FOOL ON THE HILL
Trembling With Greed

Value investing is all about getting a good business with good financials and good prospects at a good price, right? Almost, says Whitney Tilson, who prefers to wait for the perfect price. Keep Warren Buffett's simple baseball analogy in mind: In stock picking, there are no called strikes -- so investors should wait for a home run ball rather than just swinging for singles.

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By Whitney Tilson
February 13, 2001

Based on the dozens of emails I receive from readers each week, I believe that there are many miserable investors out there. Driven by curiosity, greed, or excitement, they were drawn into buying stocks during the mania over the past few years, and suffered big losses last year. Now, either addicted to the excitement or perhaps desperately trying to recoup their losses, they continue to trade -- often only exacerbating the problem.

If this description fits you in any way, take heart. While nothing can be done to change the past, the future can be different.

The first step is to ask whether you enjoy picking stocks. Do you like learning about new companies and industries? Do you enjoy reading annual reports and major business publications? Note that I didn't ask whether you get a rush from watching stocks' day-to-day gyrations -- that's a good contrary-indicator in my opinion.

If you don't enjoy picking stocks, then don't do it! I think the overwhelming majority of investors would be well served by a simple approach to accumulating wealth over time: live below your means and invest your savings steadily in one or two low-fee, broadly diversified index funds (or an exchanged traded fund equivalent) -- and then forget about investing and get on with your life.

But what if you haven't saved enough for a comfortable retirement or really want a new house/car/boat? To meet your financial goals, isn't it worth the extra effort to research and buy a few stocks so you can benefit from outsized returns? Sure, but only if you have good reason to believe that you can, in fact, be a successful stock picker.

Beating the market over a long time period is extremely hard. The majority of professional investment managers fail to do so, despite full-time effort and access to immense amounts of information and a team of analysts to process it. It takes quite a bit of hubris to think you can beat the pros at their game, which is why I titled one column on this topic "The Arrogance of Stock Picking" rather than "The Challenges of Stock Picking."

After carefully and honestly assessing your capabilities, let's say you decide that you have the three T's -- time, training, and temperament -- to be a winning stock picker. What, then, are the keys to success? In past columns, I've written about many of them: an understanding of sustainable competitive advantage and the perils of overconfidence; an ability to analyze cash flows; identifying stocks to avoid; remaining flexible; a belief that valuation matters and that deferring taxes is critical; and a willingness to learn from mistakes. Today, I'd like to add one more critical element to that list.

Margin of safety
The market presents you with countless investment opportunities each and every day. A few of them will undoubtedly prove to be interesting enough, at first glance, to investigate further. The next steps are running the numbers, reading annual reports and other materials, digging for scuttlebutt, and so on. At the same time, you (hopefully) are asking yourself whether this investment falls within your circle of competence and if it's attractively priced.

Let's say a stock passes all these tests. Time to buy it, right? No! Being attractively priced isn't good enough.

I spend a substantial fraction of my time investigating new stocks to buy. Of the one or two dozen stocks I analyze every week, I estimate that at least one meets my tests for being a good company, with solid prospects, in an industry that I understand, and carrying a valuation of at least 20% below what I believe is its intrinsic value. In my last two columns, I wrote about four such companies: Autozone (NYSE: AZO), Graco (NYSE: GGG), Strattec Security (Nasdaq: STRT), and Outback Steakhouse (NYSE: OSI).

Yet I don't own any of these stocks. Why? Because they're not 50% undervalued. Given the inherent difficulty of predicting the future and the risk of owning a stock rather than earning a guaranteed 6% or so by sitting on cash, a 20% margin of safety isn't enough for me -- and I venture that it shouldn't be for you either.

Warren Buffett uses two good analogies to make this point. In one, he asks you, the investor, to imagine that you're at bat in a baseball game in which there are no called strikes. In this case, would you swing the bat if you thought there was a good chance of getting a single? Of course not. Instead, however boring this might sound, you would be better served to look at hundreds of pitches and wait until the pitcher serves you up a pitch that you were almost certain to whack out of the park. There are no guarantees, of course -- you still might pop it up -- but the point remains that you should only swing at the juiciest of pitches.

Buffett gave another analogy in a speech to a group of business school students. He asked them to imagine that they were given a punchcard with 20 holes at the beginning of their investment careers. Each time they made an investment, they had to punch one hole. When all 20 were punched, that was it -- no more investments. You'd think long and hard before making an investment if you knew that it was one of only 20 you could make in your lifetime, wouldn't you? (The Rule Maker team's Richard McCaffery discussed this concept at length in last night's column.)

Trembling with greed
Let's bring the discussion back to the real world. Think about the most successful investments you've ever made. What did they have in common? If you're like me, they were situations you understood backward and forward. They were high-quality companies with bright futures, yet unbelievably, pinch-me-I-must-be-dreaming cheap. You knew exactly why the market had so undervalued the stocks, and had total confidence that the market's fears were ill-founded and that your analysis was correct.

In my investment career, the best example of this situation was buying Berkshire Hathaway (NYSE: BRK.A) last spring at prices ranging from $41,500 to $43,700 per share. Today, the shares are trading above $70,000.

I used to refer to situations like this as slam dunks, but one of my friends came up with an even better description: He says he's "trembling with greed." Great image, isn't it?

The next time you're thinking about buying a stock, ask yourself if you're trembling with greed. If not, you're probably better off waiting until a better investment comes along.

-- Whitney Tilson

Guest columnist Whitney Tilson is Managing Partner of Tilson Capital Partners, LLC, a New York City-based money management firm. He owned shares of Berkshire Hathaway at the time of publication. Mr. Tilson appreciates your feedback at Tilson@Tilsonfunds.com. To read his previous columns for The Motley Fool and other writings, visit www.tilsonfunds.com.