The name Tom Gayner may not immediately ring any bells for you. If you're not familiar with Gayner, he's the much-lauded president and chief investment officer of specialty insurer Markel (NYSE: MKL). Gayner has compiled quite an impressive long-term investing track record at Markel by following the basic value-investing tenets as laid out by Warren Buffett.
With that as a backdrop, I recently found myself watching an interview with Gayner from 2007. As Gayner laid out his basic investment philosophy to the interviewer, I was nodding along. As he talked about a couple of his major investments -- including Berkshire Hathaway (NYSE: BRK-A)(NYSE: BRK-B), which still remains Markel's largest equity position -- I kept nodding. But then the topic turned to Bank of America (NYSE: BAC). (Dum, dum, dum!)
Speaking about Bank of America and banks in general, Gayner said:
I think that they're all actually positioned relatively well. Banking historically has been a very good business. By law, it's against the law to lose money in banking. ... So even in things that they do wrong or make a mistake, pretty quickly individual banks, and systemically banks in general, adjust -- stop doing those things, cut back, fatten the prices, whatever they have to do -- in order to maintain profitability over long periods of time. There's just no bank in the world that can get away with not doing that, they'll lose their license if they don't. So you look at Bank of America, I think it's very attractively priced ...
Go ahead, cringe. In retrospect that is disastrously wrong. All of it. Banks in general were positioned awfully as they had loaded up on mortgages on overpriced real estate that borrowers could never afford to pay back. In the case of many bigger banks, they made matters worse by piling dangerous derivative exposure onto their balance sheets.
And Bank of America? Oh, Lordy, Lordy. The 2007 vintage Bank of America may not have been one of the worst offenders in the bubble days leading up to the crisis, but it made up for that by making the disastrous decision to buy Countrywide Financial and Merrill Lynch.
So Mr. Gayner got it very wrong. And it would appear that he paid dearly for it too. In 2008, Markel's equity investments declined by 34%.
But wait just a second ...
Think this Tom Gayner character is just another example of how deluded some investors were prior to the meltdown? Consider this.
|
Year |
S&P 500 Returns |
Markel Equity Returns |
|---|---|---|
|
2006 |
13.6% |
25.9% |
|
2007 |
3.5% |
(0.4%) |
|
2008 |
(38.5%) |
(34.0%) |
|
2009 |
23.5% |
25.7% |
|
2010 |
12.8% |
20.8% |
|
Five-year average return |
0.7% |
6.2% |
|
10-year average return |
(2.0%) |
7.6% |
Source: Yahoo!Finance and Markel filings.
Could this mean ... ? Wait a second. Is it possible to get something wrong and still produce attractive returns and beat the market? Well, when it comes to Bank of America and banking in general, Gayner certainly seemed to get it wrong. And over the past decade -- lovingly referred to as a "lost decade" by many investors -- his equity portfolio at Markel produced a none-too-shabby 7.6% annual return.
For obvious reasons, it's better to be right. However, it's a simple truth that as an investor, you will get it wrong sometimes. Guaranteed. Maybe even spectacularly wrong at times.
So while it's great to strive to be a smart investor and be right more often, the wise investor accepts that he'll be wrong sometimes and, as a result, constructs a portfolio that can succeed in spite of the occasional misfires. How exactly can this be done? Here are two ideas that will go a long way toward that goal.
1. Diversify
It's not new. It's certainly not fancy. And nobody's going to be impressed when you start talking about your diversification (they'd rather hear about the next stock that will go up 8,000%). But if you don't place all of your eggs in one basket, then it'll be tougher for even a big mistake to turn your retirement savings into a scrambled egg breakfast buffet.
At the end of 2007, Gayner had $45 million of Markel's portfolio in Citigroup (NYSE: C) and $30 million in B of A. He also had $31 million in now-bankrupt title insurer LandAmerica Financial and $137 million in General Electric (NYSE: GE), which was on the verge of getting hammered by its financial services business.
However, Gayner had plenty of Markel's money outside of the financial services industry. He had a $109 million position in spirits giant Diageo (NYSE: DEO), a $107 million stake in CarMax (which today is his second largest position), and $83 million in beer baron Anheuser-Busch.
Speaking about banking in 2007, Gayner seemed pretty confident in the industry's prospects. Yet he didn't overload his portfolio with banks and real-estate-related financials and that kept 2008 from being a complete disaster for Markel's equity investments.
2. Forget the jumping
In his 1989 letter to Berkshire Hathaway shareholders, Buffett wrote:
After 25 years of buying and supervising a great variety of businesses, Charlie and I have not learned how to solve difficult business problems. What we have learned is to avoid them. To the extent we have been successful, it is because we concentrated on identifying one-foot hurdles that we could step over rather than because we acquired any ability to clear seven-footers.
In the same interview as above, Gayner had this to say about investing in profitable companies:
Why does this business make money? Is there a record of it making money? That has to be there. That seems so basic, it's hardly worth saying, but I've seen a lot of money invested in businesses that don't make money. Some people know how to do that -- I don't, and it has saved a lot of tears for us over the years.
If you want to get good at dealing with being wrong, focus on investing in the seven-foot jumps that Warren Buffett refers to above. However, there're no extra bonus points for choosing the hardest investments to decipher.
For example, I think solar may have a very bright future ahead of it, but in the meantime I have no idea how to determine which solar companies will even exist five years from now, let alone which will lead the industry. On the other hand, Wal-Mart has been a dominant force in retail for a long time, produces very attractive returns on capital for its shareholders, and currently trades at less than 12 times trailing earnings. That strikes me as one of those one-foot hurdles.
In other words, make it easier on yourself as an investor by taking a pass on complicated, tough-to-decipher businesses in favor of ones that you can easily understand.
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