Investing Against the Tide

Lessons From a Life Running Money

Anthony Bolton

• Publisher: Financial Times/ Prentice Hall
• Year: 2012
• ISBN:
  9780273747079
• Edition: 1
• Topic: Betriebswirtschaft
• Subtopic: Investitionen & Wertpapiere

This authoritative and accessible investment classic promises rare insight into what it really takes to run money in a top-performing investment fund.

Anthony Bolton, the UK’s most successful stock market investor, tells the story of his contrarian approach to managing money. He provides invaluable lessons on the factors that really matter in picking a stock: the need to identify good managers, how to run a portfolio, the importance of value investing, reading charts and how to trade successfully.

It’s not easy to continually buy low and sell high. This book gives clear directions for doing well in the stock market, and doing well consistently. Investing Against the Tide shows you how to make the right decisions at the right time.

Anthony Bolton is considered the UK’s most successful stock market investor and fund manager. Over twenty five years he delivered a market-beating return of 20% in his Fidelity Special Situations Fund. How did he do it, and what can you learn from him?

In Investing Against the Tide, Anthony Bolton tells the story of his contrarian approach to managing money. He provides invaluable lessons on the factors that really matter when investing: how to pick a stock, the need to identify good managers, how to run a portfolio, the importance of value investing, reading charts and how to trade successfully.

In this account of financial accomplishment, Bolton reveals the secrets of his success. It’s not easy constantly to buy low and sell high and this book gives clear directions for doing well in the stock market, and doing well consistently. Chapter by chapter Investing Against the Tide shows you how to make the right decisions at the right time and featured key lessons show you how you really can learn from a life running money.

Investing Against the Tide is an authoritative guide for investment professionals, offering them a rare insight into what it really takes to run money in a top-performing fund, as well as providing amateur investors the chance to learn the stock-picking strategies from a leading money-manager.

About the author

Anthony Bolton left Cambridge University with a degree in engineering to begin a career in the City. He started as a graduate trainee working for Keyser Ullmann in 1971 before taking up a full time position as an assistant in their investment department. In 1976 he moved to Schlesingers where he became, for the first time, an investment manager. In 1979, aged 29, he was recruited by Fidelity, the international fund management group, as one of its first London-based investment managers, a move that proved to be the launch of a long and successful career. In surveys of professional investors, he is regularly voted the fund manager most respected by his peers. He retired from full-time investment management at the end of 2007, but continues to work at Fidelity as a mentor of the analysts and younger fund managers as well as being involved in overseeing Fidelity’s investment process. His hobby is composing classical music. Anthony Bolton is married with three children and lives in West Sussex.

Part One

Principles and practices from a life running money

chapter 1

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How to assess a company and the role of meetings

‘Mean reversion is one of the great truisms of capitalism’

‘Many shall be restored that now are fallen and many shall fall that are now in honour’

Horace (quoted at the start of Security Analysis by Ben Graham and Dave Dodd)

‘You should invest in a business that even a fool can run, because someday a fool will’

Warren Buffett

What to look for in a business

I always start when looking at a share by assessing the company I’m investing in. How good a business is it? How sustainable is its franchise? Businesses are not created equal – some are much better than others and most businesses vary over time due to factors such as new competition or changes in the environment. Charlie Munger, Warren Buffett’s business partner in Berkshire Hathaway, wants to understand a company’s competitive advantage in every aspect – markets, trademarks, products, employees, distribution channels, positions relative to changes in society, etc. He refers to a company’s competitive advantage as its ‘moat’, a virtual physical barrier that protects against incursions. Superior companies have deep, enduring ‘moats’. He also considers the ‘competitive destruction’ forces that, over the long term, lay siege to most companies.

In general, it’s easier to make money owning businesses with strong franchises than ones with weak franchises. The ability of a company to survive is important. Often, I ask myself a very simple question: ‘How likely is this business to be around in ten years’ time and to be more valuable than today?’ It’s surprising how many businesses fail this test. It may have a business model that meets market factors and demands today, but it is near impossible to predict that this demand will still be there ten years from now. Another important question to ask is, how much does a particular business stand on its own two feet: how does it exist relatively independent of the macro factors around it. For example, businesses that are very sensitive to interest rates or currencies are less good businesses than ones that are insulated from such factors. An exporter of commodity products would fall into this sensitive category. A few years ago, I remember only too well looking at a medium-sized, UK-based chemical company that exported most of its product to the continent. At the sterling-euro exchange rate at the time it had a good business but I worked out that, if the currency moved 15 per cent against it, it might have no business or at the very least a substantially less profitable one. It wasn’t difficult to decide to give that particular investment a miss. I like businesses that are in control of their own destiny and are not very sensitive to macro factors like this (though all businesses depend somewhat on the macro environment).

I also prefer reasonably simple businesses. If the business model is very difficult to understand I’m happy to pass on it – there are lots of others that are easier to understand. Sometimes it is possible to summarise the financial characteristics of a company in a few ratios. For example, when looking at banks the relationship between the price to book value and the return on equity is very important. Recently, a competitor argued that life insurance companies were often poor businesses because the ratio of overheads to funds under management could be too high (at say 2 per cent) to create long-term value unless high risks were taken on investments. Therefore, a single key financial ratio was at the heart of deciding the attractiveness of the business model.

A really important characteristic I look for is whether the business generates cash over the medium term. I am convinced that cash-generating businesses are superior to ones that consume cash and this factor has generally given me a bias towards service businesses and against manufacturing in the portfolios I’ve run. Businesses that can grow without requiring a lot of capital are particularly attractive. Cash-on-cash return is the ultimate measure of attractiveness in terms of valuation. In playing off cash generation against growth, I generally prefer cash – as do most private equity investors. Very few businesses give compound returns above 10 per cent for any sustained period of time. Remember, mean reversion is one of the great truisms of capitalism. For most companies, the financial statistics used to evaluate their performance, such as sales growth, margins or return on capital, revert to the mean over time. This also applies to valuations and, sometimes, even management’s ability!

Meet the company

One of the main inputs for my investment process has been talking to the management of businesses either I’m invested in or looking to invest in. At an initial meeting with a company I’ve not seen before, most of the time will be taken up asking questions that allow me to build up an informed view of the business franchise – its strengths and weaknesses. The first meeting doesn’t have to be with the chief executive; a good investor relations person at a company can be very helpful in describing the business in detail and helping me assess the business franchise. Of course, subsequently I will want to meet the executives as well.

Such meetings have changed greatly over the past thirty years. It used to be difficult to get to meet the management at many companies, particularly in Europe, and they often had a misguided view as to why we wanted to see them the first place. In the early days, if you got a meeting it would have to be at the company’s office irrespective of where that might be. If it was in London, it was probably a group session (most often lunch at a broker’s office.) Today they are, more often as not, individual, one-to-one meetings at our offices, although we still do a lot of visits to their offices and face-to-face meetings at conferences. An important service many brokers offer their institutional clients today is arranging such meetings – a glorified concierge service. A cynical broker acquaintance of mine observed that companies were in the visitor attraction business, a bit like a funfair, but for institutional investors rather than individual visitors. They are trying to make being an investor in their shares more attractive than another company’s shares, hoping this both attracts potential investors and also keeps their shareholders on board for longer. This does have a ring of truth to it.

Preparing for a company meeting

Before I meet a company there are things I want to look at. First, I will examine a chart, probably the three, five and ten-year graphs to see how the stock has been performing. Then I will want to look at some valuation measures. I like to have as long a history as possible of valuation measures such as P/E (price/earnings ratio) price to book, price or EV (enterprise value) to sales and EV to EBITDA (earnings before interest, tax, depreciation and amortisation) – twenty-year charts if possible but, if not, at least a complete business cycle. Less than ten-year data I find can be misleading as they will not contain enough variety of business conditions. I want to be able to see how today’s valuation compares with its history – is it high or around average or low against its history (of course, it’s the low ones that really interest me). Then I will look at a chart showing the history of director deals. I will look at a list of the top twenty shareholders (the shareholder list is often wrongly ignored by investors, in my view). I’m examining whether it’s diverse or concentrated, say with just a few investors controlling the company. Sometimes the names of the institutional shareholders will carry information because there are some I rate more highly than others and if one or two I rate are on the list that’s a positive. I will also see how much of the company is held by insiders. I will look at a financial strength report (H-Score report, see Chapter 7), a chart showing the net short position and how it has moved over time, a chart of the credit default spreads where these exist, as it can be an early indicator of problems ahead, an indication of whether the company is liked or not liked by brokers and an indication of whether it’s highly owned or lowly owned by the institutional investors. I will also look at a chart of earnings upgrades or downgrades so I can see at a glance whether average expectations are improving or deteriorating. Then I will want to look at the latest company results and any official releases (I am keen to be fully up-to-date with recent announcements so I can have a more fruitful discussion with management) as well as some press reports. Regarding results statements, I always like to read them in the original because managements spend a lot of time on the language and phrasing, which is often lost in a broker or press synopsis. I will then look at a few recent broker notes, if possible both positive and negative ones, and our internal analyst’s notes and financial models. Finally, and most importantly, I will review my handwritten notes of previous meetings.

Although I like reading company reports in the original, I am more sceptical about company guidance. When companies give detailed guidance and say that their profits will be up or down by a specific amount, analysts write this down religiously. I will want to know how they get there and see if I agree with the assumptions on which that ultimate figure is based.

Meeting companies

Company meetings in our offices are normally with the chief executive or finance director of a company. The meeting is run by our analyst who follows the particular company and the analyst distributes a copy of his or her questions plus the latest financial models before the meeting. The meetings normally last an hour to an hour and a half (although occasionally I’ve done much longer ones and a few shorter ones). Very importantly, we like to set the agenda (with the exception sometimes of an initial meeting with a company or if they’ve come to see us to talk about a specific deal). We like to discuss the financial trends in the business as well as strategy, recent performance and new developments. Our discussion of trends can go into great detail about volumes, prices, gross margins, costs, operating margins, interest costs, taxes, etc., division by division. This helps us build up a more informed financial picture of the company. We would also discuss balance sheet items such as capital expenditure, working capital, debt and debt covenants. When we finish the meeting we really like to feel that we understand the business model and the primary factors that affect it; that we understand the strategy and have a fair impression of the management and their incentives; that we understand the business and recent trends – both areas doing well but also areas doing less well; their view of the outlook for the divisions of their business and the market generally, and finally that we fully understand the dynamics of the P&L, the cash-flow and the balance sheet, allowing us to build more sophisticated and accurate models than many of our competitors and most brokers.

I will always try and spend the last few minutes (or the first few minutes, maybe while waiting for colleagues to assemble) to touch on a competitor, or a company they do business with, such as a supplier or customer. Although not all managements will talk about other companies, when they do it can be very revealing. The ultimate commendation is when a company talks positively about a competitor. I always put a strong weight on such a view. In fact, as a general rule, when a company says the opposite of what you expect them to say I put a double weight on it (for example, you normally expect companies to be sceptical of competitors). When they say what you might expect – like business is great across the board – I’m more sceptical and want, if possible, some form of independent confirmation. It is not that the majority lie, but there is a lot of ‘spin’. Seeing through spin is one of the most important aspects of the job.

Finally, it is worth considering how risky the business model is – some businesses are considerably more risky than others. Often, this is because of the balance sheet structure, but sometimes this is down to the nature of the business. There is no better recent example of this than Northern Rock. There was nothing seriously wrong with the management or the business in general (although maybe the bank was too focused on growth). However, the business was much more wholesale-funded than its competitors (relying on funding from other banks as opposed to their own depositors). In most conditions this works. However, if conditions change, as they did in 2007, and the availability of wholesale funding decreases and its costs increase, this can put the whole model at risk. This is what we witnessed only too dramatically in July 2007.

chapter 2

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What to look for in management

‘My recommendation is to invest in management you trust’

‘When management with a reputation for brilliance tackles a business with a reputation for bad economics, it is the reputation of the business that remains intact’

Warren Buffett

‘We also believe candour benefits us as managers. The CEO who misleads often in public eventually misleads himself in private’

Warren Buffett

‘Getting to know the management of a company is like getting married. You never really know the girl until you live with her. Until you’ve lived with a management you don’t really know them’

Phil Fisher

Get to know the management

Over the years I have come to value management integrity and openness more and more highly. In my early years of managing money I might have bought shares in a company where I liked the franchise but maybe had some doubts about the management competence or integrity. But not any longer. In the late 1980s and early 1990s I learnt my lesson with these types of companies the hard way. Despite the protection offered by outside directors and independent accountants, if a management really wants to mislead investors it has plenty of scope to do so and can get away with it for many years. Even if the management appears very competent, if they are not open then this is a significant disadvantage.

When I meet the management of a company the things I am trying to assess are their competence, their personal characteristics (e.g., are they optimists or pessimists by nature), are they more strategic or operational, how the management team works and most importantly how they are rewarded and what their incentives are. I often find that management who in a first meeting seem very impressive on subsequent meetings seem to regularly under-deliver so I really like those who give us a balanced view of their company and are good at delivering, or even better, constantly over-delivering, against plan. I find management competence can be best assessed by regular meetings with managers over an extended period of time and this is where we are ver...