Before I delve into this post, I would like to preface that this does not advocate Trump for his presidency or push my political beliefs. This, after all, is a value investing blog. I simply came across this book when in the book store (yes people still go to those) and couldn’t help but buy it out of curiosity. At my previous job, during end-of-year office presentations this is a book that we would often joke that a managing director would be reading. It made me wonder how many financiers have actually taken the time to read it and whether it was worth the read. I do recommend the book for it’s entertainment factor, but not has a must-read book for practical business or investing application. However, there are a few over-arching themes and points made within his “The Elements of the Deal” chapter that I think we can garner and utilize successfully in investing. Outside of these themes is mostly a biography of Donald Trump covering his life up until the late 1980’s written with Trump’s well-known chutzpah (for better or for worse).
Protect the Downside and the Upside Will Take Care of Itself
“It’s been said that I believe in the power of positive thinking. In fact, I believe in the power of negative thinking. I happen to be a very conservative in business. I always go into a deal anticipating the worst. If you plan for the worst–if you can live with the worst–the good will always take care of itself.” Donald Trump.
Being able to understand and protect your downside is essential. I view risk as the risk of permanent loss of capital, not the volatility of a stock. Volatility of a company is often measured by beta, which accounts for historical fluctuations in the company’s stock price relative to a given benchmark that represents the market. Protecting your downside is not avoiding volatile companies, but rather knowing how to rationally value a company. By doing so, you are able to invest in those that are significantly undervalued and have very little downside risk compared to the upside potential. This is called an asymmetric bet, where your downside is much less than your upside. Monish Pabrai in other words says, “Heads I win; tails I don’t lost much.”
These asymmetric bets hone in on the price of your investment. The lower your price, the less downside risk there is. I think it’s better to let the world’s greatest investor (Warren Buffett) explain this, rather than Donald Trump:
“I would like to say one important thing about risk and reward. Sometimes risk and reward are correlated in a positive fashion. If someone were to say to me, “I have here a six-shooter and I have slipped one cartridge into it. Why don’t you just spin it and pull it once? If you survive, I will give you $1 million.” I would decline — perhaps stating that $1 million is not enough. Then he might offer me $5 million to pull the trigger twice — now that would be a positive correlation between risk and reward!
The exact opposite is true with value investing. If you buy a dollar bill for 60 cents, it’s riskier than if you buy a dollar bill for 40 cents, but the expectation of reward is greater in the latter case. The greater the potential for reward in the value portfolio, the less risk there is.
One quick example: The Washington Post Company in 1973 was selling for $80 million in the market. At the time, that day, you could have sold the assets to any one of ten buyers for not less than $400 million, probably appreciably more. The company owned the Post, Newsweek, plus several television stations in major markets. Those same properties are worth $2 billion now, so the person who would have paid $400 million would not have been crazy.
Now, if the stock had declined even further to a price that made the valuation $40 million instead of $80 million, its beta would have been greater. And to people that think beta measures risk, the cheaper price would have made it look riskier. This is truly Alice in Wonderland. I have never been able to figure out why it’s riskier to buy $400 million worth of properties for $40 million than $80 million. And, as a matter of fact, if you buy a group of such securities and you know anything at all about business valuation, there is essentially no risk in buying $400 million for $80 million, particularly if you do it by buying ten $40 million piles of $8 million each. Since you don’t have your hands on the $400 million, you want to be sure you are in with honest and reasonably competent people, but that’s not a difficult job.” – Warren Buffett
Warren Buffett understood, through rational analysis what the going-concern liquidation value of the business was and was also able to rationally analyze an intrinsic value for the business, assuming it would continue as a whole entity. This is one major way to minimize downside risk, buying at a low price relative to the company’s true value.
Know your Market
“I’m a great believer in asking everyone their opinion before I make a decision. It’s a natural reflex. If I’m thinking of buying a piece of property, I’ll ask the people who live nearby about the area–what they think of the schools and the crime and the shops…I ask and I ask and I ask, until I begin to get a gut feeling about something…I have learned much more from conducting my own random surveys than I could ever have learned from the greatest of consulting firms. They send a crew of people down from Boston, rent a room in New York and charge you $100,000 for a lengthy study. In the end, it has no conclusion and takes so long to complete that if the deal you were considering was a good one, it will be long gone.”
This sounds similar to Phil Fisher’s investment research style. Phil Fisher was a famous growth investor who coined the “Scuttlebutt method”. This method consisted of speaking to anyone he could to gain more information on the company. This included but was not limited to speaking to current and former suppliers/vendors, current and former employees, competitors, customers, the government, universities, and the executives of the company to fill in last gaps.
Phil Fisher said, “But if the cost of poorly organized research is both high and hard to detect, the cost of too little research may be even higher.”
Independent thought and being able to make your own judgement calls is essential to the value investor. Not ascribing to the crowd and maintaining your own rational judgement is likely more valuable than anything else. Phil Fisher also said, “Doing what everybody else id doing at the moment, and therefore what you have an almost irresistible urge to do, is often the wrong thing to do at all.” Therefore, knowing and understanding your market, and also your investment opportunity, is not too bad of advice from Trump.
Contain the Costs
“I believe in spending what you have to. But I also believe in not spending more than you should.” Donald Trump.
“To this day, if I feel a contractor is over charging me, I’ll pick up the phone, even if it’s only for $5,000 or $10,000 and I’ll complain. People say to me, “What are you bothering for, over a few bucks?” My answer is that the day I can’t pick up the telephone and make a twenty-five-cent call to save $10,000 is the day I’m going to close up shop.” Donald Trump.
I thought the latter quote was one of the more profound quotes I read throughout the entire book. Being price-conscious, as explained above in “Protecting your Downside”, is an essential characteristic to have as a value investor. Not only this, but is something you want to look out for and understand in the companies you are analyzing.
Cost cutting is a topic that can have vicious consequences for a company. It has the ability to make a company more profitable but also can signal the company is having cash problems, and the affects have the ability to bring down company morale. Being able to decipher a management’s ability to make positive restructuring and cost cutting decisions is a difficult characteristic to judge. My advice is to focus on long-term initiatives that focus on creating value over time, rather than short term gains. A good example, in my opinion, is to take a look at KraftHeinz’s investor presentations, at the time of the merger as well as now and see the type of initiatives they have set forth over the next five years. This is the type of restructuring and cost cutting that I like to see. It is transparent and it’s goals are shareholder oriented and focused on long-term value, rather than cutting costs to “save the company”. In other words, KraftHeinz isn’t a dead company walking.
KraftHeinz is majority owned by 3G Capital and Berkshire Hathaway. Warren Buffett has received a lot of criticism for teaming up with the 3G team because of their background as a private equity firm that focuses on cost cutting through layoffs and other initiatives. Buffett has met this criticism with a strong defense. He is against big, bloated corporate structures. Afterall, Berkshire has a corporate headquarters of 19 people. Companies should not be big for the sake of being big, and if they are big corporations, they have to strive to be efficient. Buffett argues that for his investments through Berkshire he looks to invest in companies that are already efficient, and 3G looks for companies that are inefficient that they can make efficient. 3G also doesn’t just cut costs and sell their investments in a few year’s time. They are buying into companies that they could own forever. This is the type of active shareholder that Warren Buffett likes to be part of.
“I don’t kid myself. Life is very fragile, and success doesn’t change that. If anything, success makes it more fragile. Anything can change, without warning and that’s why I try not to take any of what’s happened too seriously. Money was never a big motivation for me, except as a way to keep score. The real excitement is playing the game. I don’t spend a lot of time worrying about what I should have done differently, or what’s going to happen next. If you ask me exactly what the deal I’m about to describe all add up to in the end, I’m not sure I have a very good answer. Except that I’ve had a very good time making them.” Donald Trump.