Market Storms, The Zulu Principle, The Material World, and Company Updates
Market Storms, The Zulu Principle, The Material World, and Company Updates
How to find and source ideas when the market doesn't leave many obvious opportunities.
Market Storms
Eventually, every investor reads the story about how Warren Buffett closed his partnership in the late 1960s just ahead of a sustained market drop.
In his January 1967 letter, he wrote:
In the last few years this situation has changed dramatically. We now find very few securities that are understandable to me, available in decent size, and which offer the expectation of investment performance meeting our yardstick of ten percentage points per annum superior to the Dow. In the last three years we have come up with only two or three new ideas a year that have had such an expectancy of superior performance. Fortunately, in some cases, we have made the most of them. However, in earlier years, a lesser effort produced literally dozens of comparable opportunities.
It proved to be a legendary timing. In January 1969, the Dow Jones Industrial Average was 8,365 and didn’t reach that level again until the 1990s.
As Buffett noted in the above quote, he grew nervous as deep value ideas became fewer in the Nifty Fifty era. Of course, he had not yet bought See’s Candy (1972) and hadn’t fully come around to Charlie’s advice in 1965 to focus on buying wonderful businesses at fair prices. That approach, as we’d learn, would be deployed at Berkshire under a corporate rather than partnership umbrella.
Still, we today can relate to Buffett’s lament that obvious ideas are harder to come by in strong markets.
I’ve often used the analogy of going seashell hunting with my wife, who is an avid beachcomber. The way to find the best seashells is go out after a storm and/or to go to uninhabited beaches.
It’s similar to finding investment ideas. Either you need to venture out while others are still sheltered from the storm, or you need to look in places that take a little extra effort to get to. More on that in a moment.
This doesn’t mean that you can’t stumble on a great specimen while walking down a popular beach on a sunny day. The opportunities are just fewer and further between.
We haven’t had a good “storm” in the market since 2022 when the spike in inflation and interest rates collapsed multiples, leaving more “aim small, miss small” opportunities.
We can’t control the timing or duration of market storms. In storms, where the entire market is impacted, what you need is the right behavior (i.e. using a bucket rather than a thimble) - and available cash - more than anything else to have a successful hunt.
Absent a storm, the opportunities are less obvious and require additional work on our part.
The Zulu Principle
When I worked in London years ago, I was introduced to an popular investor there called Jim Slater who developed a research concept called “The Zulu Principle.”
One day, Slater noticed that after his wife read a Reader’s Digest article on the Zulu tribe that she was better informed on the subject than he was. If she were to take it a step further and read books on the Zulus at their local library, she might be the best informed person in their town.
If she traveled to South Africa and lived among the tribe for six months, she might be one of the best informed people in the world.
In his book, Slater then explains how this approach can be applied to investing:
The key point is that the history of Zulus and their habits and customs today is a clearly defined and narrow area of knowledge into which my wife would have invested a disproportionate amount of her time and effort, with the result that she would have become an acknowledged expert. The study of this noble people might not have been profitable, but there are many other very specialized subjects that would have been very rewarding financially.
This is the type of approach that can help you find investment opportunities absent a market storm.
Let me explain.
As we discussed in “Look at Your Fish”, the longer you study something, the better you understand its true form, or its essence.
When Slater’s wife read the Reader’s Digest article on the Zulus, for example, she likely had some neat facts to share about the tribe, but would not yet have developed a deep understanding of why the Zulu tribe operates the way it does.
That level of understanding only comes with time and effort and, quite frankly, the professional money management industry is not set up to reward this approach.
How can it when the average stock is held for just 10 months?
The attention is instead placed on finding relative valuation opportunities and catalysts that might unlock value in a short period of time.
If you’ve carefully read a company’s annual report (including the footnotes) and the proxy statement, you’ve already done more work than most bother to do. Read the last ten year’s annual reports and you’re now in a different class. Follow the company for five years, listen to all the earnings calls, talk to other investors about it, speak with former employees of the company, and so on and you’ll find yourself in the top 1% of investors who understand the company.
One way to be contrarian, then, is to “invest a disproportionate amount of time and effort” in a “defined and narrow area of knowledge.” Tying this back to my seashell analogy, this is the work others aren’t willing to do to find ideas.
As I was recently filling out my new firm’s portfolio, for example, I added a company I’ve followed for over 13 years and turned down once before following what I believed was a poor acquisition.
This time around, when I spoke with the company and a former employee who had knowledge of the acquisition in question, and paired it with some other work I’d been doing, I gained some new insights that improved my understanding of the business. It became clear that I was undervaluing the company and the market probably was, too.
That opportunity would not have come about if it was my first time looking at the company and I hadn’t already put many hours of work into it.
The current market doesn’t have many obvious value opportunities. It’s not like walking down a beach after a storm and picking up beautiful shells by the bucketful. Abundant opportunities provided by storms will happen again, of course, but they’re unpredictable.
The only thing we can control is the work we’re doing each day. Follow companies, industries, and ideas that fascinate you, and over time, opportunities can present themselves that are non-obvious to those who haven’t done the work.
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At the time of publication, Todd, his immediate family, and/or KNA Capital Management owned shares of Berkshire Hathaway.
Please see important disclaimers.