Tilson & Heins on Staying Disciplined

Warren Buffett has said that investing is simple, but it’s not easy, and in their latest Kiplinger’s column, value investors Whitney Tilson and John Heins explore that subject.

“In The Little Book That Beats the Market, published in 2005, star money manager Joel Greenblatt describes a ‘magic formula’ for success that ranks stocks based on only two factors: share price relative to a firm’s earnings and return on capital,” Tilson and Heins write. “After reading his book, we asked Greenblatt if widespread adoption of his simple plan might undermine its effectiveness. He was unconcerned: ‘Value investing strategies have worked for years and everyone’s known about them. They continue to work because it’s hard for people to do, for two main reasons. First, the companies that show up on value screens can be scary and not doing so well, so people find them hard to buy. Second, there can be one-, two- or three-year periods when a strategy like this doesn’t work. Most people aren’t capable of sticking it out through that.'”

Tilson and Heins say that touches on the main challenge for value investors — the fact that in order to beat the crowd you have to go against it, and in going against it you can run into short-term underperformance that can make you look very, very bad.

An example is Bruce Berkowitz, who was named one of Morningstar’s fund managers of the decade but has struggled mightily this year because of his bets on financial stocks. Tilson and Heins say they doubt Berkowitz has lost his touch. “But,” they add, “Berkowitz’s uncomfortable position underscores why most active managers don’t stray far from the composition of their benchmark indexes.”

Tilson and Heins say they own a number of stocks that “the market has been maddeningly slow to recognize as having a wide gap between the value we see and the price at which the shares trade”. Among them: Microsoft and Intel. They remain high on these stocks’ prospects, and continue to think the market will eventually recognize their value.