by Frederik Vanhaverbeke
In the latest of a new series for SBM Frederik Vanhaverbeke, author of Excess Returns: A comparative study of the methods of the world’s greatest investors, looks at how some of the world’s greatest investors are so successful.
The biggest mistakes I’ve made over the years have nearly always been in companies with poor balance sheets.
—-Anthony Bolton
Anthony Bolton is one of the U.K.’s most accomplished investors. Between 1979 and 2007 he achieved an annual compound return of about 20% in his Fidelity Special Situations Fund, crushing the market by about 6% a year. More recently, he tried to replicate his success in Fidelity’s China’s Special Situations investment trust. Unfortunately, after a few years of disappointing returns Bolton threw in the towel.
One can only speculate about the reasons for the poor performance of the trust. Maybe Bolton stepped outside of his circle of competence, as investing in China is of course very different from investing in European or American stocks. Another possibility is that he simply hasn’t given himself enough time to build a superior track record in the trust.
Whatever the reason, it is undeniable that Bolton is an exceptional investor who is not too shy to share his invaluable investment wisdom with everyone who is willing to listen.
Many of his ideas are very similar to the ideas of numerous other top investors and are therefore thoroughly covered in my book Excess Returns: a comparative study of the methods of the world’s greatest investors. Here we discuss the main lines of his investment approach.
Not unlike many other top investors, Bolton likes to lift the ideas of people in the know. For instance, when he notices in a conversation with managers that they stand in awe of a competitor, he likes to check that competitor out. After all, managers have to know their competitors well if they want to compete successfully. So, when they are impressed with a competitor, one can rest assured that that competitor is doing something well.
Another tip-off to worthwhile investment ideas is the ownership of a stock. Seeing that some reputable investors have a stake in a business reassures Bolton that the stock may be a worthwhile investment. A third tip-off for Bolton is insider transactions. He is primarily interested in transactions by the CEO and the CFO because they tend to know much more about the business than other insiders. Also unexpected insider transactions peak his interest. These can be important purchases after a strong price increase, or massive sales after a steep drop of the stock.
Admiration by competitors, insider purchases and ownership by excellent investors are obviously only indications that a stock may be a bargain. Bolton always does his own independent due diligence on every idea. After this homework he reads reports that are written by analysts who disagree with his conclusions to check the strength of his thesis.
Bolton
Similar to many other top investors, highly leveraged businesses put Bolton off.
He therefore always checks out the balance sheet, and routinely checks the H-score (a measure of a company’s financial and business risk) of potential buys. Bolton also doesn’t invest in businesses when he doesn’t have confidence in management. He stresses the importance of integrity.
According to him managers must speak open-heartedly about problems and about the negatives. They must deliver on their promises and preferably even beat their own targets (e.g., as evidenced by earnings upgrades). He also wants to establish that management’s objectives are aligned with those of shareholders through “skin in the game” in terms of shareholdings (not options). Furthermore, Bolton wants management to know their business inside out. He expects them to have a clear strategic view, to be workaholics, and to be fanatical about their business. As an additional check, Bolton also carefully evaluates the board of directors, to see if it is sufficiently experienced and forceful. Another factor that Bolton pays special attention to is management’s pay, which should be fair and closely linked to the performance of the business.
As all top investors, Bolton believes that it is impossible to time the market.
Notwithstanding, he uses some indicators to assess the market outlook. The economy is not part of his toolkit as he points out that markets always anticipate economic changes. He looks instead at investor sentiment and behavior, advisor recommendations, the put/call ratio, cash positions in funds, and the exposure of hedge funds.
These are all contrarian indicators that Bolton bets against when they reach extreme levels. To get a complete picture he combines these indicators with the fundamental market valuation (e.g., price-to-book or price to free cash flow) in a historical context (i.e., over several decades). Also the length of a market cycle and its price change (drop or rise) versus historical averages is an important factor Bolton likes to incorporate in his analysis. Based on this methodology he correctly called the market bottom in March 2009. At that moment his observation was that most investors expected the stock market to double dip. This very bearish sentiment implied that there were only few people left to sell. Hence, everything was in place for a sustained rebound.
Finally, Bolton rarely buys or sells a position in one go.
He rather buys and sells gradually, especially when there is high uncertainty about a company, or when he doesn’t have strong convictions about an idea. He also decries the obsession with “catalysts” in the investment world. Many professional investors hold off buying stocks with excellent long-term potential because they can’t see a catalyst that will push the price higher in the short term. Bolton states that apparent catalysts (which many analysts are looking for) are priced into the stock price, leaving no opportunity for the investor.
As shown in my book there is a striking similarity between the investment wisdom of UK-based Anthony Bolton and that of many American top investors. This illustrates that the basic investment principles and sound investment practices are valid irrespective of geography.
In our next article we look into the wisdom of another investment legend and friend of Anthony Bolton: Peter Lynch.