How Losers Win
Ralph Wanger is an expert investor…a true expert. Under
his shrewd guidance from 1970–2003, the Acorn Fund (a
mutual fund dedicated to small-cap stocks) produced an
astounding 17.2% annualized returns. A mere $10,000
investment in 1970 grew to $174,059 by 1998.
Last month, I hopped a plane to Chicago to meet with Mr.
Wanger for one precious hour. (That’s all the time that he
had promised to give me). But after the first sixty minutes
of our conversation rushed by, he agreed to give me another
60 minutes of his time. That may have been the most
valuable gift I have ever received.
During my two hours with Ralph Wanger, he shared the three
key investment tactics that propelled his fund to such
Investment Insight #1: Stray from the herd every once in a
Wanger’s 1997 book, A Zebra in Lion Country, examines the
virtues of staying with smaller, lesser-known companies.
The basic metaphor behind Wanger’s book is implied in the
title. If a zebra hopes to find the best grass – the stuff
that is untrodden by the herd – the zebra must selectively
stray from the safety of the herd on occasion.
Investors must do the same thing…if they are to prosper.
One of the ways to "stray," Wanger says, is to think long-
term. Because most investors – professionals and
individuals alike – think short-term, they often dump the
very stocks they should be buying, simply because temporary
setbacks cause the share price to drop. The successful
investor, therefore, must sometimes take the other side of
these panicked sell offs. He must pick up great long-term
investments by buying when other investors are dumping
Short-term thinking dominates the investment world – a fact
that Michael Panzner explores in his recent book, The New
Laws of the Stock Market Jungle. Panzner notes, for
example, that the average holding period for an NYSE stock
has fallen to less than one year! As recently as 1990, the
average holding period exceeded two years; in 1975, it was
"This is why long-term investing ought to work," Wanger
said. "If most people are worried about the short term,
say, the next quarter or two, then you can exploit that by
buying stocks with temporary setbacks but solid longer-term
Investment Insight #2: Know When to Sell
If an investor knows exactly why he is buying a given
stock, he can also know exactly when to sell the stock. In
other words, says Wanger, "Make the reason you buy a stock
so specific that you know when the reason is no longer
Make the reasons for buying and owning a given stock
"falsifiable" or "checkable." That way, you can
continuously validate your reasons for owning a stock. If
at some point, the reason(s) no longer hold true, sell.
Let’s say you buy a stock because you believe its profit
margins will expand from 5% to 8% over the next three
years. Perhaps you have identified a catalyst that is
likely to improve profitability. If the company steadily
progresses toward 8% margins, you hold on. Your original
premise remains valid.
But if the company fails to meet your expectations, your
original reason for buying the stock is no longer valid.
Let’s say that after year three, the company’s profit
margin is only 6%. You were wrong, so you sell. It doesn’t
matter how well – or poorly – the stock might be
Of course, you can revise and revisit your reasoning on a
periodic basis. But you must always retain very specific,
verifiable reasons for owning each stock in your portfolio.
Investment Insight #3: Understand that the Stock Market is
a Loser’s Game
"Chris, if you do NOTHING else in your newsletter," Wanger
emphasized, "remind your subscribers every month that the
stock market is a loser’s game."
"Um, okay," I replied, without really understanding what he
meant…But I eventually understood.
Wanger meant that investment success comes from exploiting
the mistakes of others. Charles Ellis’ book, Winning the
Loser’s Game, which Wanger recommended, elaborates the
point by examining the game of tennis. There are two types
of tennis, Ellis relates, the game played by the
professionals and the game played by the amateurs.
The professional level is characterized by a great deal of
skill and ability. Players hit the ball hard and usually
where they want to. It becomes a strategic and tactical
battle, as well as an athletic contest. The professionals
make very few mistakes. Theirs is a "winner’s game."
The amateurs, however, play a different game. The amateurs
make very few brilliant shots or vollies. They commit many,
many "unforced errors," by hitting balls hit out of bounds
or into the net. The winner of an amateur tennis game,
therefore, is usually the one who makes the fewest
mistakes. Amateur tennis is a "loser’s game"…and so is
The way to win a loser’s game is to make fewer mistakes.
You play not to lose. So the advice for amateur tennis
players is to worry less about powerful serves and focus
more on just getting the ball back over the net and in
Most mutual fund managers don’t beat the market. They don’t
beat the market, because they make many mistakes. They buy
and sell too frequently, for example, incurring excessive
transaction costs. "To achieve superior or better-than-
average results through active management," Ellis writes,
"you depend directly on exploiting the mistakes and
blunders of others."
This means the investors who make the fewest mistakes will
be the winners. Investing is not about making explosive
gains. It’s more about avoiding losses. Investing is a
defensive process. The essential task of the investor boils
down to an exercise in managing risks. It requires patience
and commitment to avoid the temptation of trying to hit
home runs every time up. Always think about the possibility
of losses and how to limit them.
"The great secret of success in long-term investing," says
Wanger, "is to avoid the serious losers."
But even if you manage to avoid big losers, it helps to own
a winner or two from time to time. So, after bidding Wanger
adieu, we took a peek at his latest quarterly reports to
find out what he’s been buying recently.
I am happy to report that three of the names his firm has
been buying are stocks that we hold in the portfolio of the
Fleet Street Letter: Intrawest (NYSE: IDR), Grupo
Aeroportuario del Sureste (NYSE: ASR) and Scottish Re
I also discovered that he is buying a few other compelling
stocks that are not in the Fleet Street Portfolio…yet.
By Eric J. Fry
Would you believe that the most widely watched inflation
index, the consumer price index (CPI), does not measure the
increase in the price of housing?
According to the National Association of realtors, the
price of a house has increased 15% from a year ago. The CPI
does not reflect this change. Without getting too
technical, the CPI accounts for housing using something
called "owner’s equivalent rent of primary residence,"
which is basically an estimate of what an owner would
hypothetically have to pay to rent his own house. It is an
estimate based on a lot of guesswork and manual adjustments
on the part of government statisticians.
This owner’s equivalent rent is given a 23% weighting in
the index. This is a large piece of the index and greatly
skews the final result.
As Grant’s Interest Rate Observer notes, the relatively
sluggish rental market has "helped tamp down the measured
rate of inflation." While housing prices continue to climb,
the CPI barely crawls along at 3.5%. Even so, the CPI, as
constructed, has been rising since January 2002, when it
was barely above 1%.
But what would the CPI look like if you could, in fact,
recalculate it using housing prices, instead of imaginary
rental equivalents (which is the way it was done prior to
the early 1980s, when the Bureau of Labor Statistics
adopted the present, convoluted measurement)?
Grant’s has done the work for us, reporting, "The CPI would
be showing year-over-year gains on the order of 5%, rather
than 3.5%." This means that all those folks buying 10-year
Treasury notes at 4% are under water from the start.
10-year bonds yielding 4% are a bad bet when TRUE inflation
is 5%. But buying tangible assets may be a good idea in
such an environment. In periods of rising inflation,
tangible assets tend to gain value, which is another way of
saying that paper money loses its value against tangible
assets, especially those tangible assets that throw off
increasing amounts of cash.
In times of turmoil, most investors instinctively think of
gold. But there are other stores of value that also make
superior investments. As Warren Buffett pointed out to
attendees at this year’s Berkshire Hathaway shareholder
meeting, "Gold can be a store of value, but so can an acre
of land or a barrel of oil…"
Or, I would add, so can hotel properties, timberland,
hydroelectric dams, and many of the other types of
investments that we’ve recommended in the past.
"We’d rather own an asset that will be useful even if the
currency drops to 10 cents on the dollar," Buffett
concludes. "We wouldn’t trade ownership of businesses for a
hunk of yellow metal."
A hunk of yellow metal may not be a bad thing to own, but
we prefer owning tangible assets that produce a return on
investment, even when no crisis exists.
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