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Lou Simpson, like his friend Warren Buffett, developed his investment approach through trial and error, evolving over decades. Certainly, earlier in his career, long before being hired by GEICO, he was a “growth investor” often failing to properly consider whether that growth was being offered at a reasonable price. He was aiming for a spectacular return from a few star performers, hoping that he had guessed the future correctly.
But, through bitter experience he learned that good long-run results come from buying companies with established and proven high performance (rather than promises of future riches but lacking solid evidence in the past) with low risk and on a low price.
Read all day if you can
Simpson has a voracious appetite for financial newspapers, other intelligent press, annual reports, industry reports, and generally reads five to eight hours a day. He, like Buffett, is not trading-intensive but reading-intensive and thought-intensive
Think independently
Be sceptical of conventional wisdom. Obtain your own information and do your own analysis. Do not get caught up in waves of irrational behaviour and emotion. Be willing to consider unpopular and unloved companies as they often offer the greatest opportunities.
Invest in high return businesses run for shareholders
Look at the rate of return on shareholders’ money used within the business. If it is high and, in your judgement, sustainable given the strategic position of the company and the quality of management, then there is a good chance of long-run appreciation in the share price. Cash flow return, rather than profit return, can be a useful additional metric given that it is more difficult to manipulate than profit.
Make few investments.
At a Kellogg School of Management Q&A session in November 2017 he said “The more you trade, the harder it is to add value because you’re absorbing a lot of transaction costs, not to mention taxes.” (After retiring from GEICO he has maintained an interest in investing through his chairmanship of SQ Advisors and as an adjunct professor of finance at Kellogg).
Making only a few investments means you can devote the requisite amount of time to understand the companies very well, which leads onto “What we do is run a long-time-horizon portfolio comprised of ten to fifteen stocks…….Basically, they’re good businesses. They have a high return on capital, consistently good returns, and they’re run by leaders who want to create long-term value for shareholders while also treating their stakeholders right”. (Kellogg Q&A, 2017)
Good investment ideas – companies meeting his investment criteria – are hard to find. Thus when he finds one he makes a large commitment.
“You can only know so many companies. If you’re managing 50 or 100 positions, the chances that you can add value are much, much lower. So far, this year we bought one new position, and we’re looking pretty seriously at one more. I don’t know what we’ll decide to do. Our turnover [proportion of the portfolio changed in a year] is 15, 20 percent. Usually we add one or two things and get rid of one or two things.” (Kellogg Q&A, 2017)
Sometimes the best plan is to do nothing. Simpson admits that masterly inactivity is difficult to do because it “is very boring”, but it is often the right thing to do.
Scuttlebutt
Get to know the management teams in the investee companies. Also, seek out the views of customers, suppliers and competitors on the compa…………
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