One of Charlie Munger’s most repeated aphorisms is: “Invert, always invert.” If you want to find great investments, start by filtering out all the bad investment ideas. Buffett often refers to Munger as “The Abominable No-Man.”
Buffett’s description of what he is looking for in an investment stands as the best I have ever read. The only problem is you have to sit on your hands and wait for quite some time for a good idea to meet these criteria. And in the meantime, you have to say “No” quite often.
Buffett’s four criteria are as follows:
We want the business to be (1) one that we can understand, (2) with favorable long-term prospects, (3) operated by honest and competent people, and (4) available at a reasonable price.
Numbers 1, 2 and 4 are points where reasonable people can disagree. The genesis of this post is how often investors are in full agreement that management is either dishonest or incompetent (or both), but still try to justify the investment as a good one.
I want to post a few excerpts from a well-read and respectable website, which contains a host of quality investing write-ups. The website is valueinvestorsclub.com. The quality of the website supports the idea that intelligent investors feel the need to swing at bad pitches.
These excerpts are all from “long-pitches, ”where the writer believes you should buy the stock.
1: Medley Capital Corporation (MCC) is an externally managed BDC currently in the midst of a three-way merger with its manager (MDLY) and an affiliated private non-traded BDC (Sierra). MCC is not a good BDC. The Taube brothers who oversee the Medley complex have a well-deserved reputation for self-interest and incompetence which I won’t try to defend. Nevertheless, the setup here provides for an asymmetric risk-return profile around the prospective transaction with 25%+ upside if the deal closes and limited downside if the deal breaks.
2: Another quarter of a down ~40% on continued write-downs on construction projects. This management team has blatantly lied to investors and the street over and over again. Enough is enough. Charlie Bacon is arguably the most incompetent CEO of any micro/small cap company in the public market. That being said, this has now turned into a $20m market cap cigar butt with $40m of claims. On a good day they should get $0.40 to $0.60 cents on the dollar. Someone will make easy risk free $$ buying at $2.80 if the claims come in.
3: Our field visits reveal a ho-hum operation in a steady decline. The most recent quarter yielded -2% comps. The new CEO is uninspiring. Their new strategy entitled “Build the Business Better” is about all you need to know about management and company strategy. If you listen to their most recent earnings call and eat a peanut every time they use an MBA buzzword yet say nothing of meaning, by the end of the call you will have had enough peanuts that you can go into hibernation (as a bear is wont to do) until springtime.
Buffett likes to reference an old joke about an oil man at the pearly gates, which goes something like this: An oil prospector, on his way to Heaven, is met by St. Peter at the pearly gates with some bad news. “You’re qualified for residence,” St. Peter said, “but, as you can see, the compound reserved for oil men is packed. There’s no way to squeeze you in.” After thinking for a moment, the prospector asked if he could say four words to the present occupants. St. Peter thought it seemed harmless, so the prospector cupped his hands and yelled, “Oil discovered in Hell.” The gate immediately opened and all of the oil men marched out of the compound to head for the nether regions. Impressed, St. Peter invited the prospector in. The prospector paused, then said, “No, I think I’ll go along with the rest of the boys. There might be some truth to that rumor after all.”
This joke reminds me of the investor who knows the management is either dishonest or incompetent (or both), but decides there might be some truth to that rumor about the company being a good investment.
Why don’t people wait?
There are lots of reasons, but here are a few:
- Some investors think a business is good, but know that management is bad. These investors justify the investment based on the idea that the great price of the business is worth the bad management. This is akin to marrying a supermodel who is going to yell at you all day. Whatever pleasure your eyes may derive from the marriage, your ears will endure a greater amount of pain in the long run. The pocketbooks of those partnering with bad management are likely to see a similar 50%+ decline in their net worth.
- A lot of people don’t have the temperament to sit around and do nothing. They get bored. They see others doing stuff and they want to do stuff too.
- Swinging at bad pitches sometimes works. Check out this video. Getting lucky hitting a bad pitch should not be the basis of a long-term investment strategy.
- If you are an investment advisor, it is much easier to sell your “services” with new ideas. I have never heard of a retailer advertising things it isn’t selling.
Bad management provides investors with a pitch far outside the strike zone. Investing is a game with no called strikes, so don’t swing.
“I didn’t get to where I am by going after mediocre opportunities.” Charlie Munger
Matt Brice can be reached at email@example.com