Last month, baseball fans enjoyed the return of their favorite players as another season began. Perhaps owing to the shared desire to quantify and measure everything, many notable investors are avid baseball fans. In fact, some investors use the game to explain their thinking and to teach others about the practice of investing.
Warren Buffett, perhaps the best teacher among the great investors, used the work of legendary Red Sox hitter Ted Williams to make the process of investing easier to understand. As documented in his book, The Science of Hitting, Williams developed a unique approach to understanding which types of pitches he had the best chance of hitting. Using this information, he tried to limit his swings to those pitches most likely to result in hits. Buffett used this same concept to preach patience to investors: “The trick in investing is just to sit there and watch pitch after pitch go by and wait for the one right in your sweet spot.” For investors, the “sweet spot” is likely to be a company that they understand, trading well below their conservative estimate of value.
Contrast this patient, knowledge-based approach to that of hedge fund manager John Paulson. Paulson vaulted from obscure money manager to investment legend based on the success of his bets against the subprime mortgage market in 2007. In what can only be described as one of the greatest investment home runs of all time, Paulson personally netted about $4 billion when home prices fell and subprime mortgage prices collapsed. Since then, however, Paulson’s hedge funds have collected more strikeouts than hits. Investing not only in common stocks but also placing big, often leveraged, bets on everything from commodity prices to mergers and acquisitions to early-stage biotechnology companies, his hedge funds posted big losses over the last several years. One fund closed after declining more than 70%, and the firm’s oldest fund fell more than 42%. In baseball parlance, John Paulson is like the inconsistent slugger happy to swing for the fences at almost any pitch that comes along, convinced of his ability to hit everything out of the park.
Investors, like athletes, develop their own unique styles and approaches to achieving their investment goals. While big sluggers are spectacular when they connect, sometimes they don’t connect often enough to matter, since piling up too many strikeouts can be a one-way ticket to the bench. We believe a more methodical approach based on an analysis of how a business works, the quality of its management team, the relevant competitive environment and future prospects, combined with a conservative estimate of value, will create an edge for us. If so, compounding that edge over time ought to lead to long-term success. To be sure, we’ll focus our client’s capital in what we believe to be the best investment opportunities, but we’re happy to leave the all-or-nothing approach to others.