By the time I reached my early twenties, I knew I wanted to be an investor. Not just any investor, but a great one. As I started to lay the foundation for my chosen path, it dawned on me that being an investor usually meant being entrusted with other people’s money, and I could never imagine investing other people’s money with the goal of being just average. After all, investors could achieve average returns on their own by investing in index funds. So, in the pursuit of excellence—but even more out of a sense of duty—I read everything related to investing. Many of those books still influence my approach to investing today.
The more I read, the more my investment philosophy evolved. A few books and academic papers became the pillars on which my investing philosophy rests (even today).
A professor I had at Georgia Tech recommended The Intelligent Investor. The book is a manifesto on value investing—an investment strategy that seeks to identify discounted stocks of companies that will perform well over long periods of time. Value investors are not concerned with short-term trends and market fads. They believe that the market often overreacts to news, which affords patient investors with opportunities to buy great companies at deeply discounted prices. Patience is the ‘trick’ to value investing because the market only offers deep discounts on decent companies periodically, and most human beings are not wired for patience.
In contrast to value investing, where investors look for decent companies trading at discounted prices, Philip Fisher espouses a growth investing strategy. Growth investors invest in companies that produce above-average revenue and earnings growth, even if the share prices appear expensive in terms of metrics such as price-to-sales ratio, price-to-earnings ratio, and price-to-book ratio. They buy into companies that have yet to reach their full potential (venture capital is an example of this strategy). The ‘trick’ to growth investing is identifying companies that will have persistent, above-average growth into the future. That requires knowledge of microeconomic forces and game theory, awareness of emerging innovation, and sector-specific knowledge—combined with strong reasoning skills. In other words, successful growth investors must be capable of developing consistently good “industrial logic.” Those reasoning skills are also rare traits in humans.
Peter Lynch had an entirely different approach to investing. He regarded reliance on quantitative models as being a great handicap for investors. It’s not coincidental that Lynch majored in philosophy in college. He suggested that everyday Americans, using the information they could garner from living their everyday lives, gave them a significant informational advantage over “professional” Wall Street investors. He viewed investing as being more qualitative than quantitative.
Lynch even went so far as to list the qualities that made some people better investors than others. Those qualities included patience, self-reliance, common sense, a tolerance for pain, open-mindedness, detachment, persistence, humility, flexibility, willingness to go against the crowd, and the ability to ignore general panic. Reading One Up on Wall Street taught me the value of unique information and independent thinking. If you always do what the crowd (i.e., the market) does, then you will get market returns.
By the time I arrived at graduate school in 1995, I had already read 100+ books on investing and finance. In fact, I’d read each of the previously mentioned books two or three times. However, it wasn’t until my second year of graduate school that I learned how to quantify and measure the theories in these books.
In 1996, I read an academic paper, “The Cross-Section of Expected Stock Returns,” by Eugene Fama and Ken French. It was published in the Journal of Finance in 1992. At the time, Fama and French were already emerging superstars in the world of academic finance. Their theory of The Cross-Section of Expected Stock Returns (also known as the 3-Factor Model) was rapidly replacing CAPM as the predominant asset pricing and portfolio management model in academic finance. At the time, only one commercial entity was leveraging the powerful insights produced by the 3-Factor Model—Dimensional Fund Advisors (DFA). Essentially, the 3-Factor Model measured three variables in predicting the return expectations of a given stock or portfolio:
As academic debate surfaced around the latter two factors of the 3-Factor Model, Fama and French expanded their model to a 5-Factor Model to better explain the variability of stock market prices. The new factors included two more factors. The fourth factor was profitability (stocks of companies with higher profitability produce higher returns than companies with lower profitability). The fifth factor was the investment factor (the return differences associated with companies that invest conservatively and those that invest aggressively). These newer factors had much higher correlations with stock price returns than the previous factors, and the 5-Factor Model was significantly more predictive of stock price and portfolio returns than the prior 3-Factor Model.
Said plainly, companies with better business models (evidenced by higher profit margins) that invest aggressively in R&D (to maintain competitiveness) that can be bought at a reasonable price (relative to Price-to-Earnings and Book-to-Market ratios) perform better than those with lower profitability, lower investment rates, and higher relative stock price ratios.
I first heard about Warren Buffet when I was a college junior. I did not learn about his partner, Charlie Munger, until I was on the cusp of leaving graduate school. A professor handed me a copy of the 1997 Berkshire Hathaway Annual Letter. It was then that I learned who Munger was. After that, I devoured everything I could read about him and his approach to building companies and investing.
Munger is often called the Architect of Berkshire Hathaway and is credited with shifting Buffet’s investing philosophy from deep value investor to a “growth-at-a-reasonable-price” investor. He is famous for quotes like, “A great business at a fair price is much better than a fair business at a great price.” His wisdom and ethics helped me synthesize years of study about investing. His focus on building “mental models” to make investment decisions underpins the investment approach at BIP Capital. Although I never met him personally, Munger showed me how to build a practical, powerful investing framework.
Charlie Munger passed away in late 2023 at the age of 99. His passing prompted me to go back and read Poor Charlie’s Almanack (an autobiography and manifesto wrapped into one) and to revisit many of his famous quotes.
If you want deeper insights into how we think about building businesses and making investments at BIP Capital, start by reading anything by Munger.
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