Legendary investor and billionaire looks amongst the dirt for diamonds.
Almost two decades ago, Fortune wrote a fascinating article on Michael Price that
began with a captivating incident.
John Teets, the CEO of a conglomerate called Dial, was going through a bad phase.
The company’s profits were down, morale was low, and its brands were tired.
Accusations were doing the rounds of Teets utilizing the company’s assets
for his own personal use, including a New York penthouse and a Gulfstream jet, as
well committing sexual improprieties. But here’s the clincher - the writer
did not feel the above were Teets' biggest problem. Teets’ biggest worry was
Michael Price, who had taken a 9.9% position in Dial's stock, worth more than $250
Why would this cause so much of trepidation?
Because Michael Price, the legendary mutual fund manager and value investor, was
known as a corporate raider and very dramatically described as the stalker of underperforming
Eight years prior to this incident, Price grabbed control of Sunbeam and put his
own chief executive officers in place (he replaced one CEO with another when unhappy
with the results). Not surprisingly, Teets was shown the door. Price was also responsible
for the merger of Chase Manhattan Bank and Chemical Bank after he purchased 11 million
shares of Chase Manhattan.
In both the above instances, massive layoffs took place, around 6,000 in the case
of Sunbeam and 12,000 due to the bank merger. And in both cases, Price benefitted,
as a result of which investors in his fund did too.
Unlike other corporate predators, Price was a fund manager, which translated into
retail investors being allowed to hop on for the ride.
Price was hired by Max Heine of Mutual Series mutual funds. After Heine’s
death, he took over control and ownership of the fund. In 1996, when the value of
the funds crossed $17 billion, he sold it off to Franklin Securities for $670 million.
He now manages his own personal wealth through his private firm, MFP Investors LLC,
a value focused hedge fund that he founded in 1998.
Price likes to describe himself as a value investor who, by making such moves, unlocks
value in a stock. He told the reporter at Fortune, "I'm just trying to find cheap
stocks and realize the value." And unlocking that value could often mean ousting
Looking for dirt
At a talk to the students in Columbia Business School, he shot a question: “When
most people look at the day's stock tables, what do they turn to first?" He himself
provided the answer: "The day's most active stocks” before going on to state
that he looks “at the day's biggest decliners” because “I love
to read about losses."
In a conference in London, he told a bunch of investors to go where others are not.
“When you play tennis, you hit the ball where the opponent is not.”
This explains the principle he follows when constructing a portfolio: buy cheap.
He once explained that two-thirds of his portfolio trades below its intrinsic value
and the balance are those involved in special situations such as a proxy fight,
lawsuit, litigation, government action, fight for control, a takeover, bankruptcy,
liquidation, or even a tragedy like the BP oil spill.
Such a portfolio, he believes, weathers the storms.
Here is an example he cited.
Hospira was a pharmaceutical company that manufactured drugs. Its earnings per share
were at $3 that kept growing steadily and were connected to the basic growth of
healthcare in the U.S. Being a popular growth stock, its stock price was $45 (15
Then came the bad news: The FDA investigated and shut down its largest plant. The
stock market overreacted and the stock price dropped to $28 overnight.
Price explained that if there were 200 million shares of Hospira in the market,
a drop from $45 to $28 (17 points x 200 million shares) would result in a $3.5 billion
discount from the night before.
Will it cost $3.5 billion to fix the plant? No.
Yet the stock market put that much of a discount on the bad news.
Will the company shut down? No.
There were 17 other plants and it would only be a matter of time before the shut
down plant was up and running once again.
Price concluded: This is what value investors wait for, the time when growth investors
sell to them because they want out due to bad news on the table.
The value investor knows that the stock is going to get back to $3 in earnings after
a few years. And it will cost the company around $500 million to fix the plant.
But the intrinsic value of the business is intact and once the company is past its
problem, the stock price will go up to $45 once again. That is when the value investors
sell back to the growth investors.
He also looks at management making mistakes resulting in underperformance. However,
the key is that the companies that stumble should have built up intrinsic value.
How does he define intrinsic value?
He is emphatic that intrinsic value is not 12PE in a market which is 15PE. It is
not what sell-side analysts say it is worth.
It is what a businessman would pay to own 100% of the company after having conducted
a complete and thorough due diligence.
After arriving at its intrinsic value, he will wait for the market to hand it to
him at a huge discount to that value. Note, the key word here is wait. He is extremely
comfortable with sitting on cash if he does not find anything cheap.
He believes that a potential investment is best evaluated through its capital structure
- equity (where you own part of the company) and debt (where you lend to it). Everything
else, in his view, has been invented by Wall Street to rip off investors and generate
To put it in his own words, he “focuses on the steak and not the sizzle”.
Steak in this analogy is the balance sheet and the notes to the financials; it is
what you are buying – earnings stream, asset values, cash, real estate, and
so on and so forth. He figures out the intrinsic worth of the steak and then attempts
to buy it at a big discount, say 25-30%. In other words, you figure what is cheap
and buy it. If you can’t find cheap stocks, you wait.
He has often explained his construction of the portfolio as one that has a natural
propensity to add to stocks as they get cheaper.
The top 5 holdings will each corner 3-5% of the assets.
The next 10 will each be 2-3% of the assets.
The balance (which should be around 20 to 30 stocks) would be held at 1% each.
The latter will be constantly monitored to see if the position should be upped.
As for the top stocks, they will be monitored to see whether they should be sold
and their position reduced in the portfolio.
So basically he trades around positions on which he has conducted extensive research
and is convinced that the stock will do well over time. He also believes in constantly
re-evaluating if he wants to continue to hold his position in a given stock.
He cautions investors about getting lost in spreadsheets and relying solely on projections
put in them. Depending too much on the excel spreadsheet and forecast of discounted
cash flows is a big mistake.
Price does not approach valuation by discounting a stream of future earnings, nor
does he use price-to-book or price-to-EBITDA. He believes in starting where the
transactions exist and seeing what companies are doing with their cash flows. The
merger proxies and bankruptcy disclosure documents are a treasure trove of industry
data – an area not frequented by analysts.
But Price has also had his share of losses.
In 1989 he was betting that the court would block the Time-Warner merger and allow
Paramount Communications to carry out a hostile bid for Time. The court ruled against
Paramount, Time merged with Warner, and Price lost around $100 million.
His funds underperformed the market in 1989, 1990, and 1991. He was heavy in cash
post the Gulf war in 1990. When the market picked up, he missed much of the gain.
When asked once what investors should look for, he cited three steps:
But most importantly, he believes that the key in the business is weathering the
bear markets, not outperforming the bull ones.
Advice all of us would do well to pay heed to.
This article was also published in Morningstar on 16th November 2015.
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