WEBVTT NOTE Authors Forum: Applied Investing 1 00:00:00.000 --> 00:00:08.000 Our next presenter is Joseph Calandro from the University of Connecticut, and he's going to be talking to us about his new book, Applied Investing. 2 00:00:17.000 --> 00:00:21.000 Thank you. It's Applied Value Investing. 3 00:00:21.000 --> 00:00:29.040 To give you a background on the talk, I'm going to start with kind of an overview of Benjamin 4 00:00:29.040 --> 00:00:35.400 Graham who founded Value Investing and then segue that into how modern value investing 5 00:00:35.400 --> 00:00:40.520 practice is practiced. For the simple reason that today's economy is much different than 6 00:00:40.520 --> 00:00:44.840 the economy that Graham founded a discipline in and talk a little bit about my research 7 00:00:44.840 --> 00:00:49.720 and get into some of the research contained in my book, Applied Value Investing and then 8 00:00:49.720 --> 00:00:59.800 Benjamin Graham founded what's known as value investing in the 1920s and 1930s. He was heavily 9 00:00:59.800 --> 00:01:06.840 influenced by the new era boom of the 1920s and the subsequent bust or Great Depression. 10 00:01:06.840 --> 00:01:12.920 It's essentially a price arbitrage strategy. He referred to it as cigar butt investing. 11 00:01:12.920 --> 00:01:18.000 What he meant by that was companies that were selling at less than their liquidation value 12 00:01:18.000 --> 00:01:22.720 were analogous to like an old cigar butt that had a couple puffs of smoke left in it. 13 00:01:22.720 --> 00:01:28.720 If you could purchase it below its liquidation value, you essentially could achieve an arbitrage 14 00:01:28.720 --> 00:01:34.120 profit, a riskless profit, and that gave you what he called a margin of safety, and that 15 00:01:34.120 --> 00:01:38.960 is the cornerstone of the approach, it remains so today, and it's what differentiates an 16 00:01:38.960 --> 00:01:43.480 investment from a speculation to Graham and his students. 17 00:01:43.480 --> 00:01:47.840 The most famous student obviously is Warren Buffett, the chairman and CEO of Berkshire 18 00:01:47.840 --> 00:01:48.840 Hathaway. 19 00:01:48.840 --> 00:01:52.720 I actually worked for him at one of his subsidiaries for a number of years. 20 00:01:52.720 --> 00:01:57.240 I'll talk about that if anybody has a question. 21 00:01:57.240 --> 00:02:01.520 What differentiates value investing from what's typically being taught in MBA schools today 22 00:02:01.520 --> 00:02:06.540 is it's strictly a bottom-up approach, it is not top-down. 23 00:02:06.540 --> 00:02:12.240 And as a result, value investors pretty much opposed modern financial economic theory from 24 00:02:12.240 --> 00:02:18.400 from the beginning. And to give you an idea of what that means, it essentially has to 25 00:02:18.400 --> 00:02:24.000 do with, it's an accumulation of theories, efficient market theory, portfolio theory, 26 00:02:24.000 --> 00:02:28.880 a theory that says capital structure doesn't matter, which is probably the dumbest theory 27 00:02:28.880 --> 00:02:34.280 on that slide, asset pricing models, option pricing models, pretty much from the beginning. 28 00:02:34.280 --> 00:02:39.340 Now they've opposed all that and they've also substantially outperformed the market averages 29 00:02:39.340 --> 00:02:48.620 over time. So the modern approach to value investing occurs over a continuum of value, 30 00:02:48.620 --> 00:02:52.540 and what I mean by that is it starts with net asset value, and that's essentially reproducing 31 00:02:52.540 --> 00:02:57.740 the balance sheet. Balance sheet analysis formed the basis of what Graham did in the 32 00:02:57.740 --> 00:03:03.440 1920s and 30s, and it remains a cornerstone of the approach today. Next we go to earnings 33 00:03:03.440 --> 00:03:08.180 power value, and this is different than the traditional discounted cash flow that MBA 34 00:03:08.180 --> 00:03:12.820 are taught and by that I mean it's based on a level of past earnings that should be sustainable 35 00:03:12.820 --> 00:03:14.360 into perpetuity. 36 00:03:14.360 --> 00:03:17.860 So it's much more tangible than discounted cash flow because you're not projecting out 37 00:03:17.860 --> 00:03:20.700 to the future and discounting back. 38 00:03:20.700 --> 00:03:25.620 Next you move to franchise value and if there's a spread between your earnings power and your 39 00:03:25.620 --> 00:03:31.080 net asset value, that's a tip off that either A, there's a sustainable competitive advantage 40 00:03:31.080 --> 00:03:36.400 that you have to value or B, if there's not one and there aren't many, then your earnings 41 00:03:36.400 --> 00:04:03.640 One of the keys to the approach is the assumptions are upfront in each level because it's bottom 42 00:04:03.640 --> 00:04:11.640 So, that's important. Investment is not, and never will be, purely quantitative. 43 00:04:11.640 --> 00:04:16.640 Everybody kind of says that, but when the rubber hits the road, most people want a simple equation. 44 00:04:16.640 --> 00:04:28.640 And the only way to get that is either you assume away all the qualitative and behavioral elements that are inherent in an investment, or you address them up front. 45 00:04:28.640 --> 00:04:36.640 So, by way of my background, I came to Austrian economics and value investing late. 46 00:04:36.640 --> 00:04:44.640 I was trading currencies and commodities in the 90s and I did, you know, real well for about four years. 47 00:04:44.640 --> 00:04:49.640 Year five, fortunes changed very, very quickly in the Asian Contagion. 48 00:04:49.640 --> 00:04:53.640 And I really don't want to say too much more about that because it's pretty painful. 49 00:04:53.640 --> 00:05:04.640 But re-examining the mistakes I made led me to study value investing formally and also to study Austrian economics, which was fortunate timing-wise, in a sense. 50 00:05:04.640 --> 00:05:10.640 And I say in a sense because if I had done this 10 years before, I'd probably be very wealthy right now. 51 00:05:10.640 --> 00:05:21.640 But during that time, I mean, the new economy was booming and there were direct parallels between what I was seeing in the quote-unquote new economy and what Graham wrote about the new era. 52 00:05:21.640 --> 00:05:25.720 And obviously, there were definite parallels between what, especially what Murray wrote 53 00:05:25.720 --> 00:05:30.420 about the Great Depression and the boom, and again, what I was saying. 54 00:05:30.420 --> 00:05:37.600 And significantly, Austrian business cycle theory predicted both the boom and bus waves 55 00:05:37.600 --> 00:05:42.920 of both business cycles, which is important, right? 56 00:05:42.920 --> 00:05:49.060 Graham, like I said, this is a bottom-up orientation, and Graham's kind of approach to top-down 57 00:05:49.060 --> 00:05:52.920 was you know buy during periods of pessimism when prices are low and sell 58 00:05:52.920 --> 00:05:57.100 when everybody's like happy and prices are high well I mean I think it could be 59 00:05:57.100 --> 00:06:01.300 easier to do that if you understand the macroeconomic reasons driving the 60 00:06:01.300 --> 00:06:07.460 optimism and pessimism that's the first thing and then the second thing you 61 00:06:07.460 --> 00:06:12.100 could use I think macro based insights in a Graham and Dodd context 62 00:06:12.100 --> 00:06:16.360 to screen for potential investment opportunities and in chapter 5 of my 63 00:06:16.360 --> 00:06:21.280 In my book, I essentially present an approach that does that, that integrates Austrian business 64 00:06:21.280 --> 00:06:26.800 cycle theory, George Soros' boombust model and behavioral characteristics. 65 00:06:26.800 --> 00:06:31.400 Now these are based on a paper that I initially presented at an earlier Austrian Scholars 66 00:06:31.400 --> 00:06:36.180 Conference that turned into a published paper in the Quarterly Journal of Austrian Economics 67 00:06:36.180 --> 00:06:41.600 and then a working paper, subsequent working paper that's posted at Mises. 68 00:06:41.600 --> 00:06:46.640 Several chapters of the book present valuation case studies on high-profile deals. Eddie 69 00:06:46.640 --> 00:06:52.840 Lampert's acquisition of Sears, Buffett's acquisitions of Geico and Jean-Rie, and Buffett's 70 00:06:52.840 --> 00:06:57.200 alternative investment on the Pepsi Play for a Billion Sweepstakes. Now, I essentially 71 00:06:57.200 --> 00:07:03.600 hit the price of each of those investments, and I do so using very, very basic assumptions, 72 00:07:03.600 --> 00:07:09.800 and you can see them as you track the cases level by level. Incredibly, this is the first 73 00:07:09.800 --> 00:07:15.320 book that actually applies Graham and Dodd to value investments, significant value investments. 74 00:07:15.320 --> 00:07:21.240 I'm not sure why that is. I hope it's not the last. There's another chapter presents an approach on 75 00:07:21.240 --> 00:07:25.560 managing, on management, managing for value creation and I'm a manager so that has particular 76 00:07:25.560 --> 00:07:31.480 applicability to me and assessing management for valuation purposes. I'm very fortunate that the 77 00:07:31.480 --> 00:07:37.240 investment community has really taken to the book top investors like Seth Klarman, Mario Gabelli, 78 00:07:37.240 --> 00:07:42.520 and Mitch Jules have given very positive endorsements and it also received two 79 00:07:42.520 --> 00:07:51.440 positive reviews from Doug French and CJ Maloney at Mises Daly's. So, questions 80 00:07:51.440 --> 00:07:54.480 later. Thank you.