‘Our Recent Performance Sucks.’ Here’s Your $10 Billion Back.
This was recently quoted as a headline to a WSJ article citing the closure of AJO Partners, a boutique value-investing firm founded by Ted Aronson which once had USD 30 bn as Assets Under Management (AUM) at the 2007 peak.
So what made AJO partners shut their fund?
Short answer – Under-performance coupled with the biggest client pulling their money out (USD 500 mn in ticket size.)
Let’s back up a little bit here.
What is value investing?
Value Investing is the practice of buying an asset ‘cheap’ and selling it when it becomes ‘expensive’. This often begs the question – What is cheap? and What is expensive?
Well, for starters we will not talk about PE ratio today.
Oops.
Mr. Sanjoy Bhattacharyya is a lesser-known individual who’s talked about in the investing circles in this country. His thoughts are often free-flowing and filled with a lot of wisdom. This is precisely the reason we will try to objectively filter Value Investing from his lens from a talk he almost gave 10 years ago!
Buying a Great Business at a Great Price
Price is what you pay, value is what you get.
Warren Buffett
Sanjoy argues that the right price is very important to identify the first step in value investing.
But this great price should belong to a ‘great’ business.
There’s no point trying to find a ‘great’ price to a ‘bad’ or a ‘gruesome’ business.
Bad or Gruesome businesses are often the ones that end up either burning a lot of money or need constant capital infusions to keep earning money or simply, stay afloat. More on this, later.
Stock Market – Works against the basic principle of economics
Stock market is a funny place when one tries to look at it from the lens of the basic principle of economics.
Lower the price, higher the demand and vice-versa?
The markets seem to work contrary to this basic principle.
Often you’ll see when prices are climbing, the demand for the stock rises. The opposite is often true when the price drops and it is often coupled with incessant selling.
Why does this happen?
Optimism.
Optimism is the biggest enemy for a value investor.
Importance of Price
Speculation and Investing are two different things.
Graham was very objective when he defined what Investing is
“An operation upon which thorough analysis promises safety of principle & a satisfactory return.”
Notice how satisfactory return is secondary. The primary objective in value investing is safety of principle.
This makes the importance of price very paramount.
One should try and objectively understand the worth of the business. Do not try to look at the price of the stock but the worth of the whole company to realize what is it worth.
What about Markets?
What most people often fail to understand is the fact that markets are not efficient all the time. They are efficient most of the time.
While in today’s day and age we can all argue that information is being processed at lightning speed and all trades are being done by algo bots, it is important to understand that while information is available all the time – processing is still done by the human brain.
The human mind is filled with multiple emotions that makes it act in different ways a lot of times.
What to avoid?
LEVERAGE.
The only way to go broke is – GREED.
Concluding Thoughts
Sanjoy argues that the only way to make stupendous wealth by value investing is to make a significant bet on the point of maximum pessimism.
At the point of maximum pessimism, the margin of safety is higher because the price is, in all probability at the ‘right range’.
This will also prevent you from the shackles of trying to sell smart because there is reasonable margin of safety.
This finally begs the question.
Is value investing dead?
I was ending this post very comfortably at 3:45 AM when professor Damodaran dropped a truth bomb.
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Saket Mehrotra
Thanks!