A Stock Picker’s Recipe for Success
The CFA Institute Equity Research and Valuation Conference is an annual event covering global investing strategies and valuation approaches and analysis. The Equity Research and Valuation 2018 Conference, hosted by CFA Institute and CFA Society New York, will be held 6–7 November in New York City.
Fidelity fund manager Chuck Myers, CFA, got started in investing at the age of 12, and before he had finished high school, he placed second in a national stock-picking competition. Since 2006, he has been at the helm of the Fidelity Small Cap Discovery Fund, which has significantly outperformed the Russell 2000 Index over the last decade.
At the CFA Institute Equity Research and Valuation 2015 Conference in Philadelphia, Myers credited much of his success to the influences of legendary investors like Warren Buffett, Benjamin Graham, and Seth Klarman, as well as to genetics. As Myers explained, appreciating the wisdom found in Buffett’s shareholder letters, Graham’s The Intelligent Investor, and Klarman’s Margin of Safety is “either in your DNA or it isn’t.” In practice, Myers has applied the collective work of his investing forebears to his search for those rare standout stocks that he refers to as “six-foot-tall second graders.”
Myers drew on his experiences as a value investor and shared some of the lessons he learned along the way that have come to shape his investing philosophy. These lessons are summarized below and are well worth heeding.
- Learn from the best, but think independently. Besides reading the investing classics, Myers has had the benefit of working alongside portfolio managers with stellar long-term track records, like Fidelity colleagues Joel Tillinghast and Will Danoff. He found that there are many paths to investing success, and the best investors are the ones who have learned from others but gone on to chart their own courses based on their unique skill sets. Myers has done just that in developing his own brand of “low expectations” value investing, whereby he seeks out-of-favor stocks that are ripe for a turnaround.
- Stay within your “circle of competence.” Early on in his career, Myers had a six-month stretch during which his fund underperformed its benchmark by over 1,000 basis points (bps). While his strength had always been stock picking, his portfolio contained significant sector bets and a big overweight in international stocks. It was these ill-timed factor bets outside his circle of competence, and not his stock selection, that dragged down his performance.
- Aim for the “middle of the fairway.” Building on the previous lesson, Myers underscored the importance of portfolio construction when it comes to beating your benchmark. Prudent golfers will sacrifice a little bit of distance off the tee to ensure that they keep the ball in the middle of the fairway, increasing their odds of success. Having to hit your ball out of the rough or a fairway bunker is likely to cost you strokes. Similarly, portfolio managers would do well to minimize risk in those areas where they lack expertise. If your strength is stock selection, avoid making significant bets on factors like sectors, style, and market capitalization.
- Relative valuation matters. While most investors seek to buy assets for less than their intrinsic value, Myers noted that it was equally important to understand the opportunity set and relative valuation. Hedge fund investors will typically focus on absolute returns, and mutual fund managers usually talk in terms of relative returns, but Myers pays close attention to both. In 2008, his fund was defensively positioned and this served him well when stocks plunged. However, as Myers’s portfolio of stocks still looked attractively valued on an absolute basis, its defensive nature would likely cause it to underperform as the market rebounded. As a result, he turned over his portfolio by over 100%, positioning it in beaten down stocks, including home builders and REITs, which went on to lead the market’s recovery.
- When it comes to turnover, patience is a virtue. Citing Morningstar data, Myers noted that across market-cap segments and style, the top performing funds over long time periods have lower turnover than the poorest performers. Sell a stock in your portfolio, he said, only if you’ve found one “orders of magnitude better to replace it.” And while Myers generally subscribes to such a hands-off approach in times of low valuation dispersion (defined by Fidelity as the difference in earnings yield between the 20th percentile and the 80th percentile of stocks, standardized through time), he also thinks portfolio turnover should be dynamic. In 2008, valuation dispersion spiked, and Myers took advantage of the “changing prices on the menu.”
- Focus on a margin of safety. According to Myers, a true test of an investment’s margin of safety is found on the balance sheet. Investors should consider whether a company can weather a severe financial crisis like 2008 without having to raise money and dilute its shareholders at an inopportune time.
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All posts are the opinion of the author. As such, they should not be construed as investment advice, nor do the opinions expressed necessarily reflect the views of CFA Institute or the author’s employer.
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