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“The Intelligent Investor’s Unfair Advantage…”

Monthly Publication of Vantage Investment Research * InvestorVantage.com * May 2016

Investor Vantage Report

Ben Carlson is the Director of Institutional Asset Management at Riholtz Wealth

Management. He create detailed investment plans and manages portfolios for insti-

tutions and individuals. He also runs awealthofcommonsense.com, a website dedi-

cated to explain the complexities of finance in a way that everyone can understand.

Ben’s been managing institutional portfolios his entire career. He started out devel-

oping portfolio strategies and creating investment plans for various foundation, en-

dowment, pensions, hospitals, insurance companies and high net worth individuals

at an institutional investment consulting firm. More recently he managed a large en-

dowment fund for a charitable organization as part of a portfolio management team.

In this interview, Ben highlights his philosophy to investing and some of his daily

routines. —CONTINUE PAGE 2 Ben Carlson

Ahmed Husain is the co-founder, partner and portfolio manager at London-based

Altice Capital. He is responsible for managing an absolute return portfolio across

equities, bonds, and currencies.

Previously, Ahmed was a managing director at Goldman Sachs. He was focused

on advising European ultra-high net worth clients and their family offices. Now, at

Altice, he executes a value investing philosophy in order to find high quality invest-

ment opportunities.

Currently, Ahmed is finding opportunity in a recently spun-off coating company:

Axalta. The company is a low CapEx, high margin business with only 3-4 big play-

ers, and the company appears to be reasonably priced, The company meets his

stringent criteria for value investing. —CONTINUE PAGE 4 Ahmed Husain

Value Revisited: Freddie Mac / Fannie Mae A common theme lately has been the difficulty of finding value in a

market that has continued to beat the drums of an improving econ-

omy. And of course there are some investors who find value in the

oddest of places. “Buying hated companies requires patience and

courage of conviction,” says Bruce Berkowitz (Fairholme). “We

need volatility to prosper, we need false perceptions...Risk does

not equal volatility.” Freddie Mac (FMCC) and Fannie Mae

(FNMA) are certainly one of those companies (F&F). F&F are

probably two of the most vital financial institutions in the U.S.

(maybe the word). —CONTINUE PAGE 9

February 3, 2015

Ben Carlson — AWealthOfCommonSense.com

Great to have you here Stephen. Before we get into the

nuts and bolts, could you give us a little bit of your

background and how investing started for you?

Ben Carlson: I was something of a late bloomer to the

markets. I had an internship my senior year of college with

an investment firm and realized pretty quickly that textbook

theories I had learned in class would only take me so far. I

had to learn how the markets actually functioned and how

investors handled things in the real world. So I read every

book I could find. The first investment book I ever read was

The Intelligent Investor by Benjamin Graham. Value invest-

ing clicked with me right away. My views on investing are

constantly evolving. The more I learn the more I realize

how much more I don’t know. There isn’t a single way for

everyone to invest. It all depends on your personality and

finding something that works for you.

What does your day look like from beginning to end?

BC: There are two things that I make sure to do every

single day – read and write. I was never much of a writer

before starting my site, but it’s now part of my routine. I’ve

found that you can become a better writer by simply writing

more. I’m never going to be Hemingway, but you can im-

prove yourself by writing more. Reading is also another

way to improve as a writer. I’m a huge fan of standing on

the shoulders of giants, so reading it a huge part of my day.

What do the first 60 minutes of your days look like?

BC: I have a 2-year-old, so my mornings are pretty hectic

getting her ready and out the door. I’m more of a night owl

and not much of a morning person, so I don’t do anything

special in my morning routine. I just make sure to have a

good breakfast right when I wake up to start the day off

right.

If you have complete control, what would the two days

look like on the weekends or holidays ?

BC: Time is our most important asset, so this is a great

question. In the past, I may have said spending the day on

a beach somewhere, but I’m pretty happy spending time

anywhere these days with my wife and daughter, as long

as everyone is happy.

Do you exercise regularly?

BC: Yes, I also get a lot of my thinking done by work-

ing out on a daily basis. It’s my own form of meditation and

peace of mind. I don’t do anything special beyond lifting

weights and running. But I do find that I get some of my

best thinking done when I’m jogging, so that acts as a great

way to clear my head.

Who are the people that inspire you the most? And

why?

BC: I’ve always looked up to my older brother. He has a

great mind for business, and he is constantly challenging

my thinking and offering up new ideas and different ways

for me to view the world. I think everyone needs someone

in their life who will be straight up with them about their de-

cisions – good or bad -- and he is that person for me.

Is there an investor you look up to the most? And

why?

BC: I work on the institutional side of the business, so

David Swensen, who runs the Yale Endowment Fund, is

someone I’ve always looked up to. And it’s not just that he

has a phenomenal track record (he does), but it’s how he

runs the organization that I find fascinating. He could have

easily left to run a hedge fund and make billions, but chose

to continue to work for his alma mater. I respect that.

What are the top 3 books people don’t talk about, but

that you would recommend to investors?

BC: I think you have to have the psychological side of

investing down if you’re going to be a successful investor.

Here are three books not as many people point to that I

think are very helpful on this side of the equation: Your

Money and Your Brain by Jason Zweig, The Power of Hab-

its by Charles Duhigg, and Mindless Eating by Brian Wan-

sink Only one of those is actually an investing book.

Is there a portion of your investment process or philos-

ophy that you would consider unique?

BC: Outside of the occasional rebalance, I have a very

long holding period for my investments and don’t really

make a ton of changes to my portfolio. Having a long time

horizon is not an earth-shattering move by any means, but I

think that one of the last truly safe edges in a market that

continues to get faster by the day is an extended holding

period. It’s impossible to arbitrage away long-term thinking

Ben Carlson explains his philosophy to investing, his daily habits, how he respects David

Swenson as an investor and person, his biggest investment mistake, and the most common

mistake investors make today.

Investment Ideas For Intelligent Investors

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February 3, 2015

and the art of doing nothing. I think that the most successful in-vestors understand themselves more than anything. They understand how to reduce or eliminate their lesser self to some degree. There are plenty of smart people out there, but not all smart people are great investors. You also have to bee patient and disci-plined enough to control your emotions when others can’t. That’s not an easy thing to do because of how we’re hard-wired. How important is it for you to have a client base that shares your focus on the long-term? BC: Having a client base who under-stands how you invest and why you invest in a certain way is extremely important. This is why a professional investor’s job doesn’t stop at portfolio and risk management. It goes beyond that to things like client education, con-stant communication, setting reasona-ble expectations and being accounta-ble for your decisions. The best invest-ment strategy in the world is not going to matter if your clients can’t follow their plan when things get tough. Do you have interest or expertise in a particular industry that you would call your “circle of competence”? Or are you more of a generalist in search of value or market inefficien-cies? BC: I think one of the most im-portant things for investors to under-stand about their portfolio is what they own and why they own it. You have to understand not only your individual investments but also how they come together to complement one another in a portfolio. Portfolio management goes far beyond picking individual funds or securities. It’s about understanding how risk and return are related and how your holdings can help minimize the former and maximize the latter. What is the most common mistake that investors make as it relates to investing?

BC: From a broad perspective, most investors fail to have a plan or defined investment philosophy. A strategy with-out a plan is like a ship without a sail. This is why so many people hop around from strategy to strategy with no coherent overarching philosophy. You need that to guide your actions and keep yourself disciplined as an investor. What was the worst investment you've ever made? What happened, and how could you have prevented it from happening? BC: The worst decision I’ve ever made was to put off saving money right when I was out of college. Time is our greatest asset so missing out on those early years of compounding are investments I’ll never get back. What was the best investment you’ve ever made? What happened? BC: The best investment I ever made was actually a series of invest-ments. It’s not even a single security. The best investment I ever made was my decision to increase my savings rate during the financial crisis and con-tinue to plow money into the stock market as they seemingly fell every single day. Investing during the late-

2008, early-2009 period looks easy in hindsight but was anything but at the time. That really was a “blood in the streets” environment, and no one really knew what the outcome was going to be. What are The 3 Things an investor should focus on the most to pro-duce outsized investment returns over the long-term? 1. Your investment success will be de-termined not by your actions, but by your reactions. 2. Discipline and patience are more important than intelligence and market knowledge. 3. Understanding yourself – your risk profile and time horizon – is the most important aspect of a successful in-vestment approach. Even the greatest strategy in the world won’t make a dif-ference if you can’t or won’t follow it. I would tell my 20-year-old self not to be so enthralled with the smartest per-son in the room. It’s actually the wisest person in the room who you want to hitch your wagon to. I would also tell myself to start saving money earlier, read more books and don’t stress so much about your career prospects. Life has a funny way of working out.

On What Ben Would Tell His 20-Year-Old Self:

I would tell my 20-year-old self not to be so enthralled with the smartest person in the

room. It’s actually the wisest person in the room who you want to hitch your wagon

to. I would also tell myself to start saving money earlier...

Investment Ideas For Intelligent Investors

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February 3, 2015

Ahmed Husain — Altice Capital

How did investing start for you? And how has your

view of investing evolved (if at all)?

Ahmed Husain: I grew up in an emerging market coun-

try where I was born, Pakistan. I didn’t know what value

investing was at the time, but I remember being, at the age

of 8, a money hoarder. I loved to collect money, hold onto

it, and see it grow. In those days, I’d see it grow by waiting

for the next birthday or Christmas to add more to the mon-

ey I had already saved. If people wanted to give me a gift

for a special event, I’d tell them just to give me money to

add to my savings. In 1999, at Northwestern University, it

was an interesting time to be in school as we were nearing

the end of the tech boom. Companies like Yahoo and

Google were shooting up 10% per day. I happened to be a

Computer Science major at the time, so I was interested in

what was going on in the markets. After college, I joined

Lehman and then Goldman. I heard of Buffett, but I never

actually read all of his writings. Lots of people discovered

him in their teens and early 20s. I was definitely a late com-

er as it took me to my early 30s to realize how great his

writings were.

So I went back to first principles to see what the ways

were of making money. Value investing is one of many

ways to make money in the market. You’d only want to be

a value investor if you had the predisposition and that’s

what you enjoyed doing. You can make billions of dollars

doing plenty of other things. So I don’t think value investing

is the most efficient way of making money. Many of the

richest people in the history of the world weren’t value in-

vestors, such as Gates and Rockefeller.

What does your day look like from beginning to end?

AH: People used to call me a robot in college because I

am so regimented in the mornings. I do the same thing

most mornings. I eat breakfast at home, iron my clothes,

and polish my shoes. I do that to stay humble because,

whether you have $50,000 or $5-million in your bank ac-

count, it’s important not to lose sight of the hunger. So

those are some habits in the morning to keep me humble

and hungry. Some bad habits are checking my email first

thing in the morning to make sure nothing is blowing up,

which I got from working at Goldman. At Goldman, I’d get

emails at 2:00 or 3:00 in the morning from a partner in To-

kyo and I’d had to respond to them. Just as a matter of

habit, I’ll get up at 1:00 am to see how Tokyo is trading and

then I’ll wake up at 4:00 to see how it’s progressing. Good

or bad, I do this most nights.

I’ve also learned, over the years, some things that I be-

lieve have helped me become a better investor, such as

mindfulness and meditation. I do 10 minutes of meditation

in the morning and recommend a book called The Giant

Within by Tony Robbins. That really got me thinking about

the head game because 80-90% isn’t about spreadsheets

or modeling. It’s about behavioral analysis and not being

your worst enemy. I had my work cut out for me because I

was introduced to the world of finance on a trading floor at

an investment bank. This can lead to a lot of bad behavior

because you’re part of that herd all the time. Developing

your own way of thinking is tough. Over the years, I’ve had

to develop new habits like not looking at my Blackberry and

thinking independently. Another thing I tell young people to

do all the time is you should have a to-do list of what you

want to get done before you arrive at your desk. List out

your top three priorities and attack those things. Another

great book on this topic is The One Things by Gary Keller.

It’s all about focusing in on those one or two big things that

will have the biggest impact and getting those done every

day. Having a list of you priorities that week or that day will

help you stay focused even if you’re inundated with emails

or calls throughout the day. Don’t’ check your email and get

it done as soon as you get to work. An email here or phone

call there and before you know it, the day is gone. Focusing

on you toughest tasks first will allow you to be much more

productive than other people.

If you have complete control, what would the two days

look like on the weekends or holidays ?

AH: I typically have control over my weekends, but I use it for my non-work tasks, such as spending time with my two daughters. The average life expectancy now is in the mid-70s, so I’m cognizant of the fact that I’m half way through my life already. That means I’ll use weekends to have a life. I love my day job and investing, but, as you go through life, you realize how important relationships and family are to you.

Ahmed Husain explains his philosophy to value investing, his habits that keep him hungry in

investing, how he learns from everyone, how he controls one of the biggest mistakes in in-

vesting, and why he sees upside in Axalta.

Investment Ideas For Intelligent Investors

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February 3, 2015

Also, I love to read. I try to read 30-35 books per year, so I try to get through half a book per week if possi-ble. My weekends are a compilation of family, reading, and gym activities. Do you exercise regularly? If you do, what are the 1 or two exercises that work best for you? AH: I try to walk a lot, and I’ll typically schedule meeting or calls while I do that. I’m in London, so it’s a pleasant time to do that right now. Otherwise, I try to go to the gym three times per week. I’m more of a heavy lifting guy like Nassim Taleb, rather than a “treadmill” guy. Who are the people that inspire (or inspired) you the most? And why? JZ: One of the things I try to do with everyone I come across is focus on the one thing they do great and try to take something away from that. I could meet someone and say, “Look at this person running this business. They are running it in a world class way. How are they doing that?” When I approach encounters like this I can gain incredi-ble insights and admiration from all kinds of people. On Wall Street, I would come across some people that had great quant skills, so I would try to learn as much about that as possible. Then I would see another person with excellent trading skills, so I would bor-row and learn as much about his pro-cess as possible and have him teach me. My admiration for people comes from being open minded and being humble around people, and then learning from what they do best. I think everyone has something to teach me. I have to find the one thing inside them that is unique and world-class and try to make it my own. Either they’ll teach it to me, or I will try to pick it up on my own from them. If you can take every-one’s best things and make it your own, you’re going to be an incredible person. I’d say one of the most important

things I learned was from my boss when I was 23 years old at Lehman. He said, “Look, the one thing you have to remember about a career on Wall Street is, in the beginning, they pay you to learn, then they pay you for what you know, and then they pay you for who you know.” At the time, I was a very introverted kid from Pakistan, and I didn’t speak English very well. I didn’t know many people when I arrived in America. I knew that if I wanted to get to that place, I needed to get better at my so-cial skills and to be in a room with peo-ple to talk and network with them. I think I was able to pick up those skills from lots of different individuals over the years. The ability to have a net-work and help other people can build a tremendous amount of goodwill over time. Lots of value investors warm up to the idea of Michael Burry. And I think that scares me because not everyone is going to be as smart as Michael Bur-ry. He’s an unusual character, and I think he may have been a genius be-cause he had Asperger’s. I think there is a better model out there, and it’s one where you surround yourself with peo-ple who are better than you at different things. Then you use their expertise to make a decision. I believe this is the Buffett model. He doesn’t try to be everything at all times. He’ll do the things that he’s good at and enjoys doing. And other things that are a little more complicated he’ll out-source to people that are a bit more knowledgeable on the subject. He’ll reach out to people like Gates or Munger for advice. That’s the kind of world that I’ve built, and now I know a lot of individuals who are good at dif-ferent things. So when the time comes, I can leverage their expertise and knowledge on things that I might now know very well. Is there an investor you look up to the most? And why? AH: I’ve tried to learn the best parts of great investors, but I wouldn’t say I’ve made any investor an idol. My view-

point is once I’ve made them an icon, it makes me fallible because then I could start copying their positions. I would be beholden to their investing decisions not knowing why they're making the decision or what their thought process is. I respect all kinds of different inves-tors. Personally, I like to find some-thing great about everyone’s process and use it in my process. It can be a slippery slope to make someone a god or an idol. It’s scary to me. I believe everyone has something to offer me. Not even Buffett says his mentor Ben-jamin Graham is the greatest investor ever. As we know, Buffett evolved and adapted from Graham’s teachings to allow him to become the investor he is today. What are the top 3 books people don’t talk about, but that you would recommend to an investor? AH: I think it's of vital importance when discussing investments, to un-derstand if someone is lying or trying to influence you. That’s why I recom-mend Influence: The Psychology of Persuasion by Robert Cialdini. It’s nat-ural that we will have all sorts of bias-es, and we need to know how to spot them. I believe Cialdini’s book is the seminal piece of information on the subject, and everyone should read it. Making friends in the real world, helping people and developing a net-work is different than what you learn in school. The books Never Eat Alone by Keith Ferrazzi and The Start-Up of You by Reid Hoffman are great to learn more about developing a network and how important it is. As far as investing, The Most Im-portant Thing by Howard Marks is a great read. If you want to make sure you aren’t overconfident or developing a huge ego, you should probably read Fooled by Randomness by Nassim Taleb. I also think The 4-Hour Work-week by Tim Ferriss was instrumental to me in helping me understand that there were numerous things I could automate or outsource to help me fo-cus on the things I do best.

On One of Buffett’s Models:

He doesn’t try to be everything at all times. He’ll do the things that he’s good at

and enjoys doing. And other things that are a little more complicated he’ll out-

source to people that are a bit more knowledgeable on the subject.

Investment Ideas For Intelligent Investors

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February 3, 2015

What is your philosophy and pro-cess to investing? AH: I would say it ’s always a work in progress. When I first started out, I was all about screening. As I got older, I realized there were great opportuni-ties that do not show up on screens. And the situations that don’t appear on screens are the opportunities you should be invested in to gain outsized returns. Over time I’ve always thought to my-self whether I should only be involved in high-quality businesses or should I just invest in cheaper stocks. I would say I’m flexible in the way I go about searching for investment opportunities. When you are starting to manage mon-ey in a portfolio, each stock is not as important as the overall construction of the portfolio. It’s likely that most inves-tors will make mistakes with individual companies. Even the best investors don’t get it right that often. But if you think about it from a portfolio construc-tion level, you can make mistakes on individual securities and still do very well. Chris Crawford was interviewed by the Manual of Ideas recently, and he explained it as, when you’re putting a portfolio together, we think about all the sources of returns. Trying to deter-mine what the factors or variables which are driving those returns. With that in mind, I break down it down into various components. So I’ll look for something that will benefit from drug discovery or pharma growth, then I’ll try to find the best possible company in that segment. Maybe I’d look at a com-pany that would benefit from commodi-ty price increases the most. So first, I’d understand what the na-ture of the portfolio is that I’m trying to construct? And what is my time hori-zon? Then I’d populate it with value stocks and some stocks that don’t vis-ually look like value stocks, but the companies are cheap for other rea-sons or maybe they have hidden as-sets. I’ll try to construct a portfolio with all kinds of different return profiles ra-ther than just looking for the cheapest stocks. When you think about it, what

does the word cheap even mean? Your goal is to turn $100 into $200; your goal isn’t to buy cheap stocks. How important is it for you to have a client base that shares your focus on the long-term and how important is permanent capital to you? AH: Permanent capital is incredibly important. I looked at the problem and said, “If I’m going to be a value inves-tor, where I’m going to be wrong for 2-3 years sometimes, then a hedge fund capital base where I could be re-deemed every quarter doesn’t make a great deal of sense.” When you think about who has permanent capital, the one segment that comes up the most is families or family offices. Also, pri-vate equity companies like Blackstone have permanent capital. I wanted to be in the public markets, so I focused on family offices, and there are hundreds of them out there with relatively perma-nent capital. Permanent capital is criti-cal or else the value investing strategy isn’t going to work. So that’s the world I ended up going into overtime. Do you have interest or expertise in a particular industry that you would call your “circle of competence”? Or are you more of a generalist in search of value or market inefficien-cies? AH: In this instance, I’m reminded of one of Charlie Munger’s many mental models, Invert. Rather than thinking about what I want to focus on, what is it that I know I can’t do or shouldn’t do? As a result, I try to stay away from commodity related industries because I have no control over the input price. I also try to stay away from banks be-cause I know how complicated they are because I’ve worked inside of them. In general, I try to stay away from commoditized industries where companies are selling the same widg-ets. Also, I stay away from businesses in countries where I don’t understand geopolitical forces. This means I prob-ably won’t be investing much in emerg-ing markets because I would have no

idea how those countries work or what their governance looks like. I try to be in areas other than the things I just discussed. I don’t want to be in situations that can cause me per-manent loss of capital. So I take all of the bad sectors, bad industries, and bad countries out of the equation. Whatever is left over is where my fo-cus will be to uncover opportunities. I’m an equal opportunity investor at that point. Are there sectors or industries that you think offer the potential for out-sized returns over the long-term? AH: Everyone defines “long-term” differently. However, looking out three years, emerging markets and com-modity-related sectors will probably be better places to invest compared to the general market or tech industry. Mainly because price determines, to a large extent, your potential return. If a stock or sector is down 70-80%, then you probably have much less downside compared to a stock that’s up 200-300%. If you look at where we poten-tially are at this point in the cycle (with 2009 being the last crash), we are sev-en years into this move with valuations and margins on the upper echelon. We’re always trying to find cheap things, but that seems to be concen-trated in commodity related compa-nies. So, in general, a person should probably be spending more time in places like that to find opportunity. And instead of going into companies that are strictly commodity businesses, you could look at other industries that have been affected by the down cycle in commodities like the railroads. Many of the railroads are down over 50% from their peaks so that they might be interesting. Building material stocks have come off 30-40% too, so that might be something to look at too. Those are the types of places you have to be to find undervalued stocks right now. Many are cyclical stocks that are off 50% or more. Betting on defen-sive stocks or pharma here doesn’t feel like the right move here.

On Sectors That May Offer Outsized Returns:

...looking out three years, emerging markets and commodity-related

sectors will probably be better places to invest compared to

the general market or tech industry.

Investment Ideas For Intelligent Investors

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February 3, 2015

Describe your value discipline once you have arrived at an understand-ing of the Intrinsic Value of the busi-ness? AH: Let’s break that into parts. If something doesn’t have at least 30% upside, it’s tough for me to buy it. Re-member the value you calculate changes and you might be wrong. The larger the margin of safety the better. Lots of investors have read about Buffett and the power of focused in-vesting. Lots of investors now think you should only be long 5 or 6 compa-nies with 15% or more positions in each. I think that’s a mistake because lots of the investors out there trying to execute this strategy are not as smart as Buffett or the other professional in-vestors who have the experience. I think the market is much more volatile now due to more algos and computer-driven strategies. The markets aren’t what they used to be in Buffett’s time. So in terms of portfolio construction, you’re supposed to more nimble and, as a result, you should hold more in-vestments with smaller sized positions when the opportunity presents itself. The smaller positions will also allow investors the opportunity to add to po-sitions. Also, value investors should learn to use stop losses. Unless you’re invest-ing with permanent capital, any pro-longed period of underperformance means your clients are probably going to move their capital to another inves-tor. Stop losses are instruments I en-courage everyone to use diligently to minimize the downside at the 10-20% level. If you bought a stock at $100 and it goes to $85, you probably say to yourself, “Wow, it’s cheap. Let’s buy some more.” What happens if it goes to $75 or $50? Most value investors will probably buy some more. Value investors, in particular, can get stuck in the thought process of adding to posi-tions as the price goes lower. A lot of investors don’t take a moment to think that they might be wrong, or the mar-ket doesn’t understand it. If you just had a stop-loss at $85,

you could’ve taken a step back to look at it objectively without all your biases surrounding the company. Investors get in a position like this and start get-ting redemptions when the stock goes down to $50. The stock may well be at $150 in three years, but you weren’t able to realize those gains because of the volatility. Lots of investors invest like they have more permanent capital than they do. Unfortunately, the capital has become less permanent in the hedge fund world. What is the most common mistake that investors make as it relates to investing? AH: Investing is quite difficult. You don’t know exactly how a business executes or if you’ll be able to predict its numbers. Also, you don’t know how the stock market will perform even if you do predict the numbers and wheth-er or not the stock will go up if you’re right. I can’t speak for all investors, but I would say one of the biggest mis-takes is not spending enough time knowing the business. If you’ve only spent 2-3 months researching a com-pany, you absolutely should not be buying the stock. It may seem like its cheap if it’s down 40-50%, but three months is not enough time to know about a company or its stock even if you’ve met management and talked to consultants. You need to spend more time understanding the business bet-ter. People get into bed with a stock sooner than they should thinking they know the business. And when they buy into a stock it leads to all sorts of bias-es that can harm you if you’re not pre-pared. What I’ve learned is investing is much harder on the surface, and you should be humble about it and say, “You know what, after a couple of months, I probably don’t know as much about the business or the sector as I should.” Sometimes you spend time on the business and really should be spend-ing more time on the industry and the competitors within that industry. If you spend some time understanding some

of the competitors, you might find something better. Spending only 2-3 months on a company and deciding it’s a buy is a bit egotistical and can lead to bad decision making over the long-term. It’s important to stay humble and understand how complex many of these business are. A billion dollar company is very com-plex. It has thousands of employees, numerous suppliers, and various facto-ries. How are we going to predict all of that? It’s not easy. I think investors need at least 5-6 months of watching the stock and understanding the busi-ness before they can make an invest-ment. What was the worst investment you've ever made? What happened, and how could you have kept it from happening? AH: I can’t talk about the stock, but I will talk about stop-losses again as a mechanism for helping to control loss-es. If I buy a stock, and it goes down 15%, I need to reconsider whether I’ve made a mistake or not. If you really think it’s the greatest time to be buying this stock, then it shouldn’t be going down on you. And if it does, you should probably admit that you were wrong. If you think to yourself that it’s the best possible time to buy a stock, how did it become 15% cheaper? Now we already know we’ve made a mistake buying the stock when we did, but, now with the stock down 15%, you think you’re going to make the right decision to add to it. I’ve been that guy who’s bought stock down 15% only to say to myself, “Well, I called it wrong the first time when I bought it, but I can’t wrong now. It’s a better price.” So personally, one of my biggest mistakes is not using stop-losses often enough. Describe your investment thesis in Axalta? AH: I don’t typically discuss current investment positions. I learned this

On The Most Common Mistake Investors Make:

...one of the biggest mistakes is not spending enough time knowing the

business. If you’ve only spent 2-3 months researching a company,

you absolutely should not be buying the stock.

Investment Ideas For Intelligent Investors

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February 3, 2015

from Mohnish Pabrai and Guy Spier, because whenever I publically discuss a stock that I bought, I become wishful-ly attached to it. After you pitch a stock to someone, you think to yourself you can’t wrong now. Your ego gets at-tached to it, and then you start getting emails from people saying, “Hey, that stock you put me into isn’t doing so well.” And I think to myself, “You’ve got to be kidding me.” So I will talk about one hesitatingly. The company’s name is Axalta (AXTA). It’s a coating company that went public in 2014 after it was spun-off from Dupont. There were headlines a year ago that Buffett was buying the stock at $29 per share. Buffett certainly knows the paint business since he owns Benjamin Moore. Also, he is also long General Motors (GM), which has substantial demand for paint. The coat-ing business is interesting because it’s a low CapEx, high margin business model with only 3-4 big players. Because Axalta was part of Dupont, it had a lot of fat on it which leaves from for additional margin increases. With oil prices coming down from $100 to the low $40s, there is a huge com-modity tailwind because the bulk of the inputs into producing coating or paint is mainly Brent oil based.

The size of the cost-cutting plan that management just announced is about $200 million over the next two years with an EBITDA of around $900 million right now. So you see a potential 20% growth in EBITDA just from cost cut-ting alone. Additionally, the company is growing its top-line by about 3-4% in volume terms. In addition to the top-line growth, the company also put on a price increase of 5%. This is the kind of market that can take a price increase because the buyers are fairly fragmented. The buy-ers are mainly small “mom-and-pop” shops or MSOs (multi-shop operators like AutoZone or Pep Boys). For the most part, these buyers fragmented, so they have no negotiating or bargain-ing power. Another great thing about this busi-ness is 50-60% of the business is re-curring in nature. They have a strong focus on the body shop market, which means if your car gets in an accident, you take it to the body shop. The body shop will say it costs $1,000 to repair it. About $70-80 of that total could be the paint. So whenever someone gets in an accident, they are paying for paint. Vehicular accidents are one of the most recurring incidents in the world today and are likely to continue for some time. It’s a common miscon-

ception that that paint market is linked to car sales, but it’s linked more to miles driven rather than car sales. With oil and gas prices near multi-year lows, people are driving more than ever which means more accidents. This is another tailwind for the business. It’s a global business with 40% of sales in Europe, and it’s growing well in China. So you’re getting a global exposure to car accidents too, which is a relatively uncorrelated risk to have in your portfolio. Describe how you arrived at the val-uation of the business? AH: We think cash flow will be go-ing up in the business for the reasons mentioned previously. Right now the company is priced at a 5% free cash flow yield, and should be stepping up to 7% FCF yield with EBITDA increas-ing from cost cutting. Also, the compa-ny is running around four times lever-age, and they’ll be deleveraging over time, which means interest expense will start going away with additional profit now moving its way to the bottom line. Remember, it’s not a high CapEx business. At $4 billion in sales, it’s about $50 million in CapEx, which is great.

INVESTMENT SUMMARY

Right now the company is priced at a 5% free cash flow yield, and should be stepping up to 7% FCF yield with EBITDA increasing from cost cutting. Remember, it’s not a high CapEx business. At $4 billion in sales, it’s about $50 million in CapEx, which is great.

Sources: Company reports (10Ks, 10Qs), other public information

INVESTMENT SPOTLIGHT: Axalta Coating Systems (AXTA)

Axalta Coating Systems

(NYSE:AXTA)

Description: Manufacturer, marketer

and distributor of coatings systems.

Price $28.70

52-Week Range $ 20.67—36.50

Dividend Yield N/A

Enterprise Value $9.95B

Basic Valuation:

Forward P/E 18.12

P/FCF 20.49

EV/EBIT 21.18

Notable Owners:

Berkshire Hathaway

Glenn Greenberg

Dan Loeb

Investment Ideas For Intelligent Investors

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February 3, 2015

The U.S. 30-year fixed rate mortgage would have difficulty

standing on its own, and they directly support housing ac-

cessibility and affordability. They are a big reason for the

U.S. not entering another Great Depression. And they have

very little “real” competitors.

They have be operating in conservatorship since Sep-

tember 2008, and are currently required to pay 100% of it’s

earnings to the U.S. Treasury. They are the low cost pro-

vider of low rate mortgage which is provided by great scale

advantages. And the guarantee business provides them

with an untapped opportunity to increase rates ever so

slightly (pricing power). The company’s stock performance

hasn’t been anything impressive. Fannie shares, at a re-

cent $1.73, are off nearly 60% (high-to-low) — over the last

12-months. Investors appear to be fearful by the compa-

nies never escaping the clutches of the U.S. gov’t and exit-

ing conservatorship.

A couple of high-profile investors, Bill Ackman, Richard

Perry, and Bruce Berkowitz, think otherwise. They think the

government has gone too far, and their continued litigation

against the U.S. Gov’t proves their conviction. “The govern-

ment is effectively taking 100% profits forever,” says Ack-

man. The pending litigation has taken some ups and downs

but it seems the federal claims court will be a good barom-

eter of when they are in their pursuit of justice for F&F, and

its shareholders. The federal claims court has been sympa-

thetic to investors in the past, so there is reason to be opti-

mistic. F&F shares trade today for only 1x the $1.67 per

share Ackman believes the two businesses can earn with a

60bps bump in guarantee fees.

Valuing shares at 10x his earnings power estimate, Ack-

man believes the shares are worth at least $16 (low end).

Not a bad risk-reward scenario, even if the government

continues to seize control of a public company. “We think

we can make 25x our money in F&F. A small investment in

F&F can still be very material in terms of profits for the firm,

yet if something happens and we lose our entire invest-

ment, we won’t really notice,” says Ackman.

Small position sizing (<3%), and/or a basket approach of

common and preferred stock is probably best way to ap-

proach this opportunity.

Fannie Mae

(NYSE:FNMA)

Description: A GSE used to support li-

quidity, stability and affordability in the

secondary mortgage market.

Price $1.73

52-Week Range $0.98—2.73

Dividend Yield N/A

Notable Owners:

U.S. Government

Pershing Square

Fairholme Capital

Perry Capital

Ruane Cunniff INVESTMENT SUMMARY

Trading at only 1x Bill Ackman’s estimate of normalized earnings, the company’s

stock seems to reflect market uncertainty that that the issues he considers tem-

porary are more permanent. If he’s proven right, he believes the shares are

worth more than 25x, which would put the stock at over $50 per share.

Sources: Company reports (10Ks, 10Qs, etc..), other public information

A Government Stronghold?

There is no doubt that government conservatorship will scare the majority of inves-

tors. It’s true, conservatorship doesn’t normally garner a great deal of excitement in

the investment community. But that doesn’t mean the investment can’t be an incredi-

bly profitable endeavor.

INVESTMENT SPOTLIGHT: Fannie Mae (FNMA)

Investment Ideas For Intelligent Investors

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February 3, 2015

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Investment Ideas For Intelligent Investors