In the second 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.
Diversify – by company, by industry. In stocks and bonds, there is safety in numbers. No matter how careful you are, you can neither predict nor control the future. So you must diversify.
—-John Templeton
In my previous article about the investment methods of some top investors (as featured in my book Excess Returns: A Comparative Study of the Methods of the World’s Greatest Investors) we saw how Prem Watsa, the CEO of Fairfax Financial Holdings, managed to make a killing on the credit crisis of 2008-2009. Now we look at a former friend of his: the late John Templeton.
Templeton is famous for being a pioneer of global investing. While many investors prefer to stay close to home, Templeton looked for bargains all over the world. This didn’t do him any harm as his Templeton Growth Fund compounded at a rate of about 15% a year between 1954 and 1992. This is 3.6% better (after fees and expenses) than the annual return of the S&P 500 with dividends reinvested.
John Templeton
John Templeton dared to tread in foreign countries that other investors shunned because he was willing to go the extra mile. For example, most American investors ignored Japanese stocks before the 1980s because Japanese accounting was opaque and because it was hard to find information about Japanese companies. Knowing that stocks other people ignore tend to be mispriced, Templeton believed that Japanese stocks might be a hidden opportunity.
He therefore took the trouble to get familiar with Japanese accounting in the 1960s. He was rewarded lavishly when his sleuthing taught him that many small Japanese stocks were vastly undervalued. Fully in line with his contrarian disposition Templeton got out of Japan when it became hot in the 1980s. Hereby he sidestepped the market’s collapse in the 1990s.
Another excellent example of the kind of heroic efforts that John Templeton undertook (and that few other investors or analysts would even consider) to get the information right was his analysis of the Mexican telecom company Teléfonos de Mexico in the mid 1980s. Because he didn’t trust its reported financial statements he counted the number of telephone lines in Mexico. By multiplying this number by the going rate per line he discovered that the stock was seriously undervalued.
When it came to the selection of emerging countries to invest in, Templeton looked for countries with high savings rates (which reduces dependence on foreign financing), a focus on exports (because exports tend to lead to a trade surplus), with modest government borrowing (indicating disciplined spending), little regulation and government interference (which leaves room for entrepreneurs to achieve their goals), and a preference for privatisation rather than nationalisation and expropriation (because the latter stifles entrepreneurial spirit).
As far as individual companies in emerging countries were concerned he took a special liking to banks and insurance companies, because the large investment portfolios of these institutions typically offer direct exposure to the (often hard-to-trade) local stock market.
Diversification
Unlike many other top investors John Templeton preferred to have a widely diversified stock portfolio. Although he acknowledged the merits of a focused portfolio (he frequently focused on a few of his best ideas in his private stock portfolio), he believed that a focused portfolio is less suited when managing the money of others.
In the same vein, Templeton applied from time to time a unique “basket” approach when he bought bargains. In 1939, for instance, after the US stock market had plunged by almost 50%, he purchased a basket of all the industrial firms that were trading on the US stock exchange with a stock price below $1 (i.e., the most beaten-down stocks). His reasoning was that, because he believed that the USA would be dragged into World War II, even inefficient industrials would prosper as they would be pushed to support the war efforts. Likewise, when the market reopened after the 9/11 Twin Tower attacks he indiscriminately purchased low P/E airline stocks that dropped 50% on that day because he argued that the government would be forced to bail the hard hit airlines out.
The fact that Templeton’s investment approach differs in some respects from that of many other top investors illustrates that there are many ways to achieve market beating returns. In addition, the observation that the basket approach that worked in 1939 still works more than 60 years later is a testament to the fact that the investment methods of top investors are sound and stand the test of time. In the next article of the series we will go further back in time when we discuss Bernard Baruch.