Summaries below are extracted from a speech Michael Price gave at the 2013 (June) London Value Investor Conference. If you have read our previous article based on an interview Peter J. Tanous conducted with Michael Price many years ago, you’ll find that Price’s portfolio management philosophy has not changed much since then. Many thanks to my friend John Huber of BaseHitInvesting for sharing this me with me. The complete video can be found here (Market Folly). Cash, Volatility, Patience, Hurdle Rate
2/3 of his portfolio consists of “value” securities (those trading at a discount to intrinsic value), and remaining 1/3 are special situations (activism, liquidation, etc). When he can’t find opportunities for either category, he holds cash.
The expected downside volatility of this type of portfolio in a bear market (excluding extreme events like 2008) is benign because when the overall market declines, cash won’t move at all and securities trading at 60% of intrinsic value won’t move down very much.
The key to constructing a portfolio like this is patience, because you must be willing to wait for assets to trade to 1/2 or 1/3 discount to intrinsic value, or sit with cash and wait when you can’t find them right away.
Price says he does not have any preconceived notions of what amount of cash to hold within the portfolio (aside from a 3-5% minimum because he likes “having the ammunition”). Instead, the portfolio cash balance is a function of what he is buying or selling. Cash increases when markets go up because he is selling securities/assets, and cash decreases when markets go down because he is buying securities/assets. He also mentions that he doesn’t care what he’s earning on cash, which is interesting because does this imply that Price’s hurdle rate for investments is likely always higher than what he can earn on cash?
Sizing, Diversification
Price prefers to hold a more diversified portfolio of cheap names, spreading his risk across 30-70 positions, “not 13 holdings.” Over time, as he does more work, good ideas float to the top, and he sizes up the good ideas as he builds more conviction, whereas names that are merely “interesting” stay at 1% of NAV.
The resulting portfolio may have 40 securities, with the top 5 names @ 5% NAV each, the next 5-10 names @ 3% NAV each, and the next 20-30 names @ 1% NAV each.
Price likes constructing his portfolio this way because he is then able to compare and contrast across more companies/securities, to help drive conviction, making him smarter over time. It’s a style decision, and may not work for everyone, but it works for him.
When To Sell, Mistakes, Tax
Price calls it the “art of when to sell things” because it’s not always straightforward, and especially tricky when a security you purchased at a discount to intrinsic value appreciates to 90-100% of intrinsic value. For example, he bought into the Ruth's Chris rights offering at $2.50/share, and the stock is now trading at $11/share. He sold a quarter of his stake because “it’s getting there” and “you don’t know when to unwind the whole thing so you dribble it out.”
Other rules for selling: when you make a mistake, or lose conviction. Especially important before it becomes long-term gains because it will then offset other short-term gains dollar-for-dollar (anyone investing in special situations / event-driven equities will likely generate a good portion of short-term gains).