Ask A Fund Manager
The Motley Fool chats with the best in the industry so that you can get an insight into how the professionals think. In this edition, Auscap Asset Management portfolio manager Tim Carleton explains why investors should always ask 'Do I want to own this business forever?' before buying an ASX share.
Looking back
The Motley Fool: Is there a move that you regret from the past? For example, a missed opportunity or buying a stock at the wrong timing or price.
Tim Carleton: Well, there's plenty of regrets. At the end of the day, hopefully, you are always learning and refining your investment approach as an investment manager.
If I just limit it to the last 10 years of managing Auscap, I think probably the biggest regrets come from making investments in what you'd classify as traditional value traps.
So as a value manager, you can't help but look at stocks that have declined a long way and they might be reasonably good businesses and you are very confident that the cash flows will continue to come through over time. And you just think that the business is far too cheap for its earnings profile. The problem is often that you have a business that doesn't necessarily have significant earnings growth. Their existing earnings might be resilient, but maybe they don't have significant opportunities to grow those earnings, or maybe they're a cyclical business.
So what you're really doing is betting that the market will recognise that the stock is undervalued, compared to what it should be and re-rate the company. The problem with that is that you might be right, but you are very dependent on how quickly the market recognises that in terms of how successful that investment will be. So if I give you an example, if you buy something for 80 cents that you think's worth a dollar, [if] the market recognises that in a year, that's a very, very handsome 25% return. But if it takes three years to recognise that then suddenly the annualised return is sub-8% and it's average at best.
Of course, the longer it takes to recognise that, the more you're at risk that something within the business deteriorates or some negative macroeconomic development occurs and causes the earnings to decline — and suddenly the margin of safety that you thought was there isn't there at all.
Again, that's a problem that's accentuated in businesses that aren't growing earnings. Because if you buy into a business that's growing earnings well, time is your friend because it's likely that even if the stock stays at the same price, it is becoming a more attractive proposition as time passes. Whereas that's not the case with the traditional value trap.
So if I was going to highlight a mistake it's, like many value managers, getting involved in value traps.
The focus there is more on the value and less on the quality of the business. I always come back to a quote from [Warren] Buffett in what I think was his 1989 letter to his investors, that it's always far better to buy a wonderful company at a fair price than a fair company at a wonderful price. I have learned that painfully through experience.
MF: It's easier said than done though, isn't it?
TC: Much easier said than done. At the end of the day, you can't help you see something that's fallen 50%, 60%, 70%. You think that business is definitely worth more than that and you can't help but want to get involved.
But you have to resist that temptation and try to limit yourself to businesses where you really do want to own that business for, preferably, forever. And if you start out with that mindset, then you make, I think, fewer regrettable decisions.
