makes Security Analysis’ Chapter 2 so vital. In its own way it allows investors to expunge the fear and terror as they watch their investments drop in price (along with a steady stream of epithets).
Conclusions
Every investor will go through a dramatic period of underperformance in his/her career. It’s just a question of whose turn it is to be - as John Dorfman and I say– “in the barrel”. It’s safe to say the past 30 days it’s been this humbled writer’s turn to go over the falls. It isn’t very pleasant for me as an investment advisor and even less fun for my investors. The key is to avoid making any hasty decisions that assure locking in bad decisions through uncontrolled emotions. Each time I read Chapter 2 it allows me to reel these in and get back to basics. By answering Graham and Dodd’s question, I can feel comfortable the smartest move might be to do nothing at all.
As always I look forward to your thoughts and comments.
Disclosure: Nintai Charitable Trust is long NVO, HRGLF, MANH and TROW, as are some individual accounts at Dorfman Value Investments.
[1] “Security Analysis”, Sixth Edition, Benjamin Graham and David L. Dodd, McGraw Hill, 2009
[2] We can take heart in the fact 60% of all funds that outperformed their bogey over a 15-year period (1998-2013) underperformed in 7 of those years. See here for more information.
[3] Graham and Dodd are addressing more “timing” than “time”. Utilizing time as risk mitigation is an entirely separate concept deserving it’s own article.
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