格雷厄姆与多兹维尔访谈（第33期）

a packaged food industry   Tom was a senior manager   want to understand how things
analyst and was named   in the tax department of   work from the ground up.
Chief U.S. Investment   KPMG Peat Marwick,   While the world was and still
Strategist in 1999.   where he worked   is replete with rules of thumb

   Equation: Untangling Skill   Tom is a member of the   projects, I remember thinking:
   and Luck in Business,   CFA Institute and the   what do the great investors
   Sports, and Investing and is   American Institute of   do? I built files on Warren
   also co-author, with Alfred   Certified Public   Buffett and Ben Graham and
 Michael   Rappaport, of Expectations   Accountants, and he is on   other great investors, just to
Mauboussin   Investing: Reading Stock   the board of CFA Society   study how these folks operate.
   Prices for Better Returns.   Chicago. He is currently   There were some common

finance at Columbia   Tom was an adjunct   not accounting numbers. They
Business School since 1993   professor in the Marquette   seemed to really value good
and is on the faculty of the   University Graduate   businesses. Those are the sorts
Heilbrunn Center for   School of Business from   of things that stood out to me.

   Tom Digenan is the head   your background?   book, Creating Shareholder
   Tom   of the US Intrinsic Value   Value. It was awesome. There
Digenan, CFA   Equity team at UBS Asset   Michael Mauboussin (MM):   were three things in that book
   Management. In this role,   I was a liberal arts major in   that have remained the
   he is responsible for U.S.   college so I never studied   bedrock of everything I do, and
   equities portfolio   business. It’s an interesting   are things Tom and I have
   construction and research.   question whether that’s an   talked a lot about over the
   Prior to this role, Tom had   asset or a liability. I came to   years. The first was: value is
   been a Strategist with the   the business world knowing   not about accounting numbers,
   team since 2001, where he   close to nothing. My father   it’s about cash. This is a lesson
   participated in the analysis   made me take principles of   that we relearn from time to
   and development of U.S.   accounting when I was a senior   time. The great analysts always
   equities portfolios,   in college and I got a C+ in the   focus on cash.

Prior to his role with the   which is now defunct but was   business school we teach
U.S. Intrinsic Value Equity   an amazing place to learn   strategy and finance separately.
team, Tom was president   about the business. I was in the   The strategy professors will
of the firm’s mutual funds   training program and was   say, “well, you want your
and relationship funds   confused for a very long time. I   strategy to create value” but
organization.   guess I still am confused to   they don’t really explain the

fields. You can’t do an   tepid. But he figures, nobody   Tom Digenan (TD): I didn’t
intelligent valuation without   cares, let’s just publish the   go out into the world knowing
understanding strategy. And   piece anyway. The content was   I was going to be an investor. I
the litmus test for a strategy is   all Rappaport. It was all cash   worked at the Chicago
whether it creates value. Even   flow, why buybacks made   Mercantile Exchange in college
though the book was written   sense in the context of what   as a runner. That’s not
for corporate executives, the   they were doing, and so forth.   investing. The one investment

the market thinks, your stock   out and talk to our senior   I’d be driving in to work and
is actually going to   executive team about how you   somebody calls in these stock
underperform. Again,   think about valuation?” I’m a   shows on the radio and they
executives were the audience   pretty young guy at the time,   ask, “should I sell XYZ?” And
but the implication for   and so it was a very exciting   the host asks, “well what did
investors was also clear.   imprimatur.   you buy it at?” And I’m almost
   going off the road saying, “it
In the early 1990s, I was   After that, I became a senior   doesn’t matter what you
working for a senior analyst   analyst at First Boston   bought it at!”

One day, he said, “You work   companies. I had other jobs   I was an accounting major in
for me from 9 to 5, but if you   there, which is now Credit   college because I wanted that
want do more on the   Suisse, and is was around the   stability and I liked having an
weekends, you can write about   time I joined First Boston that I   answer. And I’ve got to tell
whatever company you want.   started teaching at Columbia   you, this is a business where
But my name will be on the   Business School.   you don’t get an answer. In

wrote about was Ralston   From there I went to Legg   In the early 90s, I had an
Purina. The CEO of Ralston at   Mason Capital Management for   opportunity to join Brinson
the time was Bill Stiritz. You   nine years, implementing a lot   Partners and work with Gary
may have read the book The   of these same ideas on the buy   Brinson and Jeff Diermeier.
Outsiders by Will Thorndike,   -side. Then I went back to   They were my two most
which is awesome. There’s a   Credit Suisse for a short stint,   significant mentors from an
whole section on Bill Stiritz.   and now I’m back on the buy-   investment perspective. They
He was considered the   side. So I’ve been back and   followed a pure discounted
smartest guy in the food   forth between sell-side and buy   cash flow approach. If you stick
industry, kind of like the   -side, but really thinking about   to it, it helps you avoid
Warren Buffett of the industry.   the investment process the   bubbles, but you must have

faith in it, and your faith will   heuristics like P/E or   they didn’t do – but also
get tested. For you young guys   Enterprise Value to EBITDA,   added, “we're going to grow
going into the business, I   you don’t blow yourself up   50% a year for ten years with
would say you will be wrong a   because the markets are   an eventual net margin of 10%
lot — even when you follow   smarter than you are, so your   and a P/E multiple of 20x.” If
your process — but be ready   heuristics don’t really make   you work out the math, it gets
to be right and have the world   that big a difference.   to $700 billion. By the way, if

wrong. In the end, you’re only   You mentioned the “Base Rate   me, I would do what you guys
wrong if you don’t stick to   Book.” If you asked me what I   would do. I would open an
your process.   wish I knew when I was a 22-   Excel spreadsheet, then figure
   out how big the auto market

ended up spending a lot of   year-old analyst starting out, I   about Amazon. An analyst
time just talking about how to   would say without hesitation,   projected them growing 15% a
do valuation. It was a natural   it’s on the idea of base rates.   year off a $100 billion revenue
evolution because that’s what   Danny Kahneman, the   base. Has that ever been done
people were asking about.   renowned psychologist, calls   before? No. Might Amazon be

If I were to break down my   view. The idea is to integrate   base case? It would seem
approach, the first really   historical corporate   optimistic for that to be your
important thing to think about   performance into my bottoms-   base case. You might assign it
is why stocks are mispriced.   up model.   some modest probability, but

know?” That’s a nontrivial   path for Tesla to get to a $700   The outside view is incredibly
problem. The second   billion market capitalization.   powerful, and gives you a
component is valuation and   That was Apple’s market cap   practical way to integrate
how to do it properly.   at the time, so it was a very   concepts such as regression

especially if you’re a value   addition, there is a value trap   These are the people you
investor, and the “Base Rate   element in play where you can   trade with. It’s ridiculous.
Book” tells you how to   justify maintaining the position   People get set in their ways. I
operationalize it. It’s not just   by saying, “but it’s really cheap   don’t think most organizations
that you understand there’s   now.”   have an actual process that

toward the mean, you now   It was the appropriate sale for   improvement and it’s
know how to do it   the portfolio I manage and   something that you’ve got to
quantitatively, which is really   based on other opportunities   be adamant about because it’s
helpful.   available to me at the time.   not comfortable. I have one

G&D: Speaking of base rates,   Global Equity portfolio,   “but that would be overriding
Tom, do you and your team   managed by one of my   analyst judgment.” I said,
utilize these types of   colleagues. That team, after   “that’s exactly right.” There
frameworks?   analyzing the situation, felt   are times when you must

a return of food inflation in the   analyst. I don’t know more   the buy-side, there were these
U.S. which will improve   than the analysts do about   unfortunate incidents where
margins in the grocery   these companies. I have faith in   we’d have a stock go down
business, and two, Amazon will   our process. I realize that if   more than 10% versus the
have less than 1% market share   you don’t formalize the   market. As an analyst, you’re
in groceries.   process, you won’t follow it,   disappointed, you’re frustrated,

earnings and lowered guidance   managers stray from their   MM: You’re defensive. No
because they weren’t seeing   process more often than they   one’s happy. We created this
any signs of food inflation.   don’t. I'll use a baseball analogy   analysis going back to 1990,
Then literally the following day,   Moneyball by Michael Lewis   just looking at thousands of
Amazon announced the Whole   came out in 2003. In 2005, if   instances of stocks going down
Foods acquisition. We had an   you asked general managers in   10% versus the S&P. Then we
analyst who is incredibly smart,   Major League Baseball if they   introduced factors including
very well-educated. The   had read Moneyball, over half   momentum, valuation, and
natural analyst bias is to   of them hadn’t read it. Can   quality. As you introduce the
maintain the position.   you imagine that? You’re one   factors, you increase your
Cognitive dissonance impairs   of 30 competitors in the   specificity but you reduce your
our ability to immediately   world, and one of them is   sample size. We then asked,
incorporate evidence refuting   telling you exactly how he   “how did the stocks do in
your current hypothesis. In   does things.   subsequent periods?”

That analysis does two things.   valuation, or knowing how to   hardest part of the business. If
First, it gives you a naïve   do the strategy analysis is   you can be right 55% of the
default. If you know nothing   almost the ante to the game. If   time, you’ll be good. If you can
about the situation and the   you can’t do that, you’re not   admit when you’re wrong,
stock has bad momentum,   even in the game. Everyone has   then you will be great.

quality, it will say: buy, sell, or   distinguish the great investors   MM: There's a famous quote
hold. Now you have the   from the average investors, it’s   from John Maynard Keynes,
default. It’s not an answer. It’s   not because their cost of   “worldly wisdom teaches that
a part of a distribution, but at   capital calculation is more   it is better for reputation to
least something to hold onto.   accurate. It almost always has   fail conventionally than to
Second, I think because you   to do with the fact that they’re   succeed unconventionally.” If
have that naïve default in your   able to make good decisions   I’m short retail, and everybody
back pocket, you can have a   and be correctly contrarian in   else is short retail and it goes
calmer conversation. You have   adversity.   up, yeah, it’s too bad, but

We wrote two pieces. The   contrarian streak and a   investors I’ve been around,
first was “Managing the Man   calculator.” The contrarian   somehow they don’t care
Overboard Moment,” and the   streak means if everyone   much about what other people
other was “Celebrating the   thinks one thing, I’m going to   think. It’s actually a
Summit,” which dealt with   at least examine the other   phenomenally good trait as an
situations in which stocks had   side. But the consensus is   investor and a phenomenally
outperformed. I don’t know if   often right. Being a contrarian   not good trait as a human
this is true, but apparently   for the sake of being a   being.

because people are more   willing to take the other side   TD: My flagship strategy is a
excited at the top of the   when expectations are   core U.S. equity fund. It has
mountain. They’re high-fiving,   mispriced. There’s another   about 70 names. There are
taking pictures, and they let   interesting question, which is,   periods when we have pretty
their guard down. I don’t want   how much of this is just your   high tracking error, and
to stretch the analogy too far,   natural personality? How many   periods when it’s not as high. I
but in investing too, we were   value investors are born that   tend not to be sensitive to
trying to say, “let’s address   way, and how many can be   sector allocations. I think
process at emotional   trained? I think a lot of this is   there’s some opportunities out
extremes, when you’ve made a   based on people’s natural   there right now. We find both
lot of money or you’ve lost a   proclivities, and we can add on   semiconductors and financials
lot of money.”   some tools to help people get   really attractive, which is great

strategies, which I think is a   compare price to pure value.   efficient. When the standard
secular shift and not a trend.   Then we get a ranking of   deviation of the alphas widens,
There is also growing   stocks. I can print out a   and I can tell you that when
sensitivity to sustainability, like   histogram. I can rank it by   the distribution goes from
Environmental, Social, and   analyst, by sector, and by   narrow to wide, we will
Governance, or ESG. What   country. The other thing that’s   underperform in that area,

  Greg Doger de Speville   incorporate some ESG metrics   the expensive stocks are
  ’19, Neethling McGrath   into our valuation   “I think one of the   getting more expensive and
’19, and Arthur Brousseau   methodology. If you’re a pure   the cheaper stocks are getting
   ’19 deliver their HVN   investor trying to figure out   biggest mistakes you   cheaper. We’ll underperform
   pitch   the cash flows that are going   see in the investment   when this widening occurs

Diermeier, and Bob Moore   The nice thing is, if you come   you’ll purchase in your life that
built this thing in 1980. Back   in and say, “IBM looks cheap,” I   you don’t get excited about
then we called it EVS, Equity   can see if it looks look cheap   when it goes on sale.” If you
Valuation System. They threw   relative to our history. How   wanted some new Nike shoes,
a ‘G’ on there at some point,   have we modeled this   and you see they’re on sale,
for Global. I’m surprised Gary   historically? Have we tended   you get all excited. When the
did, because when I started   to be right on IBM? No, we’ve   stock goes on sale, you say,
with the firm, our 401(k) had   been wrong. Since I have all of   “uh, I’m not sure.”

The valuation system for us is   underperform. We measure   kind of “true North” that will
basically a means of   the standard deviation of the   tell them when the
incorporating all of the   alphas, because the alpha from   opportunity set is wide and
analyst’s ideas and insights into   our valuation system is   when the world is expensive
something where I can use the   expected excess return, and if   or cheap. At the moment, it’s
calculated part for my   the alphas are really tight, that   not that exciting. The spread’s
contrarian analysis and   means the market's pretty   about average, which is okay.

range from quantitative and   MM: He’s getting people to   two out of three votes. So, if I
systematic strategies to   wash their hands. Now, by the   vote yes and the other two
fundamental analysis, credit,   way, I wouldn’t want to be too   vote no, it’s not going in the
and parts of discretionary   critical, because if I’m a   portfolio, even though I’m the
equity. It runs the gamut. The   physician, and I’m trying to   head of our team.

equity analyst, is it helpful to   When I think about investing,   being smarter than the next
talk to a credit analyst, or even   it’s really trying to bring both   guy, we’re not going to win.
someone who trades volatility?   of those things to bear. Are   Once you have a well-
My job as Director of   there tools that we can   developed process, it’s easier
Research is basically to work   provide people with to make   when you bring people in. And
on all aspects of the   them even more effective at   it’s easier with the current
investment process.   what they do?   team, if they understand and

G&D: What are the biggest   The second part is we make   in that you need to be
challenges you face as a   sure people are very   consistent. If you start
Director of Research,   methodical in their decision-   deviating, then there are no
overseeing that many different   making. Every time we make a   rules. In the investment
types of strategies and so many   decision, are we thinking about   process it’s important that you
different types of people?   things properly and considering   have tight guidelines and rules.

MM: There’s a great essay that   Why do investment   MM: I want to say a couple
I learned about from Atul   committees exist? Why are   more things about investment
Gawande, who wrote The   there committees at all? Why   process. One is to have a
Checklist Manifesto. It was an   do people work in teams? The   clearly stated thesis and some
essay written back in the 1970s   answer is that a team, if done   sort of identifiable edge when
by, of all things, two   properly, surfaces and   entering into a position. The
philosophers about medicine.   considers more alternatives   phrase I really like is “linchpin
The question was, “why do   than you might consider by   issues.” What are the key
doctors fail?” They said it   yourself. It offsets some of the   things that this story’s going to
basically comes down to two   biases that we all bring to the   pivot on? Usually as an analyst,

mentioned with Kroger the   run by individual PMs, and a   The second component is
food inflation and Amazon   very small minority was run by   team composition. The ideal
participation, but it could be   teams, but now it’s the   here is to have what social
whatever is relevant in that   opposite. Something like three-   scientists call cognitive
particular case.   quarters of all mutual funds in   diversity, people with different

part of it is overconfidence.   For teams to be successful,   you’re the head guy and you
Another huge component is   there are sort of three key   sort of indicate that you like it
confirmation bias. Even if you   elements to get right. The first   or don’t like it, people will
struggle to invest in something   is the size of the team. Tom   tend to fall in line for social
you’ve done a lot of work on,   mentioned this, but the   reasons, whereas if you truly
once you’ve made the decision   empirical research shows that   are managing the process
and it’s in the portfolio, your   the ideal team size, the team   correctly, you’re soliciting
reputation is on the line. You   size that creates the most   views openly, getting them on
will tend to seek information   excess return relative to an   the table, and properly vetting
that confirms your view.   individual management   them. You’re even conducting
You’re going to dismiss   portfolio, is three. The second   your voting with secret ballots.
information that disconfirms   best is five.   By the way, when I talk to

MM: We’ve also done a lot of   interesting. People talk about   the importance of admitting
work on teams in general, and   decision making like it’s all   when you’re wrong, and
I have some thoughts on that.   about consensus. This is not an   Michael you mentioned sign-
The first thing I’ll say is that   industry where there’s going   posts. How do you marry the

underperformed its sector by   it’s obvious that most people   TD: Think about it as though
25% since the date we initiated   are not used to thinking about   you’re fishing on a big lake, and
our last review, we do what   things like Brier scores.   you’re going to go in one
we call a “stop look.” The   They’re much more   segment of the lake. Well,
analyst comes back in to pitch   comfortable with vague   sometimes the fish aren’t
the stock.   language.   there. Sometimes they’re at
   the other side of the lake. If
The third scenario we look at   TD: My guess is they don’t like   you’re a quality guy, you’re
is if a stock that we’ve held for   it.   basically limiting yourself to

its sector. We identified that   MM: Yeah, well, the key is to   Maybe you’re a good stock
holding onto old losers was   not frame it as a scoreboard   picker, but your opportunities
hurting our performance.   or as a way to embarrass   have been minimized just by
When you think about it, if our   people. It can be personalized;   putting yourself in that box.

years, maybe we were just   and it’s here to make you   MM: To me, I would translate
wrong in the first place. We   better. We know that   value investing into an
owned Teva a couple years   everywhere that Brier scores   expectations model, so that
back and our linchpin was that   have been kept and the   what you’re trying to do is buy
they’re not going to lose the   feedback’s been shared on a   low expectations and sell high
Copaxone patent. Well, they   timely basis, people get better   expectations. Everything else
didn’t, and it was still a   at making probabilistic   follows from that. Value
horrible stock. This was in our   forecasts.   investing to me is just buying

one where I went to the   Another thing we’ve been   French model, value is
analysts and said, “You know   doing a lot of work on lately is   statistically cheap stuff, which
what, unless this is the most   portfolio construction. It’s a   is a proxy for low
compelling idea we have, we’re   thing that seems to be   expectations, but sometimes
getting this out of the   remarkably underdiscussed.   it’s just bad stuff. That said you
portfolio.”   When you read books about   might ask, “what does quality

MM: It goes back to Brinson,   given the edge you have. We   associated with low leverage
just the discipline of the   spend a ton of time thinking   because you can finance your
Brinson approach. That’s   about this. Many people spend   growth internally and
something I’ve always admired   almost no time thinking about   reasonably readily.

quality might imply   TD: People like to say, “it’s   any difference. I think bitcoin is
management that’s really   different this time,” but that’s   a big limit to arbitrage. I think
judicious with capital   the one thing that can never be   tons of people would love to
allocation. So this all becomes   different. “It’s different this   go short, but it’s just not really
part of the analysis of   time” implies finding a new   viable to go short.

investment business is people   G&D: Is the future of investing   to play a big role. These are
fail to distinguish between   going to consist solely of   interesting questions, even for
what’s priced in and what’s   algorithms and artificial   you guys who are thinking
going to happen fundamentally.   intelligence or will humans   about going into the

always separate those in their   Can that ultimately get   proposition in economics
head. Just because things are   arbitraged out by a machine? I   which has more solid empirical
going well doesn’t mean the   think that’s an open question.   evidence supporting it than the
stock is good. Just because   Bitcoin is evidence that’s not   Efficient Market Hypothesis.”
things are going badly doesn’t   the case. An idea that’s   The argument in Grossman-
mean the stock is not   important in the finance   Stiglitz is pretty

“markets have to be efficiently   MM: The 2008 financial crisis,   ETF, you’re selling stuff in
inefficient.” Enough inefficiency   which started in housing   proportion without regard for
to get you to do it, but not so   before spilling over into other   value, so everything goes up or
much inefficiency that you   sectors, was more leverage   everything goes down. It
avoid markets altogether.   related. Today, the concern   reintroduces the question:

So, if the amount of available   and regulators are taking care   change? It’s very important to
alpha has been coming down,   of that, for the most part. I   understand that the
the amount you should be   think the concern is more   ecosystems are very different
wanting to pay to capture the   liquidity.   today. It will be a different

cartoon version of what we’ve   ETF with a bad liquidity profile   TD: The growth of passive has
actually seen: people flipping   — high yield is probably the   been very tough on active
from active to passive in order   best example. You trade your   management. It has really
to reduce their fees. If you   high yield ETF all day, but the   changed the business. The
look at the standard deviation   underlying liquidity is not as   investment opportunity would
of excess returns from mutual   good as you’d expect. Today,   be if Michael and I were the
funds on an alpha basis, you   the authorized participants are   only two investors in the
see that alpha used to have a   okay, but if there was a wave   world and we’re both trying to
big, fat distribution. There was   of sellers, there isn’t the   make money. I’m trying to beat
lots of positive alpha and lots   underlying liquidity, so they   the market and he’s trying to
of negative alpha. Smart guys   might have some problems.   beat the market. Then, one

That partly relates to the lack   on the bank, and then what   other and say, “Finally!” It’s
of volatility in the market. It’s   will happen is, all the   like you’re playing poker. You
very difficult to distinguish   newspapers will write, “ETFs   want something you can make
yourself when realized   are bad.” Mom and pop will   money at, right? You don’t
volatility is around 6-7%. Is this   see that, and they won’t   want to sit down with world-
volatility decline secular or   distinguish between high yield   class poker players.

answer. Having been around   the thing just cascades. You   MM: I think the weak players
for a long time, I don't know   might initially say, “I own   at the poker table used to play
what the mechanism is to   SPDRs,” or “I own the   and lose. Now, they’re
make volatility go up, but I’d be   financials ETF. I’m cool.” The   indexed. They show up at your
willing to bet that the current   problem is, if it cascades,   house Friday night and they
low volatility environment is   you’re not going to be cool.   drink your beer, but they don’t
not going to stay here forever.   That to me would be the way   play poker. I think it’s actually
We’ll see a reintroduction of   the disaster scenario might   gotten harder to generate
volatility at some point. That’s   propagate. I’m not predicting   alpha, even though intuitively
going to freak out a lot of   it, but I’m saying that’s not an   you might think fewer
people, I think, when that   implausible scenario to   participants should make the
occurs.   consider. I think very few   game easier.
   people are really totally