4 Smokin’ Hot Tips from Marty Whitman and Third Avenue
There’s always an opportunity to learn something new or to re-calibrate yourself to classic investing lessons. Thanks to BeyondProxy, I’ve come across 4 smoking hot tips from Third Avenue’s investment philosophy.
In case you are unfamiliar with Third Avenue, the asset management firm was created by legendary bankruptcy investor Marty Whitman back in the 80’s with a focus on balance sheet fundamentals and bottom-up investing.
But Whitman and Third Avenue also add a very important criteria. They look for companies with strong balance sheets.
As a bankruptcy and activist investor in his prime, Whitman ran across many good companies that were in trouble simply because they were not well financed. He took that experience and applied it to his funds and the way companies are selected in his portfolios.
From Third Avenue’s Small Cap Value Fund, here are 4 hot tips to takes away.
#1: Find Companies That are Extremely Well Financed
We’re happy to trade off an element of return on equity for a higher degree of safety in the business. One thing that you would see distinguishing our portfolio companies is that we tend to have companies that are overly capitalized and have surplus capital.
Similarly, a thorough discussion is raging on in the forum discussing whether or not companies with high debt exhibit higher returns.
#2 Look for Sound Business Models
It’s very hard to buy the best companies in the world cheaply. They just don’t get cheaply that often. We’re looking really to buy improving business models at a discount or high quality companies that for one reason or another are mispriced in the marketplace even temporarily.
I find it interesting how Third Avenue has evolved.
Whitman was a full contrarian. You need to be in order to do well in bankruptcies. Maybe it was the growth of their fund, but Third Avenue is a now a classic value investing house.
What better advice to remember than to look for companies with good business models.
Actually, good + easy business models are better.
#3 Look for Management Teams with a Good Track Record as Owners and Operators
Are they making the right decisions operationally and able to execute, but also asking ourselves whether their incentives are aligned towards building the business on a long term basis.
One area that I discounted for many years was the impact of management.
I underestimated how a manager could take a company from bad to worse to extinct. I’d buy companies because they truly were cheap. Had a good manager focused on delivering business growth and performance run the company, I’m sure I would have made money.
Instead, I lost money by ignoring an insider focused on greed.
#4 Buy at a Margin of Safety based on Conservative Estimates
Try and buy the securities at a discount from what we conservatively estimate as the intrinsic value of the business. We create a range of values at the low end and the high end, and try to go in at a meaningful discount to those values. Ideally, we’re going in at a 20% or 30%, or more percent kind of discount to our estimate to protect our downside and try to create as much upside for ourselves as possible.
Margin of safety again.
Something that Whitman practiced religiously when he was scooping up bankrupt companies. With equities, you look for a margin of safety anywhere from 20-50% depending on the business. With bankruptcies, Whitman was looking to buy a dollar for 10 to 20 cents. That’s a 80-90% margin of safety on top of conservative estimates.
I love how he uses the word “estimate” to reference intrinsic value. I get lazy sometimes and will just put out a rough fair value number. So every time you see just a single valuation number, on old school value or anywhere else, remember that it is an estimate and read it as $X.XX plus or minus 10%.
3 Minute Video of Third Avenue’s Investment Philosophy from BeyondProxy
Here’s the link if you viewing from email.