Investment Style

'The Wonderful World of Value Investing'

Hogan Brother's investment approach is based upon an indepth study of the famous US investor, Warren Buffett and the classic Value Investment philosophies of the man who trained him Ben Graham, author of 'The Intelligent Investor' (1973) and co-author with David Dodd of 'Security Analysis' (1934). Accordingly, we are Value Investors. Please note though, that we are not AFS licensed advisors and do not give financial advice. So don't contact us asking for a share tip!

According to Barrie Dunstan, the author of an article headed 'Value Comes Back', published in The Australian Financial Review on Thursday 25th May 2000; "Value Investors follow the approach of looking for stocks with low share prices relative to earnings, net asset backing and with a high dividend yield." Barrie went on to describe this as the 'classic' approach which he differentiated from the more modern style of using, "a composite of classic value plus net present value."

We were impressed by Barrie's astute differentiation as few people make that distinction. Having done so though, it appears that we are more orientated towards the classic style as we don't rely on conventional NPV analysis. We do however apply a very basic but somewhat unconventional form of Discounted Cash Flow, which is based on Ben Graham's theory of Continuity and tied to the long term bond rate. How we came to be that way though is quite interesting!

We have always been 'value investors', because although we were originally focused on property, we inevitably set out to acquire assets for well below their intrinsic value. We used to call it 'Counter-Cyclical Investing' as we found that most assets could only be bought for very good value during depressed times in the economic cycle. For an example, please refer to the attached extract from a newspaper article in October 1991 which highlighted our activities (click here).

There are many similarities between what we did then and what Barrie described, but instead of focusing on 'P/E Ratios' we examined 'Projected Yields' and instead of looking at 'Net Assets' we used to calculate the 'Replacement Cost' of the property.

Accordingly, when I read an article in the October 1993 edition of Forbes Magazine about Warren Buffett, the world's greatest investor, I decided to seek his advice. After due deliberation I wrote requesting an audience with the great man and a list of his recommended reading. Although he couldn't grant my first request, in January 1994 I received a letter from his Personal Assistant, Ms Bosaneck along with a list of Mr Buffett's recommended reading.

What immediately struck me though, was the age of the books and the editions he prescribed. Most importantly, his stipulation of the 1934 or 1940 editions of 'Security Analysis' by Graham & Dodd. The point being that you could buy the 5th edition off the shelf updated by Murray, Cottle & Block but the 1934 and 40 editions were very hard to find. In light of such I wrote to Ms Bosaneck to check that it had to be those editions and to seek her help. I subsequently received the attached response which is not confidential information and will no doubt save her having to write it again for some of the other people she mentions in her letter. (click here)

I still didn't understand why it had to be those editions but eventually obtained a copy of the 1940 edition and studied it in detail. Ironically, McGraw-Hill republished the 1934 edition in Oct' 1996 but it wasn't until I read page 199 of 'Benjamin Graham on Value Investing', an excellent book by Janet Lowe which featured an interview (court report) with Warren Buffett that I really understood why it 'had to be' those editions. (click here)

Our Approach to Value Investing

Although the concept of value investing is simple, to understand it requires a certain type of mind set. As Buffett himself explains on p.298 in the Appendix to 'The Intelligent Investor' by Benjamin Graham,

"It's like an inoculation. If it doesn't grab a person right away, I find that you can talk to them for years and show them records, and it doesn't make any difference. They just don't seem able to grasp the concept, simple as it is."

Nevertheless, I will do my best to explain it simply. Basically we begin with the belief that contrary to popular opinion, the market, who Ben Graham sometimes refered to as 'Mr Market', is not perfect and does undervalue stocks at times, and often by a large proportion. So the starting point is to calculate what 'we believe', not what the newspaper or anyone else tells us but 'what we believe' to be a fair and reasonable intrinsic value for each stock.

To do this we first have to place a value on the whole company and then essentially divide that value up by the number of shares on issue. In order to do so we apply fundamental quantitative and qualitative analysis. By 'quantitative', we mean an analysis of the company's earnings history, cash flow, balance sheet etc, and by 'qualitative', we mean a review of the management, brands etc. The same as a private business person would do when buying a business!

However, as we also believe that valuing any business is an inexact science, we concentrate on six related industries (our cirlcle of competence) to heighten our chances of getting it right. Most importantly though, we then reduce that calculated value by applying a pre-determined 'Margin of Safety'. In other words, we work out a value and then discount it considerably, so that we only buy when Mr Market is having a bargain sale. Ironically, we don't anticipate the price to rise straight away as you can't expect to hit them right at the bottom. What we do expect though is that if we wait patiently, within a few years Mr. Market will realise his mistake and buy them back off us at a premium, if we wish to sell.

This may sound simple, unless of course you don't get it, in which case it will sound crazy but it's not. It does however require the right temperament, patience and hard work. Other than that, I can't tell you too much as aspects of our approach are confidential and have literally taken us years to develop. Likewise, as we are not in the business of giving financial advice, we have never had a need to obtain a dealers license and as such, are not licensed to do so.

We can tell you though that we are genuine value investors who lean heavily towards the classic style prescribed by Graham & Dodd and that our approach is contrarian. We have little faith in much of the modern theory and would prefer to rely on our own interpretation of Warren Buffett's reading list. However, we don't profess to be Buffett clones. There will only ever be one Warren Buffett with the possible exception of his partner, Charlie Munger.

Our Favourite Stock Market Investors

We have studied a number of successful investors and tried to adopt the best attributes from each. Most importantly though, we have also concentrated on those qualities, which best suit our own unique circumstances and experience.

Besides Benjamin Graham, Warren Buffett and Charlie Munger, we also favour some of the techniques adopted by other legendary investors like Sir John Templeton. In particular we like Sir John's approach of always seeking out 'situations of maximium pessimism'. Likewise, we've adopted some of the less popular views of Phil Fisher and believe that a wise person is one who puts a lot of their eggs into a few very well analysed baskets. We also have a soft spot for Sir Ronald Brierley who has captivated our attention over the years and been a source of inspiration, as well as Jeremy Grantham, the famous US funds manager. Though it may seem unrelated, we are also fans of a Japanese Samurai called Miyamoto Musashi who lived in the 16th Century and wrote, 'A Book of Five Rings'.

At the end of the day though, we do rate Buffett number one and try to follow his advice. In saying this though, we should mention that we have never met Mr. Buffett and rely entirely on his recommended reading list, letters to shareholders and direct quotes. Once again though, we don't pay too much attention to other people's interpretation of such. We just can't kick that habit of doing our own thinking and would prefer to learn from our mistakes!

In closing though, we will leave you with a few of our favourite quotes.

To distill the secret of investment into a few words, Ben Graham ventured the motto,
"Margin of Safety."

As Warren Buffett also commented,
"It's true… If (the value of a company) doesn't just scream out at you, it's too close."

On the topic of DCF analysis, Charlie Munger commented,
"Warren talks about these discounted cash flows ..... I've never seen him do one."

John Maynard Keynes had similar views,
"I would rather be vaguely right than precisely wrong."

In our opinion though, the best thing Warren Buffett ever said was,
"Read Ben Graham and Phil Fisher, read annual reports but don't do equations with Greek letters in them."

My own favourite though is the following quote by Leo Tolstoy,
"The strongest of all warriors are these two - time and patience."

In closing, the Buffett quote that is particularly relevant to us is:
"I'm a better investor because I am a businessman, an
d a better businessman because I am an investor!"

Phillip Hogan
2 June 2000

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