Thursday, January 9, 2014

Henry Singleton: Why Flexibility Beats Long-Range Planning

James Grant recently reviewed a new book by Walter Friedman about the first economic forecasters in America.

Book Review: 'Fortune Tellers'

It's mostly about the folly of attempting to predict future financial and economic outcomes. From the review:

"The financial and economic future has been, is now and forever will be a mystery. Yet the power and dominion of the forecasting profession only seem to grow..."

Grant points to how Henry Singleton viewed forecasting:

"Henry Singleton (1916-99), longtime chief executive officer of the technology conglomerate Teledyne Inc., is not one of Mr. Friedman's subjects, but the corporate visionary understood the limits of forecasting. Once a Business Week reporter asked him if he had a long-range plan. No, Singleton replied, 'we're subject to a tremendous number of outside influences and the vast majority of them cannot be predicted. So my idea is to stay flexible.' His plan was to bring an open mind to work every morning."

This is, of course, just one man's view of the world, but considering his long-term track record I think his view deserves above average consideration. Investing with the long-term primarily in mind does not mean trying to figure out what's going to happen many years down the road. That's effectively impossible to do and mostly a waste of energy.
(Even if, as Grant points out, this reality hasn't exactly discouraged those in prediction business and their followers.)

Investing long-term means being positioned for just about whatever the world throws at you and accepting that the world will always be unpredictable.

Think of the position of strength that Berkshire Hathaway was in during the financial crisis. It wasn't necessarily due to brilliant foresight regarding the crisis; it was mostly due to the company's inherent flexibility that allowed for decisive action when others could not act in such a way.

This Bloomberg article quickly summarizes Singleton's approach to investing. It also mentions the incredible 23 percent annual returns he produced over two decades.

According to John Train's book The Money Masters, Warren Buffett once said the following about Singleton:

"Henry Singleton of Teledyne has the best operating and capital deployment record in American business."

Here's another good excerpt from Train's book:

"According to Buffett, if one took the top 100 business school graduates and made a composite of their triumphs, their record would not be as good as that of Singleton, who incidentally was trained as a scientist, not an MBA. The failure of business schools to study men like Singleton is a crime, he says. Instead, they insist on holding up as models executives cut from a McKinsey & Company cookie cutter."

Singleton's results are nothing short of impressive, but it's not just the returns that are admirable. It's the way that he accomplished those returns that, to me, makes him so worthwhile to study further.

Some might think investing well requires some unique ability to see the future. In fact, it's recognizing that you mostly can't. It's understanding that some who make predictions for a living are better at selling the brilliance of their unique crystal ball than providing useful prognostications.

From this interview with Charlie Munger:

"Warren and I have not made our way in life by making successful macroeconomic predictions and betting on our conclusions.

Our system is to swim as competently as we can and sometimes the tide will be with us and sometimes it will be against us. But by and large we don't much bother with trying to predict the tides because we plan to play the game for a long time.

I recommend to all of you exactly the same attitude.

It's kind of a snare and a delusion to outguess macroeconomic cycles...very few people do it successfully and some of them do it by accident. When the game is that tough, why not adopt the other system of swimming as competently as you can and figuring that over a long life you'll have your share of good tides and bad tides?"

So consistently correct and useful predictions may not be impossible, but they sure seem to be an exception to the rule.

Well, an investment strategy based upon the exception seems like no strategy at all.

The good news for the long-term investor is that an unusual talent for making predictions is not a required skill. Investing certainly isn't an easy thing to do well. If it was more market participants would outperform the market as a whole. A sound investment process is made of many things (the right skills, experience, knowledge, and temperament etc.) and, at times, requires difficult judgment calls. The nice thing about investing is that the investor can always choose to take a pass if it's too close a call.

Buffett once explained it this way:

"I call investing the greatest business in the world...because you never have to swing."

Patiently wait for a "pitch" you like and have enough justifiable confidence to act decisively. The reason to buy should be obvious and provide a large margin of safety.

That's the idea. Sound easy enough but, well, it's not. One tricky aspect of all this can be that much of what matters in investing is hard to quantify. Investing requires, instead, lots of sound qualitative judgments combined with a good understanding of the numbers.

Here's how Charlie Munger explained it at the 2002 Wesco shareholder meeting:

"Organized common (or uncommon) sense -- very basic knowledge -- is an enormously powerful tool. There are huge dangers with computers. People calculate too much and think too little."

More recently, at last year's Berkshire annual meeting, here's an exchange between Warren Buffett and Charlie Munger that was captured on Wall Street Journal's live blog:

Munger: "We don't know how to buy stocks by metrics ... We know that Burlington Northern will have a competitive advantage in years ... we don't know what the heck Apple will have. ... You really have to understand the company and its competitive positions. ... That's not disclosed by the math.

Buffett: "I don't know how I would manage money if I had to do it just on the numbers."

Munger, interupting, "You'd do it badly."

Munger also said the following back in 2003:

"...practically (1) everybody overweighs the stuff that can be numbered, because it yields to the statistical techniques they're taught in academia, and (2) doesn't mix in the hard-to-measure stuff that may be more important. That is a mistake I've tried all my life to avoid, and I have no regrets for having done that."

Beyond that critical mistake, recognizing that the future is always uncertain -- even when it seems otherwise -- isn't a bad place to start for investors. In other words, just because the world happens to seem more certain from time to time doesn't mean that it actually is.

"The world's always uncertain. The world was uncertain on December 6th, 1941, we just didn't know it. The world was uncertain on October 18th, 1987, you know, we just didn't know it. The world was uncertain on September 10th, 2001, we just didn't know it. The worldthere's always uncertainty. Now the question is, what do you do with your money? And if you—the one thing is if you leave it in your pocket, it'll become worth less—not worthless—worth less over time. That's certain—that's almost certain. You can put it in bonds and then you can get a certain 2 percent for 10 years and that's almost certain to be less than the decline in the purchasing power." - Warren Buffett on CNBC

Much goes into the generation of attractive long-term investment outcomes. There'll never be an easy recipe for investing effectively because, well, so much of it necessarily comes down to the experience, abilities, and limits of each individual investor.

Successfully allocating capital is never going to be an easy job, but it's not quite so difficult to create a what NOT to do list of the things that tend to hurt investment performance.

So here goes my what NOT to do list:

- Buy what is not well understood.

- Always seek confirming information.

- Never carefully examine misjudgments.

- Be overconfident in (and overestimate) your own investment talents and insights.

- Focus on the easy to quantify in lieu of the more important but sometimes tough to measure stuff.

- Ignore the many psychological factors (i.e. things like emotional and cognitive biases, fallacies, and illusions) that lead to misjudgments (even when the investment process is otherwise sound).

- Invest without an appropriate margin of safety considering the specific risks and opportunities.*

- Do not sell assets -- even very good ones -- when they get plainly expensive.**

- Do not carefully weigh opportunity costs.

- Focus on near-term price action.***

Among other things.

Though hardly exhaustive, the above list seems as sound a way as any to begin absolutely minimizing potential long run investment results.

Wise investors will, more or less, basically do something close to the opposite.

That, in itself, won't necessarily lead to great investment results, but at least is likely a step in the right direction.

Adam

Long positions in Berkshire Hathaway (BRKb) and Apple (AAPL) established at much lower than recent market prices

Related prior posts:
Buffett: Forecasters & Fortune Tellers
Not Picking Stocks By The Numbers
Buffett on Teledyne's Henry Singleton

* Margin of safety is necessary because the future is always uncertain and mistakes inevitably get made. Yet the overconfident investor might feel sure that the investment they've made will eventually justify what initially seems a rich valuation. Sometimes they do, of course, but I always find it amusing when I read or someone says that a particular investment will eventually grow into its valuation. Investing isn't about growing into a particular valuation; it's about -- or should be about -- whether the forward returns are attractive considering the specific risks and compared to other well understood investment alternatives. Partial ownership of even the best business can become a dumb investment if the share price paid isn't right.
** This would seem obvious but some market participants are willing to own an expensive stock for technical reasons (e.g. momentum). Others will get caught up in a compelling -- possibly even legitimately so -- story despite the fact that so much has to go right to even justify the current price (never mind produce an attractive return going forward). On the other hand, this doesn't mean shares of a very high quality business should be sold just because it has become fully valued. That's a recipe for unnecessary mistakes and frictional costs. Buying and selling isn't just a opportunity to improve results, it's a chance to make a mistake. Making fewer well thought out decisive moves generally beats lots of unwarranted activity. Invest with "forever" or, at least, decades in mind whenever possible. The best businesses increase intrinsic value at an attractive rate and over a very long time horizon. 
*** Near-term is not measured in days weeks, or even months. Here's how Peter Lynch looks at it: "Absent a lot of surprises, stocks are relatively predictable over twenty years. As to whether they're going to be higher or lower in two to three years, you might as well flip a coin to decide."
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