From Quantitative To Qualitative
In several parts of this sometimes lonesome blog, I have spoken about why deep value investing and net current asset value investing which is a subset of deep value investing, should be viewed through the eyes of a quant. In general, what you want is a scenario where you would avoid the gambler’s ruin at all costs. You want to survive and live another day. And to do so, one would apply the law of large numbers in such a way where gambler’s ruin can be avoided. And then, you try to attain a statistical average in your returns over a large random sample. That sounds simple enough. But some of the net current asset value stocks are just downright ugly I have to admit. So ugly that I would even be thinking twice about investing in them. But some of these really ugly stocks really do rise from the ashes so to speak. I have had one too many instances of that happening. And that is also the reason net current asset value investing, when done mathematically and mechanically requires the law of large numbers approach, very much similar to card counting in the game BlackJack in “Beat The Dealers” where Ed Thorp talks about a positive expectation of an overall win over a large number of attempts.
So that is one reason to look at deep value investing from a purely quantitative investing screen. And one super investor I know of, I bet you would have heard of him before – Walter Schloss. Yes, I have written about him in a number of articles and he is certainly one person that I look up to, the one person whose portfolio I model after. Well, Walter Schloss would admit he is more of a quant. He readily admits that he has had difficulty deciphering the intentions of management. In his portfolio, he is known to have a 100 positions open at a time.
My own story has led me to the same conclusion. I think about some 15 – 16 years ago, I was investing in a furniture company in Singapore. I shall not mention its name. But one day, I attended the annual general meeting of the company. And after the annual general meeting, there is usually a buffet lunch that is served and sometimes, you will see the company directors and C-level executives hanging around, distributing name cards, talking to minority investors who own the shares of the company. In such an instance, I stood around hoping to ask some questions while I had lunch. I found a director quite ready to hand out his name card and talk to me. And we had a conversation about the company, with me peppering him with questions along the way about the company. But along the way, he sold me on the idea that the company was on the way to becoming a billion dollars in market capitalisation. I went back, redid my excel sheets and found that it was a probability if things went the way he described. Back then, I didn’t know that that would have been a speculation by Be Graham’s standards. And so I was happy to hold on to it.
Not long after, the company disappointed on its reported earnings can cash flows and you could definitely guess what happened to the stock price subsequently. Of course, the stock price crashed. It never recovered. So from then on, I was always suspicious of any sort of “adjusted figures” and any sort of story telling that the company could one day be worth this much. I am quite sure that I did not ask the right questions then. But the case in point is this. You really have to be on your guard with management when you speak to them. Some of them are charismatic as hell and you will come along feeling really good about your investment thesis.
As you can imagine, I was “blessed” with a number of lessons. So lesson number 1 was don’t believe anything that management says readily unless the stock prices were really low in relation to the earnings and the assets or/and unless the management themselves had some skin in the game. The other lesson was to ask questions related to the downside rather than the upside. most investors look towards the upside and there is nothing wrong with that except that one comes away with a gaping hole on the thesis of investing in some of these companies on the downside.
My approach is more quantitative now than qualitative but I do include some qualitative layers to it. I would like to think that I do. The qualitative layers include elements of corporate governance, fact checking of what the company has executed on versus what they have said, asking management the right questions and finding out if the company does indeed have any sort of competitive advantage, understanding the business really really well and studying the notes to the accounts and much more.
You would really have to get your hands dirty and dig deep if you want to be more qualitative in your approach towards deep value investing. And of course, the qualitative takes a lot more time than the quantitative. You would have to dig through years of the company’s annual reports and try to understand how the cash flow statements interact with the balance sheets and the income statement. And if you don’t understand all of that for any reason, that puts a stop to your investing in that company.
This is the approach that some investors layer on with the quantitative. And if this is up your alley, then I suppose a concentrated portfolio is for you. But if you are new to the game of investing, I would advise you against going full swing on the “qualitative” especially if you are new to the game of investing. Stick to the quantitative and your portfolio would in all likelihood grow. Go on to the qualitative as your confidence in value investing grows. Knowledge in value investing is cumulative and this is one area in which experience pays off over the long run. That is my advice for you. But if you want to know more about having a concentrated deep value investing portfolio, you can try searching about Jeroen Bos and find out more about him. Perhaps, I will write an article about him sometime in the future. But I did write about one of his investments, Barratt Developments which went on to become a 10 bagger stock over the last decade.
May you be blessed with prosperity, health and happiness!
These books which I have written are case study driven and discuss strategies, mindsets and situational approaches to employing the net current asset value strategy.
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