Value Investor Interview: Jae Jun, Old School Value

This interview was part of the May 2015 issue of my premium newsletter on value investing, behavioural finance, and business analysis – Value Investing Almanack (VIA). If you wish to read more interviews with value investors, you can click here to subscribe to VIA now.

I’ve admired Jae’s work at OSV and thoughts on investing for long, much before I started Safal Niveshak. So it was great to interview him for Value Investing Almanack. Let’s get straight into Jae’s experience and philosophy on investing.

Safal Niveshak (SN): Could you tell us a little about your background, and also about your wonderful blog Old School Value?

Jae Jun (JJ): I believe my path to investing is very similar to most people. I met a life insurance salesman who convinced me that I needed life insurance that also acted as an “investment” account. A 2-in-1 deal which I blindly agreed to without doing any homework.

The reason for my poor decision was because I saw friends and colleagues making money in stocks and I wanted to do the same. I also believed that anyone in the financial industry knew a lot more than I ever would. After I started Old School Value, I realized it was the opposite. Most people in the finance industry don’t know a thing about finance.

After several months, I would check my shiny new “investment” account, but things didn’t look right. The market was up 10%, but my account was doing nothing and a lot of the insurance premium were deducted as fees. After some digging around, the veil fell from my eyes and I saw the sucker I was. I immediately cancelled the life insurance, forfeited all the money and locked in my first 100% investment loss.

I figured that, if I wanted to lose money, I could do it myself and at least have some fun doing it. That’s when I started digging into articles, magazines and books and documented my learning through Old School Value.

I thoroughly enjoy sharing and educating people and the blog is an outlet for me so that I don’t have to bore my wife or friends to death about balance sheet analysis and how to value stocks.

Coming from a telecommunications engineering background, I grew up with tunnel vision. I never considered the possibility that I would enjoy business or finance. So my entire schooling years were dedicated to math, physics and other engineering courses. I never took a course in accounting, business or economics. Investing and starting Old School Value really opened my eyes to a new world.

SN: What got you interested in investing, and how you’ve evolved over time as an investor?

JJ: My dad is a trader and I witnessed the emotional highs and lows he experienced from making and losing a huge amount of money. At an early age, I concluded that investing in the stock market was equivalent to gambling.

After having lost everything that I put into the life insurance investment account, the initial anger was a huge motivator for me to put aside my biases about the stock market and to really learn how it worked.

My wife (girlfriend at the time) had a book called “The Intelligent Investor” which was recommended to her because she too wanted to become a life insurance saleswoman.

The irony – the book itself was horrible!

I must have fallen asleep 10 times or more before I finished the book and to this day, the only aspect I do remember is the reference to Mr. Market which was the only thing that made sense. However, the book acted as a lighthouse to the value investing path.

In the beginning, I solely focused on buying cheap cigar butt stocks (net-nets) and experimented with many different strategies to return as much profit as possible. This is where my biggest evolution has come from. Instead of searching for high upside stocks, I now look for opportunities where the downside is low.

By focusing on the downside first, the upside always takes care of itself.

SN: How did you train yourself to be a value investor? Did any particular books or investors inspire you?

JJ: I read about Buffett, read about Mohnish Pabrai, Charlie Munger and all the other value investing greats you know about. I even learnt how to value stocks using a DCF early on and I spent days playing around with it and “testing” it with play money.

I did well in those play money accounts.

But do you remember how in school you come to a realization that there’s theory and then there’s the real world?

As soon as I put down all those books and started a real money account, that came into practice immediately.

The best training came from the money I lost. I experimented in areas I wasn’t cut out for; investing in junior mining stocks, macro calls, bankruptcies and using too much money in a single arbitrage situation. That’s just a short list.

For a list of books that have helped shaped me as an investor, I’ve created a dedicated page with the list of books sorted by difficulty.

SN: Speaking of personality traits and life experiences, what are some that you think have shaped you as an investor?

JJ: There are two.

First, as Warren Buffett said –

I am a better investor because I am a businessman and a better businessman because I am an investor.

Unless you are an executive level manager at a company or you run your own business, you won’t fully understand and appreciate what the above quote means.

Before I started my own business, my focus was on making money which caused me to miss or ignore important information over the profit potentials. Red flags such as excessive related party transactions, overcompensating a CEO and too much power held by a CEO.

Now I see a much fuller picture and am able to apply it when analysing and choosing the companies I wish to invest in.

The second is Charlie Munger’s multidisciplinary approach that he believes is the best method to deal with a set of problems –

You’ve got to have multiple models. And the models have to come from multiple disciplines because all the wisdom of the world is not to be found in one little academic department. That’s why poetry professors, by and large, are so unwise in a worldly sense. They don’t have enough models in their heads. … You may say, ‘My God, this is already getting way too tough.’ But, fortunately, it isn’t that tough because 80 or 90 important models will carry about 90% of the freight in making you a worldly wise person. And, of those, only a mere handful really carry very heavy freight.

Many times, my analysis or understanding of a business or industry is enhanced from the experience I’ve gained from my engineering, marketing, sales, and even simple everyday life events. Investing mostly involves understanding the situation as opposed to trying to solve a problem, so that makes it even easier.

I used to sell a lot of things on eBay during the early years so from that experience, I’m able to understand the business of eBay, why they make changes to certain fee structures and the layout of the website, the e-commerce industry, the challenges of growing in such a space, the disadvantages of eBay compared to competitors as well as the advantages.

All this from simply selling my rubbish on the site. That’s the power of a multidisciplinary approach.

SN: What are some of the characteristics you look for in a high-quality business?

JJ: Moat is very high on the list but the thing is that most companies don’t have one. So it’s important to check that the numbers from the financial statements confirm that a moat exists. Some rules of thumb for a high quality business are – return on invested capital above 15%, free cash flow growth with a low level of capex needed, and a consistent or improving cash conversion cycle.

SN: How do you think about valuation? Do you have a preferred valuation framework to assess the attractiveness of an investment?

JJ: Outside of the stock market, valuation is all people care about. Whether it’s buying a new home, new car or something as simple as a microwave, people will spend hours days and months to find that perfectly price car or home. This is how I approach valuation. It’s is the single biggest controllable factor for an investor that will either make it or break it for you.

I don’t have a single preferred framework or valuation method as I find that it forces me to fit things into a box.

Remember those children’s toys where there are holes made of various shapes and you have to put the correct shape into the matching hole? That’s how I feel about valuation. With just a single framework or valuation method, it’s easy to use a DCF for companies where a DCF may not be appropriate, or base a decision using a P/B ratio where P/B might not make sense.

The first step of any valuation framework is to first understand what type of company it is, and then apply rules and formulas that are appropriate for that particular business.

SN: What have been your biggest investment mistakes and what lessons have you learned from them?

JJ: If valuation is the biggest factor for an investment, position-sizing is second. When all my mistakes are boiled down, it fits into either category, but my biggest are a combination of both.

I bought a company where I compromised on the price. I was too eager to buy and pulled the trigger. Buffett calls investing a no-strike baseball game. There was no need to swing until it became a fat pitch, but I swung anyways.

My position sizing was good to start with, but as the stock moved up a little, I felt like I was going to miss out on this great opportunity and bought more than I could chew.

Over the next few quarters, things started to go south and by the time I sold out, the loss was much bigger and affected my portfolio more than it would have had I stuck with my original sizing strategy.

Every investment involves risk and the best way to mitigate risk is to make sure you buy it at an attractive price and limit damage with good position sizing. As small investors, we can’t take over the board, change the behavior of management, influence how a product will be bought and sold. These are external factors that certainly need to be analyzed, but the internal factors that can be controlled are via good valuation and allocation.

SN: Do you believe in investment checklists? If yes, what are the most important points in your checklist?

JJ: If checklists have proven to work in other industries (aeronautical, medical, car mechanics), there is no reason why it doesn’t work in the investment field.

However, checklists have to be used wisely. It’s so easy to create a 200-points checklist, but there has to be a clear purpose to the checklist. Just like what I mentioned about an investing framework, I believe that it’s best to have numerous short checklists specific for industries or situations. You wouldn’t use the same checklist that you use on IBM for a special situation investment like a spin off.

There’s also a danger to a checklist. If you have a 10 page checklist that takes 5 hours to go through, you run the risk of feeling obligated to buy the stock due to the time you’ve invested. That’s why it’s important to keep it as simple as possible. Remove old and outdated checkpoints. Einstein simplified the theory of relativity into an equation that anyone can remember. E= mc^2.

SN: How do you check for corporate governance in a company? What factors do you consider in doing so?

JJ: I keep it simple by checking the proxy documents a company has to file in the US to see whether management are getting special perks that should be personal expenses. Things like company paid jets, yachts, gym memberships and full health insurance coverage that should come out of pocket.

I also check to make sure that if SG&A (sales, general, and administrative) overhead rises sharply, it’s not due to expenses like the ones mentioned above. Lastly, another quick check I like to perform is to compare the ratio between executive compensation and revenue.

SN: What are some of the tricks that you use to save yourself from behavioural biases? In other words, how do you minimize the mistakes of behaviour in your investment decision making?

JJ: I wouldn’t say these are tricks because the number one defence is to acknowledge your weak areas and know when it’s likely to happen. In other words, it’s about setting up boundaries to save yourself from falling to behaviour biases.

A recovering alcoholic is going to set up boundaries to put himself in a position to succeed by avoid routes that take him by the liquor store. A business relationship remains strong when boundaries and systems are set up to help and benefit both parties.

So this is what I do. I’m trying to put myself into a position where I can succeed. If I put myself in a situation where I’m constantly thinking about the stock price or worried about losing money, then I’m bound to fall into bad habits. That’s why I stay away from stock talking media, I don’t talk about stocks with friends or family, I don’t read too many stock articles, I’m not out looking for a new idea every day.

SN: What’s your two-minute advice to new investors or students interested in a career in investing?

JJ: Become an expert in accounting. The language of business and investing is accounting. But don’t just end there. Learn to understand, speak and interpret the language instead of just knowing the alphabets.

SN: How do you avoid the noise and the overload of information that is available these days?

JJ: Similar to what I mentioned above. I also go to the source to get my facts like the company filed documents. Noise is made up of people’s opinions and most people don’t know what they are talking about. They just regurgitate what they hear. I also make sure to follow credible people that I trust in order to get information that has been filtered out already.

SN: Well, thanks a lot Jae for the amazing insights you shared with Safal Niveshak readers.

JJ: It was my pleasure, Vishal. Thanks!