You Can't Uncouple from Valuation
Kinetics Paradigm Fund
Author: Dave Jennings
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|Peter Doyle mentioned Warren Buffett, the famed Oracle of Omaha, in the conversation. Like Buffett, TICKER learned that the 40-year-old money manager was schooled in the deep value investment approach of Ben Graham. He's read Graham & Dodd's classic TheIntelligent Investor 25 times. Lipper ranks his deep value Paradigm Fund, now available to advisers, in the top 10% of mid cap blend funds for three-year performance.
||Kinetics Paradigm Fund|
What we try to do even before we look at the numbers is we're trying to think qualitatively. What exactly does the company do? What are the competitive threats? Is this a business that five years from now is more or less going to be the same type of business that it is today? Warren Buffett said that one of the things that has made him so successful is that he buys companies that are highly predictive. And he doesn't stray too far from that. When he buys a shoe company, he realizes that five years from now people are going to be basically buying shoes. It doesn't mean that they have to be buying his shoes, but at least he knows that the business is going to be around.
Q: How do you screen for companies?
Primarily, what we're looking for is high returns on invested capital without having to use substantial leverage. We're willing to take a lower return on equity if we believe we're buying in well below book value. Letís say the regulated return on Centerpoint is going to be 11%, but if you believe that the book value is 16%, because they're owed that $5 billion and you're buying in at $7, your real return on equity is 23%. We don't use computer screens. We do fundamental analysis. We write a lot of research. We look at the world in ways where we think there are inefficiencies, so we write on spin offs. We write on contrarian research. If the world needs something, we have an interest in it. Sometimes they dislike it for very legitimate reasons because the operations of the companies are in decline. Sometimes they dislike it because it now falls outside of their time horizon. If you own undervalued situations and if you have patience, they will get revalued over the course of time.
Q: Who schooled you in this method of stock valuation?
[A: One of my professors at St. John's University was in the same class as Warren Buffett. They took a class at Columbia with Ben Graham. I'm a disciple of Graham and Dodd. I have read The Intelligent Investors probably 25 times. The interesting thing is the book is written for the layperson. On its surface, it looks like a very simple book. But the more you know, the more you appreciate how profound it is: I would actually say The Intelligent Investor is the best book on investments ever written. And Warren Buffett writes that in the forward of the book. I actually agree with him. If you reread it, the more you know and the more you learn, the more you appreciate how smart he is. He was a bright, smart guy and he approached owning stocks the way you should from a businesslike perspective. He's saying what would I pay for the entire company? And if he came up with a price and found that he could buy the stock for half of what he could pay for the entire company then he would say that it's a great deal. In the case of Centerpoint, I would tell you that if I had the money and the public utilities company holding act would allow me to do it, I would buy the whole thing. At $1.2 billion, in two years' time, I would be making $600 million in net income.
Q: You're still young. You have plenty of time to get to that point in your fund where you can buy a company outright.
I fully expect it to happen at some time in the future. We're just not there yet. What happens is that basically people are looking around to see who has held up over the last several years. That fund is starting to get more interest. We could have had the same performance if we were $600 million just in that fund. Everything we own is large, liquid, so we have no problem buying as much of El Paso, Centerpoint or Williams.
Q: It sounds like you will probably outperform most of the major indexes.
If you look at the performance of the Paradigm Fund over the last years, it's basically in the top 1% in the category called mid-cap blend. Whatever it is, the vast majority of funds aren't beating it. Letís put it that way. When I look at what they own and what we own, and I say there is no way in the world they're going to come close to us. People's expectations are way out of line with reality. It's that you can't uncouple valuations with the expected return. People are confusing good companies with overvalued stock prices. Warren Buffett said not too many months ago that the vast majority of stocks that he's analyzing are overvalued. I couldn't agree more.
Q: This fund is definitely different. It's more fascinating than the Internet Fund.
The Internet fund is interesting. But I tell people that they shouldn't have more than 10% equity of their equity in that fund and that they really should have closer to 5%. It's constrained by where we can go and be creative about getting value. And why put that limitation on yourself?
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