The Iconoclast Investor

I learned a lot about how hedge fund managers consistently make money in the stock market at the Value Investing Congress.  We have all heard about how hedge fund managers leverage their investments and take high risks to produce extraordinary returns, but most of the investors at the Congress use a conservative value approach.  Value hedge fund managers typically purchase large amounts of stock in a few small- to mid-size companies.  They establish a personal rapport with management, gain a seat on the Board of Directors, and urge management to make changes that will make the company more successful and thereby increase the value of the stock.  Value hedge fund managers make their investments with the objective of holding their stock positions for at least five years.  It doesn’t really matter if the company stumbles along during the first couple of years, as long as a solid long-term goal is achievable.

Small investors like you and me cannot take dominant positions in companies and then direct changes.  So what do we do?  Several speakers suggested that smaller investors should invest in high quality companies that are clearly undervalued and hold for at least three to five years.  Eighty percent of the material reported on TV or in research reports pertains to company financial information and forecasts for the next three- to 12-month period.  Another 10% of information pertains to two-year forecasts.  The remaining 10% pertains to forecasts of more than two years.  In other words, investors are concentrating heavily on short-term investments, and very few investors think long-term.

My advice, based upon my years of experience and confirmed by speakers at the Congress, is that you should invest in high quality companies at reduced prices.  If a company is experiencing short-term difficulties, that’s OK; in fact it might even be preferable.  Investors tend to overreact and send the stock prices of very good companies absurdly low when short-term disappointments surface.  Long-term investors can overlook those problems and concentrate on the three to five year prospects.

An example of a high-quality company with short-term problems, but with a good long-term outlook is Colgate-Palmolive (CL), which is a company that I recommended in Cabot Wealth Advisory last month.  Four years ago, the company was plodding along at an agonizingly slow pace, and the stock was going nowhere.  Management created a comprehensive plan to overhaul the entire company to become significantly more efficient and more profitable.  Progress started slowly, but long-term investors have been richly rewarded.  CL shares have increased 50% during the last four years, despite the recent drop in the stock market.