Published on March 12, 2017

“There is always something to do.  You just need to look harder, be creative and a little flexible.”

— Irving Kahn

One of the interesting aspects of the stock market involves the peculiar attitude many investors have when it comes to reacting to market advances.  If the price of groceries, gasoline, or clothing rises, most individuals are going to feel poorer rather than euphoric because each dollar will have less purchasing power than before.  The same is not true when it comes to stocks.  Investors typically are more excited about buying stocks as prices rise.  Why is this the case?  Human psychology seems to lead many of us astray.  We assume continuation of a trend and it is easy to feel “left behind” when looking at other people who are getting rich, at least on paper.  The opposite is true in market declines as investors abandon stocks due to fear of further declines even as each dollar invested is purchasing a greater ownership interest than before.

The stock market has been on a generally upward trajectory for many years and has rallied strongly since Donald Trump won the presidential election in November 2016, which incidentally was the exact opposite of market expectations at the time.  It seems like many individuals took notice when the Dow Jones Industrial Average reached the 20,000 milestone and then quickly broke through 21,000.  The Dow might be a highly flawed benchmark but it is one that people seem to follow.  Of course, a record high does not necessarily indicate overvaluation, but the recent rally has coincided with the highest Shiller PE Ratio since the dot com bubble.  The Shiller PE is based on the average inflation-adjusted earnings from the prior ten years.  As we can see from the chart below, the Shiller PE has rarely been higher than it is today:

What does this really mean?  The honest answer is that we have no way of knowing what the stock market is going to do in the short run.  As Howard Marks has pointed out, one can view investor sentiment as a “pendulum” swinging between fear and greed.  We cannot know when the pendulum has reached the furthest point and is about to swing back, but we should be able to tell when the pendulum is on the upswing toward greed.  Individual investors are again piling into stocks, Snap Inc. just went public and rallied sharply despite serious questions regarding corporate governance, and market rumors are swirling regarding potential IPOs for hot stocks such as Uber and Airbnb.

It would be arrogant and ill advised to “call” a market top, but it would be foolish to not at least note that the pendulum is firmly in an upswing.  Besides, as value investors, we should not make decisions based on market indices and instead look at individual companies.  Obviously, the market for individual companies is impacted by overall sentiment and we aren’t likely to find many companies selling below net current asset value these days.  Nevertheless, there should always be something to do for an enterprising investor.

The Story of Peter Cundill

Peter Cundill’s value investing odyssey began when he experienced a “road to Damascus” moment in late 1973 as he read Security Analysis and, like Warren Buffett and many others, was immediately struck by the power of Benjamin Graham’s logical approach.  The Cundill Value Fund, starting in 1975, established one of the strongest track records in the industry with a 15.2 percent annualized return over 33 years.

Was this excellent record due to skill or random luck?  As Warren Buffett pointed out in his classic essay, The Superinvestors of Graham and Doddsvillea certain number of investors from a large population could very well outperform over many years due to random factors.  However, the examples Mr. Buffett presented had something in common:  they were all from a “zoo in Omaha” that had been “fed the same diet”.  That is, they had operated based on the principles developed by Benjamin Graham and David Dodd starting in the 1930s.  Importantly, these investors achieved their records in very different stocks rather than piling into the same ideas.  The foundational concepts were shared by these investors but how they applied the concepts varied widely.

Peter Cundill kept a daily journal from 1963 to 2007 in which he recorded a variety of thoughts ranging from his personal life to business and investing.  Christopher Risso-Gill was a director of the Cundill Value Fund for ten years and had exclusive access to Mr. Cundill’s journals.  This positioned Mr. Risso-Gill perfectly to write There’s Always Something to Do, a book about Mr. Cundill’s life and the evolution of his investment philosophy over more than three decades.  Journals allow us to view a contemporaneous account of an individual’s life and thought process.  Mr. Cundill was diagnosed with Fragile X Syndrome, a rare and untreatable neurological condition, in 2006 and passed away in 2011.  We are fortunate that Mr. Cundill kept a detailed journal that allowed Mr. Risso-Gill to document his investment philosophy and many case studies applying his approach.

A Whiff of Bad Breath

Most arguments against insider trading appeal to our sense of fair play and ethics.  It seems dishonorable to trade based on information that is not available to others because the deck is stacked against your counterparty.  However, there are other valid reasons in favor of keeping away from inside information out of pure self interest.  By getting close to management, we can pollute our minds and compromise our reasoning process, as Mr. Cundill points out in his journal:

I will never use inside information or seek it out.  I do implicitly believe in Sir Sigmund Warburg’s adage, “All you get from inside information is a whiff of bad breath.”  In fact it is worse than that because it can actually paralyze reasoning powers; imperiling the cold detached judgement required so that the hard facts can shape decisions.  Intuition, whether positive or negative, is quite another matter.  It is a vital component of my art.  

Stock manipulations only have a limited and temporary effect on markets.  In the end it is always the economic facts and the values which are the determining factors.  Actually value in an investment is similar to character in an individual — it stands up better in adversity which it overcomes more readily.

So we should certainly avoid inside information for ethical reasons, not to mention the risk of going to prison, but also because it simply is not a great way to improve our results over long periods of time.  Our logical reasoning powers and ability to dispassionately assess facts and come to valid judgments is how we can make money investing for the long run.  The temptation to take shortcuts might always exist but should be resisted out of pure self interest.  Appealing to self interest is often a better way to achieve socially desirable outcomes compared to appealing to a sense of ethics.

When to Buy

How do we know when to purchase a security?  Do we rely on our own analysis or allow others to impact our decision making process? This can be a very important question when buying into distressed situations which, by definition, are usually hated by the vast majority of our peers:

As I proceed with this specialization into buying cheap securities I have reached two conclusions.  Firstly, very few people really do their homework properly, so now I always check for myself.  Secondly, if you have confidence in your own work, you have to take the initiative without waiting around for someone else to take the first plunge.  

Does this sound familiar?  It might to those who were actively investing in the aftermath of the 2008-09 financial crisis when pessimism was rampant and stocks had declined over fifty percent in a short period of time.  Mr. Cundill wrote the preceding words in the midst of the 1973-74 bear market which was a similar time of pessimism in the stock market.  Pessimism can be a virtue and can also lead to opportunities for investors who do their own work and have the courage to act on their convictions.

When to Sell (and associated frustrations)

Mr. Risso-Gill provides a fascinating case study of Mr. Cundill’s investment in Tiffany during the 1973-74 bear market, a time when the stock sold for less than the value of fixed assets on the balance sheet including the company’s Fifth Avenue flagship store in New York City as well as the Tiffany Diamond.  The iconic brand was effectively being given away for free so Mr. Cundill started buying the stock.  At the time, Tiffany was controlled by Walter Hoving, the company’s CEO, who clearly stated that he had no intention of ever selling his controlling stake. Mr. Cundill assured Mr. Hoving that he was “quite content to be patient and await the inevitable recognition of the fact that Tiffany shares were fundamentally undervalued.”  The two men became good friends.

After accumulating 3 percent of the company at an average cost of $8 per share, Mr. Cundill quickly declared victory and sold his entire position within a year at $19 and was able to “rub his hands contentedly.”  It appears that Mr. Cundill was content with his decision to sell because he assumed that Mr. Hoving was serious about “never selling” his controlling stake, thereby discounting the possibility that the entire company would be acquired at a control premium.  But this turned out to not be the case:

“Peter’s assessment had turned out to be entirely accurate and within a year he was able to sell his entire position at $19.00 and rub his hands contentedly.  But six months later there was a “sting” when Avon Products made an all share offer for Tiffany worth $50.00 per share and Hoving unhesitatingly accepted it.  Peter’s comment was that he ought to have asked Hoving, “Never, ever – at any price?”  

Most readers will be able to relate to the experience of selling too early.  It can really sting to sell at what we consider to be “full value” only to watch the stock price continue to ascend.  Sometimes the ascent might be for fundamental reasons that were not adequately considered.  At other times, speculative factors could come into play.  But it must especially sting when one feels misled about the intentions of a controlling shareholder and misses out on a massive control premium.  The Cundill Value Fund board members were concerned about this situation and debated the question of when to sell:

“In the end the solution turned out to be something of a compromise:  the fund would automatically sell half of any given position when it had doubled, in effect thereby writing down the cost of the remainder to zero with the fund manager then left with the full discretion as to when to sell the balance.”

Strictly speaking, this compromise is not logical.  If a manager finds a security trading at 25 percent of intrinsic value, why should he be forced to sell half of the position when it doubles in price and is still selling at 50 percent of intrinsic value?  Nevertheless, the solution is quite common among investors.  Mentally thinking of the remaining half of a position that has doubled as a “free position” has some pitfalls but could mentally make a scenario like Tiffany’s more palatable in the end.  It is somewhat refreshing to see that even an investor of Mr. Cundill’s caliber had to deal with these sorts of questions and ultimately came up with a compromise that all could live with even if it was not completely optimal.

Much later in his career, Mr. Cundill made the following observation about selling too early:

“This is a recurring problem for most value investors — that tendency to buy and to sell too early.  The virtues of patience are severely tested and you get to thinking it’s never going to work and then finally your ship comes home and you’re so relieved that you sell before it’s time.  What we ought to do is go off to Bali or some such place and sit in the sun to avoid the temptation to sell too early.”

This is reminiscent of Charlie Munger’s famous quip about “sit on your ass investing”, as discussed in Poor Charlie’s Almanack.  Sometimes we are our worst enemy when it comes to investing, and value investors can really be their own worst enemy when it comes to selling far too soon.  This is why one of the most important metrics to track each year is the result of an investor’s “do nothing portfolio” – that is, the performance of your portfolio had you done absolutely nothing all year long.  Did your trading activity add or detract value during a given year?  One way to know is to compare your results to Charlie Munger’s “sit on your ass” method of investing.

1987 Crash

It is easy to look back at any crash and fool ourselves into thinking that it was “obvious” that it would happen to those operating in the markets at the time.  Of course, this is absurd because if everyone expects a crash to occur in the future, the crash would occur immediately as everyone would sell immediately.  The same is true of post-crash bottoms.  It is never “obvious” that the market will sharply rebound.  This is why it is so valuable to keep a journal (or a blog) documenting our thoughts at the time.  For example, this article from early March 2009 on The Rational Walk makes it pretty clear that it was far from “obvious” that the market was close to a bottom.

Getting back to Mr. Cundill’s journal, we have the ability to see what he was thinking in the months leading up to the 1987 crash.  This excerpt from his journal from March 1987 documents his meeting with Jean-Francois Canton of the Caisse des Depots, the largest investment institution in Paris at the time:

“He is as bearish as I am.  He told me that Soros has gone short Japan, not something that Soros himself mentioned at our recent meeting but definitely in harmony with my instincts.  Canton and I had an excellent exchange — he understands value investment thoroughly.  As I see it, with money being recklessly printed, higher inflation and higher interest rates must be just around the corner and so much the likelihood of a real and possibly violent stock market collapse.  I have an unpleasant feeling that a tidal wave is preparing to overwhelm the financial system, so in the midst of the euphoria around I’m just planning for survival.”

How did Mr. Cundill plan for survival?  By the time the crash took place in October 1987, the Cundill Value Fund was holding over 40 percent of its assets in short term money market instruments.  Was Mr. Cundill a market timer?  Mr. Risso-Gill does not think so:

“… This positioning was not the result of a deliberate decision to build up cash because, although he had anticipated a crash, he could not have predicted its exact timing.  The enlarged cash position was actually the result of the increasing number of securities in the portfolio that had been attaining prices considerably in excess of book value, consequently qualifying them for an automatic sale unless there were overriding reasons to hold on to them.”

Due to the fact that he had ample liquidity in the days after the crash, Mr. Cundill was able to repurchase some of the positions he sold earlier in the year and the fund ended 1987 up by 13 percent.  Unfortunately, shareholders of the Cundill Value Fund redeemed shares in the wake of the crash and the fund’s capital actually declined for the year in spite of the excellent results.  Mr. Cundill was disappointed, as must be the case for any manager of an open-ended mutual fund who might wish to have permanent capital to work with.

Smart People Failing, Dictatorship, and Committees

As Warren Buffett often says, a sky high IQ is not necessary to be very successful in the field of investing.  What is required is a strong temperament coupled with the basic concepts outlined by Graham and Dodd.  Mr. Cundill makes the following observation in a journal entry on New Year’s Day 1990:

“Just as many smart people fail in the investment business as stupid ones.  Intellectually active people are particularly attracted to elegant concepts, which can have the effect of distracting them from the simpler, more fundamental, truths.”

This effect can be even worse when you get a large number of very smart people in the same room and attempt to manage by committee.  In another journal entry, Mr. Cundill reveals his views on committees versus dictatorship in the business world:

“To my knowledge there are no good records that have been built by institutions run by committee.  In almost all cases the great records are the product of individuals, perhaps working together, but always within a clearly defined framework.  Their names are on the door and they are quite visible to the investing public.  In reality outstanding records are made by dictators, hopefully benevolent, but nonetheless dictators.  And another thing, most top managers really do exchange ideas without fear or ego.  They always will.  I don’t think I’ve ever walking into an excellent investor’s office who hasn’t openly said “Yeah sure, here’s what I’m doing.” or, “What did you do about that one?  I blew it.”  We all know we aren’t always going to get it right and it’s an invaluable thing to be able to talk to others who understand.”

Warren Buffett has said that he usually learns about the actions of Todd Combs and Ted Weschler through their monthly trading reports, not by walking down the hallway at Berkshire Hathaway and interrogating his subordinates regarding their current investment moves.  Each investor is a “dictator” within the area of responsibility he has been assigned and that is how it should be.  Does this mean that no discussions take place regarding investments?  Obviously not.  Mr. Buffett’s recent purchase of Apple for the portfolio he manages for Berkshire followed the Apple investment of either Mr. Combs or Mr. Weschler.  They obviously talk about investments and mull over shared ideas, but at the end of the day, decisions are each investor’s to make and there are no committees.

Something to Do Today

As the stock market continues to levitate, we all have to figure out what actions to take, if any, in order to capitalize on opportunities and mitigate risk.  Perhaps the best approach is to emulate Charlie Munger and “sit on your ass” if you already own excellent companies and intend to own them for decades or, perhaps, even for the remainder of your life.  Or the best approach might involve selling securities as they reach or exceed prices at which any margin of safety exists.  There might even be remaining opportunities to purchase investments well below intrinsic value for those willing to look.  The answer regarding what to do today is one for each individual to answer.

Perhaps the most productive endeavor during times like this is to look for businesses that you find interesting regardless of the current valuation of the companies in question.  The key to being able to take advantage of opportunities in the future is to have a prepared mind and a list of companies that you would like to own if available at the right price.  A market crash offers few opportunities and mainly fear to those who do not have any idea what to do.  Those of us who build up an inventory of ideas far in advance of a crash are better equipped to take advantage of opportunities when they arise.  In many cases, rebounds can be as quick as a crash and those who prepare in advance might be able to capitalize.

The story of Mr. Cundill’s life and his investment track record is well worth careful study.  He is not a household name in the same way as Warren Buffett or Charlie Munger, nor does he have quite the same track record, but this is part of the attraction.  After all, there are many ways to win in the field of investing.

Book Review: There’s Always Something to Do
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