Why the price you pay is always wrong – with Tom Slater

You know when you look at yourself in one of those distorting mirrors at a funfair and see a person you know is definitely you and yet there are some aspects that are weirdly different? Well, talking to our latest guest on The Value Perspective podcast, we were at times left with the opposite sensation – of talking to someone who definitely has a different style of investment and yet there are some aspects that are weirdly ‘us’.

Take what Tom Slater, co-manager of the Scottish Mortgage investment trust, has to say about conducting your own research, low portfolio turnover and adopting a long-term time horizon, when we ask him how he goes about identifying his preferred investment targets. After all, you will not find many descriptions for a business further down a value investor’s shopping list than ‘transformational growth opportunities’.

“Part of the starting point here is information sources,” Slater begins. “If you look at the fund management sector as a whole, so much of the information that flows through it comes from a very narrow set of sources. There is just a relatively small group of people, generally sitting in London and New York, who pump all of the information – at times it would be a stretch to say ‘research’ – into the industry.

“With a relatively modest amount of effort, though, there is a whole world of sources out there that is accessible to investors and might give you a different perspective on things.” Quite so – in article such as Just one more reason, here on The Value Perspective, we have consistently pointed to the merits of conducting your own research as an investor.

Turnover and time horizon

From here, Slater turns to portfolio turnover – simply put, how often a fund manager buys and sells stocks – and time horizon. “Say you have a 100-stock portfolio and you turn it over 100%, then you need to come up with 100 ideas a year,” he says. “That means you will be constantly filtering your available universe to find businesses that interest you.

“If you are going to own a business for 10 years, though, you only need to add a handful of stocks every year so your broad, shallow coverage does not matter as much. Instead, you can spend time on the areas you think are most exciting – get to know the companies, learn who the interesting academics, the bloggers and the opinion formers are in these spaces and what makes them tick, identify where you think the opportunities are.

“It comes back to what we were saying earlier about considering what happens if things go right. We are trying to identify companies with the potential to deliver amazing growth – but the truth is, most of them will not. If you pay up for a company because you think there is real potential and it does deliver on that potential, you have paid far too little for it. In the same way, for the ones that do not, you will have paid far too much.

“Either way, the price will have been wrong – you just do not know at the start in which direction. So it is not necessarily that we have much greater insight than anybody else in terms of thinking about companies – it is much more that we are prepared to accept the risk that goes with them because we know, if we do hit those outlier-type companies, it will pay for the inevitable mistakes we make as we seek out those opportunities.”

Learning from mistakes

The hunt for ‘transformational growth’ may not be our thing, here on The Value Perspective, but we too have always acknowledged mistakes are a fact of investment life and thus have evolved a process to deal with that – referring to a checklist of seven ‘Red’ questions’ for every business we analyse, for example, and each January looking to see what lessons we can learn from the previous year’s investments.

In particular, we analyse what we did right in our portfolios – and what we did wrong – and, while the great majority of people would say that all comes down to what made and lost us money, the great majority of people would be completely mistaken. For us, the right lesson to take from the process is, if I took a particular decision 100 times, would I make money on average?

As value investors, we accept we are not going to make money from every single company we buy but we do want to make investments that make money 60 or 70 times out of 100. As such, if a particular course of action turns out to have been one of the times we lose money, the lesson is not ‘never do that again’ but ‘just keep doing it – over and over and over’.

That, in essence, is what value investing is: a set of rules that helps to keep you on the right side of the averages so that, instead of being caught out by your own emotions – how ‘likely’, at the time, you believe any event is to happen or decision is to play out – you put yourself in the best possible position to exploit the emotions of others.