Part IV: Derivatives, Kmart, and More
TMF: Warren Buffett has been very critical about derivatives and their complexity, basically saying the only thing he understands is that he doesn't understand the risks they present in financial institutions. You have holdings in Citigroup (NYSE: C ) , Fannie Mae (NYSE: FNM ) , and Washington Mutual (NYSE: WM ) , but the derivatives are probably less of a worry there. How have you grown comfortable with the derivative activities at the various firms?
Nygren: There are limits as to what you can know as an outside investor about derivatives the company uses. And I certainly agree that the reasonable reaction to that is it should give us pause. We have gotten comfortable largely through confidence in people and the way they run a business, the way they communicate about a business. But in the end, you can't get around the fact that trust is an important issue. Some of it is more quantifiable when they talk about the credit ratings of companies that they're willing to accept derivatives from. And to the extent we can quantify risk through credit ratings, we're obviously more comfortable with companies that are more stringent on the credit ratings. With something like Citigroup, the business is so diversified there, both across business lines and across geographies, I think you have tremendous headline risk in a name like Citigroup. Because if there's a problem, chances are they're involved in it. But also, because they are so large, chances are it's not very significant to the overall enterprise.
TMF: So for those three firms, and in any firm you'd invest in with large derivative operations, it comes down to trusting the management, which is in sync with the rest of your reasons for buying.
Nygren: Right. And the other thing I would say: Move away from the financials and the derivative risks. If you don't think you can trust a management, the investment ought to be a non-starter anyway. Because there's just too much room for them to be able to fool you with the way they communicate about the business and the way they present the results. If you don't think somebody is trustworthy -- unless you've got plans to change the management -- you shouldn't be invested with them.
TMF: Let's move on to another interesting company. You know the investment and retail scenes really well. What are your thoughts on Kmart (Nasdaq: KMRT ) ? There's the rumor that it's going to be transformed into the next Berkshire Hathaway (NYSE: BRK.A ) (NYSE: BRK.B ) .
Nygren: I think what I missed when Kmart came out of bankruptcy -- and we don't own the stock -- I was thinking about the probability of Kmart succeeding as a retailer. The way retail economics work in discounting, it seems that the companies with the No. 1 or No. 2 market share can be quite profitable, but the No. 3 struggles to make money. I had incorrectly thought that Kmart would need to displace Target (NYSE: TGT ) or Wal-Mart (NYSE: WMT ) in their various markets to become a good stock. I still think that's probably true, to become a successful retailer. But what has been shown in the real estate transactions that Kmart has engaged in was there was enough real estate value here that you didn't need success as a retailer to make it a successful stock.
TMF: Is it your feeling that Eddie Lampert, Kmart's controlling investor, plans on closing down operations?
Nygren: I don't know Mr. Lampert, and I have absolutely no insight into what his ultimate goal is here. Again, the key thing that we missed in evaluating Kmart was the tremendous real estate value. We valued it as a retailer, not as a real estate play.
TMF: Whom in the investment business do you admire?
Nygren: I think because of my investment approach -- because of the Oakmark approach -- I'm drawn toward people who have been successful value investors. The top of that list has to be Warren Buffett. The other names are the usual suspects -- Mason Hawkins at Longleaf, Wally Weitz at Weitz Funds, Jim Gibson at Clipper. I would also put very high on the list Bill Miller at Legg Mason (NYSE: LM ) . I think Bill is an incredibly bright guy who has helped expand the boundaries of value investing in a healthy way. Nothing but admiration for the streak that he has put together of beating the S&P 500 so many years in a row. And the other name -- not so much a name but an organization -- that I admire is Dodge & Cox. I think the results they have created have clearly been admirable.
TMF: Are there any books or publications off of the beaten path that over your career you found useful? So not Fortune and not the Intelligent Investor....
Nygren: I don't know how off the beaten path it would be, but I think Roger Lowenstein's column in SmartMoney every month is worth more than the price of the publication. When I was just starting in the business and trying to figure out what approach made sense for me, I found the books most helpful that had chapters about successful money managers, like the Money Masters, by John Train, and the Market Wizards, by Jack Schwager. Maybe they'd have a 30-page chapter about an approach that someone used that was successful for them, and you could read, in a few days, highlights about how 15 successful people had invested. And you could go through and say, I can kind of see this in myself that this guy's used, and this other trait that seemed to work for him is something that I think I share. By reading enough about other successful investors, I could start to see that there were some things that made sense for me to think about given my personality and strengths and weaknesses intellectually. There are some things that worked well for me and others that didn't, and could start to see my own investment approach evolving. Those kinds of books even made relatively good beach reading.
TMF: That's a great point. If you look at other greats in their field -- whether it's Tiger Woods or Michael Jordan -- a lot of them study success. That's interesting that you mention that as well.
Nygren: As you mentioned earlier, I do have a passion for sports. I think you can see a lot in how various sports organizations have operated and what has made for successful dynasties that is also useful in thinking about running a business. How do they treat employees? How do they economically look at how they spend their money? Last year, basically anybody who had a shred of interest in value investing was recommending Money Ball as a book to be read. It was a really direct comparison of how an organization spent its budget on talent that was quite similar to how most of us on the value side think about investing our dollars. So I think there is more to draw from than, as you said, the usual names like Intelligent Investor, which is a great book, by the way. And if somebody hasn't read that, they should. The new Jason Zweig version of it brings the examples a little bit more current than they were 40 years ago.
To read more about Bill Nygren's views on investing and the market, see the interview series:
- Master Value Investor Tells All
- Is Time Warner Undervalued?
- Why This Value Guru Sleeps Well
- 5 Stocks for the Next 10 Years
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