John Huber (Founder & Portfolio Manager of Saber Capi- tal Management). BHI blog (“Base Hit Investing”), lectured on three paths. Gorman, Martin Huber, Duncan asset management, real estate, institutional investing, owners and can form the basis for collective action. John Huber is portfolio manager at Saber Capital Management and author of the popular investing blog Base Hit Investing. In his own words. OVER AND UNDER BETTING RULES OF BLACKJACK

The portfolio will look very unique. You also have 15 to 20 stocks, or 25 stocks that average that, you have to find a lot of ideas. And depending on your holding period, you might have to find an idea every three weeks or every five weeks. So it leads me to a concentrated approach. And then, more importantly, just really being opportunistic.

And that means sometimes you just have to wait and you have to do nothing. One of the best investors, I think, in the last 30 years is Stan Druckenmiller who runs a completely different strategy than I run. And oftentimes good ideas turn out to be average. But that goes in direct conflict with career risk. All right, so very concentrated. How big can the biggest position be? And then last, do you short and U. You said long only, so is it U. So I have the flexibility and the partnership to invest.

I have the ability to invest outside of the U. We have one investment outside of the U. S too, but that tends to be where I stay. Obviously, I do think about certain diversification. And I think you have to have some diversification and some risk management practices in place. But I do think that the vast majority of the benefits that you get from diversification can be achieved with far fewer securities than most people realize. But yeah, the positions can get quite big if all the stars are aligned.

But the article is a little weird, I think it was in Forbes, but there was a quote he had that is very similar to what you were talking about. John, how do you find those? How do you find these 10 or baggers? John: Yeah. And the company use those assets primarily. I think labour, obviously, these companies were very labour-intensive, many of them as well. But labour, I think, was much more of a commodity. And the primary assets were these physical, tangible assets that a company owned.

And today, I think some companies still obviously use much physical capital to do its business. But a lot of companies are much more…the intangible aspect of the company is much more important. But a big portion of that, I think, is, like I said, before human ingenuity and human know-how, an employee. Is a company an attractive place to work? But the bottom line is, does the company…what you really want to know is think about that trade off I mentioned before, exchanging capital for human effort and know-how.

So high return on capital is the bottom line. I look for other things like free cash flow. Does the company have a good balance sheet and all of that? So the return on capital. So I spent a lot of time thinking about those qualities. Another one to think about is does the management team…are they adaptable to change? One thing I spent a lot of time thinking about recently is, and this is another sort of, I think, as what you might call a secular shift or something, where in the old days used to have the technology sector, used to have the manufacturing sector, the energy sector, consumer staples, retail, all of these different sectors, and they were all siloed.

And all of those industries use technology to a certain extent, I suppose. But nowadays, it touches every industry in a much more pronounced way than it used to. Technology changed the game. I mean, Dollar Shave Club started that way. So those are just some of the things you want to think about.

I think, as a long-term investor, you want to place much more importance on the human capital, the management team. Are they adaptable to change? Can they retain talented workers? Can they attract smart people? So are you a screener? Are you a government filings 10Ks and Qs guy?

Are you a walk around the neighbourhood and knock on some doors? How do you find these names? How do you do your research? Are you down there chatting up management? John: Yeah, I mean, I think about the world in terms of two buckets, I guess. I used to, but I found a couple issues with doing that. And this is, again, just based on my own experience doing it. Some people have found successful ways to utilize screens. For me, the way I filter it is, I think of the world in two buckets.

I guess all companies fall into one of two buckets. The second bucket are eroding value over time. Or another way to think about it is two buckets. The first bucket is companies that can produce cash and the second bucket is companies that consume cash. And surprisingly, there are many companies in the public markets that fall into that latter bucket, sometimes companies fluctuate between the buckets, but over the course of the life of a company, they will fall into one of those two buckets.

And so I want to avoid all of the companies in that second bucket. And again, there are many in that bucket, sometimes entire industries. The way they finance their operations is through issuing new debt or new equity. So many companies fall into that second bucket. I try to avoid those. And again, many people can invest in those and make good money doing that. But to me, it helps me eliminate, reduce some errors, mitigate the negative effects that those could cause on the portfolio.

So once I have those two buckets, I try to build a watch list. The way I try to approach investing is to focus on the key variable. But I like to read the filings, I like to try to figure out what the key variables are for each company, and then I try to understand how those variables will be impacted going forward in the coming years.

And so my approach is to build a list of these companies. And then as the list expands, your opportunity set expands and the nature of the stock market, as you know, Meb, Mr. Market gives you an opportunity to buy these things at markdown prices from time to time.

And so if you have a list of, say, 80 companies in any given year, you might find 1 or 2 or 3 or 5 opportunities on that list. Meb: Well, you had a great quote, and feel free to expand on this. Someone was talking about this on Twitter the other day, but you had a piece that seeing and saying almost five years ago is crazy. It makes no sense that the intrinsic values of large companies can change by tens of billions of dollars in a matter of months.

And this dramatic price fluctuation occurs on a regular basis, in fact, every year. I think that would be a surprise to most listeners. And so these are the mega caps, obviously. So these are the huge companies that everyone follows. Procter and Gamble is in there or was in there. And so that was remarkable.

I mean, you sort of intuitively understand that, stock prices fluctuate, everybody knows that. But when you really look at the value of the fluctuation in these mega cap stocks, like Apple, largest stock in the market, is a great example. That company was valued at close to 1.

And it went from 1. So by early January, January 2nd or 3rd was nearly a half a trillion dollars less than it was valued just 5 months before. And then it went up, I think, another billion from there, or billion from there. So the point is, the fluctuations of these companies are the obvious implication is that the stock prices fluctuate much more than the underlying businesses.

And these are the mega caps. So small caps are…I think, everyone probably agrees, small caps are more inefficient than large caps on average. Finding stocks, he would go through 10, stocks and he would find these incredible bargains. And this was a company that was profitable, it was stable, it had a good balance sheet with no debt, there were very little debt.

I mean, it was a well-managed business. There was nothing wrong with it, but yet it was trading at one times earnings. I think it was like a bagger for Buffett in his personal account. The stock appreciated significantly from that level. And it was just sort of a bargain hiding in plain sight because no one knew about it. Nobody was following it. So Buffett was the only one that found it, and eventually stock crises tend to follow fundamentals.

But I think in the U. And the game now…the reason why the informational advantage is gone is simply because information is at our fingertips. And so now, I think the edge is much more in the behavioural component of investing, which is just staying patient, being opportunistic, being very flexible, and waiting for the market to give you a chance to swing at one of these great companies that is suffering from a certain amount of pessimism right now.

So you have to separate pessimism from actual deterioration of fundamentals. And the reason why the informational advantage is gone is the same reason why that exists, which means to say the speed of the information is so fast now. Everything, the emotion travels so quickly because information is so broad and so deep. Meb: A good example is, if you, being a quant, everyone in the U.

Everyone has the same PhDs. Anyone could probably do it in a weekend. And you can do it over and over and over again, the highest rated ones. And I know you are because I read your blog and your updates. Are there any particular companies or stocks that, you think, or in the portfolio that are pretty good indications of what you think is a good opportunity? John: What you were just talking about is sort of a preface to this.

This is not something that was by design. This is not something that I anticipate going forward because I can certainly take advantage of smaller cap companies. I think the opposite is the case now in general. Certain large caps are expensive but certain large caps are really cheap. When I look at the Russell and a lot of stocks on that list and a lot of stocks on my watch list that are smaller companies, the valuations just seem just too rich for my liking. So the portfolio right now is strangely weighted towards large caps.

I have a few in the portfolio that I…well, one that I just mentioned is Apple. And so Apple is just a great, you mentioned case study, Meb, The case study on Apple is that, in , I bought it in January of And so it was trading at around eight times earnings, eight times free cash flow, net of cash. But the other edge is same set of facts in a different way.

And so that was the worry that iPhone sales were stagnating, people can easily switch to some other product, Samsung or some other phone, and margins are going to fall. That was sort of the narrative at that time. And so, a consumer brand, the way I thought about it was Apple was much more akin to Starbucks or Nike. You know, both of those companies have huge profit margins and both of those companies take commodity inputs.

But Apple, there was actually a question about how powerful the brand was. And I thought it was more of a consumer brand. When you think about Apple, you look at the lines. This was in I remember there was a…I wrote about this actually. They opened a store, their San Francisco flagship store in , and there was no product release.

There was no new iPhone, no new product whatsoever. It was just a new store that they were opening up. And there was a line that was about a mile long waiting to just…at a. And these people could have come by anytime later that weekend, anytime that week to see the new store, but there was a line that wrapped around the building and down the sidewalk just to get into the store.

And so when you couple that with the ecosystem it has and everything else, I think Apple is really a great business. The stock then fluctuates from pessimism to optimism. So that company still, I think, is undervalued, and still, even at the current level, remains in the portfolio as my biggest position. And so, as the stock price falls, it actually benefits you as an owner because the company is using your cash dollars to acquire more, as stock falls you get more value for each dollar spent on the buyback.

Now, I just want to be able to just go and implant them, just be done with it. Because I put them in the washing machine, good news is, they actually usually survive. I love my AirPods more than any probable device or purchase over the past probably 5, 10 years. I love them. I was just saying on Twitter the other day to someone who was talking about how Apple is never going to have another product.

Certainly not as critical as a Steam Engine was, but it did change the way…it has single-handedly transformed the way we do business. You could make an argument that even some big businesses would not exist without it. Companies like Instagram.

But to your point, the other products have been extremely successful. The AirPods are one, but the watch is the bestselling watch in the world right now. So the company has a real brand. Meb: Yeah. I remember the first time I ever saw an iPhone, my buddy was showing it to me at a pool side in Las Vegas.

And this goes to show you how much of a reasonable opinion I have as a tech early adopter. So Apple is an interesting company because so often by the time you get to be these massive companies, either many stocks find themselves expensive or vulnerable.

And you certainly mentioned buybacks in this concept. We talk a lot about shareholder yield being somewhat holistic or agnostic as to how companies pay out their cash flows. But the whole key, of course, in the first place, is having lots of cash flows, payout in the first place.

I think we got time for another idea. John: Well, I think certain stocks have appreciated. So I do hold certain stocks that are not as attractive as I thought they were at one time. And then, of course, other stocks have come down some… One stock is still… I think, I probably sent you this right up, Meb, but I sent it out to my investors.

I did it right up on Facebook. Facebook is still in the portfolio. I bought Facebook last year. Facebook is an interesting one from a sentiment standpoint too. I want to stress, these are some large caps. I also have a few other smaller companies. Well, one company is NDR, which is a home builder that has really good business model. Home builders typically fall into that category. The second category I described earlier where they consume cash, NVR is one of the unique companies in that space where they produce cash.

Some are shouting louder than others. Elizabeth Warren certainly shouting louder than some. And, again, the thing I like about Wells Fargo is, I think, you get an extremely high yield right now. And the way I think about yield is the buyback yield plus the dividend yield. And I think you get the added potential kicker that, at some point the pessimism subsides.

And I think Wells Fargo is suffering from the same bout of pessimism right now. And I think with both of those two companies, at some point, the pessimism does subside. And so right now, again, not to beat a dead horse, but that portfolio does have a few large caps. Is it usually price related?

Is it story changing? How do you kick these guys out with such a small, concentrated portfolio? How do you resist the temptation to just fall in love with this dude and never sell them? John: Well, I mean, some of these companies are not…businesses like Wells Fargo might be growing its earning power at mid-single digit rates. So what is that?

Eighty-five years, and 82 and 3, 82 years of growth and 3 years of downturn. Other companies that are growing fast, you might hang on to them longer. And so sell discipline is really sell when it reaches a reasonable level. And you sell…the thesis change, you sell if your analysis was wrong, you have to be willing to change your mind and sell.

You sell something that you might still think is undervalued to buy something that is significantly more undervalued. So one of those three reasons are typically why I would sell a stock. Meb: I imagine we could just continue doing this for like two more hours. But at some point, I need to let you go home to friends and family. Like how far down the market cap scale will you go? I mean, if you saw an amazing company at 50 million market cap, is that something you could get involved in?

Or is there a hard floor that you spend a lot of time? It used to be Raging Bull message board. So when I was coming to…then it was Yahoo! John: I will go as small as I can, but I can go quite small, 50 million. At some point you run…given the fact that my portfolio is fairly concentrated, my firm is still quite small, but there is the firm has grown over the five years.

But I think for the vast majority of stocks out there, I could invest in just about anything I want with very few restrictions. So there are no restrictions on market cap size other than the size of my fund and how much I can do.

And right now, Munger, I thought a lot about that quote. And I think there are areas of the U. Writing my thoughts publicly, I get a lot of comments, I get a lot of people sending me research. I started Saber in , and before that I spent about eight or nine years in real estate investing.

And to back up a little bit further, I started, or I went to school for journalism, and so completely unrelated to business, obviously. Again, at least the type of investing, the type of research that I do. The objective is different, right? My dad was a very avid investor in his own account. He was an engineer for Delphi, which is a parts supplier for General Motors. And he spent his career there and he invested actively in his own account. And he did very well. John Huber: But I began studying Buffett.

I picked up a book in the library one day. And again this was toward the end of my time in school, and so I had a decision to make. I got very interested in investing to the point where I decided I wanted to pursue business as a career in some form. And it was just a lifestyle that seemed appealing. So that was my goal. I had no idea how I was going to get there, but I became interested in business, became interested in real estate specifically.

John Huber: And long story short, a friend of mine and I decided to set up a small partnership in and we began… So, and this is where a lot… So timing on the career decision was not great because I had just finished school, timing on this, I was much more fortunate.

So the real estate market began to crack in I think housing starts reached 1. John Huber: And fast forward a year and a half later and housing starts were cut in half down to , And so, the Foreclosure boom really began in the fall of , early Of course, Subprime Crisis hit in , and then Lehman in , and the rest.

We all know that story. But it was really a once in a generation type of an opportunity to buy single family housing as an asset class and then also multi-family housing. So we, my partner and I, did residential investing in the single family and multi-family sectors and we did things on a very small scale.

John Huber: So it was all our own money. We had a couple of investors, but primarily a small sort of very small focus group of investors and our own capital. And we would cherry-pick these incredible bargains. And I always tell people, I was like more of a Graham and Dodd investor in the real estate market.

We did a lot of things like that on a very small scale. John Huber: We built up a small portfolio of I think 20 units set at the peak. And that enabled me to collect cashflow, finance my living expenses. Should I go to Wall Street? Should I go try to work at a fund? How do I get into investing as a business or how do I get into the field? Tobias Carlisle: I understand that.

I understand that. But the other thing is getting better at your craft. So knowledge, some people call it knowledge, compounding or whatever, but basically the idea that the more time you spend, the better you get. John Huber: And so, the most satisfaction I get out of this business is the process of trying to continually get better at my craft, the craft of investing, so to speak.

I wanted to allocate the precious resource of time in the best way that I saw fit. John Huber: And so, I earned a lot less money in the early years, but I think of it as a sort of a longer term investment in learning what I wanted to learn and reading what I wanted to read and developing that skillset.

So real estate was a way for me to do that. These tend to be at the growth… Well, maybe not Berkshire so much anymore, but certainly Markel and these other ones at the growth here. Tobias Carlisle: And so, how do you transition, how do you evolve as an investor to get to those points? In the public markets, we might call it like an activist approach.

Or you get lucky like I did and you find yourself in the midst of one of the greatest fair markets in the history of real estate, which is really all that was. They fell all the way from, I think, 1. And so, there was a five year period where you could buy… Banks were in this liquidation phase and you had this extreme oversupply coupled with an extreme decline in demand.

And so, it took years, in fact. So it took 12 years to get back to what would be considered by most… Most real estate observers consider a million starts is sort of the equilibrium number that you need to support population growth. You have 3. So you need a million new houses just to sort of keep up with that. It took a decade plus to get back to just equilibrium levels. So it was a really once in a generation type opportunity.

I sort of say that as a background to say, it was quite easy to be a Graham and Dodd investor in , , probably in the public markets too. John Huber: I mean, I was following the public markets. I was investing my own personal capital. In the stock market, there were bargains in the real estate market. And so, it was easy pickings at that time. I really think of investing as a… If you think about the very simple elements of the transaction, providing a company with capital.

If you invest capital into a venture, your objective is to achieve a return on that capital. John Huber: And so, you will judge your success other than any intangible factors like helping someone out or helping your friend get started or something.

Most people will judge their success based on the return that they achieve on that capital investment. And so, investing in a business is… The point of investing is to achieve a good return on capital. And the same objective exists inside of a business. A good business can earn high returns on capital. Or if you look back in the rear view mirror, companies that have generated a lot of wealth tend to be companies whose earning power has increased dramatically over the last 10, 15, 20 years.

And so, when I think about the margin of safety concept, I think the margin of safety comes in large part due to the quality of the business as much as the perceived gap between price and value at any given moment. Because business is dynamic. John Huber: And so, those are things you have to think about as an investor now.

And margin of safety comes from a company that their earning power is going to increase going forward. How are you making that assessment? I have an objective in mind. So I kind of work backwards, sort of a reverse DCF of sorts. But, yeah, the simple explanation is, I think of it in terms of future free cash flow. And I try to do the analysis and then figure out what I think this company looks like in say five years.

And I think much beyond that is very difficult because things can change so rapidly. John Huber: But I think on the rare occasions where I have an insight on what the company looks like in five years, and that insight differs from the market, is where the opportunities are.

And those are, in my case, few and far between, but they do appear once in a while. So you capitalize those earnings in year five and you can work, what is that worth? And what does that look like? What is that worth to the market? And so, most of the work is spent really taking my time reading about companies and watching them over the years and observing how they operate and understanding their competitive advantages and their risks.

And then, at a certain time, the market gives you an opportunity to buy things at a certain price. John Huber: So the process for me is I create a watch list of these companies and then I just wait for evaluations on each company, and then I just wait for the market to give me a valuation that makes sense to me. And so, I think a lot of investors have two or three or four really good ideas and then they water those two or three or four ideas down with 15 to 20 other ideas.

And that tends to dilute the value of those few great ideas. John Huber: And so, I try to, as best as I can, eliminate the ideas that dilute those few ideas. And so, it tends to be a very concentrated approach. And I guess more importantly, the biggest ideas tend not to be the ones where I think might have the most upside but have the least downside. You know, the… Go ahead. Tobias Carlisle: Sorry, go ahead. John Huber: I was just going to say the wider range of outcome… Stocks have a certain range of outcomes.

I think about it like a barbell. So on the left, if you picture a barbell, on the left side of the barbell, you have what I consider to be like the real defensive names, the really durable names. So the Berkshires of the world. The range of outcomes is quite small for some of those types of companies. Your revenues are fairly predictable in any given year and therefore the outcomes are fairly narrow.

And then maybe more of the fast growers. John Huber: So those are sort of where I like to look for investments, but the bigger positions tend to be on the left side of the barbell and the smaller positions tend to be on the right side of the barbell because of the distribution of possible outcomes. Tobias Carlisle: The narrower the distribution of possible outcomes, the larger the position tends to be. And the wider the distribution of outcomes, the smaller the position tends to be.

Yeah, I really think about it in terms of downside. So in theory, you could have something with a wide possibility of outcomes at a certain valuation where the range of outcomes exist more on the upside and that could be potentially a bigger position.

Are you trying to trim them back to their appropriate risk weighting in the portfolio? And then is that a valuation question or is that some other consideration? And then every year you add to it. And I think individual investors probably improve their results if they thought that way. John Huber: And I think as professionals, and again, at least for my type of a longer term low turnover approach, that approach works.

For me, I tend not to trim those positions unless the valuation gets to a level where I consider it to be significantly stretched or my future returns are going to be worse than cash, for example. So I tend to think about it in terms of opportunity costs. And so, he got to invest in a lot of companies very early on, Motorola and so on, was one of them. It was just that Motorola had been such a spectacular return.

John Huber, who's the managing partner at Sabre Capital Management.

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