Secrets of an Equity Investor
by Jim Citrin
Thursday, December 10, 2009, 1:02PM ET - U.S. Markets close in 2 hours and 58 minutes.
Jim Citrin Leadership by Example
Posted on Tuesday, November 27, 2007, 12:00AM
Much of the feedback for my recent columns has included the question, "What does leadership have to do with investing and making money?"
To address this, I sought out the best investor and one of the best leaders I know: Cliff Greenberg, portfolio manager of the $3.7 billion* Baron Small Cap Fund, director of research for the Baron Family of Funds, and -- full disclosure -- a close personal friend.
Cliff is widely regarded as one of the country's most skilled equity investors in growth companies. Since the inception of his Baron Small Cap Fund (BSCFX) in 1997, he's achieved an annualized 10-year return of 12.45 percent, compared to 6.55 percent for the S&P 500, 7.22 percent for the Russell 2000, and 3.65 percent for the Russell 2000 Growth Index. His fund's one-year annualized returns have been 22.54 percent, while the three-year returns have been 16.90 percent and the five-year 18.06 percent.
In for the Long Haul
I spoke with Cliff about his investment philosophy, and asked what advice he has for individual investors. Here are some highlights from our discussion:
Q: How would you describe your investment approach?
A: My approach is to try to find special one-off growth companies that we can own for the long term, as long as we maintain our conviction that we can earn outsized compounded returns in the stock.
I like to find an industry and a business that I believe will grow rapidly for a long period of time. Then we do in-depth research to really get to know the business, management, and industry so we can project what the company can earn and what it will look like in the future. From that we determine what we think the stock will be worth in five years. If that represents an attractive return from today's price, then we buy it.
We're long-term investors. We've held some of our positions for ten years. Our portfolio turnover averages only one-third per year. And we adjust our positions to greater or lesser amounts based on how the stock price changes and its attractiveness relative to what we believe will happen.
An Investor's Prerogative
Q: How does this investment strategy differ from value investing?
A: The analysis is similar but the perspectives are different. Both approaches are based on fundamental research and judgments about what companies will earn and what they'll be worth in the future relative to their price today. But classic Graham and Dodd value investing is when you do the analysis and conclude that a stock is priced cheaply today relative to its current inherent value. In other words, you think something is worth a dollar but is only priced at fifty cents.
Our starting point is different. We try to find growing businesses that are reasonably priced today but that will grow more rapidly than other companies and than others believe, so that they'll be worth a lot more in the future. In other words, we assume that it's reasonably priced today at a dollar but that, based on its earnings growth potential, we believe it could double in three years and be worth three dollars in five years.
Q: How do you maintain selling discipline?
A: While we're doing our work, the market is guessing along with us every day, and often it comes to a different conclusion. The dynamic reality is that an investment is never what you'll think it will be. We're constantly adjusting our sights and thinking over our investment period.
The main reason to sell is that we've made a mistake -- either management isn't as strong as we thought, the company's prospects are less attractive, or the industry dynamics have changed. If the investment plays out faster than we projected and it hits our price objectives, then we might sell down. We also sell when we find a new idea that we like better than one we presently own.
If I thought that dollar today was going to increase to three dollars in five years, but nine months later it looks like it's not going to get there, we'll be flexible and open to changing our minds. The stock price constantly plays into our thinking.
Haves and Have-Nots
Q: How would you characterize the current market?
A: Right now it's a have-and-have-not market. More have-not recently. What's been in vogue has really been in vogue, and what's not has been shunned.
Those that have been strong may have now run their course, and there are some solid sectors that have been overly hurt. We're finding opportunities in out-of-favor sectors, such as commercial real estate and senior living. Even though residential homebuilding is dreadful -- and we have no opinion as to when it will get better -- this will modestly affect prospects in commercial real estate and senior living, but stocks such as CB Richard Ellis have been overly punished.
CB Richard Ellis stock is down over 50 percent from its high, and although 2008 earnings will be less than we anticipated because of credit issues, the stock is trading at only 8 times our present estimate of earnings. Historically, it has traded at 20 times. [Note: CBG represents 2 percent of the Baron Small Cap Fund's net assets].
We're also investors in the senior living sector based on demographics and the fact that many more seniors are coming into this market while there's not a ton of capacity. This drives higher rates, which allow earnings to go up a lot, despite a recent lull of move-ins due to the difficulty seniors are having selling their homes in the current market.
Nerves of Steel and a Saint's Patience
Q: What's the most common trap individual investors fall into?
A: Often, investors don't understand the actual companies they buy or at least they don't have a perspective of what's going to happen to the earnings that drive the stock. It's human nature that if you're buying a stock you'll love if it's going up and hate it if it's going down.
But if I own a stock and have conviction in it, then I'll buy more if the price goes down and will sell when I've made the return I believe is available. We're constantly asking ourselves, "Is there still enough return left in the stock?" This is hard to do emotionally, and isn't intuitive.
Q: Finally, what's your advice to individual investors?
A: Being thoughtful and patient and having a long-term perspective is the best advice I can give. For an individual investor, there's nothing wrong with investing in a mutual fund, even if it doesn't sound particularly sexy.
Find a high performing mutual fund whose strategy makes sense to you. The funds usually charge a 1 percent fee. While I believe professionals can invest more successfully than most individuals, people who watch their investments and who do the homework can also do well.
Read the financial press each day -- the Wall Street Journal, Forbes, Fortune, Business Week, and Barron's. Finally, even in difficult market conditions such as we're experiencing today, maintain your nerve and stay patient. If you do your homework and take a long-term view, you should have the courage to add to your favorite positions when stock falls.
* Figures pertaining to Baron Funds are from the company's web site.
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