An Interview with Charles Brandes

an interview with charles brandes 11988 El Camino Real ❘ Suite 500 ❘ P.O. Box 919048 ❘ San Diego, CA 92191-9048 ❘ 858.755.0239 ❘ 800.237.7119 ❘ Fax 858.755.0916 ❘ [email protected] ❘ www.brandes.com Charles Brandes, Chairman and founder of Brandes Investment Partners, L.P., has been investing in stock markets since 1968. In this interview, he dis- cusses the merits of value investing and what has – and hasn’t – changed about the stock market over the past 40 years. Value investing has been a successful strategy over long time periods, yet only a handful of market participants are able to adhere to its tenets. Why do you think value investing remains so difficult for investors to stick with? I get this question a lot from people who aren’t quite familiar with value investing and the stock market in general. While the techniques and thinking behind value investing are simple, there are two basic things that make it a difficult investment discipline to follow. Both of them have to do with behavioral economics. Ben Graham didn’t call it behavioral economics, but that’s really what he was talking about in The Intelligent Investor when he talked about “Mr. Market.” Mr. Market really represented the behavioral biases investors are subject to. That’s the first thing that I think makes value investing so difficult. It’s unnatural for humans to think totally different from the crowd. I don’t know why that’s true, but it’s true. It’s difficult to act completely independent. It’s difficult to disregard conventional thinking. But that’s also what’s good about value investing. It’s totally different from conventional wisdom, and it has worked over the long term. Sometimes it’s difficult to see that, and for human beings, it’s tough to act different from other investors – even if we believe the process will work. The second reason value investing is so difficult is that everybody has a tendency to think about what has just hap- pened in the immediate past and extrapolate that into the immediate future. We all have the tendency to be influ- enced by short-term events – and that tendency makes people stock market speculators. It’s difficult for a lot of us to think the way we need to to be value investors. We should be thinking over much longer time periods – a minimum of three to five years. But how many of us sit around in the morning, eat breakfast and think about the next five years? We don’t. We think about what we’re going to do that day. And when you don’t keep that long-term perspective in mind, it makes adhering to value investing a difficult thing to do. Performance for select portfolios over the most recent 3- and 5-year periods has trailed respective indices. How do you maintain conviction that value investing is still working even during periods when it seems like it’s not? There are a couple of reasons. There is a famous article by Warren Buffett, “The Super Investors of Graham and Doddsville,” and the people he profiled in that article had extraordinary long-term performance numbers. Yet these same investors had periods of long-term underperformance. Unfortunately, underperformance goes hand in hand with outperformance. Nobody can always outperform. I can remember investors saying things like, “I’m going to hire this money manager because every single year he or she has outperformed over the last so many years.” I’d argue that is a dangerous criterion to have in mind when it an interview with charles brandes comes to manager selection. Good investors who outperformed over the long term haven’t outperformed every single year. And there are long stretches of time when those good investors have experienced substantial underperformance. That’s been the history of any good investor’s results. I am not concerned with our recent underperformance, especially when we have what we believe to be large margins of safety in our portfolios. We believe that our portfolios are currently well-positioned for long-term appreciation. Many investors view volatility as risk, but that’s not how you define it. How do you assess risk in the portfolio? You’re right; our firm doesn’t define volatility as risk. However, volatility certainly can be viewed as risk if you are a short-term player in the stock market. Then of course, volatility is risk. But that’s not what we do at all. We define risk as the long-term fluctuations in the economic value of the companies themselves, not the overall stock market. Whether a company’s economic value will deteriorate on the downside, and whether that will be a permanent deterioration, is what we consider risk. Unfortunately, we don’t have the ability to always accurately forecast that kind of risk, and consequently, that’s why we build diversified portfolios. If you look historically over long periods of time, buying stocks with large margins of safety and maintaining a diversified portfolio has been a successful strategy. The probabilities of how companies operate, how the economies operate, and how industries operate offer you a good chance of outperforming by taking that fundamental economic risk of how a company will do in the future. So we don’t believe we need to forecast, as long as we have well-diversified portfolios. You talked earlier about how straightforward value investing is, yet it’s hard to stay the course. What do you consider the quintessential traits of a successful value investor? I think the fundamental traits of a successful value investor would be to have enough knowledge of the companies and the industries in which you’re investing, know the probabilities of the potential outcomes, know the normalized trends well enough that you can comfortably take a position in that company, and not be emotionally disturbed by short-term stock price movements. Warren Buffett made an interesting statement, and some people thought that this was the craziest thing in the world. If it is, you can take a look at his results and wonder why he said he “wouldn’t care if the stock market closed for five years” and he never got a quote on any of his companies. Because it’s not the stock market quotes that are important, it’s how the companies are doing that is important. Buffett thinks long term, and he wouldn’t care whether anybody wants to price a company that he owns, even within a five-year period. He wouldn’t care. That’s not what he’s looking for. He’s not looking to get in and out depending on stock market fluctuations. He’s thinking about being an owner of that company, and how well that company does for its owners has nothing to do with stock price. People always ask, “What do you mean? You’re investing in the stock market and you don’t want any quotes for five years?!” I tell them, “Yeah, exactly.” The misperception is you are investing in the stock market, not companies. Turning it around from a value investor to a value investing firm, what do you think distinguishes Brandes Investment Partners? What distinguishes a successful value investing firm? Foremost, I think it’s a core focus on adhering to the tenets of value investing. It’s also the knowledge and belief in the nature of value investing. At Brandes Investment Partners, we are steeped in the Graham and an interview with charles brandes Dodd philosophy. We don’t change our direction or thought, and that’s one of the things that has made the company successful. The people who work here are the big key to how successful the company is. People want to work here because they believe in the philosophy that we follow. They come here and fit in immediately. That makes for solid teamwork. That’s one of the important factors of how we operate. Has there ever been a period when you’ve needed to update the value investing formula or updated your investment approach? The basic principles of how companies in a free enterprise economy earn money for their owners haven’t changed, so we haven’t needed to change our approach. Those basic principles don’t change, whether you’re applying them to a technological company, a utility, or a bank. So the answer to that is no, we haven’t changed because the world of free enterprise economy and the basic nature of investors haven’t changed. However, there have been changes in technology, changes in efficiency, and a lot of changes in knowledge – for instance the Internet is amazing. If you have a question, the Internet allows you to find out the answer right away. It’s unbelievable. That has been a major change in terms of information, and a positive change. Changes that we’ve decided on, or looked at, are implementation changes and changes of how to look at the basic nature of an industry or a company. As time goes by, the basic nature of an industry or a company may change. So we change with that, but the principles we use to invest haven’t changed. You just mentioned the Internet, and there’s been a proliferation of technology in terms of investment tools. Do you think it’s made it easier or more difficult to find opportunity? In some ways, the market price inefficiencies attributed purely to a lack of knowledge and a lack of information sources – those particular market inefficiencies – are going away somewhat.

Load more