In this month’s edition we will review 5 Auctus Investment Principles that have stood the test of time and have been applicable over my 15 plus year investment career. Our team reflects on these lessons frequently, especially given the current state of the markets.
1. Management matters
When it comes to the ultimate success or failure of a company, the most important lesson I’ve learned over the years is that management really does matter…a lot. If you have a great company run by a poor CEO, the odds of that company turning into a good investment are low. On the other hand, if you have a so-so company in a so-so industry with a superb CEO, then it is much more likely that company will turn out to be a good investment in the long run.
For example, on a recent due diligence visit I met with one of our managers that shared a story of a company visit in Chicago. She met with the large company, thinking this company might have some interesting technology. Upon arrival she noticed the CEO’s desk was extremely clean, there was nothing on it except a pencil holder and some perfectly sharpened pencils---no active projects in sight. Once they sat down to meet, the CEO’s assistant interrupted multiple times with questions about production-line issues. In a large company such as this, the CEO of the company should not be directly managing the production line. She concluded that the CEO was a micro-manager and this company was too big to have a micro-manager as CEO. Consequently, no investment in the business was made.
As it turns out, the stock went down a lot, the CEO was fired, and the company basically broke up because it was so mismanaged. If our manager had not gone to that meeting and had that interaction, they might have invested in the company because it looked attractive on paper. Management was the problem. The moral here isn’t that there’s anything wrong with perfectly sharpened pencils and a clean desk, but it was a case of classic micromanagement that made the company a poor investment.
2. Beware of too much debt
One very large and very clear problem today is the high level of debt that has accumulated over the years. Furthermore, this growing debt load is not isolated to any one corner of the economy. It is pervasive and widespread. Government, corporate and consumer debt has grown dramatically at a time of historically low borrowing costs.
In today’s ultra-low interest-rate environment, the cost of the debt looks very manageable. But when rates move higher (as they have already started to do) the cost is going to look more and more onerous. It’s a long-term issue that isn’t going to implode anytime soon, but I think it is a serious headwind for the global economy.
3. Don't fear drown markets
Another lesson I learned early in my career (Tech Bubble) and then again years later (Great Recession) is that you need to take advantage of bear markets. Broadly speaking, declining markets give you a chance to invest in companies at lower prices. I remember a quote from Shelby Cullom Davis—“You make most of your money in a bear market, you just don’t realize it at the time.” That particular quote has influenced a lot of my investment style and manager selection. I look to be opportunistic, and I have always been slightly defensive until valuations become compelling. It’s not an easy thing to do. Typically clients want to chase returns when defense is prudent and valuations are high, and they want to get defensive during bear markets when valuations are very attractive. In the end, a good investment thesis focuses on a prudent allocation to accomplish goals and uses emotional reactions by retail investors to add alpha (excess return over the expected risk adjusted return).
Sometimes in a down market, you get a chance to do well by identifying a great company or a great manager that has underperformed; however, more often than not, the best investment decisions have come about because of research to identify great managers with a great process and consistency over full market cycles.
4. Valuations are lofty
The flip side of a bear market is the bull market we’ve seen since 2009, one of the longest-running bulls in history. This exceptionally strong market has resulted in equity valuations that are high by any estimation. Whether you look at them on a price-to-earnings basis or relative to gross domestic product (or just about any other standard measure), U.S. equities are very highly valued.
That doesn’t mean the stock market is going to fall anytime soon. It just means you probably won’t see the extra tailwind of rising valuations as this bull market continues to age. That’s something investors need to keep in mind as they consider their total-return expectations going forward.
5. Embrace innovation
In some cases, however, high valuations are well deserved. Case in point: We are in one of the most exciting periods of innovation in many of our lifetimes. When I started in this business, there were no smartphones and no internet. Over the past four decades, technological innovations have been enormous. And now we are seeing additional innovation in the areas of artificial intelligence, machine learning and social media. This extremely rapid pace of change creates a very disruptive environment, which is always exciting to me as an investor as opportunities emerge as things are disrupted. I remain very excited about these opportunities while at the same time keeping an eye on the potential headwinds in this extraordinary market environment.
I thoroughly hoped you enjoyed our first edition of “The Perspective”. I am honored and humbled by the trust and confidence you have placed in Auctus Advisors, and our team looks forward to continuing to earn it every day. As always, please contact us with any questions!
David B. Miller
Managing Partner | CIO