Host Tano Santos, the Robert Heilbrunn Professor of Asset Management and Finance and faculty director of the Heilbrunn Center for Graham & Dodd Investing at Columbia Business School, welcomed two experts for an in-depth look at how their firm blends analysis with experience to build a portfolio: Andrew Wellington, founder and chief investment officer of Lyrical Asset Management, and Dan Kaskawits ’11, portfolio manager at Lyrical and a graduate of Columbia’s Value Investing Program.
In the discussion, they articulate their investment philosophy and explain Lyrical’s three investing pillars: value, quality, and “analyzability.”
The following five key takeaways from their wide-ranging conversation provide a brief overview of an episode that’s well worth listening to in full.
- Start your search in the discount bin. There’s a quant truism that Wellington credits as the foundation for Lyrical’s initial stock screening process: “The cheapest stocks offer the highest return; the most expensive stocks offer the lowest return.” For its U.S. portfolio, for instance, Lyrical starts with a list of the 1,000 largest companies and whittles it down to the cheapest 20 percent. “If you look at all the companies that show up as the cheapest 200, usually our first reaction is, ‘My god, what a pile of junk,’” Wellington says. “But right next to some really cheap junk are some really cheap gems. There are good companies just as cheap as the bad companies.”
- When assessing quality, don’t just chase ROIC. Although return on invested capital is important, once it reaches double-digit returns, a company’s growth and how capital intensive it is matter more. Companies that are capital-light are able to adapt to bad news and market downturns, enabling them to generate consistent returns over the long term. “For us, it’s more about avoiding the lowest 20 percent of ROIC than it is about seeking the highest,” Wellington says.
- “Analyzability” is key to smart investing. While the investor can never know everything about a company, some businesses are simply easier to analyze than others. Kaskawits explains how this concept, which is a central pillar in the Lyrical approach, helps steer them away from the deceptive lure of a low price. “There’s always the appeal of, ‘But it’s that cheap! It’s got a 200 percent upside if this all goes just right, and the margin of safety is just so much better than a stock with, say, 50 or 60 percent upside,’” he says. “But the problem with that concept is you just tend to make more errors in the lower quality, less analyzable company. So that perceived margin of safety sometimes doesn’t protect you as much as you expect.”
- When it comes to stock picking, the generalist has an advantage over the specialist. The industry specialist may spend most of their time on the sector’s core companies, investing little bandwidth in peripheral players such as distributors. “They’re often on the fringe of a specialist’s radar,” Kaskawits says. But Lyrical applies the same analytical attention to every company in the “cheapest” sector, whatever that company’s business is. “As a generalist, you can very clearly see … the competitive advantages and attributes we like in all of these business models, regardless of what they’re actually distributing,” he says.
- Temperament is an investor’s secret weapon. Wellington credits his success and longevity to an even temperament that saves him from rash decision-making in response to market moves. He recommends investors read the books of modern stoic Ryan Holiday as a tool for cultivating equanimity. “It’s not the psychological side of decision-making,” Wellington says. “But stilling your mind, clearing your mind, not having all those outside influences affect your decision-making is just as critical as understanding endowment theory and loss aversion.”
Companies mentioned in the podcast:
- Quit: The Power of Knowing When to Walk Away by Annie Duke
- Thinking in Bets: Making Smarter Decisions When You Don't Have All the Facts by Annie Duke
- The Intelligent Investor: The Definitive Book on Value Investing (Revised Edition) by Benjamin Graham
- Competition Demystified: A Radically Simplified Approach to Business Strategy by Bruce C. Greenwald
- Stillness Is the Key by Ryan Holiday
- The Code Breaker: Jennifer Doudna, Gene Editing, and the Future of the Human Race by Walter Isaacson
- Steve Jobs by Walter Isaacson
- Value Investing: Tools and Techniques for Intelligent Investment by James Montier