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This is written with serious investors in mind. I'm a former reporter, private investigator and institutional equity analyst who digs deep to find niche undervalued and undiscovered securities. I manage money for individuals, institutions and family offices via my business Long Cast Advisers. This blog is part decision-diary, part investment observations and part general musings about Philadelphia sports. It should not be viewed as a solicitation for business or a recommendation to buy or sell securities.

Tuesday, August 14, 2012

The analyst as philosopher and fisherman

A stock picker is a bit philosopher and a bit fisherman. A philosopher in respect to the search for "truth" (ie. value) and a fisherman in respect to finding value in a sea of stocks. 

Just as the rod does not make the fisherman, neither does a degree in finance, CAPM or excel make one a stock picker. It's easy to forget - in the age of "one size fits all" tools like CAPM - that value, truth and fishing are also highly personal. 

The philosophy behind CAPM is quite incredible and my disdain for it is not without recognition for what it aims to achieve; an objective definition of value. It tells the truth! ... not based on the "eye of the beholder" or a comparative valuation analysis or a historical study of multiples, but on the present value of future cash flows, discounted back at some rate. 

Just pretend CAPM isn't susceptible to changes in expectations, like what future cash flow looks like, and its a tool that works everywhere! 

Or not. 

In my opinion, the individual styles of value makes the markets much more fascinating. What investors will pay for growth or value, as a multiple of EBITDA, EPS, free cash flow, square feet, RevPAR, etc is all a private choice, based on comfort and expectations, and it changes over time. 

A detailed model is nice, and anyone can calculate odds with reasonable certainty but - I know this goes in the face of truth seekers everywhere - common sense, an understanding of management's strategy, a  few years of 10Q's, K's and proxy statements is more then sufficient for a stock picker to succeed. 

Except for one thing; every few years new technologies come around that disrupt the industry. ETF's and high frequency trading are doing to the stock picker what trawling and draglining has done to fisherman. 

In a proximate sense, HFT obviates fundamental methods and raises the cost of business for those who want to keep up and grow assets as quickly (get a bigger boat). 

For now, therefore, I think it's inevitable that stock pickers will lose market share to the index funds. 

But as the the pendulum swings towards undifferentiated buying, it might in fact put a premium on those stock pickers who stick to their knitting, deeply understand businesses and industries and know how to acquire them at low prices with low correlations to the overall market. 

In short, investors seeking differentiated ideas and differentiated returns will have to search a little harder for differentiated stewards of their hard earned capital.  

My long held philosophy - and many others' - is that the costs of buying shares of publicly traded companies will always be lower than the costs of replicating said businesses on my own so I make my business looking for other great businesses run by great managers doing interesting things profitably and I buy their shares when I think they are trading at reasonable prices, owning them as part of my own business, growing with them as they grow, keeping part of the cash flows or simply waiting for others to recognize the underlying value. 

It is a long term approach but it is my harbor and haven from the turbulence of undifferentiated programmatic trading and ETF indexing. 

It's hard to fish in a storm tossed sea but having a portfolio of great businesses run by great managers doing interesting things profitably and acquired at low valuations will be a steady boat through all conditions. 

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