1. “We don’t predict. We price. Predictions are terrible.” Value investors put predictions, especially macroeconomic predictions, in the “too hard” pile. Ben Graham and his disciples have developed a system which avoids doing things that are “too hard.” Looking at data from today, rather than a prediction about tomorrow, the value investor “prices” the asset and makes the investing decision. The key question is simple: what would a private buyer pay for the asset and does that price reflect a significant discount from that price. For many investors the value investing system has evolved from the “cigar butts era” (which became less useful as time passed after the Great Depression) to an approach which includes some elements of Phil Fisher’s philosophy (which I have discussed previously in this series on my blog).

2. “Almost by definition we are running towards that which most people are running away from because how else are you going to get a very reasonable, cheap price on a good company unless the marketplace believes something is terribly wrong.” The probability that you will encounter an asset at a significant discount to private market value is significantly higher when Mr. Market is fearful. So a value investor needs both patience (since often Mr. .Market may be instead be greedy) and courage (blood may be running in the streets when bargains appear).

3. “The business of making odds goes back a long way and is the concept of trying to ﬁgure out what you give and what you get. That’s pretty much the same as the business of investing.…you have to come up with some kind of odds. Also, if you are smart and you know what you are doing, then you build in a huge margin of safety so that the odds are in your favor.” Investors who do not understand the basics of probability and statistics are like a snake in a basketball dunking contest.

4. “The markets are made to be taken advantage of, not to be persuaded by.” To a value investor the market is not wise, but rather a potentially generous “giver of gifts.” When a value investor hears Professor Fama’s “efficient market” theories they giggle at least and often may emit a belly laugh.

5. “The only thing you can spend is cash. We want companies that generate significant cash in most times. That is how we start. We don’t care much about what they make, but we have to understand it. The balance sheet has to be strong; we want to make sure there are no tricks in the accounting. Then we try and kill the company. We think of all the ways the company can die, whether it’s stupid management or overleveraged balance sheets. If we can’t figure out a way to kill the company, and its generating good cash even in difficult times, then you have the beginning of a good investment.” Berkowitz is similar to Jeff Bezos when it comes to an intense focus on cash flow. A post about Amazon viewed through a “value investing” lens would be interesting.

6. “When times get very tough, everything is correlated. And people need to sell whatever they have. And they sell what’s most liquid. So even the baby gets, you know, baby gets thrown out with the bathwater.” A financial advisor may tell you that you are well diversified because in his or her view “covariance between your asset classes is low.” Unfortunately, as people found out during the last financial crisis, asset price correlation can quickly move toward one.

7. “That is the secret sauce: permanent capital. That is essential. I think that’s the reason Buffett gave up his partnership. You need it, because when push comes to shove, people run … That’s why we keep a lot of cash around…. Cash is the equivalent of financial Valium. It keeps you cool, calm and collected.”

8. “When something goes down in price, I know business schools tell you that if it goes down or up fast, that’s volatile. It’s riskier. But I don’t see how a security, if it goes down 50% in value, is riskier than it was when it was double that price. So it’s like grocery shopping. You know, your favorite food’s on sale, your favorite companies. You count the cash they generate. And there’s not many times when you can find good companies with a double-digit free cash flow yields, which we found. And of course, when the panic sets in, then you have some tremendous bargains.”

9. “I am not genetically engineered for shorting. If you are long and you are wrong, you go to zero. If you are short and you are wrong, you may face death. The mania of markets can last quite a long time, and when you take into account mark to market and the collateral needed, it doesn’t appeal to me.” Shorting is something lots of people talk about but few people actually do. It is potentially very dangerous. When I do short a stock, which is not very often, I buy options since all you can lose is what you paid for the option.

10. “Concentrated investing implies less risk of permanent loss as long as you maintain superior knowledge about the companies you own.” Risk comes from not knowing what you are doing.

11. “Over diversification will just lead to an average return… the price for an above-average return is short-term volatility….I want to give people above-average performance, and you have to pay for that with short-term volatility.” Berkowitz will never be confused with a closet indexer.

12. “We have outperformed over a significant period. We had a bad 2011, which confuses a lot, but that’s business. Business is a lumpy process. And for those companies and fund managers that have shown business to be a very smooth process, it hasn’t worked out real well in the end.” The decisions of a wise value investor are a trained response and are above all rational. For example, being brave when loss aversion is pushing you to sell is not easy to do.

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