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If Berkshire Hathaway's annual meeting is "Woodstock for Capitalists," I'm at the intersection of Lollapalooza, Bonnaroo, SXSW, and Coachella -- the Value Investing Congress. Warren Buffett's cultivated the notion of the rock star value investor over a 50-year career, and in this tradition, the Value Investing Congress draws the current generation of value investing superstars to a sun-bathed, idyllic stretch of Los Angeles exurbia. Below, you'll find two particularly salient nuggets from Day 1, and a stock idea that made me tick.
At the VIC, a group of value-minded folks gather to share their interpretation of a well-worn art -- buying stocks cheap. The lineup is a veritable who's who of the industry's thought leaders: Howard Marks of Oaktree Capital, David Nierenberg of D3 Family Funds, Jeff Ubben of ValueAct Capital, Steve Romick of First Pacific Advisors, and of course, the Congress' co-founder, money manager Whitney Tilson.
The atmosphere is at once collegial and friendly, while singularly focused and a tad intense. Money managers, researchers, individual investors, and journalist-types eagerly discuss ideas and issues du jour. And I'm in pig heaven.
Howard Marks on the illusion of knowledge: One quote resonated with me, as borrowed from Amos Tversky, the late cognitive and mathematical psychologist: "It's frightening to think that you might not know something, but more frightening to think that, by and large, the world is run by people who have faith that they know exactly what's going on."
Marks is a famously contrarian distressed investor, and the spoils haven't gone unrewarded: Oaktree's assets have swelled to more than $80 billion. Appropriately, his words focused on the behavioral elements to successful investing. Elements of his presentation could be mistaken for a psychoanalyst's attempt at willing a painfully disconnected individual to self-actualization.
The Tversky quote hearkens to a sometimes understated point: We're overconfidence machines. Within the confines of complex, adaptive systems -- like markets -- we're apt to be wrong, and possibly look stupid. The most successful investors do not ignore disagreeable information or the possibility they'll err, but instead, acknowledge it as par for the course. The unknowable and unexpected is de rigeur.
David Nierenberg on boards and shareholder rights: Of board behavior, Nierenberg said the following: "Boards spend too much time on the wrong things … box-checking, compliance idiocy … refighting wars of the past, passively receiving management's dog-and-pony shows."
Nierenberg has built a reputation as a gentleman's activist investor -- calling on his background as a venture capitalist, Bain consultant, and Yale-educated lawyer. He calls it constructive engagement. The semantics aren't particularly important. His success is; he cites 11.4% annual returns for D3 over an 11-year period, net of fees and carry, running a concentrated portfolio of micro-cap stocks.
Part of that owes to Nierenberg's unique approach. He takes great pains to understand management's motivations and align them with shareholders' best interests, emphasizing effective capital allocation and long-term share price gains.
What shareholders need more of, in Nierenberg's opinion, is alignment of interest. This is hardly a new concept, but its weight shouldn't be discounted. I'm of the opinion that most investors -- at least from where we sit -- aren't uniquely able to judge the skill, or motivations, of managers and boards. In the day-to-day, they're businessmen. But on a conference call, they're selling a notion to you, the investor -- about the company's stock and their plan for the business. Understandably, their interests may diverge from ours.
That makes executives' incentives doubly important. The benchmark to measure against, in Nierenberg's opinion, is total shareholder return as measured by share price appreciation, dividends, and special dividends.
What one super-investor is buying
Steve Romick -- managing director at First Pacific Advisors -- is a tad angry, very passionate, and incisive in his analysis. He's convinced the U.S. economy (and government) failed to take its medicine in 2008 and 2009. No surprise, he's not particularly bullish on the market's prospects.
Small caps got their share of market love as the Russell 2000 bounded to all-time highs, and large-cap blue chips languished in comparison. I expected this theme of relatively pricey small caps and cheaper larger caps to get some drum beating. As a group, it's hard to call small caps cheap, and in light of Romick's opinion, he's positioned FPA's accounts to reflect this reality.
Romick's idea -- CVS Caremark (NYSE: CVS ) -- delivered on this count. He sees a few high-level factors working in its favor: an aging U.S. population increasingly prone to pill-popping for whatever ills it has, and overstated concerns over mail-order competitors. Moreover, the company stands to benefit greatly from the coming generic wave as high-profile, blockbuster drugs come off patent, because generic profitability is roughly 40% higher than brand-name drugs, by Romick's account.
Coupled with potential operational improvements -- CVS's inventory, as a percentage of sales, is dramatically higher than peer Walgreen (NYSE: WAG ) -- Romick thinks that at today's prices, the shares offer decent value. But his thesis isn't entirely traditional -- where he believes continued declines are likely -- Romick has hedged out most of FPA's exposure to the Caremark PBM segment, which has underperformed peers Medco (NYSE: MHS ) and Express Scripts (Nasdaq: ESRX ) and where he believes that continued declines in operating profits are likely.
Taken in sum it looks to be an attractive gambit: Based on some calculations from Romick, the CVS part of the business net of the Caremark hedge trades at an enterprise value to EBITDA (earnings before interest, taxes, depreciation, and amortization) ratio of around 6.7. Even with Caremark included, the shares don't look too pricey to me. And suddenly, that doesn't look like a consensus large-cap idea anymore. It starts to look pretty interesting.