For some reason I took a class on C.S. Lewis in college. I guess reading The Lion, The Witch and The Wardrobe seemed like a good break from Heidegger’s Being and Time. Whatever the reason, I attribute more influence to that one class on my investing career than all my other classes combined.
Although I enjoyed a majority of C.S. Lewis’ books and writings and learned a lot about the various subjects he wrote (a lot about religion and some about fantasy), the piece that has been most influential in my life is a short introduction he wrote to a translation of Athanasius: On the Incarnation. The introduction is worth your time. See here.
Lewis focuses on a few main points throughout the introduction, but my takeaway has always been two things. Read original documents. And read old stuff (the subject of another post).
Read Original Documents
“It has always been one of my main endeavors as a teacher to persuade the young that firsthand knowledge is not only more worth acquiring than secondhand knowledge, but is usually much easier and more delightful to acquire.” Lewis
In the investment world, gaining firsthand knowledge means reading the SEC filings. Munger has often made the comment that he would pay an investment banking fee in order to not read about their “projections” or “analysis.” When I lived in NYC, I had a friend who worked at a large investment bank of german origin. He was an analyst for various energy companies and shared with me some reports he had written. I asked him what his background was in energy, he replied, “Nothing really, but I am from Texas.”
One of the best inventions to aid value investors, I believe, is the creation of XBRL. This is some sort of computer code that allows all the numbers to be drawn directly from the SEC filings (10-k 10-Q, etc), without having to actually open and read the language of these documents (technically speaking, you can draw the words from the documents by section, but that appears to be rarely done in practice). I am not typically a conspiracy theorist, but I am certain this project and its implementation has been organized and funded by a cabal of value investors, probably lead by Buffett and Munger. I don’t believe value investors have realized the potential in this new technology. XBRL may eliminate all reading of the actual SEC filings by a large majority of investors. I may be overstating my projections here, but the less others read the original filings, the better I anticipate finding value. I hope to endow a chair in XBRL’s honor at a prestigious university in the near future…
What follows is a brief example of how reading the original documents matters…
Over two years ago, CMS cut the rates of skilled nursing facilities by 11%. Since a large majority of skilled nursings’ revenue comes from Medicare patients, this caused a blood bath among such providers stock market values. One operator, Sun Healthcare Group, lost over 65% of its market value within two months of this announcement. Skilled nursing providers operate with fixed lease or mortgage payments and little pricing power and therefore a drastic reduction in revenue will directly affect their profit. However, Sun Healthcare had one major difference. It was an early entrant in providing its own patients with hospice care within its facilities and in the surrounding communities. In a matter of 3 years, it had built a small unit relative to the company’s overall revenue. On a standalone basis, this hospice unit was worth approximately $120m. In fact, it had slightly more revenues and better profits than a hospice unit that had been purchased within the past 3 months for $125m by a public home health care company.
To recap, Sun had a market cap at the time of $80m. It had a small unit that brought in about 5% of its total revenue that was probably worth around $120m. Comparing the unit within Sun to the previously acquired company isn’t an exact science obviously, but it was probably worth more than $80m (along with other factors). At that time, due to the draconian and highly public reduction in medicare rates, the pendulum for Sun had most likely swung too far in the negative direction. I could not tell you exactly how much Sun was worth, but one could certainly estimate that it was worth more than the current market value of $80m. Within 3 months, the pendulum began to swing back to the middle and the company had regained a lot of its lost value, moving back towards $150m. Within 9 months following that, or within 1 year of the medicare reduction, Sun Healthcare was acquired by another skilled nursing care provider that operated across the continuum of care (i.e. skilled nursing, assisted living and a budding hospice unit) and I presume the hospice care unit was a factor in being able to expand that option to the acquirer’s own facilities. Which brings me to the question, why discuss this story? The details regarding Sun’s hospice unit are not broken out in its financials, only the footnotes. Additionally, the details allowing someone to understand what this unit might be worth based on what other companies were paying for such companies would presumably be overlooked when focusing solely on the main XBRL data.
There are a plenty of investing tidbits that might not be immediately or directly useful to one specific company, but will help in the future. Knowledge in this area is certainly cumulative.
In investing, details matter. Reading original documents matter. Reading summaries by analysts who only have two recommendations in their quiver (buy and buy more) is a fool’s errand.