#18 - David Samra: Value Investing, Market Efficiency

0:06Welcome to the Insightful Investor Podcast, a weekly series that seeks to share industry investment and market insights. We define insights as concepts that are counterintuitive, widely misunderstood, or underappreciated. In other words, unique ideas that you probably won't hear elsewhere. I'm Alex Shahidi, the host of the podcast and co-CIO of Evoke Advisors, one of the nation's leading investment advisory firms. Learn more about our show at insightfulinvestor.org.

0:43Today's guest is David Samra. David is the Managing Director of Artisan Partners and the Founding Partner of the Artisan International Value Team. He's also the Lead Portfolio Manager of the strategy since its inception in 2002. David and his team manage about$40 billion of the firm's$160 billion. David, thank you for joining me today. Well, thank you for having me, Alex. David, you've been investing for over 30 years. Would you start with your background and how you originally got into investing? Well, you know, I think similar to today and all the way through history, education is the source of social mobility.

1:33And it was for me, having grown up in a blue collar family. I was in an undergraduate program that offered really just two majors, accounting and finance. And it was obvious to me that finance seemed to be a better road to social mobility than accounting. Accounting was just fine, very safe, but finance was far more interesting. And after having gone through a security analysis class, I instantly fell in love with the stock market and focused my efforts since then on a career in investing. And that's really the history. I bought my first security and luckily made some money on it and thought that, wow, I didn't have to bang a nail or pick up a hammer or do anything physical and really didn't have to do anything at all.

2:47And I thought I had discovered the road to riches. and you know i have to say that uh over the years although this isn't you know part of the way that i i i got involved but over the years what i've discovered is the main gratification of doing this is your ability to create wealth for your shareholders. And the shareholders being across the spectrum, endowments, hospitals, hospitals that are taking care of patients, art institutes that are buying art and displaying it out for the public. It's charities, that are helping people pay for their kids' college education, helping individuals retire.

3:49That is actually the most gratifying part of the job. Are there any lessons you learned early in your career that helped shape the investor you are today? Perhaps some painful lessons. Oftentimes we learn more from our mistakes than we learn from our successes. That may be painful lessons that permanently change the way you think about investing. There are a lot of lessons learned along the way in terms of understanding the difference between a good business and a bad business, good management team and a bad management team, and good risk reward versus a bad risk reward. And that really comes with cumulative knowledge and practice.

4:35prior to going to graduate school which i did at columbia business school which is the the center for value investing i believe in this country i had a small partnership in place with a few other my friends and one of them had decided that he would try to trade options. And well, we didn't really understand what he was doing. And turned out neither did he. And we ended up losing a fair amount of money on that. So, you know, the key lesson there is make sure that you have a deep understanding of what you're involved in and what the risks are versus the potential reward before you start allocating your capital.

5:27And I guess sometimes you may feel like you have a deep understanding, but your assessment of that is not accurate. Well, the world obviously is variable. Human beings are variable and it doesn't operate in a straight line. And, you know, you can do serious amounts of due diligence with very intelligent people looking at all aspects of a business that you're investing in. And, you know, things change. You know, you do a lot of due diligence on a management team and you find a CEO who is great at capital allocation who goes out and does a bad deal. you know politicians the government can can wake up one day and and change the rules you know so the the key there alex that we've found is and i'm i'm sort of stealing this uh from a friend of mine is you always want to be strong money you never want to find yourself in a position where the world changes or something changes inside a business or with yourself as an investor where you don't have the capital to be able to weather through a situation like that.

6:44And, you know, we as value investors have an obligation to think through issues, right? Because there are two fundamental concepts in value investing. Of course, the main driver is to generate excess returns. That is the core directive of value investing. But the second is to manage risk. And there are many components to risk management, and we can talk about them as we discuss the type of securities that we like and we don't like. but you have to have both of those objectives in mind. And one of the tools that we have in order to do that is to ensure that we always have financial strength. That makes sense.

7:38One of the things that I think is pretty fascinating about our industry is anybody can pick stocks, but picking securities well is quite challenging. There's obviously complexity. There are, there's randomness. There are a lot of things that are just inherently unpredictable. What do you think it is that allows you to pick securities well? And what is it about this industry that is just so challenging to do what you do so well? You know, a lot of this industry, the industry is populated with what I call products. you know uh large institutions like blackrock not to pick pick them out specifically but generally speaking the industry is out there selling all sorts of products a lot of them unthinking products you know etfs that are industry-based and unfortunately i think for or the consumer of these products, it tends to dumb down and tries to almost commoditize what they're doing with their money.

8:50All value in the world is created through commerce. And there is speculation, right? There's Bitcoin or gold or other forms of speculation, but all value over the long term is created by commerce. As Amazon gets bigger and generates more profits, it becomes more valuable. And that's how, and again, I'm not specifically picking on Amazon, but just to make a point. So we, and I think that that is the first item to recognize in your effort to be an investor. And then, okay, so all value is created by commerce. How do I make sure that I invest at a point in time in the proper company and at the right price?

9:43And that's where the hard work comes in. There are tens of thousands of equities listed across the globe. And you have to have some sort of framework that you use to put yourself in a position where you're invested in a business that will create value over time, that you understand enough about that business to ensure the value will be created, right? That's a lot of homework. And third, you have to be patient enough to wait for the right price to pay for that business to ensure that you don't overpay where the value that that commerce creates is already eaten up by the fact that you've overpaid for that value.

10:35You know, those are that's at least sort of that's the framework that we use, generally speaking, to invest capital on behalf of of shareholders. And therein lies the difference between a product and an investment platform. Our objective is to create wealth. Our customers over time should have more purchasing power in the future than they have today. And that's our general objective and our general ambition. And it's that simple. It's not trading in and out of a vehicle. It's not speculating on one thing or another, but finding the proper business at the right price and allowing that commerce to create enough value to improve the purchasing power of our investors.

11:32In my experience, talking to people getting into the industry, there's a natural tendency to focus on the companies that have rising prices. Yet, as opposed to companies that are facing price pressure, you have a slightly different orientation. I heard you in another podcast talk about your initial inclination was to look at companies where the price was falling because there's more likelihood to find value there. Do you feel like that's something that you were born with, meaning you were born a value investor, or was there something that pulled you in that direction? Well, I really do think it takes a certain human being to be a value investor.

12:16Over the years, we get approached by, of course, the sell side or broker dealers who want to assist us so they can generate commissions. and I've never gotten an idea from Broker Zeeler over the course of my career. And I always say to a new relationship there that, look, we'd be happy to have a relationship with you, but you need to know that every time you show me a stock where the share price is going up, it's probably unlikely we're going to do anything. And my guess is that you'll never, ever show us a stock where the price is going down. You know, the value of a business is the present value of its future cash flows.

13:08And if you have smart, diligent people and decent disclosure behind the asset, you should be able to, within the realm of reason, come to some estimate of roughly what the business is worth. And, you know, the stock market moves around it, gyrates around that price. And during times of stress, market psychology, which is the second aspect of what drives the stock market, it kicks in and it kicks in very aggressively. and share prices can fall well below any reasonable estimate of long-term intrinsic value for a decent amount of time. And that puts you in a place where you can generate significant excess returns and also accomplish the second component of value investing, which we talked about earlier, which is avoiding a permanent loss of capital.

14:14and it really is unique and special characteristic of the stock market that allows you to do that there aren't you know most investors will look at a company and say wow this is a great business and it's going to you know it's going to create a lot of value over time so i'm willing to pay a fair price and uh you know if you truly do have a compounder and you have a lot of trust and confidence in what the future is going to look like for that compounder that's a great way to make money, we attempt to take it one step further and say, wow, look, we found this great business and it should add a lot of value over time.

14:53But lo and behold, because of the delicate nature of the stock market and the psychological inputs that go along with money, we're able to not only own a piece of this fabulous company, but we're able to own it at a price that puts us in a place to make a spectacular return. And if things go wrong, you know, we've we've minimized our risk. You know, I always say to my clients, I don't know why you would ever put your money in private equity. You know, you have usually a knowledgeable seller doing a deal with the knowledgeable buyer, which means that the only way that they're going to add value to that is to leverage it up in some way to extract value.

15:50And if you're really interested in taking on the risk of leverage, you could always invest alongside us and leverage up your investment. And on top of that, you get the added benefit that a lot of the sellers in the stock market are completely uninformed. And that just doesn't exist in private equity. On that point, I'm curious about your thoughts about market efficiency, obviously in public markets. How do you think about that? Certainly the market's more efficient than it was 30 years ago when I got involved. And because I invest outside the United States, the markets outside the US 30 years ago were very inefficient, mainly because information simply wasn't available.

16:41You had to get on an airplane and you had to go. And all the financial statements and disclosures, which were sparse back then, were in foreign language. The reporting frequencies were very low and corporate governance standards and structures were pretty bad for somebody who was a minority shareholder. Now, that's changed. And so what that means is a company like Hermes or LVMH or L 'Oreal or, you know, take your popular company these days, you know, they'll trade at valuations that reflect the strong financial characteristics and the bright outlook for the future of those companies they'll trade at much much higher multiples than they used to back then and you know issues uh and opportunities travel through the market much more quickly than they used to in that sense the market has become um, very efficient.

17:50On the other hand, you know, I could give you several examples of where the market continues to be inefficient. And it really comes back to what you said, Alex, which is, you know, it takes a certain type of human being to run towards a problem, you know, where the share price is going down, where there's some sort of issue. And it's generally there where people have an aversion to bad news, where you find these, you know, inefficient opportunities. One recent example of that was last year, about this time, when, you know, Swiss had slipped on a banana peel, so to speak, and effectively lost the trust and confidence of its lenders and was forced into insolvency.

18:52UBS came to the rescue. UBS is a company that we were shareholder of, a smaller shareholder at that time. And you could instantly recognize the value created through that transaction. It was a very interesting transaction in the sense that most corporate acquisitions, they're done at fair prices. And companies have to work hard to get synergies to create any value uh this transaction was was was born out of desperation on the part of basically the swiss government to find a way to keep this institution from dissolving and the risk associated with that and as a result ubs and you could see the numbers they paid roughly three billion for 30 billion in assets wasn't hard to see now they're going to be restructuring charges and some asset write downs.

20:00So let's say they create 25 billion of value, which was roughly at the time about 40 or 50 % of the market cap. And the share price went down that day. So you got a lot of bad news. Credit Suisse is going bust. Credit Suisse has been a problematic company for 10 years. And so the headlines just keep pouring out. And most people have very simple reaction to negative headlines, which is, geez, I don't even want to be involved with that. Or if I am, and now UBS is going to buy this problem asset, I definitely don't want to be involved with that. Whereas as a value investor, we focus on the facts and circumstances.

20:41Hey, how much are we paying? What are we getting in return? Do we have the capital and the people and the capability in order to manage this, right? And, you know, in our view, because we knew the people that were involved and we knew these two institutions, in our view, they did have the ability to do that. And the value that was being created was absolutely enormous. And anybody could see it, right? All the numbers are out there on the table for anybody to look at in the same way that we looked at it. and yet the share price declined when clearly there was value created so in that sense that's a really good example of how you know and it took really sort of nine months before the market started to recognize it and so right there through that set of circumstances you can see how the market can be can be very inefficient it's way harder than it used to be.

21:42I'm sure. I suppose the other way to think about it is information is more readily available. And so the markets are more efficient in that regard. Yet the people trading humans, they're not that different today than they were 30 years ago. They're still, you know, decisions are driven by fear and greed, right? The people trading are not necessarily humans anymore, right? There's a lot of ETFs and structures that are just making trades based on the needs of the product that they're selling. And they're not paying attention to the underlying value of what they're buying or selling. They're really reflecting the flows that are going in and out of these products and then executing on an algorithm that is buying or selling with having zero understanding of the value of what they're buying and selling.

22:38And so that, in some sense, is also driving inefficiency in the stock market. And it's interesting because that has increased with time as index investing, ETFs, mutual funds that track an index, managers who are focused on minimizing their tracking error relative to an index, they all kind of move in the same direction. There's also one thing that very few people talk about is just like the general level of liquidity. We went through a decade of interest rates below zero and central banks, especially over the COVID time period, printing a lot of money. So there's just a lot more money out there in the world.

23:20And it's found itself in all sorts of places out there in the world. And one of the places it's found itself is in the stock market. So there's just a lot of money around. You could see it as several companies having trillion dollar plus market values. These numbers are mind boggling, right? They're just absolutely enormous. When I started 30 years ago, if a company was doing an IPO, you know,$500 million was a lot of money to raise. And now, you know, these IPOs are in the billions. With respect to market efficiency and the points that you made, how do you think about index investing. There's a lot of money that just goes into buying the index with this philosophy that the index reflects all known public information and also the consensus view of what the future holds.

24:13Is there something about, let's say, the value index that is just really inefficient and I guess in some ways relatively easy to outperform? How do you think about that? I looked at that value index when I started here at Artisan 20 years ago, and it was filled with banks and oil companies. And I thought, well, why would anybody want to invest more or less most of their money in banks and oil companies? It didn't make any sense. I think a broad-based index for comparison purposes, right? Am I doing a good job? Am I providing my shareholders with a return in excess of what they could get just from investing in an index?

24:59And you want something that's broad-based. In fact, because we have the flexibility to invest in emerging markets, we actually added an index on top of the broad-based index that we used to broaden it out even more to include emerging markets, which have done better over time than the European and the Japanese markets. So we actually made it harder on ourselves than, you know, I could certainly do better over time than banks and oil companies. And there's nothing wrong with them. I mean, we've invested, you know, during certain periods of time in certain institutions that we think are fantastic and we're able to get them at the right prices in those industries.

25:47But I certainly wouldn't want to have my entire portfolio and assets like that just because they don't compound over time. I think that if you are a saver, generally speaking, and you would like to have the ability to get exposure to commerce to drive value over time, but you have no knowledge or interest in getting to know managers who can help you, then an index is certainly a broad based index is certainly an excellent alternative to you know taking the risk you can use services like morningstar you know that that rank managers but really taking the time out to study a manager and look at their performance over time and reading what they say in their shareholder letters uh i think is an important aspect of of trying to find somebody who, you know, has the same disposition that you do as an investor, you know, is it an aggressive growth stock investor, a value investor or a momentum investor, you know, something that reflects the way that you like and feel comfortable doing things.

27:07But outside, if you don't have the interest or the ability, you know, you're better off indexing your capital than trying to select a manager. I know you focus on international. It is interesting when you look at the data going back a couple of decades, US has pretty materially outperformed international. Is there any reason to think that there's a structural reason for that to continue? Or do you expect that to mean revert over time where these markets get you similar returns through time? Well, the US is obviously a pretty unique place. We have 330 million wealthy people. We operate in one country with one language, one legal system, very few barriers from state to state.

28:02So you can apply commerce across the entire country without a lot of issues keeping you from doing that. And remember, our industrial base was gutted decades ago. It's starting to come back a little bit now, but it was basically gutted, leaving us with an economy that is innovation-driven, right? A lot of technology and healthcare and services, which are, by their very nature, high return on capital, faster-growing industries. And as a result, we also have, which is somewhat unique around the globe, very robust venture capital, private equity, and stronger capital markets. I mean, people save in their 401ks or their IRAs or their general brokerage accounts and are willing to take risk with their capital.

29:01That's not the same everywhere in the world. And most of the markets that I invest in outside the United States, the largest capital pool comes from U.S. investors buying equities in those markets. When you look outside the U.S., you just don't have, you know, Europe, even though they tried through economic union to, you know, pull themselves together. It's still really just a number of countries with different cultures, language barriers, legal barriers, political barriers to doing business across the continent. And of course, now with Brexit, the UK has moved out of that system. uh japan you know has 150 million what used to be wealthy people but you know very different culture and a government that was sort of hell-bent on generating inflation ended up impoverishing their population slowly but surely so they're out of the game now they've got so much debt to GDP, it's unlikely to, you know, turn into the same dynamic that the U.S.

30:26has. There's also, you know, social structures and legal labor-related structures that make it very hard for that economy to have, and also immigration structures that make it hard for that economy to have the same sort of dynamism. The one hope that was out there for a long time was China, You know, a billion people, one country, more or less one language, one legal structure that has a lot to be desired, to say the least. and they in China had developed a great venture capital and private equity industries there and for a while until the current administration came in under Xi Jinping and sort of started going backwards too aggressively you know China had the promise of turning into something that challenged the economic system here in the United States.

31:25So as a result, you've got, you know, sort of industries that are older, more capital intensive, lower return on capital, slower growth economies. And so I think that the US, you know, should, you know, all else equal, you know, you have periods of overvaluation and undervaluation, but all else equal, the U.S. should economically continue to outperform the rest of the world. Now, luckily for us, the nature of the business, there just aren't that many great businesses outside the United States. I'm not saying there aren't any, but there just aren't that many. And that really does lend itself to value investing.

32:15And so the universe for us over the last 20 years here at Artisan has been incredibly robust. Companies that are slower growing, but maybe great businesses, they have issues here and there and valuations get very, very attractive. And for people like us that have a very distinct value strategy, it creates tremendous opportunity. It's hard to be a gross stock investor outside the US. That's a tough place to be. Well, would you just talk about your general approach to value investing? Obviously, you want to buy good businesses with good management teams, strong balance sheets at a discount to intrinsic value.

33:00Is there more insight you can share about how you do that really well that maybe the market isn't properly discounting? Well, I think that stating that construct, an undervalued company that's a good business with a strong balance sheet and a good management team, stating those is very simple. Finding those in combination is like finding a needle in a haystack. It's very, very difficult. and you know you're as a value investor we don't compromise on buying an undervalued security that's where we generate our excess returns and that's how we manage risk but you're going to find that some businesses are better than others some balance sheets are stronger than others and some management teams are better than others and you're always as you go through your fundamental homework to look at the nature of the business and assess those characteristics, you're always lining up valuation relative to those other characteristics and finding that proper mix between the right price for the type of business, its underlying growth rate, its return on capital, its cash flow generation capability, the quality of the management team, the nature of the corporate governance of that company and getting that balance between quality of business and valuation correct is what makes a difference between one investor and another investor.

34:48And really, that goes back to what we talked about earlier. That's all cumulative knowledge built, Right. That's being in the markets for many years, watching businesses, watching them operate, how they create value, watching management teams, looking at corporate governance structures and incentive systems and what is effective in creating value and what structures impede the creation of value. And so experience is very, very important. Experience and discipline. One of the things you just said, I think is absolutely critical. And a lot of people may not emphasize it as much as you did, which is, it's all about price.

35:34That's the one thing you don't compromise on. Because it helps you not only on the return side, but also to help manage risk, which is, you know, the dual mandate. And if you could just talk about that a little bit more, because I think it's so critical. And I think a lot of people just miss that part. Yeah, it gets lost in a lot of dialogue, you know, because it's very seductive to talk about a business and how great it is. Right. And especially, you know, for a company like NVIDIA, or whatever is the most popular company out in the market. it. People just want to be associated with success. And it's very easy to be associated with success.

36:21You just open up a brokerage account and boom, you're in. But if that success comes at a price that's too high, you put yourself in the potential position for a permanent loss of capital. And there are many examples. Over the years, we had the tech bubble and we may have another one now, although this one is better based on fundamentals than the last one. But for us, it's exactly the opposite. Let's start with the price. right let's start with the valuation here's a group of securities that look like they're trading it reasonable to cheap multiples and then let's go in from there and start eliminating the bad businesses let's eliminate the bad balance sheets let's eliminate the incentive structures and the corporate structures that will work against us as shareholders.

37:25And then let's look at the management team and see how well they've executed over time. And let's take a look at the decisions that they've made. Are these people that we really want to be involved in? But the excess return really comes from buying a company that's worth$30 at$20. And not only do you have, let's say, a great business. It's growing at 10 % a year. So if you start out and it's worth 30 and a year goes by, now it's worth 33 and another year goes by, now it's worth 37, 38, right? And because you bought it at 20, you not only capture the unwind of the discount from 20 to 30, but you also capture that underlying growth and the value of the business.