Value Investing

The Smartest Discipline for Investors—Value Investing
Value investors are contrarians and free thinkers. The practice of value investing keeps evolving from the original work in 1934 by Graham & Dodds Security Analysis. The original premise of value investing was that the investment in any financially solid company could be profitable if it was bought cheaply enough relative to its historical price to earnings and price to cash flow. Normally a value investor looks for asset rich sleeping giants for $.50 on the dollar because they have suffered a business misfortune but where the perceived misfortune is overblown or the underlying asset misunderstood. They count on making outsized returns by waiting for the market sentiment to change and pay full price again.

Value Investors Look for Value Not Reflected on the Balance Sheet
There have been several evolutions of the strategies behind value investing with huge success for the innovators. The earliest value investors like Max Heine bought defaulted bonds in bankrupt railroads. They made fortunes because they recognized the railroads like Penn Central had huge real estate holdings that were undervalued on their balance sheets. Warren Buffet is a value investor. He recognized that the brands of Coca Cola, Gillette and Washington Post were not properly accounted for on their balance sheets and had huge marketing leverage. David Dreman recognized companies with low expectations outperform companies with high expectations. Most recently Bill Miller of Legg Mason has outperformed the S&P 500 Index for an incredible 15 straight years by expanding the definition of value investing to include internet retailers like Amazon and EBay because he felt they were beneficiaries of secular trends and the shares were available at prices below their intrinsic business value. I have been a student of value investing for the past twenty years so I felt it natural to see if some of the tenets that I had learned could apply to emerging growth companies where there is no price to cash flow, dividend yield or price to earnings ratios on which to evaluate a stock.

Great Management and Strategy is the Hidden Value in Emerging Growth Value
Peter Lynch of Magellan Fund fame is often quoted that he liked to invest in businesses where “any idiot could run this joint because sooner or later any idiot probably is going to be running it.” In biotech, for example, it couldn’t be any different. The barriers against success are so huge and there are so many ways to fail in biotech that management and strategy are the key value drivers. In biotech it can cost $900 million to get a drug approved by the FDA and many great products fail in clinical trials for a whole host of reasons mostly scientific and financial. Returns in biotech are hypersensitive to management and strategy to circumvent these barriers while maximizing the shareholders’ return. Great management and go-to-market strategy combined with mediocre products like a cancer product that will extend a patient’s life by as little as three months can result in billions of dollars of value for investors. Conversely, great products that save peoples lives, when combined with mediocre management, are zeroes. Believe it or not, the science bias in most biotech companies means that mediocre management is the rule rather than the exception. My heroes in biotech are guys like John Jackson and Sol Barer at Celgene, who took thalidomide and got it approved off a four-patient clinical trial in Leprosy and today the product is a leading cancer drug.

I want to use this blog to discuss my strategy generating outsized investment returns by leveraging value investing disciplines in emerging growth opportunities in biotech, alternative energy and consumer products and services.

The Ten Lessons of Value Investing in Emerging Growth Companies

1. Invest in companies that because of macro trends are in the right place at the right time
2. Start with a great idea that is defendable
3. Bet the Jockey.The right Jockey will find a way to succeed.
4. Invest at a deep discount to intrinsic value
5. Find a cash flywheel that can fund incremental growth
6. A great team with the right organization can do anything
7. Be contrarian and change the rules of the game
8. Branding and positioning are the keys to making a big dream come true
9. Invest in companies that leverage your equity with non-dilutive financing
10. Add to your winners and sell your losers.