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Photographs by N Mahalakshmi

Masterspeak 2015

"When we make mistakes, we need to squeeze every lesson out because the tuition fee is expensive"
Aquamarine Capital's Guy Spier is the evergreen learner, who calls himself an accidental value investor 

N Mahalakshmi & Rajesh Padmashali

By all accounts 51-year-old Guy Spier is an accidental value investor. After completing his undergraduate studies at Oxford, Spier earned his MBA from the Harvard Business School. Just like the rest of his peers, Spier ended up as an investment banker on Wall Street. But he soon found the all-pervasive whatever-it-takes culture stifling his conscience. The credo “anything goes” was not for Spier who finally found his true calling when he turned to investing in 1997 by launching Aquamarine Fund, modeled largely on Warren Buffett’s investing principles.

Spier attributes a large part of his second coming to Buffett and the learnings from attending the Woodstock of Capitalism, the annual meeting of Berkshire Hathaway, since 1995. Meeting Buffett cloner Mohnish Pabrai only reinforced Spier’s faith in the tenets of value investing. But as Spier points out the best investing lessons have little to do with stocks and more to do with knowing oneself. Sitting out of his Zurich office, Spier takes us through his investment philosophy, talking about his multi-bagger picks and the lessons he learnt from missing a thing or two.

What was your biggest education as a value investor?

It all started for me with Ben Graham’s book, The Intelligent Investor. The second big influence was Warren Buffett and the biography of Ben Stein. The third influence was Mohnish Pabrai. I learnt an awful lot from Pabrai because I managed to spend time with him as he was far more accessible than Buffett.

Coming back to Graham, the three basic ideas that continue to influence me are: First, Mr Market is this manic-depressive who is our servant and not our teacher. In other words, if Mr Market wakes up depressed we can buy stock of him and when he wakes up super optimistic, about the future of companies, we can sell stuff to him. Second, stocks represent part ownership in a business and, third, buy stocks with an adequate margin of safety. I have also learnt a lot by attending the annual shareholder meetings of Berkshire Hathaway at Omaha.

What are your biggest learnings from the annual Berkshire Hathaway meetings?

The first meeting I attended was in 1995 and, unfortunately, I skipped a couple of meetings. But I have since attended 18 meetings in the past 20 years. The biggest learning for me was about understanding the value of float. Float looks like liabilities on an insurance company’s balance sheet but represents funds that can be invested by the management of that insurance company for the benefit of its equity holders. So, if you get it right, it is as good as free leverage. There are a number of studies that show how float has been an enormous contributor to Berkshire Hathaway’s returns. Incidentally, at one of the annual meetings when asked to elaborate on the concept of float, Buffett replied: “If you offer to pay us a dollar for every dollar of float on our balance sheet, we wouldn’t accept it.” So, these are liabilities that they would not even accept for a dollar. 

Normally, you would want to pay somebody to get them off your books. It was a paradoxical statement and that thought sat with me for a good four to five weeks before I started to understand that. I modelled out a balance sheet that had a dollar of assets and a dollar of float and what it would look like under different circumstances and what would be necessary for that to be worth a dollar or more. That was a really powerful concept and an idea that went into my toolkit in valuing Berkshire Hathaway and other businesses. It was a huge lesson for me and that thought process led to my investments in Alaska Milk, a dominant producer of condensed milk in the Philippines, and in credit rating agencies.

How do you go about building your portfolio?

Diversification is, as Warren Buffett says, an insurance policy against ignorance. It is impossible to own that one stock and make the highest return by entering and exiting it at the right time. There is this example of hedge fund manager Mark Sellers who invested in a natural gas company called Contango Oil & Gas and suffered huge losses in the financial crisis as the stock headed south. Eventually, he went out of business. So, that is a testament to the risk of being concentrated in just one stock. The other extreme is where you have 100 stocks, similar to mutual funds. In other words, your performance will be very much in line with that of the market. 

One of the things that we are trying to do is not risk a lot for a little. 20 is the right number of stocks to have in a portfolio, which is a 5% position in each stock. The reason for having 5% is that if your 5% doubles to 10%, it will have a meaningful impact on your portfolio. On the other hand if it unfortunately goes the other way and let’s say the stock halves then you have lost 2.5%, which is increasingly a small amount of your portfolio. So, I think that pitching a position at 5% of my portfolio is something that I am comfortable with and gets the right balance between risk and reward. That said, I don’t entirely stick to the 5% rule. There are times when I will invest as much as 10% of the value of the portfolio in one stock. 

What are the most concentrated bets in your portfolio?

I prefer not to talk about specific positions and the reason why I don’t want to talk about it is for fear of commitment and consistency. When we say something about ourselves we have a desire to be consistent with that. If I say to you why I think XYZ stock in my portfolio is a great position to own, then I make it more difficult for me to change my mind on that.

I think that one of the key things to being a good investor is the ability to change your mind and to distance yourselves from the thought that you had, maybe, not so long ago. Charlie Munger says that shouting it out is pounding it in. There are some things I am really happy to pound it in like the need to look for a margin of safety in my investments. But I don’t want to sort of publicly get married to certain stocks.

he other aspect that Buffett talks about is the inevitable. I think that the more concentrated positions that I have in my fund are companies that I would consider to be inevitable. In that, it is not a question of “if” but a question of “when”. If Facebook’s business model continues to get better, if Amazon can raise its margins to the point where it can generate cash are hard questions to answer. Easy questions to answer are to say we know that energy costs are going to rise. And we know that the cost of real estate and the rights of way are going to rise. Therefore, if you own a railway network it is just a matter of time before it is highly in demand in any country in the world.

Because as you have real estate development around the railway tracks it becomes that much harder for competitors to come along and put in their own railway tracks. So, you become a natural monopoly. So, that is just a question of “when”. Businesses that are well managed and don’t have too much of debt and that engage in not “if” but “when” kind of businesses are the ones that give me the confidence that there is margin of safety in my portfolio.

How do you figure out whether a stock trading at a discount is a real bargain or is priced low for the right reason?

I would reframe the question to state that there are many stocks that appear cheap but aren’t. In other words they are, what Whitney Tilson would call, a value trap. I don’t think there are any easy straightforward answers to that question. It is the sum of an awful lot of experience and mistakes that we get better at avoiding value traps and avoiding things that look cheap but actually aren’t. Just a few guidelines that I would give are that the underlying business has to be sound. 

I think that it is very hard to invest in businesses whose moat and business prospects are declining no matter how cheap they are. Another way to avoid value traps is that I try and not invest around bad people. I think that when you have ethical high quality people who are smart, good things tend to happen around them. So, I would rather pay up to be around those people than to invest in something that is extraordinarily cheap. 

How do you determine how much margin of safety is enough? Can you explain with some real examples of dilemmas that you have faced and how did you decide?

Warren Buffett says it should be so easy to see that it is like shooting fish in a barrel after the water has run out. I have experienced from time to time in my life though it doesn’t happen as frequently as I would like it too, but it doesn’t “never” happen either. There are situations where you throw away the calculator and just feel this is screamingly ridiculously cheap. In such an event, check and double check. And if there is nothing that you have completely missed, it is just screamingly cheap. The first credit rating agency that I looked at was Duff & Phelps. It was trading at four times earnings, it was debt free and enjoyed 25% earnings yield. That was cheap, it is simple as that. 

The other thought on the margin of safety is that if there is something that is extraordinarily cheap, then you don’t have to get too concerned about how the future will play out. Now, take the case of Amazon and Apple, which have extraordinary moats and are doing incredible things. In order to predict whether the stock has margin of safety at their current valuation, you have to be a really sophisticated analyst. But when a stock is trading cheap enough you don’t have to get that right.

How do you minimise your risk just in case something goes wrong?

Minimizing risk is more of an art than a science. I have checklist of questions that I want to ask myself after I have made the decision to buy something. In the checklist, there are questions like if the world was hit with the worst calamity known to man what would happen to this business. I think that there are some businesses where we can say that they are very likely to survive those utter calamities and there are other businesses that may well not survive. Also, in a way, risk control doesn’t come through position sizing or watching the portfolio every day. It is by owning businesses that are inevitably going to grow in value over time.

Can you talk about your biggest winners and the thought process behind them?

Early on in investing I would often look for an idea that had worked well in the US and try and replicate it outside the US. After successfully investing in Duff & Phelps and Moody’s, I looked for credit rating agencies around the globe that would make good investments. In Indonesia there was a private company that I dallied about buying, but the one that I ended up buying was Crisil in India. In 2000, I got an Indian investor licence and bought the shares of the rating agency. My first trip to India actually was to go and visit Crisil in Mumbai.

I was so scared of investing in the country that I didn’t invest a lot of money in the stock but the investment performed extraordinarily well.  When Standard & Poor’s wanted to increase their stake in Crisil, I sold my shares — a decision I regret terribly. The key thing was that I didn’t invest nearly enough and it was probably less than 1% of my portfolio. If I had invested 5-10% of my portfolio, I would be far richer today as would my investors. 

Similarly, in the branded goods space, I spent a lot of time analysing and understanding why Nestlé was as successful as it was for so long. I was on the lookout for similar kind of businesses in other countries. An analyst working with me at the time was going to look at a for-profit education company in the Philippines called Far Eastern University. But he eventually got excited by this company called Alaska Milk. In a country where the vast majority of people can’t afford a refrigerator, Alaska Milk was a canned condensed milk product that one could store for long and had a sweet creamy taste.

As people would emerge from subsistence farming and start earning real money, it was a product that they could buy without having to buy a refrigerator. Alaska Milk had a 80% market share and it was controlled by a Filipino family. One of the reasons why it was so cheap was the perception about Philippines being a corrupt and dysfunctional place. I bought Alaska Milk at around four times its earnings. But what got me comfortable about Alaska Milk was the management; the family running the business was very ethical and ran a very tight ship. 

What would you consider your biggest mistake?

Clearly by far the biggest mistake that I made in my career was to go and work for a less than reputable investment bank and to compound that mistake by not leaving within the first week. I think that did enormous damage to my reputation that if I could live my life over I would make a different choice. We are inevitably going to make mistakes in life and the key is not to regret that we have made them but to find ways to turn lemons into lemonade. When we make mistakes, we need to squeeze every last lesson out of them because the tuition fee is expensive.

You are fond of quoting chess champion Edward Lasker who says, “When you see a good move, look for a better one.” How do you apply it in investing? 

Charlie Munger makes this amazing observation in one of his speeches that in the marriage market it is not that you are looking for the best spouse but if the best spouse is willing to marry you. Objectively, that may not be the best spouse as; first, you have only a limited set of people to choose from. Second, you can only choose from the few who are willing to marry you. Another constraint in the marriage market is that these potential spouses don’t appear all at once where one can compare them and pick one. They appear sequentially in our lives. We have to spend the early part of the search learning what the landscape looks like and then at some point we have to make the decision. We may make the best decision without knowing whether the next person might be better or worse. There is limited time and, in many ways, the same applies to investment decisions as well. 

We have to deal with opportunities not as we would like them to be. We can’t choose to compare investment ideas that are available today against all the ideas that will come up in the future. I need to decide how to reposition my portfolio based on the opportunity set that is available today. But I practice Lasker’s approach that says keep looking for better moves. Look for opportunities that scream your way and it is obvious that you have to step in. And if it is not screaming your way and if you have doubts, it is probably better not to buy. The career of a successful investor is going to be full of missed opportunities and remorse over decisions not taken and decisions taken, and that is something that one has to learn to live with. 

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