Milton and Chris Olin – a father and son team based in LA – are new portfolio managers on Covestor. The Olins’ Margin of Safety model focuses on mispriced securities, aiming to profit as value and price converge over time.
Milton Olin is a lawyer with extensive business experience. His son, Chris, a brain scientist turned investing pro, has completed Level III of the CFA exam. Covestor’s Xavier Brenner recently caught up with Milton and Chris to discuss their investing philosophy, conviction holdings and market outlook.
XB: How have your unique backgrounds impacted the model’s strategy?
Milt: I think that as I lawyer, I bring the “what’s the worst that that can happen now” view to investments. I also think that our delta in ages is a good mix.
Chris: In order to “prove” something in experimental science, you have to be able to eliminate or disprove all the other explanations of the phenomena that you’re observing. A big part of this process is simply figuring out all the ways that your experiment could have gone wrong. In our investment process we similarly think about all the ways an investment could go wrong. The difference is that in investing, you don’t have to disprove the worst case scenario – you just have to make sure the price you pay compensates you for the risk.
You can see we are both pretty mindful of the downside, although we approach the issue from different perspectives.
XB: How do you guys work together as a team — and how do you break through the usual father and son conflicts?
Chris: Typically I do much of the data gathering and analytical legwork (my science background coming out again) and then bring the ideas to Milt. We discuss the big picture issues of each investment (often on a long bike ride), focusing on what we need to know to quantify the downside and what important information insiders or other investors might know that we don’t. The size of the potential upside is also an important topic of discussion.
Milt: We have never had any father and son conflicts. We work together well as a team because of our mutual respect. And because I know that Chris is much smarter than I.
XB: You are value investors. So who are your value investing mentors?
Chris: We’ve learned value investing mostly by reading a considerable amount and observing the greats. I fortunately came across the ideas of great investors like Benjamin Graham and Phillip Fisher when I first started investing, and quickly introduced them to Milt.
We’ve learned tremendous amounts from current practitioners as well, including Warren Buffett, Charlie Munger, Prem Watsa and the Hamblin-Watsa team, Seth Klarman, and Joel Greenblatt. We read everything we can find from them.
XB: Why do you prefer a concentrated portfolio?
Chris: Paraphrasing Charlie Munger, value investing is simple, but it isn’t easy. One of the hard parts is finding good ideas, which takes the most time and work. It only makes sense to invest in the handful of promising ideas that we know inside and out, instead of investing in 100 ideas that we don’t know very well and therefore can’t be so confident about.
XB: Tell us a little about your top conviction holdings. And under what circumstances do you cut loose holdings?
Chris and Milt: As is evident by our large cash position currently (as of 11/1/12), we are not very confident about the valuation of stocks in general. Although we are confident that our holdings are undervalued, we would not be surprised if we have the opportunity to pick up shares at meaningfully lower prices in the relatively near future.
Two of our other large positions, Berkshire Hathaway (BRK.B) and Fairfax Financial (CA: FFH), are also fairly defensive (in addition to being undervalued of course). Both invest the excess cash generated by their businesses in other companies and financial assets and have produced tremendous investment returns since inception.
Currently, they both have built up large cash positions that will allow them to pick up any bargains that may become available in the future. Fairfax has even hedged its stock portfolio against movements in the broader market. These positions should help counter a large market decline, while retaining significant upside potential for our model.
Although it is hard to imagine, a culture change at either company that shifted focus away from the long-term and more towards the short-term would cause us to sell. Otherwise, we would like only sell if the valuation became unfavorable.
Our other large positions, Chesapeake Energy (CHK) and Nexstar Broadcasting (NXST), are both in the special situation category. Chesapeake is an oil and natural gas production company that has been reeling from corporate governance issues and a steep decline in wholesale natural gas prices.
We think the governance issues, while they can’t be ignored, don’t rise to the level of actually harming the value of the company. Nevertheless, the board has largely been replaced with people handpicked by the company’s largest independent shareholders and we believe the CEO will be on a short leash going forward.
The company’s cash flow has been significantly reduced by low natural gas prices, but Chesapeake has been able to make dramatic progress this year on increasing the amount of revenue it earns from producing oil, which has not seen similar price declines.
Increasing demand for natural gas from non-traditional sources and the prospect of a normal winter (last year’s winter was one of the warmest on record in the Eastern US) also bode well for the price of natural gas. We would look to sell if we saw evidence that the board was not being a good shepherd of shareholder capital or if the company was unable to execute its cash-generation/debt-reduction plan.
Nexstar operates in the unloved television broadcasting industry, perhaps causing investors ignore the local monopolies of network content that it enjoys and its significant cash flow generation. Cash flow has historically been obscured by large non-cash charges and high capital expenditures that were driven by the federally-mandated analog-to-digital transition. Investors have therefore not given the company credit for its true earnings power.
However, the company is likely to begin paying a dividend in the next year, which should act as a catalyst for value recognition by the market. The company has historically been quite good at making value-creating acquisitions, but if its acquisitions start to destroy value, we would look to sell.
We would also likely sell if we saw that the business began to deteriorate faster than expected due to competition from the internet or other non-traditional content sources.
XB: What has been your biggest investing mistake and what have you learned from it?
Milt: Thinking that a company was a “good investment” because I liked their products. I’ve learned that good products are just a starting point.
Chris: I’ve made the mistake of not paying enough attention to the larger business cycle. I think 2008 was an important crucible for many value investors. Even in sectors seemingly far removed from home construction, the easy credit of the housing bubble led to earning that persisted for years at levels that were far above what could be expected in more normal times.
I now look for external forces that may be producing elevated earnings in the short-term. This is one of reasons we avoided the metals and mining sector over the last few years, as we thought valuations were too dependent on unsustainable demand from China’s massive infrastructure programs.
XB: What are the big risk factors going forward into 2013? What could surprise investors?
Chris and Milt: The likely economic and political downsides of 2013 are well known: a fiscal cliff and possible recession in the US, continuing sovereign crises in the Eurozone, and further deterioration in the Chinese economy. In contrast, we think investors could be surprised by the positives.
There have been some signs of life recently in the US home construction market, which we think could likely pick up steam in 2013 if the fiscal cliff is contained. According to the Census Bureau, the ten years ending in 2011 saw the second lowest number of housing starts in the US since the 1960s and we believe that demographically driven pent-up demand for housing is becoming difficult to contain.
In other words, despite the recent bubble, the country may be currently running out of housing, especially on a regional basis. Home construction typically represents a large portion of US GDP and if the industry starts to normalize we could see a virtuous cycle of growth as construction reduces unemployment, increasing demand throughout the economy.
XB: Thanks to both of you, and good luck with your new Covestor model.
Chris and Milt: Our pleasure.
Disclosure: The investments discussed are held in client accounts as of September 30, 2012. These investments may or may not be currently held in client accounts.The reader should not assume that any investments identified were or will be profitable or that any investment recommendations or that investment decisions we make in the future will be profitable.
Certain of the information contained in this presentation is based upon forward-looking statements, information and opinions, including descriptions of anticipated market changes and expectations of future activity. The manager believes that such statements, information, and opinions are based upon reasonable estimates and assumptions. However, forward-looking statements, information and opinions are inherently uncertain and actual events or results may differ materially from those reflected in the forward-looking statements. Therefore, undue reliance should not be placed on such forward-looking statements, information and opinions.
