We owned some financial companies that were affected more seriously than we had anticipated, and our results suffered in 2007 and early 2008. We learned to be more imaginative about what can go wrong in the world. We also learned the benefit of acknowledging mistakes and selling before the losses got worse.
We also averaged down fairly aggressively on positions we were most confident about. This exacerbated our paper losses during the decline but was very important to our strong recovery after the market bottomed.
Would you agree that most central banks are engaged in competitive devaluations now? And if so, how does that impact your investment process?
Our focus is on bottom-up stock picking rather than macroeconomic strategy. It seems clear that central banks are being extremely accommodative. You could look at this as competitive currency devaluation to stimulate exports and economic growth. Or as an attempt to rescue sovereigns that cannot pay their debts. Or as a means to prop up badly undercapitalized banking systems in various countries. We would expect financial “accidents,” where central bank activity proves ineffective and eventually has some inflationary consequences. This keeps us wary of credit and liquidity risk and focused on our companies’ ability to pass along price increases.
A number of value managers have performed poorly since the market bottomed in 2009; First Eagle, Tweedy Browne, Fairholme,and even Berkshire Hathaway have all underperformed the S&P 500. I can think of a couple of possible explanations. One is the fact that interest rates are artificially low and allowing marginal companies to survive. Or it could be the fact that the Fed is incenting investors to buy riskier assets, and that that has distorted markets and blurred the distinction between growth and value. To what do you attribute the fact that quite a large number of value investors have not done well over the last few years?
Except for a few cases of troubled financial stocks, I really don’t know what happened at other funds. Companies whose businesses were wounded by the recession may have been slower to recover, but it’s also possible that holdings of the highest-quality companies didn’t recover as fast because they didn’t go down as much.
Have you deviated all from the traditional Graham and Dodd approach over the last few years?
I don’t believe we deviated from our version of value investing (which I would describe more as “Buffett and Munger” than Graham and Dodd). We may have put more emphasis on quality and balance sheet strength than usual. As conditions change, we may have paid more attention to companies in different industries than we did five, 10 or 20 years ago. But the underlying basis for what we do has not changed. We want to buy understandable, predictable businesses that generate excess cash for their owners and that are managed by people we trust to redeploy that excess cash for the benefit of shareholders.