Investing with Anthony Bolton
Anthony Bolton writes on the lessons he has learnt in his career at Fidelity and value investing.
“Investment is not an exact science, and I know of no successful professional investor who has not had to learn from experience the many pitfalls that lie in wait. Over the course of my 26 years in charge of Special Situations, I have had plenty of time to reflect on the factors that matter in becoming a successful stockpicker. These are some of the lessons that I have taken from experience:
Understand the business franchise and its quality
Businesses vary greatly in their quality and sustainability. It is essential to understand the business, how it makes money and its competitive position. Like Warren Buffett, my ideal is to find businesses with a valuable franchise which can sustain the business over many years. A simple question I ask is: how likely is the business to be here in ten years time - and how likely is it to be more valuable than today?
Understand the key variables that drive the business
Identifying the key variables that affect a company's performance, and in particular those that it cannot control, such as currencies, interest rates and tax changes, is essential to understanding a share's dynamics. To my mind an ideal business is one that is largely in control of its own destiny. I remember the opposite of this, a UK chemical company I met a few years ago. At one exchange rate it had a prosperous business: but at a higher value of sterling it was totally uncompetitive and possibly had no business at all.
Favour simple over complex businesses
If a business is very complex, it will be difficult to work out if it has a sustainable franchise. It may need experts to spot a flaw. The ability to generate cash is a very attractive attribute: in fact, the most favourable of all attributes. All else being equal, companies that need a lot of capital expenditure to keep going are less attractive than those that don't. A private equity specialist once told me the stock market overvalues growth and undervalues cash generation. Private equity investors do the opposite. On this measure I'm on the side of the private equity investors.
Hear directly from the management
Candidness and lack of hyperbole are the key management attributes to look for. In my experience, second hand information is always inferior to first hand information. Having met hundreds of companies in many different industries over the years, the thing I value most is hearing a candid, balanced view of a business. That means the minuses as well as the pluses (all businesses have both). I like managers who do not overpromise but then consistently deliver a bit more than they indicated. Be most wary of those who promise the sky, they are unlikely to deliver. That said, I am in the Warren Buffett camp in that I would rather have a great business run by average management than a poor business run by stars.
Avoid 'dodgy' managements at all costs
I used to think the dynamics of a strong-looking business would make up even for 'dodgy' management. Having invested in a few companies that have subsequently 'blown up', managements that are either unethical or that sail close to the wind are now complete no-go areas for me. What I've learnt is that, even with corporate governance checks and outside accountants, there are too many ways that senior people can pull the wool over an investor's eyes. Several years ago an Italian contact told me, helpfully, not to touch Parmalat for this reason. It turned out to be an excellent piece of advice. As Warren Buffett says, the CEO who misleads others in public may eventually mislead himself in private (as you are by now well aware I am, like many others, a great Buffett fan. The Berkshire Hathaway annual reports are a treasure trove of investment advice and financial wisdom).
Try and think two moves ahead of the crowd
Try to identify what is being ignored today which could re-excite interest in the future. The stock market doesn't look very far ahead and therefore, somewhat like chess, looking a bit further out than others often can pay dividends. I think I'm good at knowing the types of situation that will excite investors, where there can be 'blue sky' in the future. I will try to find companies where this is currently being ignored but in my view will impact investor psychology again in the future.
Understand the balance sheet risk
If the stockpicker has to learn only one lesson, this has to be near the top of the list. If investment is about limiting the downside and avoiding disaster, then taking on balance sheet risk should only be done with one's eyes open. Balance sheet risk has been the most common factor behind my worst investments. In my experience, most analysts are poor at assessing this risk and many do not analyse balance sheets at all. As well as debt in its various forms, one needs to be able to analyse pension fund deficits and value redeemable convertible preference shares where there is little likelihood of conversion. Both these have a number of characteristics in common with conventional debt.
Seek ideas from a wide range of sources
I like lots of ideas from sources I believe to be well informed about particular companies or industries. The more there are to pick from, the more chances you have of finding a winner. The most obvious sources are not always the best. I particularly like sources not widely used by most institutions. On the other hand I'm not proud and pinching an idea from a competitor whom I rate is just as acceptable to me as from a stockbroker!
Watch closely the dealing by company insiders
No indicator is infallible, but dealings by directors of companies are a valuable confirming or non-confirming tool, particularly look for multiple transactions. Buys are generally more important than sells and some directors have better records than others.
Re-examine your investment thesis at regular intervals
Investment management is all about building conviction for an investment opportunity and then re-examining this conviction over time, particularly when new information arises. Conviction or strength of feeling is important and should be backed. However, conviction must not develop into pigheadedness. If the evidence changes, so should one's views. At any point you should be able to summarize the reasons you own a company's shares in just a few sentences.
Forget the price you paid for shares
The price you paid is totally irrelevant; it is only psychologically important. Have no hesitation in cutting losses if the situation changes. A classic example of this was Deutsche Babcock, a German engineering conglomerate that was involved in a number of areas, including shipbuilding. Our analyst who covered the stock came into my office one morning in a very excited state. The chief executive, whom we admired and who had a good record, was leaving the company. He was also planning a management buyout of its best division, shipbuilding, which was the prime reason we owned the shares. I immediately told our trading desk to sell the whole position, aggressively if need be. Although I took a big loss on the position, a few months later the receivers were called in.
Past performance attribution is generally a waste of time
If life is about making mistakes and learning from them, so too is the stock market. However, performance attribution, the business of analyzing in detail which stock or industry 'bets' a manager has made relative to an index or benchmark, has become very fashionable. However, as it mainly involves looking in the rear view mirror, it tells you nothing about the future. I recognize that with balanced mandates, some attribution is necessary and customers such as pension fund trustees require it.
Too often however, the tendency is to believe the immediate past is going to be repeated in the future. When one is not doing well, to be constantly reminded of the fact by consultants is rarely a help, and in fact may well be counter-productive! Temperament is important. If you are a manic depressive, don't think of becoming an investor. It is important to treat success and failure with equanimity. On the other hand, analyzing your mistakes ("why was I wrong and were there ways of predicting this?") is different and very worthwhile.
Pay attention to absolute valuations
Investors need some sort of reality check to avoid their being sucked into a stock at times of great exuberance. Looking at absolute valuations at times like this will help. I like to buy stocks which within the next two years you can see will be on a single figure price-earnings multiple, or have a free cash flow yield that is well above prevailing interest rates. If you only look at relative valuations, how stocks compare to each other, you can go seriously astray.
Use technical analysis as an extra indicator
I could write a whole chapter on the use of technical analysis (and one day maybe I will). I know it excites widely different views amongst investment professionals. Some are passionate exponents, while others see it as nothing more than hocus pocus. I view it as a framework for help in decision-making. It is one of the factors which helps me decide the size of bet I take. I use it as a confirming or denying factor. So if the technical analysis supports the fundamental analysis, I will be prepared to take a bigger position. If it doesn't I will take a smaller position. I will also re-examine my fundamental views to check we are not missing something if the technical situation deteriorates. I find it more useful the bigger the market capitalization of a company.
Avoid market timing and major macro bets
I want to place my bets where I believe I have a competitive advantage. Many commentators have written over the years of the difficulty of timing the market consistently. I've only had a strong view about the level or direction of the market perhaps five or six times in the last 26 years. The occasions when I have had such strong views (bullish in March 2003, bearish in March 2006) do seem to be coming more frequently recently - maybe it's to do with getting old! Even then, I certainly wouldn't bet my whole fund on such a view. A time I might add a macro input is when I am trying to decide between two shares in an industry, where I think both are fundamentally attractive, but I only want to buy one. A macro view may then be the deciding factor in which to buy (say one benefited from a strong dollar and one did not).
Be a contrarian!
If the investment feels very 'comfortable' you are probably late. Try to invest against the crowd. Avoid getting more bullish as the share price rises. When nearly everyone is cautious about the outlook, they are probably wrong and things are going to get better. Equally, when very few are worried that is the time to be most wary. I've found the times I can be the most help to some of my less experienced colleagues is when there is great optimism or pessimism. This is when I remind them that the stock market is an excellent discounting mechanism. By the time everyone is worried about something it is normally largely in the price. Investors need to be constantly reminded that this is how markets work.”
Anthony Bolton writes on the lessons he has learnt in his career at Fidelity and value investing.
“Investment is not an exact science, and I know of no successful professional investor who has not had to learn from experience the many pitfalls that lie in wait. Over the course of my 26 years in charge of Special Situations, I have had plenty of time to reflect on the factors that matter in becoming a successful stockpicker. These are some of the lessons that I have taken from experience:
Understand the business franchise and its quality
Businesses vary greatly in their quality and sustainability. It is essential to understand the business, how it makes money and its competitive position. Like Warren Buffett, my ideal is to find businesses with a valuable franchise which can sustain the business over many years. A simple question I ask is: how likely is the business to be here in ten years time - and how likely is it to be more valuable than today?
Understand the key variables that drive the business
Identifying the key variables that affect a company's performance, and in particular those that it cannot control, such as currencies, interest rates and tax changes, is essential to understanding a share's dynamics. To my mind an ideal business is one that is largely in control of its own destiny. I remember the opposite of this, a UK chemical company I met a few years ago. At one exchange rate it had a prosperous business: but at a higher value of sterling it was totally uncompetitive and possibly had no business at all.
Favour simple over complex businesses
If a business is very complex, it will be difficult to work out if it has a sustainable franchise. It may need experts to spot a flaw. The ability to generate cash is a very attractive attribute: in fact, the most favourable of all attributes. All else being equal, companies that need a lot of capital expenditure to keep going are less attractive than those that don't. A private equity specialist once told me the stock market overvalues growth and undervalues cash generation. Private equity investors do the opposite. On this measure I'm on the side of the private equity investors.
Hear directly from the management
Candidness and lack of hyperbole are the key management attributes to look for. In my experience, second hand information is always inferior to first hand information. Having met hundreds of companies in many different industries over the years, the thing I value most is hearing a candid, balanced view of a business. That means the minuses as well as the pluses (all businesses have both). I like managers who do not overpromise but then consistently deliver a bit more than they indicated. Be most wary of those who promise the sky, they are unlikely to deliver. That said, I am in the Warren Buffett camp in that I would rather have a great business run by average management than a poor business run by stars.
Avoid 'dodgy' managements at all costs
I used to think the dynamics of a strong-looking business would make up even for 'dodgy' management. Having invested in a few companies that have subsequently 'blown up', managements that are either unethical or that sail close to the wind are now complete no-go areas for me. What I've learnt is that, even with corporate governance checks and outside accountants, there are too many ways that senior people can pull the wool over an investor's eyes. Several years ago an Italian contact told me, helpfully, not to touch Parmalat for this reason. It turned out to be an excellent piece of advice. As Warren Buffett says, the CEO who misleads others in public may eventually mislead himself in private (as you are by now well aware I am, like many others, a great Buffett fan. The Berkshire Hathaway annual reports are a treasure trove of investment advice and financial wisdom).
Try and think two moves ahead of the crowd
Try to identify what is being ignored today which could re-excite interest in the future. The stock market doesn't look very far ahead and therefore, somewhat like chess, looking a bit further out than others often can pay dividends. I think I'm good at knowing the types of situation that will excite investors, where there can be 'blue sky' in the future. I will try to find companies where this is currently being ignored but in my view will impact investor psychology again in the future.
Understand the balance sheet risk
If the stockpicker has to learn only one lesson, this has to be near the top of the list. If investment is about limiting the downside and avoiding disaster, then taking on balance sheet risk should only be done with one's eyes open. Balance sheet risk has been the most common factor behind my worst investments. In my experience, most analysts are poor at assessing this risk and many do not analyse balance sheets at all. As well as debt in its various forms, one needs to be able to analyse pension fund deficits and value redeemable convertible preference shares where there is little likelihood of conversion. Both these have a number of characteristics in common with conventional debt.
Seek ideas from a wide range of sources
I like lots of ideas from sources I believe to be well informed about particular companies or industries. The more there are to pick from, the more chances you have of finding a winner. The most obvious sources are not always the best. I particularly like sources not widely used by most institutions. On the other hand I'm not proud and pinching an idea from a competitor whom I rate is just as acceptable to me as from a stockbroker!
Watch closely the dealing by company insiders
No indicator is infallible, but dealings by directors of companies are a valuable confirming or non-confirming tool, particularly look for multiple transactions. Buys are generally more important than sells and some directors have better records than others.
Re-examine your investment thesis at regular intervals
Investment management is all about building conviction for an investment opportunity and then re-examining this conviction over time, particularly when new information arises. Conviction or strength of feeling is important and should be backed. However, conviction must not develop into pigheadedness. If the evidence changes, so should one's views. At any point you should be able to summarize the reasons you own a company's shares in just a few sentences.
Forget the price you paid for shares
The price you paid is totally irrelevant; it is only psychologically important. Have no hesitation in cutting losses if the situation changes. A classic example of this was Deutsche Babcock, a German engineering conglomerate that was involved in a number of areas, including shipbuilding. Our analyst who covered the stock came into my office one morning in a very excited state. The chief executive, whom we admired and who had a good record, was leaving the company. He was also planning a management buyout of its best division, shipbuilding, which was the prime reason we owned the shares. I immediately told our trading desk to sell the whole position, aggressively if need be. Although I took a big loss on the position, a few months later the receivers were called in.
Past performance attribution is generally a waste of time
If life is about making mistakes and learning from them, so too is the stock market. However, performance attribution, the business of analyzing in detail which stock or industry 'bets' a manager has made relative to an index or benchmark, has become very fashionable. However, as it mainly involves looking in the rear view mirror, it tells you nothing about the future. I recognize that with balanced mandates, some attribution is necessary and customers such as pension fund trustees require it.
Too often however, the tendency is to believe the immediate past is going to be repeated in the future. When one is not doing well, to be constantly reminded of the fact by consultants is rarely a help, and in fact may well be counter-productive! Temperament is important. If you are a manic depressive, don't think of becoming an investor. It is important to treat success and failure with equanimity. On the other hand, analyzing your mistakes ("why was I wrong and were there ways of predicting this?") is different and very worthwhile.
Pay attention to absolute valuations
Investors need some sort of reality check to avoid their being sucked into a stock at times of great exuberance. Looking at absolute valuations at times like this will help. I like to buy stocks which within the next two years you can see will be on a single figure price-earnings multiple, or have a free cash flow yield that is well above prevailing interest rates. If you only look at relative valuations, how stocks compare to each other, you can go seriously astray.
Use technical analysis as an extra indicator
I could write a whole chapter on the use of technical analysis (and one day maybe I will). I know it excites widely different views amongst investment professionals. Some are passionate exponents, while others see it as nothing more than hocus pocus. I view it as a framework for help in decision-making. It is one of the factors which helps me decide the size of bet I take. I use it as a confirming or denying factor. So if the technical analysis supports the fundamental analysis, I will be prepared to take a bigger position. If it doesn't I will take a smaller position. I will also re-examine my fundamental views to check we are not missing something if the technical situation deteriorates. I find it more useful the bigger the market capitalization of a company.
Avoid market timing and major macro bets
I want to place my bets where I believe I have a competitive advantage. Many commentators have written over the years of the difficulty of timing the market consistently. I've only had a strong view about the level or direction of the market perhaps five or six times in the last 26 years. The occasions when I have had such strong views (bullish in March 2003, bearish in March 2006) do seem to be coming more frequently recently - maybe it's to do with getting old! Even then, I certainly wouldn't bet my whole fund on such a view. A time I might add a macro input is when I am trying to decide between two shares in an industry, where I think both are fundamentally attractive, but I only want to buy one. A macro view may then be the deciding factor in which to buy (say one benefited from a strong dollar and one did not).
Be a contrarian!
If the investment feels very 'comfortable' you are probably late. Try to invest against the crowd. Avoid getting more bullish as the share price rises. When nearly everyone is cautious about the outlook, they are probably wrong and things are going to get better. Equally, when very few are worried that is the time to be most wary. I've found the times I can be the most help to some of my less experienced colleagues is when there is great optimism or pessimism. This is when I remind them that the stock market is an excellent discounting mechanism. By the time everyone is worried about something it is normally largely in the price. Investors need to be constantly reminded that this is how markets work.”