November 18, 2015
Young Investors Society Spotlight with Claudio Brocado
Background: Claudio Brocado is a seasoned financial professional with over twenty years in the financial industry (sell-side as well as over sixteen years buy-side, including firms such as RCM, Putnam, Fidelity and Batterymarch). Claudio has substantial global expertise and interest, complemented by formal studies in foreign languages and strong understanding of multiple cultures and intercultural communications. Since 2014, he has been spending his professional time researching and investing in global financial markets (both developed and emerging).
We started the presentation with a moment of silence for those suffering from the tragic attacks in Paris
There are a few key investment life lessons I would like to share. Investing is my passion. I never thought of the actual money when I decided to start investing pretty young, though not as young as you guys, so first off, kudos to you! You are on a great and exciting path. Investing was at first for me just a way to try to better understand the world around me when I came to college in the US from Mexico. When James told me about YIS, I got extremely excited because it meant that I was to come across many young people with the potential for the same passion. The fact that James emphasizes that YIS is intended not only to try to grow the next generation of professional investors, but that we want to help teach you guys how to be investors more broadly, in yourselves and your communities, only makes it more exciting!
One of the first lessons I want to share, and that I must confess I was not fully able to instill in my own kids, is that investing (even professional investing) is not just for people with strong quantitative skills. My last official job was at a quantitative equity investment boutique. I loved it and my team, yet I did not feel like I fully fitted because I’m really not much of a quant at all. My analytical skills are OK, but probably below average. Yet, I am fully convinced (and often voiced this without any pushback at my quant firm) that you can be successful investing in stocks with an approach that is 100% science, just as much as you can excel with a process that is 100% art.
I strongly believe that investing (like even economics much more broadly) is part science and part art. Most investment processes include a mix of both, and I do believe that a balanced approach is probably best. Still, you should play to your own strengths, and don’t let your own natural inclinations ever be considered an obstacle to successful long-term investing. Despite the fact that I believe a balanced approach between art and science is best, I will focus here more on the art of investing, given that is the way I approach it because of my particular skill set. I try to play to my own strengths. I have a strong intuition, and always got a lot more out of looking a CEO in the eye, reading the body language of the management team and trying to talk to a company’s rank and file, than from very detailed financial projections for the firm’s results five years out.
I also believe that Wall Street (maybe even to make itself more relevant through intimidating average people away from investing more on their own) makes investment sound like much more of a science than it needs to be. The more scientific, the harder to understand for the average client; the smarter the investment professionals seem. In any case, I believe that understanding the culture of a company is something that does not get enough attention in professional investor circles.
Even the most scientific, objective and quantitative approaches have to rely more heavily than the practitioners would like to admit on human judgement. There are subjective calls that must be made throughout the process. The most detailed long-term financial projections require at the end of the day educated guesses on growth rates, etc. The fact that similar companies in similar industries with similar financial results and growth rates can trade at very different valuation multiples is proof that there is something all that analysis misses, and in my view, it is the culture of the corporation. Starbucks is a key example of a stock that seems to always trade at a valuation premium and, again in my view, that is due to the high quality of Starbucks’ corporate culture.
Starbucks brings me to another specific lesson, and that has to do with the power of compounding. You guys probably already know quite a bit about compounding from earlier discussions with James. This week’s Barron’s (a weekly publication I still read almost religiously) notes that $10,000 invested in Warren Buffett’s Berkshire Hathaway in 1965 would be worth $180 million today. Bringing it down to numbers that are easier for us to think about and imagine, a mere $10 would have turned into a cool $180,000! Now, that’s compounding at its very best. But more on Warren Buffett later. Back to my own experience with Starbucks and a slightly different way of looking at the power of compounding. I started my modest investment in Starbucks (SBUX) in the mid-1990s. Back then, it seemed as if every few months to a couple of years, the stock would split 2 for 1. And every time I got new shares, I would sell one-half to go back to my original position, in absolute number of shares. Boy…what a big mistake that was! And I kept repeating it time after time, very proud that I was “playing with the house’s money,” as some say.
One day, much later than I should have, I realized that what a big mistake that was. I understand at least some of you have fully grasped already the power of compounding. I really did not completely understand it until then, and I missed out on much better returns from Starbucks. Had I held on to my entire original position in SBUX, I would have been able to retire even much earlier than I managed to. Starbucks’ CEO Howard Schultz is, like Berkshire’s Warren Buffett, an amazing creator of value. They have pretty different approaches, but they both definitely accomplish it.
Mr. Buffett, also known as the Oracle of Omaha, where his conglomerate is headquartered, complements superb long-term stock picking with acquiring increasingly larger companies. Berkshire generates so much cash flow that it is able to make ever larger investments, now to the point of very large whole companies. He repeatedly talks about buying great assets that can be run by average managers…companies with a very defensible economic moat. In practice, though, my opinion is that he bases his buys also on the quality of the companies’ leaders. The reality is that Mr. Buffett lets the growing number of companies Berkshire owns run quite independently, and he is almost religiously opposed to making hostile deals. All his acquisitions have indeed been friendly.
At Starbucks, Howard Schultz who once left the top operating post to remain only at the board level, returned to running his company day to day because he had seen Starbucks lose its way (and its market cap!). Starbucks had seen its wonderful corporate culture erode, and Howard’s return made sure that it did not die. Since his return, the Starbucks culture has become ingrained. Starbucks is proof that a company can pay its employees well, give them extraordinary benefits, and still be very profit oriented. The long-term thinking espoused by the Starbucks corporate culture is actually the best way to grow profitability in the long run. Thus, long-term thinking is very important, and that’s what makes another great company incredibly successful, Google (now officially known as Alphabet).
Thus, one of the most important pieces of advice I can give you is to think long-term. Almost in anything you do, focusing on the long term is the best way to go. It is definitely true in the case of investing, and you should buy the stocks of great managements that foster a positive, purposeful culture and long-term thinking. That way, the interests of all stakeholders will have a much better shot at being well aligned.
Starting with your own money, in focusing on the long term it probably helps to think about paying “your future self” first. Whenever you get a raise, reserve a good portion of the increase in pay for the future. Do not get used to the new amount of money! It is much easier to adjust upward than downward. Defer as much as you can of your increase in pay. If you do not see it in the first place, you won’t be tempted to spending it now. It works in several ways. First, by keeping your standard of living anchored by your old pay, you get comfortable living on relatively little. Then, if you lose your job or have to take a pay cut, you will have an easier time dealing with the loss of income. Second, by building your savings and investments, you ensure that you will have some money in the future. Finally, if you invest that money you have deferred for later consumption wisely, the power of compounding will make you much better off.
Finally, another concept with which I wanted to leave you that has to do with long-term thinking is what I call time horizon arbitrage or THA for short. THA allows investors with longer time horizons to profit from the investment opportunities created by ‘short-termism’. Since everything is relative, nothing works at the absolute extreme. One can ride the stock of a company going into bankruptcy all the way down to zero under the illusion that one just has a longer time horizon than most investors. In other words, one should be careful not to try to hide investment mistakes (from oneself too) behind the excuse of having a long-term focus.
Nevertheless, in well researched, sound investments, the long-term investor does generally have time on his or her side. Because investors tend to have very different time horizons and markets do trend up over time, the investor who can hold out longer term will tend to outperform, everything else being equal. All too often, investors bail out too early just because they did not give management enough time to execute on a successful strategy.
Thus, the better the understanding an investor has of what a management strategy is and how long it will take to deliver on it, the better the chance of success with that investment. In some of the more extreme cases, a company that seems to be investing too much in the short term (thus rendering it currently less profitable than it otherwise would be), may actually represent a value stock if judged with a sufficiently long time horizon.
QUESTIONS AND ANSWERS:
Why did you go into investing? That’s a great question. I started out working in the restaurant business. I was working as the director of financial planning and analysis at El Torito Restaurants over there in California. I realized that I loved the analysis part of the job, but I started reading investment books on the side and got passionate about investing in stocks. I then worked on the sell-side for a few years, which is writing research on companies to investors. I was then hired by one of my clients (RCM) to be a buy-side analyst. The buy-side is where you’re most directly making the investment decisions. I worked then at Putnam, Fidelity and eventually Batterymarch. At Batterymarch, it was more of a quantitative shop, with many MIT grads, and I am not as quantitative as an investor. I value things like the culture of a company as well. But Batterymarch to their credit gave our team the autonomy we needed. It was a great experience.
What do you think about BitCoin? That one I’m going to have to say “I don’t know” on this one. I told you there would be questions I would say “I don’t know” on. I haven’t looked into it too much, so I’d not have too much of an opinion at this point. It shows we always need to keep learning!
You mentioned analyzing the culture of a company, what makes a good culture? Great question! I was just reading a book called How Google Works, which highlights just how important culture is for a business. Remember Google, or now Alphabet, they brought in Eric Shmidt to be CEO to provide “adult supervision” but in the end he said that he probably learned more than he brought to the company because of the unique and powerful culture that they had established. A culture is the things the company does and why they do it. Every company has an investor relations or marketing department that will write a nice statement on the annual report. But few companies really live it. Many companies say they want to “delight the customer” but few companies truly put the customer first and do whats right for customers in the long run.
If you could only buy three stocks for the long run, which three stocks would you buy? Number one would be Apple. It is a spectacular business. The culture at Apple is what sets it a part. People think that it is all about iPhones, but they forget that 10 years ago Apple didn’t even make phones. The company can evolve, and it has built a powerful ecosystem. The second would be Starbucks. This is another company with an exceptional culture. Howard Schultz is a visionary, and there is much growth still ahead, globally! The third would be Berkshire Hathaway. Warren Buffett is an unparalleled investor, and you can buy it at not too much above book value. You get diversification into a lot of really great businesses.
What do you think about Facebook? I own Facebook personally, not a huge stake, it is maybe 1% of my portfolio. It is not a traditional value stock like most of my investments, but it is an exceptional business. There is a lot of growth potential still remaining, and it is an asset-light business. Mark seems to know how to stay focused on the long-term, which is great. So while traditionally I have not done too much in growth stocks, businesses like Amazon and Facebook seem to be transformational.
What do you think about self-driving cars? What are the stocks to buy if this takes off? I think they are real and will have a major impact in the next decades. The technology seems to be close to ready. Obviously companies like Google are developing products. Apple I believe also has plans to enter this segment. Tesla is involved. There is a company in Germany called Continental which makes tires but also are on the forefront of self-driving technology and may be a great way to play it. You could also think about sectors like retail and transportation that can benefit from lower cost of transportation and more efficient services. Wal-Mart for example, is a contrarian stock which can be bought at a low valuation. Many think that the transition from bricks and mortar to online is going to kill them, but I think that this is an exaggeration. The company has the infrastructure (and even the tech knowhow) to become a key player in omni-channel retailing.
Thank you Claudio! Cheers and applause!