Tilson On The Three Most Dangerous Words In Investing

Even the most astute investors can fall prey to emotions and behavioral biases, and in a recent interview value guru Whitney Tilson talks about how to keep those emotions and biases in check.

“There is no sure-fire way to get rich quickly,” Tilson tells Steve Forbes. “In fact the pursuit of that usually leads to ruin. The best way I know to get rich long term is to invest prudently and conservatively and not try and get rich quick, but try and get rich slowly, basically. Especially in an environment like this where the stock market is hitting new highs every day, practically, it seems. It’s not a target-rich environment, so playing defense, being conservative and applying the basic principles of value investing.”

Tilson says that “there are dozens and dozens of mistakes, but in general the single greatest mistake investors make is projecting the immediate past indefinitely into the future. … And the reality is there are very powerful reversion to the mean trends. There’s always statistical noise, and so people tend to overweight whatever has happened recently, whatever is vivid. And they chase that, and that of course results in terrible outcomes where people pile into the hottest stocks. They pile into the hottest funds right at the peak, right before whatever fad or whatever wave that stock or fund has been riding cracks. And then of course it goes down a bunch, and then they leave right at the bottom.”

He also talks about why the three most dangerous words in investing are “I missed it”. As a value investor, Tilson says, he looks for stocks that are beaten-down. When he sees a stock that has been going up recently, his first response is thus to avoid it, thinking he missed the chance to buy  — but that’s not rational, he says. “It shouldn’t matter whether the stock has been down 50% or up 100% in the past 12 months,” Tilson says. “You should wipe your mind clear of what happened in the past, and just simply analyze a stock, analyze a business at today’s price and decide whether it’s cheap. … The only thing that matters to me today is I can buy this stock today at this price, and is that price a substantial discount to intrinsic value?”

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Tilson Talks Valuations, Profit Margins

Top manager Whitney Tilson says the environment has become tough for value investors, but adds that he’s still finding some bargains out there.

“This is not an ideal environment for a value investor like me because to find wonderful bargains it helps to have some distress in the market — or at least some area of the market — but there’s very little of this today,” Tilson wrote in his latest quarterly letter (hat tip to ValueWalk.com). “The major indices are at or near all-time highs and, for example, the VIX, a volatility measure of the S&P 500, dropped 30% during the first quarter. Nevertheless, I’m confident that I can continue to find attractive investments.”

Tilson says he’s guided by Warren Buffett’s famous saying, “Be fearful when others are greedy and greedy when others are fearful.” He says he doesn’t think greed “has reached the point that we’re in a stock market bubble (the bond market is another matter!), but our fund is quite conservatively positioned right now because valuations are full, complacency is high, and bargains are scarce — and there are plenty of things that could change this.” Among the risk factors he sees: a tepid recovery in the U.S., recession in Europe, a “potential mother-of-all-real-estate/infrastructure bubbles bursting in China”; and bankruptcy for Japan, as well as a conflict in Korea.

Tilson says his fund is 66% long and 22% short, and he had about a third of the fund in cash in the first quarter. A key question for U.S. stocks, he says, is profit margins, and whether they can remain at all-time highs. Historically, margins have always reverted to their means, and he thinks the fund’s high cash position and low stock exposure has sit well-positioned to benefit if such reversion occurs.

Tilson On His New Strategy

In his annual letter to clients, top value investor Whitney Tilson says he is getting back to basics now that he is managing money on his own.

“I truly believe that less is more,” writes Tilson in his first annual letter since he and former business partner Glenn Tongue parted ways. “Going forward, the funds I manage will be concentrated in my very best, carefully researched investment ideas, with approximately 15 meaningful positions on the long side and a similar number of (much smaller) positions on the short side. My target portfolio exposure is 80-100% long and 15-30% short. In this increasingly short-term, trading-oriented environment, I aim to do as little trading as possible, and would be delighted if I am able to generate a handful of great investment ideas each year.”

Tilson says that currently, his fund is 62% long. “My highest priority is to identify a small number of cheap, safe, new investments that will take the fund’s long exposure to the 80-100% range,” he says. “This won’t be easy, unfortunately. In today’s markets, complacency abounds — market volatility levels haven’t been this low since before the financial crisis in early 2007 — so high-conviction long ideas are few and far between right now. I’ve been doing a lot of work on a range of companies and am finding many stocks that are trading at a 10-20% discount to intrinsic value, but that’s not a big enough margin of safety, so I continue to look.” He offers up a list of companies he’s recently been looking into.

Among the stocks in Tilson’s portfolio at the time he wrote the letter: Berkshire Hathaway, AIG, Howard Hughes, Citigroup, Goldman Sachs, and Netflix. He says that, while his fund has struggled in the past couple years, he will not go about trying to bounce back in the “wrong” way. “I’ve seen too many fund managers try to quickly make back losses by swinging for the fences — trading rapidly, using leverage and options, and buying speculative stocks — and they invariably blow themselves (and their investors) up,” he writes. “I’m taking the opposite approach, which can by summarized by the first rule of holes: ‘When you’re in one, stop digging!’ (hat tip to Molly Ivins).”

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Where Tilson Is Finding Value

Top value investor Whitney Tilson recently gave an extensive presentation at the Value Investing Congress, saying he is “cautiously optimistic” that the U.S. economic recovery will continue and offering some of his top investing ideas.

“I am cautiously optimistic that a tepid economic recovery will continue in the U.S.,” Tilson said, “but with the S&P 500 up more than 16% YTD, the markets have already had a good year so I don’t see much upside unless the economy really takes off, which I think is unlikely.” (A tip of the hat to Business Insider for posting the presentation.) He also says several factors could derail the recovery, including problems in Europe, a downturn in the U.S. housing market, a hard landing for China, and a sovereign debt crisis in Japan.

Tilson suggests that high-quality blue-chip stocks are a much better option for long-term investors than bonds right now. Among the stocks he likes: Netflix, Berkshire Hathaway, and Howard Hughes Corp., each of which he examines in detail. Tilson also provides some very interesting charts and graphs about the economy, U.S. deficit, and stock and bond inflows/outflows.

 

Tilson: China Is “Completely Uninvestable”

While Chinese stocks have fallen in recent months, top value investor Whitney Tilson isn’t seeing value in the Asian giant. In fact, he says China is “uninvestable”.

In an email to ValueWalk.com, Tilson explains how his father appears to have been scammed after recently buying a product from a Chinese website, “yet another case study that reinforces my belief that if you do business or invest in China or with Chinese companies, there’s an alarmingly high likelihood that you will get scammed”. Tilson says that rather than trying to address fraud, the Chinese government “instead … attacks those who seek to uncover it — no doubt largely because princelings (children of powerful senior leaders) are directly complicit in (and profiting enormously from) the fraud.”

Tilson adds that there are many legitimate, honest people and businesses in China. “But,” he says, “I’m convinced that the fraud is so pervasive that, as an outsider who can’t tell who/what is legit, you’re likely to get scammed.” And, for investors, here’s the kicker: “In my view,” Tilson says, “China falls into the same risk category as Russia and Zimbabwe — completely uninvestable.”

 

 

Contrarian Picks for the Gurus

In his latest Nasdaq.com column, Validea CEO John Reese looks at some stocks that have been hit hard in the market’s recent downturn, and which now look like bargains. 

Reese talks about how top value investors like Whitney Tilson and Warren Buffett use downturns as opportunities to add to their favorite picks — not reason to flee the market. “In the dozen-plus years that I’ve been studying history’s most successful investors, I’ve found that far more often than not they use an approach like Buffett or Tilson — that is, they buy fundamentally sound stocks that others are shunning,” he writes. “Most of my Guru Strategies, each of which is based on the approach of a different investing great, reflect this.”

Reese takes a look at a few stocks that have been hit hard recently but still get high marks from his models. Among them: The Mosaic Company, which gets strong interest from his Benjamin Graham-inspired model. To read the full article and see all the picks, click here. 

Tilson on Handling Short-Term Trouble

Value fund manager Whitney Tilson, who has a solid long-term track record but has struggled over the past month, recently talked with CNBC about how to handle short-term losses. Tilson says that as long as he still has strong conviction in his picks, he’ll use short-term declines as opportunities to add to those positions, which he says he’s been doing recently. “A bumpy ride in the short term is fine for us as long as we make very nice money in the long term,” he says. He says he thinks stocks — particularly U.S. stocks — look “pretty cheap” right now, and says he’d be surprised to see a major market correction. Tilson also talks about some of his favorite picks, including financials like Citigroup and Goldman Sachs.

Tilson on “Panicked Headline Investing”

In a recent interview with CNBC, Whitney Tilson talked about why his firm likes to invest in firms that are the subject of “panicked headline investing”. Tilson says that “we love buying stocks when we think the sellers don’t care about price,” and cites BP as an example, saying that the oil giant had such negative publicity after its Gulf of Mexico spill that investors lost sight of value and sold the stock indiscriminately. He’s made a handsome profit on the stock since then, and says he finds similar panic-triggered opportunities quite often. But he says the key is to separate the firms that have the ability to right the ship from those that are rightly being pummeled.

Tilson: Big Value in Big Caps

Whitney Tilson is finding some of the best opportunities in the market in some of the market’s largest companies.

“It’s one of the most attractive areas in the market,” he tells CNBC. “They’re incredible companies that are earning profits and trading at 10 to 12 times earnings with strong balance sheets and they’re returning cash to shareholders — they’re not exciting but if you’ve got a 5-10 year horizon and you want to earn better returns than Treasurys I think they’re the way to go.”

Tilson counts Berkshire Hathaway, Coca-Cola, and McDonald’s among his current big-cap favorites. He also offers his take on Netflix, and some tech plays that he’s high on.

How Many Stocks Is Enough?

How many stocks should an investor own in order to diversify away stock-specific risk? Some interesting data shows that it may be fewer than you think.

The data comes from hedge fund guru Joel Greenblatt’s book, You Can Be A Stock Market Genius, and was highlighted by top value investor Whitney Tilson a few years back (and recently reprinted on The Motley Fool website). According to Greenblatt’s book, the risk-reduction benefits of adding more stocks to your portfolio significantly decreases once you get to about 20 or so stocks. Tilson, citing the data, said that “owning two stocks eliminates 46% of nonmarket risk of just owning one stock.” As you add stocks to the portfolio, that nonmarket risk declines as such:

• Owning four stocks eliminates 72% of the risk

• Owning eight stocks eliminates 81% of the risk

• Owning 16 stocks eliminates 93% of the risk

• Owning 32 stocks eliminates 96% of the risk

• Owning 500 stocks eliminates 99% of the risk

“Generally speaking, my ideal portfolio would have 12-20 well-diversified 50-cent dollars (e.g., stocks trading at half of my conservative estimate of their intrinsic value), of which roughly five were 10% positions and rest were 5-9% positions,” Tilson wrote. “Once one has a well-diversified, balanced portfolio of a dozen or so stocks, adding additional stocks does little to reduce risk, yet there’s obviously a big penalty in terms of performance if one’s best ideas are 3-5% positions instead of 7-10% positions.” (Keep in mind that Tilson’s artice was published in 2004, so his approach may have been altered since then.)