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The Value Interviews

The Value Interviews Part One:

Finding Value – The Process

This is the first part in a new ten part series from ValueWalk on value interviews. Over the past three
years, ValueWalk has conducted exclusive interviews with some of the best value managers around. These
value interviews contain some highly insightful nuggets of information for value investors, as well as
ideas, portfolio management tips and some advice on what not to do.

Throughout the value interviews ten part series, I’m going to pick out some of the most insightful value
interviews giving a link back to each full interview if you’re interested in finding out more.

All of the interviewees are managers of investment partnerships, some of which are modeled around
Warren Buffett’s original partnerships. All of the partnerships invest with a value slant.

All of these interviews are at least several months old, but the information contained within is timeless.
However, if you’re looking for more up-to-date interviews and ideas, you should take a look at Val-
ueWalk’s exclusive quarterly magazine, Hidden Value Stocks. Each issue contains two value interviews
with managers as well as four stock ideas and a detailed Q&A session on each idea. Click here to find
out more today.

Value interviews with Curtis Jensen, former CIO of Third Ave. Management
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The Value Interviews

What are the qualities you believe investors should be looking for when trying to
identify the best value companies?

There are a few keys ways to lose money in investing:

1. Buy a buggy whip business (i.e., one where obsolescence, substitution or competitive forces perma-
nently change the economics);
2. Too much leverage (business risk ought to vary inversely with financial risk);
3. Overpay (paying too much exposes your downside, particularly where business values stagnate);
4. Position size (may stem from overconfidence or poor process).

I am trying to identify companies with a strong competitive position, a presence of high-quality assets
or where management has a credible plan and the incentives to improve the operations or capital alloca-
tion, but where temporary issues have depressed the share price. The company’s balance sheet ought to
afford ample financial flexibility such that it can survive a difficult business environment.

Value interviews with John Khabbaz of Phoenician Capital

What are the qualities investors should be looking for when trying to identify the
best companies?

The best companies are those that; take care of their customers’ needs better than anyone else, have a
large and unaddressed market, have managements that demonstrably think and act like owners, and pro-
duce significant returns on invested capital. Great businesses tend to surpass expectations over and over
again, yet few investors ever hold them for the long term. Value investors sometimes do not understand
the exceptional value of what they own and trade down for a lower quality business that looks cheaper.
It is difficult to acquire the discipline of active patients.

Value interviews with Zeke Ashton of Centaur Capital Partners

How do you approach valuation?

This is a subject that requires a whole book, because the craft of valuing businesses is effectively a ca-
reer-long journey. I find that one never really becomes a master because every stock and every industry
is different. I like to say that every stock has a story to tell and a lesson to teach.

In order to keep my answer to a reasonable length, I will simply offer two insights that experience con-
tinues to pound into me. One is very simply that valuing any company requires a certain familiarity
with and a decent understanding of the business. The idea that an investor can just slap a multiple to
earnings or stated book value is a highly superficial notion – though of course it does sometimes work.
The better you understand a specific business and the industry that business competes in, the better the
valuation work is likely to be. That said, some businesses are easier to understand than others, and there
are many businesses that simply can’t be valued with much precision. That’s a difficult concept, I think,
for sophisticated investors to accept. There is a temptation to believe that every business can be valued
with enough informational input, but we’ve found that for us there is a good percentage of the investable
universe that really and truly belongs in the “too hard” pile.

The other insight I will offer is that at least in our experience, the further we drift from true cash flow
profitability as a starting point in our valuation work, the more difficulty we have. What does this mean?

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The Value Interviews

To me, it means that using EBITDA is far less trustworthy than true cash flow. GAAP or adjusted net
income is far less reliable than true cash flow. And when you find yourself running DCF models where
most of the cash flow is expected to materialize many years out into the future and you are discounting
that back to today at some arbitrary rate, let’s just say there are lots of ways for that to go wrong. We
almost always use a DCF at some point in our valuation work, especially to help us with scenario anal-
ysis, but we have to remind ourselves that a DCF model isn’t gospel. DCFs are very useful as a sanity
check and thought experiment, but shouldn’t be a substitute for a more complete valuation exercise.

Value interviews With Old West Investment Management

How do you go about finding potential opportunities, where do you think the best
ideas come from?

We find potential investment opportunities in a number of ways. We read a lot of industry periodicals,
we look at special situations, we talk to our network of business leaders from varying industries and we
talk to other like-minded and value oriented investors. However, I have found that our best ideas are
sourced from Form 4 filings and 13-D filings. We monitor every purchase or sale of stock by insiders,
every day. If a CEO and/or several directors purchase millions of dollars of their own stock in the pub-
lic markets, we will print out the proxy statement to determine if we too think it might be an attractive
investment. Once the proxy is printed, we will look at total stock ownership by management, study
how that ownership was accumulated, and most critically, seek to understand total stock ownership as
it relates to compensation.

What do you look for in a prospective investment, what makes you say, “yes we
want that” or “no we don’t”?

We look for undervalued and/or misunderstood investments that can ideally earn high returns on
capital, and for investments where we can invest alongside great and proven owner/managers as silent
partners. The process by which business value will grow is a direct function of management’s approach
to capital allocation, and we spend a lot of time trying to understand the various capital allocation
levers at management’s disposal.

Because there is not a single and quantifiable data source to vet such issues, it requires a fluid and qual-
itative analysis that considers past actions as a way to understand how management will make future
decisions. If we can’t get comfortable with management, we simply move on no matter how compelling
the valuation.

Value interviews with Amit Wadhwaney of Moerus Capital On Value Investing

I just want to dig a little bit more into your valuation process here. In your first let-
ter to investors, a copy of which was published on ValueWalk, and in your answer
above, you state that you shy away from any valuation models that rely on cash
flows, such as the DCF model. So could you explain why this is the case and why
you prefer asset-based valuation models over cash flows?

Well, let me use an example to explain how we think about valuing assets or businesses. With the DCF
model two numbers are critical, the numerator and the denominator, and in order to decide on each of
them, you have to make several assumptions. We believe that the fewer assumptions you need to make,

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The Value Interviews

the more robust your valuation model will be, and the less fraught with valuation risks.

Different methodologies will give you vastly different valuations for the same security. For example, in
2002 it was the third year of the tech downturn, which gives you some kind of context of the environ-
ment we were in. An opportunity presented itself as the large financial institutions began to retreat from
Stockholm. Now, why Stockholm? Well, throughout the tech bubble Ericsson became a very important
company on Stockholm’s stock exchange. Ericsson’s shares fell when the bubble deflated, dragging down
the rest of the market. But Helsinki Exchange had had a bigger problem in the form of Nokia. As the
tech bubble deflated, the valuations of these companies declined, pulling the rest of their respective mar-
kets down with them.

Financial firms in Sweden and Finland were hit hard by this change in sentiment. This led to an oppor-
tunity in D. Carnegie & Co, one of the largest securities brokers, asset managers and investment banks
in Norway, Finland, Sweden and Denmark. It was a very big player in each of those segments in each of
the markets.

The company had a very flexible cost structure and a relatively clean balance sheet. A big unknown was
how long would the economic or financial downturn last? So, any valuation methodology for the shares
of Carnegie would have to be robust under extended periods of uncertainty. We set about valuing the
three key parts of the business. The first part was the brokerage business. Here we made the assumption
that if the bear market were to continue, trading volumes would slowly evaporate over time and staff
would leave the company, as talent in the financial industry is highly mobile. If this scenario were to
play out, then we assessed that this business would be worth its tangible book value. That was how we
valued the brokerage business on its tangible net asset value alone with no regard to prospective earnings.
Then came the investment banking business. This is quite a hard business to place a valuation on because
the people that work in this division tend to be extremely profitable, making sizable profit contributions
in good times, but expensive to retain in bad times. These employees were also highly mobile. So, we
thought, what would people like this be worth in a protracted bear market? We arrived at the contro-
versial assumption that this business had the potential of being worth zero in a protracted bear market.
And then we had the third part of the business: asset management. Carnegie had a fairly sizeable asset
management arm and ran a number of mutual funds throughout the Nordic countries. What’s more,
the group had recently acquired two smaller asset managers for around 2% of assets under management.
Mutual funds suffer attrition through withdrawals in a protracted bear market, so this is something we
had to factor in. We thought a multiple of 2% of assets under management is a fair way to value the asset
management arm but we shaved the number down a bit to 1% to 1.5% of assets under management.
If you put all together, our valuation looked like this: we had the brokerage business at the tangible book,
the investment bank at zero, and the asset management business valued at 1.5% of assets under manage-
ment. We came up with a bedrock valuation of 40 to 45 Swedish krona per share.

We waited a few months for the stock to come down into the 30s so we could start nibbling and building
a position. After a few months of this, brokerage firm Cazenove came out with a research note on Car-
negie and it turns out Cazenove had a much better crystal ball than mine. They used a DCF methodol-
ogy. They expected the market to bottom in 2002 and start to improve during 2003 and 2004. Carnegie
operated in businesses which had very high operating leverage. As soon as markets started to improve,
the brokerage business, investment banking and asset management would do better. By assuming that
the market would bottom in 2002, Cazenove concluded that Carnegie’s equity was worth 135 Swedish
krona per share. This is a great example of how one little number in your valuation methodology can
completely change the valuation you arrive at.

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The Value Interviews

Value Investors Define The Value

Christian Olesen, founder and managing partner of the Olesen Value Fund.

You mentioned you’re finding plenty of opportunities outside the US in interna-

tional markets. Are there any particular reasons you find attractive here?

We’re bottom-up investors and very opportunistic. We find opportunities in all kinds of places. I do
think there are a lot of things are quantitatively cheap in Australia, but there are actually a lot of risks
relating to the economy there such as the real estate bubble and the exposure to China. Other than Aus-
tralia, I don’t see any regions with an unusually high number of good opportunities right now. We have
traditionally, and still do, have a lot of exposure to developed Europe and mostly the UK. But I don’t
see an unusually large number of opportunities in those places right now.

Do you think managements are as shareholder friendly in these regions, especially

the UK, as they can be in the US?

In my experience yes. I’m not sure there’s any difference in the small-cap universe. Maybe one difference,
especially if you include micro-caps, in the UK these companies have a much higher institutional own-
ership than those micro caps in the US, so they tend to have better shareholder communication policies.
I think the US and the UK have the most shareholder-friendly managements around.

Ori Eyal, Founder and Managing Partner of Emerging Value Capital Management

So would you say your style is based on a ‘top down approach’?

In terms of selecting the best countries – yes, there’s a big macro element. A lot of value investors, who
invest in the US say macro factors, such as politics and economics don’t matter, which is true to a certain
extent, accurately predicting US economic growth isn’t going to give you any particular edge in that mar-
ket. But in international markets, it’s really important to pay attention to economics and politics. Even
if you have a great company, if the country’s falling apart you’re not going to make any money. There
is a top-down approach to filtering the countries. But then there’s a bottom-up approach to finding the
companies in each country.

Is there a list of the countries you’re avoiding right now?

I try to follow global geopolitics quite closely, and keep an eye on what’s going on in different countries
around the world. With this information, I’ve devised a list in my mind of the most and least attractive
investment destinations.

Emerging markets, in general, have had a pretty rough time recently, are there any

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The Value Interviews

specific markets that are looking attractive to you right now?

When I came out of Deutsche Bank in 2006/2007, there was a big thing with the BRICs, Brazil, Russia,
India and China and this never really made sense to me. Why limit your international investments to
these countries? What’s happened since has validated this view. So, rather than looking at ‘emerging
markets’ as a group, I tend to look at specific markets in particular. I classify Israel and South Korea as
emerging markets. I think they’re both very attractive. You have to be careful which countries you choose.

So when you finally find a market to invest in, how do you go about searching for
prospective investments?

After determining the countries that I’m interested in, I just go back to basic value investing. I look at
the company, the balance sheet, and the assets, at the moat, management team and cash flow analysis.
This type of analysis is half science, half art. You need to look at the company and say, “what would
this company be worth in five years’ time, under different economic scenarios”? And then I look to buy
with an attractive margin of safety, we’re traditional value investors. We’re looking for companies that
are cheap based on assets, earnings or cash flows.

Interview With Richard Fogler Of Kingwest & Company

How do you go about assessing a business’s underlying value? Is your process qual-
itative or quantitative?

We assess the value of a business the way a businessman would assess a company he is looking to acquire.
We start with what one can be most certain of; the assets. Does the company have an asset, like real estate,
that is either unrecognized or is not being used to its full potential? The value will only be reflected in
the share price if management changes its use.

Second, we focus on the cash earnings power (the cash the business should generate in a normal envi-
ronment), the capital needed to invest back in the company to maintain its competitive position, the
opportunities to invest to expand the business at returns above the cost of capital, and the companies
target debt structure. Those are the quantitative measures we use to assess value.

On the qualitative side, we look for a competitive advantage because it gives the business the ability to
earn supra-normal returns on capital. Does the company do something that its customers value and will
pay for and that its rivals cannot easily replicate? Will it last? A competitive advantage only has substan-
tial value if it is durable.

Interview with azVALOR: Former executives of Bestinver

How do you go about looking for ideas, what’s your value process?

We avoid the typical screening/filtering. Instead, we have a mental database of companies we’ve deeply
looked at in the last 20 years. Then ideas come naturally through many ways: profit warnings in places
we know, or a competitor’s praise of a business model for example, or just chatting with like-minded
value investors

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The Value Interviews

In your first letter to investors, you highlight the fact that you’re looking for ‘cheap companies,’ how
does the fund define cheap in this case and how do you go about calculating your estimate of intrinsic

We first try to answer an apparently simple question: will the business be around in ten years? Then, we
try to answer a little harder one: will it make more money than today, and why. If the answer is YES in
both cases, we then look at the FCF yield to the firm. We are not comfortable with anything below 8-9%…
Sometimes we’ve made exceptions if the ROCE is really good and the barrier to entry very solid, in which
cases we can settle at 7-7.5%. Below that we do not dare to venture…

Do you think Spain is a market that international investors should consider? Why is
this the case?

We do not have opinions about markets “in general”, but rather tend to ask for a particular market: “are
there enough cheap good businesses.” In Spain, we have roughly 100 investable companies. Most of them
are global, and I would not link them thematically.

Telefonica is to be benchmarked to Telecom Italia or may be Brazil as much more than to the Spanish
Economy. We believe there are some very interesting situations for a stock picker, like the one we mention
below, Técnicas Reunidas.

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The Value Interviews

The Key To Successful Shorting

The Key To Successful Shorting: Ori Eyal — Emerging Value Capital Management

There’s one side of Emerging Value’s portfolio that I wanted to ask you about,
and that’s your successful shorting book. The majority of your successful shorting
book is in two key positions, two key ETFs to be exact, TNA and USO. You believe
both of these are heading to zero, could you provide some more detail on this?

Sure, I think shorting is a unique and specialist strategy. I always ask investors which would you rather
short, a levered or unleveraged company? If you short the levered one, you’re going to get killed if the
company does well the equity is going to surge higher, and you don’t stand a chance but if you short
an unleveraged company the trade could take a long time to unfold because there’s no leverage.

So, the correct answer is short neither, you short the bonds. When you short the bonds, there’s very
limited upside and unlimited downside – exactly what you want in a short. You have to be careful
when shorting companies. I think that shorting is a very risky, dangerous game to play. What I do is
short, what I call ‘bad Wall Street products’. ETF’s fall into this category. They’re not a company, no
one will fall in love with them, they won’t be taken over — they’re just packaged products. If you do
your research, you can see that there are quite a few flaws in the way TNA and USO are constructed. A
few other ETFs are also exposed to the same flaws: the idea behind the ETF isn’t all that bad, but the
implementation of the strategy is horrific.

Take USO for example, the idea was to give average investors access to the price of oil, which makes
sense. However, USO doesn’t own any oil; all the fund does is buy futures contracts on a monthly ba-
sis. The fund is constantly buying these futures contracts every month, and the problem is that you a)
get lots of trading costs with this approach and b) the price of oil is usually in contango, which means
that the spot or cash price of a commodity is lower than the forward price. So, if you keep buying one
month out, and selling at a spot you’re buying high and selling low continually. I suspect the people
that buy this just haven’t read the prospectus. The numbers sold it to me, I pulled up a chart of USO
and the price of oil, USO has historically underperformed oil due to its ‘buy high sell low strategy’.

I think it’s quite obvious that USO is going to zero. It may take a few years, but I believe that’s where
it’s heading.

The TNA short is based on the same thesis. The ETF is triple leveraged, so it has to use derivatives to
create daily leverage, it has to adjust the amount of leverage every single day. If markets go up, it has
to increase leverage, if markets fall it has to decrease leverage, which exposes the fund to the same ‘buy
high, sell low’ problem as USO. Eventually, this flawed strategy will push the price of the ETF down to
zero. Overall, by shorting these two products, I’m able to maintain a short exposure without having to
worry about the takeover or market over excitement risks usually associated with shorting stocks.

The Key To Successful Shorting: Interview with Ravee Mehta, the founder and portfolio manager of
Nishkama Capital LLC

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The Value Interviews

Nishkama runs both a long and short book. What traits do you look at for success-
ful shorting?

Unlike other investment managers that tend to focus on bad businesses, frauds and fads, we generally
look to short decent companies, but where there is negative marginal change causing a shareholder
transition. We short both “value traps” and “broken momentum” stocks. “Value traps” are primarily
owned by value investors that we think can transition to deeper value or distressed holders.

This usually occurs when the value investors realize that sustainable earnings power is lower than what
they had thought. “Broken momentum” stocks are primarily owned by growth / momentum investors
that we think will transition to value or GARP type holders over time. This transition can occur be-
cause of slowing growth, increasing competition, increased regulatory risk or for various other reasons.
The disadvantage of avoiding frauds, fads and bad businesses on the short side is that we do not have
shorts that go to zero. However, the offsetting advantages are numerous. First, we are playing in a less
competitive area and have less borrow costs. Second, we have a natural factor balance in our portfolio,
which reduces volatility. We are long and short decent quality companies. This balance can help in
years (like so far in 2016) when low quality stocks significantly outperform high-quality stocks. We also
have a style balance. We are long and short both value and growth stocks.

Third, we can better leverage institutional knowledge that gets built up. When one shorts a fraud, fad
or a bad business, one makes money or loses money and moves on. All of that financial modeling,
building of relationships with management and industry experts, and company and industry-specific
knowledge goes out the window. However, when one shorts a good quality business because of negative
marginal change, one can potentially leverage all that work at some point down the road to go long
that same stock when there is a positive marginal change that causes a shareholder transition to occur
in reverse.

The Key To Successful Shorting: Zeke Ashton Portfolio Manager and founder of Centaur Capital Part-

Could you tell our readers about the Centaur Value Fund and your successful short-

The basic strategy for our hedge fund is pretty straightforward. We look to own a portfolio of stocks
that we think represent good value, and then we also look to short or otherwise bet against a handful of
stocks that we think are trading for prices far in excess of what we believe the underlying businesses are
worth. On the long side, we are looking for the ingredients you’d expect from fundamental, value-ori-
ented investors: good businesses, strong balance sheets, good management, and then very importantly,
a stock price that doesn’t fully reflect all those qualities. On the short side, we largely think of the
things we like to see in a good long idea and then flip it around. In other words, we are looking for
bad businesses, poor management, weak balance sheets, or egregiously overvalued stocks, though not all
those ingredients are necessary for a good short idea. One might think of our ideal short candidate as
something like a photo negative of value, or what we often call “anti-value.” So that’s really the basic
strategy: long value, short anti-value.

We are always long-biased, such that our long exposure is typically at least three times our short expo-
sure. For example, it has been typical for us in the past to have 95-100% market exposure on the long
side and 20-25% exposure on the short side. Such a portfolio, assuming the underlying stock selection

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The Value Interviews

is decent, should allow the fund to make decent money in strong markets, protect capital better than
average in down markets, and gives us a chance to do reasonably well in the occasional stretches where
the market wiggles around but doesn’t really go anywhere.

The attraction of such a strategy is that if well executed, it should generate equity-like returns over a
full market cycle and not really encounter a market environment in which it performs terribly. Most
importantly to us, we want to reduce the chances for any kind of catastrophic loss to as low to zero as
we can. We would define catastrophic in this sense as a percentage loss that is too big to recover within
a reasonable period of time. In investing it is really important to avoid those losses that erase three or
four years’ worth of compounding.

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The Value Interviews

Value Veterans Reveal How To Find

The Margin Of Safety
Value Veterans: Wally Weitz Talks Investment Process, Buffett And Omaha

You mentioned your ‘on deck list.’ Could you give us a quick primer of your invest-
ment process and how ideas get on to this list?

The ideas come from all over, but once we get an idea that a company might be interesting, we’ll try to
understand how the business works and what the key variables are. We need to find out everything we
need to be comfortable in making a five or ten-year rough projection of cash flows. Because that’s what
our valuation is based on; what an owner would be able to collect over the next five or ten years if they
owned the whole company. So, if we think we know how the business does or doesn’t work, and we think
earnings are going to be predictable enough — that is we can believe in our discounted cash flow model —
then we’ll do the reading of the 10-Qs and 10-Ks. We’ll also read conference calls transcripts for the past
three years; all the basic background checks. We’ll try to understand the competitive environment and try
to understand if the company is about to be eclipsed by someone else. All the things you’d think about
before buying an investment. We build a model of how the income statement works. All too often this
is based on estimates, which, hopefully, we are appropriately skeptical about, but we are trying to under-
stand how the profit margins work, how leverage works, changes in capital structure and so on. Then we
do a discounted cash flow model using a 12% discount rate. And we get a number. That’s our — as I say
we try and be appropriately skeptical about out inputs — but that’s our number, an approximate base case
for what the business is worth. Then we’ll make a high case for, if a few things go right, how good could
it be. Then a low case based on if something goes wrong — hopefully we’ve already figured out what could
go wrong — we try to figure out how bad things could be, and then compare to the current price. We want
to buy at a deep discount to business value. We’ll usually add a qualitative overlay to that based on how
confident we are on all of our assumptions.

Value Veterans: Interview with azVALOR: Former executives of Bestinver

In your first letter to investors, you highlight the fact that you’re looking for ‘cheap
companies,’ how does the fund define cheap in this case and how do you go about
calculating your estimate of intrinsic value?

We first try to answer an apparently simple question: will the business be around in ten years? Then, we
try to answer a little harder one: will it make more money than today, and why. If the answer is YES in
both cases, we then look at the FCF yield to the firm. We are not comfortable with anything below 8-9%…
Sometimes we’ve made exceptions if the ROCE is really good and the barrier to entry very solid, in which
cases we can settle at 7-7.5%. Below that we do not dare to venture…

Value Veterans: Moerus Capital On The Margin Of Safety

I’d like to dig a little deeper into your investment process here. There are two main
questions I’d like to ask, firstly how do you go about finding the ideas? And secondly

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The Value Interviews

what kind of margin of safety or discount to your estimate of intrinsic value do you
look for before beginning to buy into a new position?

I’ll tackle the second part of that question first. With the regard to the margin of safety, it really depends
on the opportunity in question. When I look at a business, obviously I see different types of businesses
and each different type of business comes with a different level of risk. You have businesses that are
relatively capital intensive, businesses that may need huge amounts of capital spending to continue op-
erating, businesses in industries that are fragmented and businesses in industries that are cyclical. When
these kind of companies appear on our radar, we expect much bigger discounts than we usually would,
quite simply because there is a greater risk attached to these companies. So we estimate the value much
more conservatively and look for a wider discount. Conversely, with capital-light, less-cyclical businesses
in more concentrated industries, we are okay with a smaller discount.

Is there a specific discount you look for?

Not really. In the past we’ve bought at discounts of 30%, 40% and even 60% — actually, that one turned
out to be by accident. I thought I was buying at a 40% discount and it turned out to be 60%.

On the other hand, if you take a company like Carnegie it was clear the business was operating in a
consolidated industry, they were making money, and so there was limited risk that the business might
go under. Here you could get away with buying at a discount of 20% to 30% to the very conservative-
ly estimated Net Asset Value. But really we tend to look at it from the point of view of what sort of
discount would make sense for us. We also think about our buying behavior; we like to buy more as
the price falls. The first and second tranches are the least price sensitive, so when we’ve bought these,
we hope prices decline further so that we can add to our position. The next tranches are more price
sensitive because with these purchases the position size starts to get larger. So that’s how we think about
both the discount to intrinsic value and how we implement a position.

Value Veterans: Interview with Steven Wood, the founder of GreenWood Investors

I think one of the ways that helps us “not to trip up” is our focus on the returns on capital the busi-
ness can generate. A poor business will generate a return on invested capital of say 5% and for a great
business it will be e 25% or 30% — in Apple’s case, it was over 100%. When we’re valuing the business,
we adjust the ROIC figure for the price we paid for the assets.

For example, Fiat Chrysler generates an ROIC of 8%, but we paid just 1/10 of the replacement cost of
Fiat Chrysler’s assets. So, we have effectively been able to pick up a business with an ROIC of 70% to
100% because we paid almost nothing for the assets. If you look at this from a different angle, Apple
generates a return on invested capital of over 100%, but we are willing to pay over ten times the value
of invested capital.

This approach really helps us compare a cigar butt to a high-quality company. If it a mediocre 15%
ROIC business but we are paying 5x the return on invested capital, that’s not as compelling as a busi-
ness that generates 5% ROIC but is trading for only 10% of the replacement cost of its assets.

At the same time, we have quality metrics we include. For example, if we have a three-to-one risk reward
on a company like Apple, compared to a risky early-stage biotech stock with the same R/R; that’s a

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The Value Interviews

no-brainer you want to go with Apple. That’s how I’ve developed my system; I’ll still look at the net-net
biotech stock, but it has to have well over the average risk-adjusted return profile.

Value Veterans: Interview with Scott Miller Of Greenhaven Road Capital

How do you approach valuation, and what type of returns do you target?

Valuation is the last piece that I look at closely, and I don’t have a strict number I am looking for. I
like quirky and off the beaten path situations. Often, the reported GAAP numbers are misleading which
helps to create the opportunity and muddies the valuation picture. At a high level, I want to have a
chance at 50-100% returns in a couple of years. I am not looking for a company that trades at 9 times
earnings when peers trade at 10 times earnings. Given that I just need a couple of ideas a year, I want
something more compelling than that. I think I will also ascribe value where others may not.

For example, I owned a company Rally Software, where I think I appreciated the core customer base that
was growing every year – more than most investors. IBM has since bought the company, and I think
shared my view. Sometimes patents, or spectrum, or real estate that has been owned for decades can be
materially undervalued on the financial statements. I try and make those adjustments. I also try to have a
mix of types of value in the portfolio. This is my life savings; I don’t just want insurance companies trad-
ing below book value and buying back stock, like AIG. I don’t just want companies trading significantly
below their liquidation value like JW Mays. My favorite companies are quality growing businesses with
high free cash flow yields and reasonable balance sheets. Those are hard to find right now, so we look off
the beaten path for misunderstood companies.

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The Value Interviews

Value In Exotic Asset, fade focusing

on short-term returns
Christopher Pavese, value investor and the Chief Investment Officer of Broyhill Asset Management

And finally, you mentioned in your August letter that Broyhill is buying mispriced
options to generate short-term returns. What was your thesis behind this trade and
how does it fit into your value mandate? Do you frequently use derivatives to boost
short-term returns?

I wouldn’t say that we frequently use derivatives to boost short-term returns. But we don’t think the words
“options” and “value” are mutually exclusive. And to be clear, the single largest driver of our returns has
been, and will generally be, driven by direct investments in individual securities.

We are fundamental investors, and we tend to worry more than most. As a result, we are willing to trade
some upside during good times for the ability to sleep better at night. Holding cash in the absence of
compelling opportunities helps us sleep. At the right price, and under certain conditions, hedging a
portion of our risk through the purchase of put options helps us sleep even better. This was certainly
the case last quarter as our declines were limited to a fraction of the losses experienced by stock indices.
More importantly, while many investors were paralyzed by short-term fear and rapid price declines, we
were positioned to buy more of the businesses we own at better prices, and as a result, we recouped our
unrealized losses more quickly.

The occasional use of options in this manner serves to reduce our risk, rather than boost short-term
returns. Our use of options is not unlike our other value-driven investments. We aim to buy low and
sell high. Occasionally, spikes in volatility allow us to sell high and collect rich premiums which give us
the right to buy companies we’d like to own at lower prices. And since we typically have plenty of cash
on hand, these positions are always fully collateralized. Again, we view this is as an inherently lower risk
proposition than owning the stock outright.

We don’t use leverage, but we are more than happy to enhance the return on our cash while waiting for
lower prices and a wider margin of safety. In August, for example, volatility spiked to levels last seen
in the wake of Lehman’s collapse. In response, we sold options to increase our exposure to several core
holdings in the portfolio earning returns on our cash approaching double-digits over the course of a few
weeks. With the overall market barely correcting 10%, selling options with the VIX at 50 appeared to be
a better risk/reward than buying the stock outright.

In addition to put selling, we will occasionally use options to exit positions by writing covered calls at
strike prices near intrinsic value. This is less common for us as the premium rarely offsets the downside
risk of holding onto a fully valued position. That said, the premium can serve to offset partially declines
in market value when markets are falling. More importantly, in both cases, we are being paid to do some-
thing we would do anyway.

Chris Abraham the Chief Investment Officer of CVA Investment Management, who uses options as part
of a traditional value strategy to add alpha.

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The Value Interviews

You run a unique, value-based options strategy which is designed to take advantage
of price inefficiencies in the market. Could you give our readers a brief description
of the strategy and why you decided to use it?

It is basically a concentrated, long-term, all-cap value-oriented strategy primarily focused on the equities
and options of high-quality companies. Ideally, I look for companies with a competitive advantage that
trade at a margin of safety. I typically have around 10 to 20 equity holdings in my portfolio, preferably
closer to 10.

Regarding option positions, the way I look at the strategy is kind of like running an insurance book along
with existing equity holdings — similar to Buffett’s concept at Berkshire. Buffett has been able to create
permanent capital for investing by using Berkshire’s insurance subsidiaries’ float. And that’s the kind of
business model that I’ve tried to create, except with options.

So you write options to generate income and grow the float?

Exactly. The vast majority of options trading is on ETFs, and most of that is short-term trading, for
hedging and speculating. Because most traders concentrate on these limited markets, there’s very little at-
tention focused on longer term options of individual companies. A lot of institutional investors just can’t
invest in this sector, because their investment mandates won’t allow it and hedge funds are only interested
in the short-term use of options to hedge positions. The great thing is you can find some options with
significant mispricing across the entire market. A couple of weeks ago, I found options on a company
with a $100 million market cap! So, there are definitely opportunities out there to take advantage of with
these derivatives, but structural reasons prevent many investors from making the most of the opportuni-
ties available to them. There’s also a general lack of interest in this area.

If you find a security that is undervalued and has a margin of safety, generally speaking there will be an
even bigger mispricing in the options. To profit from this you can sell put spreads or buy call spreads – the
former eliminates the tail risk. If you feel comfortable just selling naked puts that will help you generate
even more float, but you have to be comfortable buying the stock at the set price if it comes to it.

Steven Kiel, President and Chief Investment Officer of Arquitos Capital Management.

You seem to focus on a company’s Net Operating Losses (NOLs) more than any
other metric when analyzing its future potential. Why do you prefer to use NOLs to
evaluate a company, rather than more traditional valuation methods?

The focus on NOLs is a moment-in-time focus. I don’t know if the opportunity will be there five years
from now.

Certainly, they won’t be as prevalent. The idea is to find hidden value. Where can I find opportunities
that aren’t showing up on screens or that other investors aren’t seeing? There are these pockets of value in
the market that are low-risk and potentially high reward. My challenge is to try to find those.

The focus isn’t on the value of the NOLs. I don’t think anyone can accurately value them. My focus is
on the incentives that the NOLs provide. The NOLs attract investors, directors, and executives that are
focused on effective capital allocation. They encourage thoughtful decision-making on internal invest-

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The Value Interviews

ments. Many of these companies are initially valued on their balance sheet characteristics, and then, as
they transition through an acquisition or corporate reorganization, other investors begin to value the
company on its earnings power. This is how you can sometimes get significant gains.

Ali Meshkati, founder and investment manager of T11 Capital

I believe you own Lehman Brothers Capital Trust Preferred shares. What made you
take a position here and do you continue to see upside?

This is our smallest position, representing about 2% of overall equity. The recovery for Lehman creditors
has been more than $100 billion to date. The trups receiving a creditor recovery is a low probability
proposition. However, there is a possibility that the trups can be converted into new equity representing
the various profitable operating remnants of Lehman to take advantage of the $50 billion-plus net op-
erating loss that is leftover.

Shortly after the Lehman bankruptcy, those in charge of the liquidation formed a company they named
LAMCO to assist in the liquidation of the remaining assets. This wasn’t a small operation, as LAMCO
originally had close to 500 employees. The assets in liquidation have exceeded even the most aggressive
estimates. In the meantime, LAMCO has become a substantial business, although the exact numbers are
difficult to ascertain.

The most logical move forward would be to create a public traded company that would take advantage
of the NOLs leftover from Lehman through LAMCO initially, possibly rolling in smart acquisitions
over time. This would give former equity, including the trups, a stake in the newly formed company.

The stick in the wheel is the cancellation of debt income that can nullify the NOL. There is precedent
through the courts for preservation of the NOLs working around the cancelation of debt income re-
quirements, however.

Our position in the Capital Trust shares is basically a call option on a positive outcome for the reemer-
gence of Lehman in a yet to be determined form.

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The Value Interviews

Professional investors reveal the im-

portance of cash
Interview with Zeke Ashton of Centaur Capital Partners

According to a recent interview you gave to Value Investor Insight, Centaur’s cur-
rent cash allocation is more than 35%. Does this mean you’re preparing for a market

We are always preparing for a market crash, whether we are 10% in cash or 50% in cash, at least mentally.
Nobody can predict the timing of market corrections or crashes with perfect accuracy, but a professional
investor always has to be prepared to wake up in the morning to a vastly different market than the one
prevailing when he or she went to bed. Also, being mentally prepared for a crash and being positioned for
a crash are two completely different things. There have been times in the past where we’d been prepared
for a crash (or at least further declines) but positioned for a recovery. If a crash happened tomorrow, we’d
be both mentally prepared and reasonably well (but not ideally) positioned.

I’ve been responsible for managing other people’s money in one vehicle or another since late 1998, and I
have learned that the scoreboard changes very quickly in the stock market.

Very few people in March of 2000 would have believed that the NASDAQ index would fall 80% from its
peak to the trough in early 2003, but it did. That is a major index, by the way, not some small corner of
the stock market. I can assure you that in mid-2007 very few people saw a 50% decline in the S&P500
coming, or at least very few were positioned for it.

All that said we don’t use some kind of crash probability generator to determine how much cash we hold.
The amount of cash we hold in our funds is almost 100% correlated to our ability to find really compel-
ling long ideas that meet our criteria for value, safety, and liquidity. Right now, the pickings amongst the
ideas we feel that we can evaluate are pretty slim.

The U.S. stock market today is probably more uniformly overvalued than it was prior to either of the two
prior bear markets. Total debt outstanding in the world is far higher now than it was prior to the credit
crisis of 2008. So yes, we are prepared for a correction, though I am not predicting a crash. I am also
prepared for a multi-year period where the market bounces around a lot and doesn’t go anywhere, or a
period where the market doesn’t crash or correct, but just loses ground for an extended period of time.
But mostly we are just trying to exercise patience until we see the next compelling bargain security that
we can buy.

Brian Boyle, the founder and portfolio manager of Boyle Capital.

How do you weight your portfolio: do you tend to run a concentrated or highly diver-
sified portfolio of equities?

We are definitely considered focused managers. Of course, it varies between each client’s account but
generally, we have between 10 and 20 equities per portfolio.

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The Value Interviews

We feel it is difficult to exceed 20 holdings due to the level of research we put in to each of our holdings.
We don’t think you can reasonably know more than 20 different holdings at a given time, considering
the amount of research and analysis that needs to go into each holding.

In terms of a weighting among the three categories mentioned above; we don’t have a set allocation,
we let the market dictate what sort of allocations we should hold. For example, coming out of the
2008/2009 financial crisis we were more overweight the ‘higher quality great business’ category.

I should make clear that with our investments what we are usually looking for is a certain return over a
given period. With the ‘good businesses trading at fair prices’, we are looking to get a return of around
7% per annum over a five-year period.

In the middle category, ‘good businesses trading at great prices’, we are looking for an expected return of
15% per annum over a five-year holding period.

And with special situations, given the risk involved we are looking for a return of 25% per annum at
least over a five-year holding period. We won’t take a position unless these return targets are available.
We take a similar approach to cash, we will let the investment environment dictate what level of cash we
should be holding at any given time.

Ben Strubel of Strubel Investment Management

Are all your positions equally weighted in the portfolio or do you tend to direct more
cash towards your higher conviction ideas?

That’s an interesting question. You know you hear a lot about these famous investors that say you should
concentrate your bets on your best ideas, but you never really hear the other side of the story. Many
people have tried it and haven’t been successful?

I know some people personally who have tried it and failed. There was no reason to believe that they
wouldn’t have been successful to start with, but a concentrated portfolio cost them a substantial amount
of money. That’s the side you don’t hear about. You only hear the success stories. So we tend to use equal

In some cases, we will underweight positions if they are a bit more risky or if there are questions about
the business. I’ll admit this is a bit strange for a value investor, most tend to rebalance but I’ve had suc-
cess using this method, so I’m going to stick with it. I think it also helps enforce buy and sell decisions.
Because I’m fully invested if I want to add a stock I have to sell something first. I need to be sure that I
want to make the trade-off, so its helps with discipline.

That said, we do own multiple stocks in the same industry, which could be considered a form of over-
weighting, other than that it’s equal weighting.

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The Value Interviews

Benefits Of A Concentrated Portfolio

John Khabbaz founder of Phoenician Capital

How much concentration are you prepared to take in a portfolio, how would you
weight your best idea?

Historically, our portfolio has consisted of approximately twenty-five companies. Our top five positions
have averaged 8% each of the total portfolio, the next five have averaged 4% each and we’ve held approx-
imately 15% in cash. We don’t borrow and are fairly liquid – more than 75% of our portfolio could be
liquidated within one week and 100% could be liquidated within four weeks.

After an idea has passed the initial screening and research phase, we run it through a proprietary process
which we refer to internally as the “sixteen points”. All ideas go through the same rigorous process and the
one that ranks the highest makes it to the “best idea” stage. The concentration limit for our top position
is 10% at cost and 15% at market.

Sandon Capital, a Australian-based, deep value, activist investment firm.

How much concentration are you prepared to take in a portfolio?

We run a reasonably concentrated portfolio with the top 10-15 positions generally making up 50-70% of
the portfolio, with another 20-30% of the portfolio typically held in cash. We tend to carry large amounts
of cash, not because we have a bearish view on the market, but because we like to be able to take advantage
of opportunities as they arise without having to “play favorites” and sell existing positions to fund new
positions. Cash is an important offensive tool for our approach.

A good example is a position we purchased in Alchemia (ASX: ACL) in mid-2015. We had been keeping
an eye on the company for over six months, waiting for the right price to buy the stock. One morning
we received a call from a broker who had a large line of stock and we were able to deploy 4-5% of the
portfolio immediately into that position. After achieving changes at the Board level, the new Board sold
the most valuable asset that Alchemia owned – a profit share agreement with Dr Reddys (NYSE: RDY)
for a generic anticoagulant named Fondaparinux (Fonda). Post the completion of the Fonda sale, the
company traded at a discount to cash backing, so we added further to our position such that it was close
to 15% of the portfolio. But that was a special situation – rarely do we get the opportunity to deploy that
much of the portfolio in a stock that is trading below cash backing (where obviously the risk of perma-
nent impairment to capital is very, very low).

As a general rule, we never like a position to be >7.5% of the portfolio at inception and more than likely
we will be trimming a position for portfolio management reasons when it approaches 15% of the total

Richard Fogler, Managing Director, Chief Investment Officer and PM of Kingwest & Company.

Kingwest runs a highly concentrated portfolio of approximately 25 securities in both

Canada and the US. Why did you decide this is the best approach to take and what

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The Value Interviews

controls do you have in place to minimize the risk that a massive blow-up could
eliminate years of returns?

Yes, our portfolio includes 25 stocks. Like John Maynard Keynes, we believe that “As time goes on, I get
more and more convinced that the right method in investment is to put fairly large sums into enter-
prises which one thinks one knows something about and in the management of which one thoroughly
believes.” One does not reduce risk by owning a wide range of investments of which they know little, but
rather by knowing more.

Equity investing is all about making good investments and avoiding bad investments. Investing well is
hard. The thing that limits you most is knowledge. You can never know enough. And just as in sports the
way a group plays together brings collective knowledge and enables you to make much better decisions.
Our Team has been working together for over a decade and that lets us be better investors.

Michael van Biema and Allen Benello, two of the three authors of the book, Concentrated Investing:
Strategies of the World’s Greatest Concentrated Value Investors.

Allen Benello: The inspiration for the book came from a discussion that Michael and I were having
several years ago. Michael was on his way to do a manager interview — Michael is in the fund of funds
business –, and he invited me to come along and meet this manager as we happened to be in the same
place and I had some time between meetings. We started talking about the managers we’ve seen in the
past and the number of occasions we’ve seen a good manager, who has excellent analytical skills, knows
an industry inside out and can recite figures from the balance sheet, but fails to produce good results.
On the other hand, we’ve also seen plenty of managers who have less analytical ability but produce pretty
good results. Another trend we noticed was that those managers who had both good analytical skills, and
were producing good results tended to run concentrated portfolios with several significant positions. A
lightbulb went off in our head at this moment. It’s at this point that we decided we should explore con-
centrated investing a bit more.

Allen Benello: All of the investors that we look at in the book have one thing in common; they are
investing permanent capital, such as university endowments and insurance company floats. It’s very very
difficult to run a concentrated portfolio if you’re running a mutual fund or hedge fund that has to pub-
lish quarterly performance figures. To be able to use a concentrated strategy successfully, you need to have
long-term investors backing you.

Concentrated investing only works with a long-term outlook because the portfolio is almost certainly
going to experience a drawdown at some point that would freak out regular investors and send them run-
ning for the exits. A lot of the investors we profile in the book have had pretty severe drawdowns, these
don’t necessarily ruin your very long-term results but can impact the short-term picture.

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The Value Interviews

Value Interviews: Investors’ Biggest

Abhay Deshpande, former Portfolio Manager of the First Eagle Global and Overseas strategies.

Any case studies where it all went wrong that you could share?

In the late 1990s, as an analyst, I recommended the shares of footwear company Fila. Fila had been grow-
ing rapidly on the back of an endorsement deal with NBA star Grant Hill but then began to show some
order weakness of its flagship shoe. The stock, which peaked near $80 declined to $40 when I recom-
mended its purchase. The appeal was that they had been successful in the recent past, that the stock had
declined by 50%, and that based on history, the stock appeared undervalued. There were three mistakes.
First, I was reflexively contrarian, a trait of many value types. Over the years, I would learn that it’s better
to be skeptical, rather than cynical. Second, I relied on “reversion to the mean” in a famously fad-driven
industry. In this case, they compete against much larger companies with much deeper pockets for en-
dorsement deals, which made it very hard to recreate what they had with the Grant hill shoe. Third, the
cash flow statement should have led me to conclude that the business never generated any free cash flow
to owners. The company eventually went bankrupt.

John Khabbaz founder of Phoenician Capital

And lastly, what advice would you give to value investors who are just starting out (or
even experienced value investors) to help them navigate today’s market?

Find your niche, find your own style, craft a robust investment process, and stick with it.
On a more personal level, I would add that to run a business that rewards not only the founder but also
investors, the people who believed in what was being created, can be of enormous personal satisfaction.

Zeke Ashton Portfolio Manager and founder of Centaur Capital Partners

And lastly, what advice would you give to value investors who are just starting out (or
even experienced value investors) to help them navigate today’s market?

I’ve come to believe that learning to master the art of investing really boils down to finding a game that
you can win, and then playing that game really well. I’ve come across all kinds of investors in my career,
and all of the successful ones learn to differentiate the ideas that they can handle where they have some
sort of system or approach that really works for them from ideas that they can’t handle or where they
really aren’t any better at than the market at large. Value investing as a philosophy is actually a very broad
framework, and there is a lot of room for many different styles, but starting with the idea that you are
looking to buy underpriced securities is a pretty good place to start. Once you’ve mastered the basics, it
is about developing a process that protects you from your own specific weaknesses and allows you to play
to your strengths.

Chief investment officer and founder of Weitz Investments, Wally Weitz

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The Value Interviews

I’ve made plenty. Some of them are embarrassing, and some have been costly in dollar terms. But I think
one of worst, something that unfolded over many years, 15 or 20 years, that I only came to realize later,
was that I’ve been an owner of mortgage banks, thrifts, S&Ls, off and on for 30 years plus and have made
a lot of money trading these. They tend to fall sharply when the Fed is raising interest rates, then jump
sharply when the Fed stops. I got very comfortable buying at five times earnings and selling back when
they rose to 10 [times earnings]. What I found out the 07/08/09 mortgage crisis was that for the past
several decades, these banks and thrifts had really used too much leverage, they had poor underwriting
criteria; but they got away with it because the price of homes always rose. That didn’t work in the latest
mortgage crisis because the losses completely swamped the portfolios of these banks; they couldn’t just
flip the houses back out of their foreclosure pool and make up for it. I came to realize that my seemingly
good ideas during the 70s, 80s and 90s were just really bad ideas that we got away with. We learned that the
hard way in 07/08…..I get together with a group of old-timers — whose names you’d know — and we get
together and swap ideas once a year. And I tried to get a conversation going one night among these guys.
I said “looking back, you all have good records for the past 20 or 30 years. How much of that record was
built on bad ideas that you got away with?” and I couldn’t get anyone to talk about it! [Laughs]. But for
me it was the financials. We gave some money back in 07/08, but overall we came out on top — it’s sort
of sobering to think that what you thought was your own great investment ability, was really a mistake
that you got away with for a long time.

Jeroen Bos, one of the premier deep value investors in Europe who worked as a scout for Peter Cundill
in the London market

And lastly, what has been your most notable mistake over the years?

There have been many. I think one of the greatest things I’ve learned is to pay attention to debt. As you
noted at the beginning, on the whole, these companies tend to be pretty cyclical and going into a down-
turn with a balance sheet full of debt brings a lot of pain and tears down the road. So that’s something
to be extremely careful of.

Stay away from indebted companies?

It does depend on where you are in the cycle, though. If earnings start to recover, and things are starting
to pick up then that’s fine, but when you’re heading into a downturn. Take Glencore for example. Gearing
helped them fantastically when the commodity markets were favorable but when things started to turn
sour, cracks started to appear. You need to know at which point of the cycle you are, to determine if debt
is going to be earnings enhancing, or if it’s going to become a problem for the company.

Steven Kiel, President and Chief Investment Officer of Arquitos Capital

And lastly, a question I like to ask at the end of every interview: what’s been the big-
gest mistake of your investing career so far?

Probably the biggest mistake since the launch of the partnership was JC Penney (JCP) during the Bill
Ackman hype. JCP was a company that I traditionally would not have had an interest, but I was drawn
in by Ron Johnson. There were too many uncertain variables involved in that situation without even
considering that retail is inherently unpredictable.

(C) ValueWalk 2017 - All rights Reserved

The Value Interviews

From a different perspective, it was also a mistake to trim my ALJJ position as it ran up. Good companies
with solid, entrepreneurial management repeatedly find ways to create value. ALJJ is still a large holding,
but our returns would be higher if I would not have sold off some of our holdings.

Joe Koster of Boyles Asset Management

What’s been the biggest mistake of your investing career so far?

Our worst mistake, which we made at the previous fund when we were a little less battle-tested, was in
a company called Feldman Mall Properties. It was leveraged REIT that owned several malls. Its strategy
was to basically purchase underperforming malls and turn them around. In preview of the explanation
that follows, you can probably guess that a leveraged operator of malls, bought on the eve of the Great
Financial Crisis, would not turn out well.

We purchased our stake shortly after Larry Feldman, the company’s CEO and founder, purchased a siz-
able number of shares in the open market. We began buying at around $2.80 per share which represented
just 36% of stated book value and was $1.20 below our estimate of the company’s liquidation value of
$4.00 per share. Crucial to our thesis was our analysis of the company’s funding needs. We fully recog-
nized the potential difficulty a real estate development company might have in funding its initiatives in
a difficult credit environment, but given our assessment of the company’s debt maturities, cash on hand
and commitments for cash, we felt Feldman would have enough capital to weather any prolonged storm
and see each of its properties through to complete renovation. And even if a particular property ran into
difficulty, the lax, non-recourse terms of a substantial portion of its debts would not, we believed, jeop-
ardize the entire company.

After a visit with the company and Mr. Feldman early in 2008, additional problems began to surface after
the company reported its first quarter 2008 results. Unfortunately, our analysis of the company’s liquidity
and debt maturities missed debt covenants that if broken would prevent the company from automatically
extending several mortgage notes. After reporting its first quarter results, it came to light that the compa-
ny did in fact break several covenants and it would have to renegotiate three mortgage notes. The stock
fell from the mid $2’s to $1.50. Several days later the stock had returned to over $2 per share. Our second
mistake, and perhaps most significant, was not selling at this point. After some more problems, we later
sold our entire position at an average price of $0.21. The total loss on the position was 92.5%.

The three most crucial mistakes were: 1) The decision to buy a distressed, leveraged real estate company in
the first place; 2) Not having discovered each of the debt covenants involved with the company’s mort-
gages; and 3) Not having sold after it became clear that our original thesis was impaired.

This episode gave us a much-increased skepticism of insider stock purchases, a better appreciation for the
difficulty of accurately determining liquidation value in complex and rapidly evolving situations, and,
most importantly, just how much the dependence on credit markets and other people’s money impedes
a company’s ability to control its own destiny. To keep from making this mistake again, we’ve really
improved our filtering process so that a company like this will be filtered out from the beginning. We are
even more wary of leverage than we were before, and we don’t want to invest in any company that depends
on the kindness of strangers (e.g. lenders) in order to stay in business.

(C) ValueWalk 2017 - All rights Reserved

The Value Interviews

International Value Investing

Steven Towns, Author of Investing In Japan On The Outlook For Japanese Stocks

You have experience as an investor in both US and Japanese markets, what would
you say is the biggest difference between investing in the US and Japan?

It’s hard to call out one difference in particular since there are a number of key differences. It may be
stating the obvious, but let me mention how much time is spent -- wasted -- by the Japanese worrying
about exogenous factors. American investors used not to care so much about the outside world, but to
exemplify what I’m trying to describe, it’s like how China now can really move the market in the U.S.
My point of view as a value investor is that I don’t worry too much about macro, and thankfully with all
the attention the macro stuff gets, it leaves great values on the equity market for a longer time. Another
difference worth sharing is the one-hour lunch break in Tokyo (the exchange stops trading between 11:30
and 12:30 each day). I think it is worth considering for the U.S., but we also have multiple time zones
whereas Japan has I think many private investors are concerned about the risks (FX, time zone, lack of
information) of investing overseas, especially in a market like Japan, which has the unenviable record of
the longest bear market in history. What would you say to investors who are concerned about investing
overseas and how would you advise they mitigate key risks?

This may sound harsh, but I have effectively turned away some potential newsletter subscribers that could
not get over some of the concerns you mention. My goal is to achieve the highest possible returns sup-
ported with high margins of safety -- and I’m trying to do so permanently yen-denominated. I leave for-
eign exchange matters up to individual subscribers that include individual and private investors, wealth
managers, and hedge fund managers. The bear market/lost decades questions are coming up less frequent-
ly because of how I’ve marketed the Uguisu Value newsletter as a highly focused smaller cap value spe-
cialization that typically only relies on Japanese language sources (uncovering value where even Japanese
investors have overlooked it and reading hundreds of pages of filings that very few, if any, are reviewing).
While benchmarks may be down over a certain duration and clearly can be volatile, disciplined investing
works very well in Japan -- a market that until 2012 had largely lacked competition among global value
investors and even now with more momentum-oriented investors. There have also been many successful
companies that have compounded nicely despite the headline benchmarks’ performance.

Christian Olesen, founder and managing partner of the Olesen Value Fund.

You mentioned you’re finding plenty of opportunities outside the US in internation-

al markets. Are there any particular reasons you find attractive here?

We’re bottom-up investors and very opportunistic. We find opportunities in all kinds of places. I do think
there are a lot of things are quantitatively cheap in Australia, but there are actually a lot of risks relating to
the economy there such as the real estate bubble and the exposure to China. Other than Australia, I don’t
see any regions with an unusually high number of good opportunities right now. We have traditionally,
and still do, have a lot of exposure to developed Europe and mostly the UK. But I don’t see an unusually
large number of opportunities in those places right now.

Do you think managements are as shareholder friendly in these regions, especially

the UK, as they can be in the US?

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The Value Interviews

In my experience yes. I’m not sure there’s any difference in the small-cap universe. Maybe one difference,
especially if you include micro-caps, in the UK these companies have a much higher institutional owner-
ship than those micro caps in the US, so they tend to have better shareholder communication policies. I
think the US and the UK have the most shareholder-friendly managements around.

Amit Wadhwaney, one of the founders and portfolio managers of Moerus Capital Management, LLC.

As an international value fund, you can invest anywhere in the world but are there
any regions that you specifically want to avoid?

Ultimately, we invest in individual companies, so we’re more concerned about things going wrong at the
company level. We don’t really pick and choose regions. Even if you’re in a wonderful part of the world,
there are still many companies that we would avoid. We have had our share of hiccups in countries that
are very, very safe and investor friendly.

For example, a great country for investing is Norway. However, in the late 2000s the country, for whatev-
er reason, decided it was going to change the tax regime for the shipping industry and as a quid pro quo
for this change, companies had to pay substantial amounts of back tax. So, the shipping companies, most
of which already had a large amount of debt on their balance sheets, were suddenly hit with this huge
liability. This reduced shareholder equity across the sector, and suddenly industry debt-to-equity ratios
spiked, leading to bankruptcies and near bankruptcies across the region. This is a great example showing
that even the most stable regions in the world can be extremely unpredictable.

It is really difficult to try and say exactly where we will and won’t invest. Even in countries like Singa-
pore which has a relatively developed legal code, entirely unexpected situations can develop. There are
plenty of regions where it’s not easy to invest, but I would never say ‘I would definitely not invest there.’
Indonesia and Russia for example, both are difficult places to invest, but we’ve had great experiences in
Russia over the years. And of course, there are issues regarding accounting standards in China which
present challenges.

One thing you can’t protect against is outright fraud. That can happen anywhere. It’s happened to us
earlier when we were invested in a very large U.K. company called Cable & Wireless. In the early 2000s,
after the tech bubble had burst, we became interested in buying attractively valued telecom assets. Cable
& Wireless had what looked to be a very strong balance sheet with a sizable cash balance as well as some
mature telecoms businesses that were throwing off cash. By valuing these mature businesses at around 3
to 4 times earnings and discounting some of the more foolish acquisitions the company had made over
the years (shareholders were demanding that many of these businesses were closed down within two years)
as well as the cash, we arrived at our valuation. After arriving at a valuation, we waited around a year for
the price to come down to a level at which we were comfortable buying.

Then, sometime after we’d started buying, the company’s credit rating was downgraded due to concerns
about the effect the loss-making businesses owned by the group were having on the overall business. Ini-
tially, we thought this downgrade was a good thing as the company might be motivated to sell some of
these loss-making businesses. Then, it emerged that because Cable & Wireless had lost its investment-grade
credit rating, they had to post collateral of, I think it was around £750 million, against a potential tax
liability for one of their acquisitions. Suddenly, this huge chunk of cash disappeared off the balance
sheet, with no obvious path or timetable for its return. We asked ourselves how did this happen? Cable &
Wireless is listed in both the UK and US, two regions with impressive legal and financial regulations. But

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The Value Interviews

the company had not disclosed this liability in any of the financial documents filed with regulators. We
asked the company why, and they said because it wasn’t an actual liability, only a contingent liability…..
So yes you can get burned in any region around the world.

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The Value Interviews

How To Become A Good Investor

Wesley Gray, founder of Alpha Architect

Why do you believe it’s better for investors to follow a quantitative rules-based strat-
egy rather than a fundamental qualitative strategy based on in-depth research?

Humans suffer from behavioral biases that can cause us to make irrational decisions. There is a lot of evi-
dence from the field of psychology that suggests that simple models outperform expert human judgment
across a variety of domains. We believe investing is no different, and so we seek to eliminate our own
biases by relying on a systematic approach.

An excerpt from a longer piece on the subject:

Everyone makes mistakes. It’s part of what makes us human. Because humans understand their actions
are sometimes flawed, it was perhaps inevitable that the field of psychology would develop a rich body of
academic literature to analyze why it is that human beings often make poor decisions. Although insights
from academia can be highly theoretical, our everyday life experiences corroborate many of these findings
at a basic level: “I know I shouldn’t eat the McDonalds BigMac, but it tastes so good.” Because we recog-
nize our frequent irrational urges, we often seek the judgment of experts, to avoid becoming our own worst
enemy. We assume that experts, with years of experience in their particular fields, are better equipped and
incentivized to make unbiased decisions. But is this assumption valid? A surprisingly robust, but neglect-
ed branch of academic literature, has studied, for more than 60 years, the assumption that experts make
unbiased decisions. The evidence tells a decidedly one-sided story: systematic decision-making, through
the use of simple quantitative models with limited inputs, outperforms discretionary decisions made
by experts. This essay summarizes research related to the “models versus experts” debate and highlights
its application in the context of investment decision-making. Based on the evidence, investors should
de-emphasize their reliance on discretionary experts, and should instead approach investment decisions
with systematic models. To quote Paul Meehl, an eminent scholar in the field, “There is no controversy
in social science that shows such a large body of qualitatively diverse studies coming out so uniformly in
the same direction as this one [models outperform experts].”

Dr. Daniel Crosby On Behavioral Finance: The Laws of Wealth

Which behavior or behavioral trait do you think is the most damaging for investors
and their returns?

One of the shortfalls of previous works on behavioral finance is that they present lists of investor biases
with no organizing framework. At my last count, there are over 117 cognitive errors enumerated by psy-
chologists that can negatively impact the investment decision-making process. It’s an impressive list to be
sure, but telling the average investor, “Hey, there are 117 ways you can screw this up” isn’t exactly helpful.
One part of The Laws of Wealth of which I’m extremely proud is the chapter that outlines a taxonomy of
behavioral risk. Basically, I took the existing lists of biases and tried to organize them by their underlying
psychological construct. This reduced the 117 to 5, a much more manageable universe. In my estimation,
the five primary types of behavioral risk are ego, emotion, conservation, attention and information.

What sort of process or strategy do you believe is the best for investors to follow to

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The Value Interviews

minimize the risk from poor decisions driven by psychology?

In the book, I outline a middle ground between traditional notions of passive and active investing that I
refer to as “rules-based behavioral investing” or RBI. I also set forth four pillars of behavioral investing:
consistency, clarity, courageousness, and conviction. Consistency means systematic (i.e., discretion-free)
decision-making. Consistency frees us from the pull of ego, emotion and loss aversion, while focusing
our efforts on uniform execution. Clarity is all about simplicity. We prioritize evidence-based factors and
are not pulled down the seductive path of worrying about the frightening but unlikely or the exciting
but useless. Courageousness is all about automating the process of contrarianism: doing what the brain
knows to be best but the heart and stomach have trouble accomplishing. Finally, conviction which helps
us walk the line between hubris and fear by creating portfolios that are diverse enough to be humble and
focused enough to offer a shot at long-term outperformance. Of all of these, I feel that consistency is the
most important. Whatever rules investors choose; they are almost always better off following them than
relying on their hunches in the moment.

Interview With Keith Ashworth-Lord Author Of Invest In The Best

I know this is a broad question but what are the qualities investors should be looking
for when trying to identify the best Buffett-Graham companies?

First and foremost, companies that have an ‘economic moat’. That means something special that keeps
them protected from the incursion of competitors seeking to drive down their excess returns to the cost of
capital. That something special is often the skill set of the employees, brand pricing power or intellectual
property rights. Secondly, I look for businesses with decent growth prospects, that are earning high returns
on capital and converting those returns into strong free cash flow. As a consequence, these companies
tend to have strong balance sheets. Lastly, I am looking for management that acts with the owner’s eye.
Allocation of capital is the foremost task of management and I like to see managers that try to reinvest
retained earnings in projects that offer organic growth and high returns on the investment. I also approve
of smaller bolt-on acquisitions, where appropriate, but I abhor empire building mega acquisitions. Too
often they add no value for shareholders. If managers have a surplus of capital that they are unable to
invest profitably, then I want to see it handed back to shareholders.

Based on your research and experience, what would you say is the most common
mistake investors make when they try to follow Buffett’s style?

To be a successful investor like Buffett requires very few things. Foremost among them are discipline and

For me, discipline comes from investing only from the perspective of a businessman. You must stick to
a proven methodology and avoid style drift. Patience, however, is the not-so-slight matter of how you are
wired. And that is where most investors come unstuck. They just can’t help buying into something they
really like, even if the price they are paying is a full one in relation to the value (economic worth) that
they think they are getting.

Anatomy Of The Bear: Interview With Russell Napier

You must have built up quite a broad understanding of bear markets while research-
ing the book. So, if you had to give just one piece of advice to a novice investor, to
help them prepare for the next great bear market, what would it be?

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The Value Interviews

Invest your funds with a multi-asset fund manager and not an equity fund manager. Finding when eq-
uities represent good or bad value relative to other asset classes is very very difficult and best left to a
professional manager. An equity fund manager is simply not mandated to provide that advice so you
need to find a multi-asset fund manager who does.

Long and Short: Interview With Author Lawrence Creatura

What would you say is the most important thing you’ve learned from studying War-
ren Buffett over the years?

There are dozens of potential answers but to pick one “most important thing,” I’d say: the incomparable
value of loyalty, which Buffett practices, prizes, and rewards. For example, Berkshire charges no fees to
its shareholders, netting them billions that Warren could have taken for himself, just as rivals such as
private equity firms routinely do. Similarly, Buffett vests vast autonomy in his managers, a rare act in
corporate America that stokes return loyalty. Such behavior helps explains much of Berkshire’s peculiar
successes, contributing to what Charlie Munger calls the “weirdly intense, contagious devotion of some
shareholders and other admirers.”

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The Value Interviews

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