How I Focus on Intrinsic Value for My Own Household, Business, and Other Portfolios Under My Stewardship
Whether it is our own, personal household portfolios, the portfolios of the operating companies we own and control, or the portfolios of family and friends who have asked us to look after their financial well-being by managing their life savings, in our neck of the woods, we have several strategies for keeping the focus where it should be: Acquiring as much intrinsic value as we can then sitting on it for decades. It’s a philosophy that served us extraordinarily well and allowed us to achieve financial independence much younger than many on the journey.
- As the real-time spreadsheets update showing us exactly what is invested where, each ownership stake in a business highlights our proportionate share of sales, profits, dividends, and retained earnings, along with the market value. The column listing market value is actually named “Mr. Market” from Benjamin Graham’s famous analogy. Unless our fictional business partner is offering us extraordinarily favorable terms to our sell our stakes, we aren’t interested. In some cases, we aren’t interested in selling at all (as has often been quipped by legendary investors, including Warren Buffett, with what firm could you possibly replace Coca-Cola and receive the same certainty it is going to do well in the coming century?). There are also columns showing our earnings yields and dividend yields so on days when the markets collapse, we start seeing rising future returns, making our positions more attractive as long as the underlying business remains intact.
- We always ask ourselves about each company in which we maintain an investment, “How does this business make money? What are the factors that make it possible? What are the things that threaten it? What are the opportunities to make more? What is the likelihood of an enjoyable experience as an owner given the price we must pay relative to the owner earnings?” If we can’t tell you where the cash is coming from and how it makes its way into our hands, we say, “Thanks, but no thanks.”
- We regularly review the portfolio and ask ourselves, “If the stock market were to close for the next five years, and we couldn’t buy or sell anything, would we sleep well at night owning what we do, in the amounts we do?” If the answer is, “No”, changes are made. Crazy things happen, ranging from terrorist attacks to the outbreak of world war. While some might prefer to live dangerously, my husband and I both grew up without a silver spoon and had to work our way through college, the first in our families to get degrees. We’re keenly aware of the old adage, “You only have to get rich once”. We have no desire to “go back to go”, as it were. By making it our first priority to never lose money, we can separate fluctuations in market value (seeing a particular business down 40% on paper, which often doesn’t mean much) from intrinsic value (seeing the economic engine fall apart at a business due to changes or firm-specific problems, which forebodes real, permanent losses). A classic example: Look at what is happening to shares of the oil majors right now, which I wrote about extensively on my personal blog. Blue chip stocks like ExxonMobil have crushed the S&P 500 over the past 30 years, even with the ending period measured at the recent free fall in crude (which tells you how substantial the outperformance was) but, along the way, you had to spend periods of 3, 5, or 7 years where you saw 25% to 50% losses on your brokerage statement.
- We have spent our entire careers studying things like GAAP rules and corporate finance. We use those skills to dig into the 10-K filing and the annual report looking for warning signs, like aggressive accruals relative to reported net income or questionable practices such as inadequate loss development reserves at property and casualty insurance companies. There are times we’ll pass on a business that otherwise looks reasonable because there’s something that leaves us feeling uneasy buried hundreds of pages into the disclosures.
- Though we’re not dividend investors per se – we’ve made a lot of money buying stocks that don’t pay dividends – we can be patient if it takes years for our thesis to work out because more often than not, we sit back and collect streams of cash, eventually getting our stock for free thanks to dividends, which act like rebates on the purchase price, returning capital we laid out and letting us deploy it elsewhere. You can’t fake cash. The check either arrives or it doesn’t. The amount paid on each share either increases faster than the inflation rate or it doesn’t.
Taken together, it helps us keep our attention on what really matters. We don’t lose sleep when the stock market crashes. We are always aware of how much cash we keep in our portfolio. We tend to avoid margin debt in most situations and never utilize it to a degree it could be a problem. We also own the firm, which means no one can fire us if we want to take 5-10 years to hang on to a good idea that might look ugly on paper for awhile. We’ve arranged our entire portfolios and lives around systems that let us take advantage of rational long-term behavior. You can, too, if you really desire it.