Riding on the Coattails of Great Investors

Over the past couple of years, we have tried to educate our readers about some of the great investors. We will constantly offer snippets of wisdom from the likes of Warren Buffett, Peter Lynch and other great investors. Today I want to report on a recently released book called “Big Money Thinks Small—Bias, Blind Spots and Smarter investing.” The author: Joel Tillinghast. For those not immersed in the world of investment management, Tillinghast is the portfolio manager of the Fidelity Low Priced Stock Fund. He has been at the helm of the fund for over 28 years. Interestingly, Joel was hired by another famous investor, the aforementioned Peter Lynch, who piloted the Fidelity Magellan fund to one of the best track records of any fund ever. He destroyed the S&P 500 over his long career, and in an industry which has a rough time beating their benchmarks, it’s refreshing that investors can now peer inside the mind of a great investor and get a glimpse of how he analyzes potential investments.

The book does require a bit of market knowledge and some basic accounting background. Investors should welcome being challenged by Tillinghast as his method will make you a better investor. The book is a little over 200 pages but it was worth the cost just to read Tillinghast’s view on the debacle at Valeant Pharmaceuticals. Valeant first enriched investors with incredible gains as the stock rocketed from nothing to over $260 a share. It trapped some of the greatest investors and hedge fund managers in the world before unleashing a can of whoop ass on them. His discussion of adjusted earnings vs. GAAP earnings is a lesson in how companies can stretch the truth and convince even seasoned investors that all is well. As the profits accrued mightily, Tillinghast and a few others saw that the earnings were really distorted. Valeant argued that many costs and cash flow numbers should be ignored because of allowable adjustments. Valeant was involved in building itself through serial acquisitions and in gigantic price hikes for some of its products. But under GAAP accounting, according to Tillinghast, the numbers were akin to voodoo economics. And finally, as always happens when people get caught up in the frenzy, Valeant’s ferocious appetite for mergers and acquisitions finally led to its undoing. Some illegal activities with its specialty pharmaceutical division (which infuriated insurance companies and regulators) also helped catalyze one of the greatest swan dives in all of market history. Valeant did a great imitation of the dot.com era and proceeded to lose 90 percent of its value—taking portfolio managers (some great ones) and some well-known hedge funds with it. As the book’s sub title implies, Joel was able to see the blind spots where others failed.

Earlier in the book, he mentions a subject near and dear to In Sickness and Wealth; becoming lethargic and slothful investors (i.e. avoidance of darting in and out of stocks constantly). He shares the opinion of great investors that the big money is made with patience rather than furious trading (see blog on Coffee Can Portfolio—The Triumph of Lethargy and Sloth). He features a chart that shows four investors—all of whom buy the same stock. All receive the same 8 percent return every year compounded and the stock pays no dividend. The only difference is how often the investors sell their stock and immediately buy it back. One does so every six months, the others do so at intervals of one, ten, and thirty years. The frequency of buying and selling has a profound impact on results:

The long-term investor over thirty years accumulates almost twice as much as the short-term frequent trader.

Trades every:
6 months 1 Year 10 Years 30 Years
Pretax Return 8.0% 8.0% 8.0% 8.0%
$1,000 Compounds to $4,576 $7,197 $7,822 $8,703
After tax return 5.2% 6.8% 7.1% 7.5%

Assumptions: 35% tax bracket for stocks held less than one year. 15% tax rate for those held long term
Source: Big Money Thinks Small by Joel Tillinghast

 

The more I read about longer term, buy and hold investing, the more compelling the strategy becomes. Warren Buffett said it best when he was commenting on the annual Forbes 400 list of richest people: “The list has two things that stand out. The people are very rich and there are no day traders on the list.” Those who maintain that buy and hold is dead are dead wrong.

 

Be careful out there.
David Lerman / Jodie Warner

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