Value Investor Insight – Whitney George (Sprott Asset Management) Interview, December 30, 2017
You focused almost exclusively on small caps during your tenure at Royce & Associates, but one fund you brought with you to Sprott invests in big and small alike. How did that come about?
- We didn’t take advantage of it until 2009 when very large, high-quality companies started to trade at absolute valuations that were too attractive to ignore. When you can buy Microsoft, Exxon or Apple at valuations that you’re only accustomed to seeing in ignored and out-of-favor small- and micro-cap stocks, you should do it
- As a long-term investor in smaller stocks, you can often see ideas grow from small, to mid-cap to even large over time. I generally don’t want to have to sell the companies I know best just because of the cap size
You describe favoring high-quality companies but don’t seem to have any problem with very cyclical businesses. How do you define quality?
- Strong balance sheets, earn high returns on capital through the cycle, and have people running them who allocate capital intelligently and whose incentives are fully aligned with shareholders
- I’m also trying to buy at an attractive absolute valuation – our estimate of a company’s normalized operating earnings divided by its EV in the low-to mid-teens
- Those moments of weakness aren’t always a function of cycles but basic cyclicality that you can understand is very often a source of mispricing
- I’m basically doing time arbitrage – finding companies where economic, industry or company-specific disappointments prompt short-term investors to sell me their shares at compelling absolute valuations based on what I consider normal longer-term earnings power
- We arrive at what we believe the business is worth on five-year average earnings or some other reasonable estimate of normal; if you keep your head while the quarterly earnings game drives people batty, these types of opportunities can be very attractive over time
What other types of situations allow you to buy quality on the cheap?
- There’s still something to be said as well for detailed, fundamental research
- Have owned real estate investment company Kennedy-Wilson on and off for 15 years and consider it one of the best real estate managers in the world, with a track record to back that up. But it’s also organized in a complex, not-easy-to-understand way. If you peel apart individual projects you can better understand value and take advantage when the market isn’t recognizing it
You’ve long been active in precious metals. Describe why.
- Physical gold in particular I consider a great diversifier over the long term because it moves differently at different times from stocks and other assets. Think of it as a simple, less expensive alternative investment, providing a hedge against things not going as perfectly as expected
- Developed countries have too much debt to ultimately service or pay back, but rather than default, the likely path will be to debase currencies – gold is a way to protect against that and profit from it
What’s your take on the cycle in the gold-mining sector today?
- We’re in a sweet spot. The bear market in gold and precious metals exposed a great deal of malinvestment, resulting in a significant number of management teams being removed and replaced
- There is capital discipline now and probably even some underinvestment in development
- If interest in precious metals increases, mining companies’ leverage to higher prices is far greater than it would have been 3 years ago
Most precious-metals investors have scars from ideas gone wrong. One of those for you was Allied Nevada Gold, which went under in 2015. Lessons?
- Problem very often turns out to be deceitful management, compounded by a balance sheet that can’t withstand it when the deceit results in too much cost and not enough revenue
- That’s nothing new. Unfortunately, knowing it doesn’t guarantee it can’t still happen
Do any of your gold stocks stand out as particularly compelling today?
- Franco-Nevada and Randgold Resources are unique in that their shares have outperformed the price of gold reasonably significantly going as far back as 2000
- That’s rare and would explain why their stocks are somewhat expensive relative to peers at the moment. But that’s probably where I’d go first if there were a correction in metals prices
In general, are you finding enough to do in today’s market?
- I would normally at this stage in a bull market have to be in the weeds with micro-cap stocks to find attractive-enough valuations
- But the market seems more bifurcated, with values still showing up across the capitalization spectrum
- Valuation of Apple is not challenging. Western Digital trades at 6x this year’s earnings. I can’t make sense of those valuations any more than I can at the other end with something like Tesla or Amazon
- I look to buy when normalized operating-earnings yields are in the low- to mid-teens. On the other side, I’m looking to sell when those cap rates get closer to 8%
- One advantage of having done this for a long time is that you already know a lot of companies, know where you’d buy and where you’d sell, and can just wait for Mr. Market to throw you opportunities from time to time
- Companies I own have tended to be investing rather than hoarding capital. At the margin they’re looking to enhance their businesses while others have been more focused on paying dividends and buying back stock. I generally take it as a positive sign when well-run companies are investing rather than retreating
You’ve said you typically average in and average out of positions. Why?
- It reflects the fact that I generally don’t believe I have enough clarity to make whole-position decisions all at once
- For example, Westlake Chemical is a long-term holding that has done very well and has been hitting valuation targets. I’ll acknowledge when that happens and start selling in 5-10% intervals, but I will also go back and revisit if I’m missing something the market seems to think it knows
- I can’t reliably bottom-tick or top-tick anything
Sprott Focus Trust trades at a 12% discount to NAV. Why, and are you trying to do anything about it?
- The premium or discount of the typical closed-end fund, at least partly reflects the popularity of the underlying concept
- When we acquired Focus Trust in 1996, it traded at a 20% discount. In June 2007, it was at a 12.5% premium. After I left Royce, it traded back down to an 18% discount
- Closed-end fund is a great platform to manage money because the crowd doesn’t have to affect your investing. You have a stable capital base and that’s a tremendous advantage over an open-end mutual fund
- I don’t intend to sit here with a large discount to NAV. Nearly 25% of the capital in the fund is my own and it wouldn’t make sense to leave it chronically undervalued
- We can tell our story better but in the end, to shrink the discount, I’m going to have to perform. That tends to heal all wounds in this business
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