Thursday, October 27, 2016

Boyles Asset Management – Q3 2016 Letter Excerpt

Disclosure: I am a portfolio manager at Boyles Asset Management, LLC ("Boyles") and the fund managed by Boyles may in the future buy or sell shares of the stocks mentioned below and we are under no obligation to update our activities. This is for information purposes only and is not a recommendation to buy or sell a security. Please do your own research before making an investment decision.


Resisting Change and Searching for New Ideas

“Out of every hundred new ideas ninety-nine or more will probably be inferior to the traditional responses which they propose to replace.... It is good that new ideas should be heard, for the sake of the few that can be used; but it is also good that new ideas be compelled to go through the mill of objection, opposition, and contumely; this is the trial heat which innovations must survive before being allowed to enter the human race.” - Will and Ariel Durant, The Lessons of History

We are often asked how we find new ideas. While we discussed the specifics in detail in our Q1 2014 letter, the short summary is that we read a lot, run both quantitative and qualitative screens, and continually try to develop a network of philosophically like-minded investors with whom we can discuss ideas and learn. Basically, we turn over a lot of “rocks” in our search for worthy investment ideas. And of those many rocks, we deem only a select few worthy of being attractive enough to dive deeply into, and fewer still worthy of actual investment.

There’s a certain attraction to new things, especially when it comes to investing, where the prospect for profits often comes attached with a management team that can tell a good story. But most of the time, when new potential investments turn up, the right course of action is to do nothing at all, as far as putting capital to work is concerned. Investing is a field in which knowledge is cumulative, so objective work properly done doesn’t get wasted. It builds a base for potential future investment, even if nothing gets done when that knowledge is gained.

Overall, we’ve been managing a fund for just about ten years, mostly focused on finding small companies, so we’ve gotten to know quite a few businesses we’d like to own, should they ever get down to the price at which we’d like to own them. When we do decide to swing the investment bat, it may occur after years of following and getting to know those companies and management teams well, as was the case with two of our larger holdings in BrainJuicer and Cambria Automobiles.

“People say that you should change your mind when the data changes; but I change my mind even when the data doesn’t change, because I reanalyze the situation every day and sometimes I just come to a better analysis. And I think actually what I said yesterday I don’t believe anymore.” - Jeff Bezos, CEO,

We’re fans of reading good business biographies, and one of the books we recently read was the story of a company called Linamar in Canada. One thing that stood out in the story was a mistake the company made when it entered a new line of business that was not as good as the company’s core business. This particular venture took a lot of time and energy of the management team and, ultimately, didn’t work out. When discussing the venture, Frank Hasenfratz (founder of Linamar) said, “How do you measure the aggravation and the time it took me and some of our other people away from doing more productive things?”

Investing is often the same way. It is easy to spend time and attention on ideas that look cheap but that maybe aren’t ideal, and even if something may be undervalued, there is an opportunity cost of spending too much time thinking about an idea and industry that might not be worth the effort required to understand and keep up with. For us, we decided that Richardson Electronics, which we discussed in our Q3 2015 letter, was one of those ideas, and have since sold the shares we held.

Richardson was trading for what appeared to be a deep value price, though the cash balance does deserve a footnote because much of it is overseas and not necessarily quickly available to be put to work in the U.S. But the negative aspects of the company—lack of profitability, high management compensation, a dual class share structure, questionable capital allocation, etc.—made us decide that even though it still looked undervalued, it was no longer worth it to continue holding and spending the time staying up-to-date on the company and industry for an investment to which we’d never allocate a large amount of capital. So we sold, moved on, and wish them luck on accomplishing the things they hope to accomplish as they continue to transition their business to what they hope is a more profitable future.

Our experience with this investment, and the quote from Jeff Bezos above, also remind us of a story told by personal finance author Jason Zweig about Daniel Kahneman. Kahneman, one of the pioneers of behavioral economics, is known by those who have worked with him to be completely willing to change his mind and throw away all of his, and his collaborators’, previous hard work in an instant if he suddenly realizes it is incorrect. This is something that is often hard to do psychologically, as the more one works on something, the more committed one tends to get—wanting that work to mean something and to lead to action. But if one can get over the mental hurdle, developing the skill to remain completely objective at all times is one of the more valuable skills one can have in any field, especially investing, where significant time is spent learning and preparing for a climax that may never come.

Zweig, in his first taste of witnessing this trait in Kahneman, asked him how he had started afresh on the research that he and his colleagues had been working on, as if all the previous work had never happened. Kahneman replied with words that Zweig said he’s never forgotten, and that we as investors should also never forget: “I have no sunk costs.”