Investment advice: Cash flow return is a useful metric because it can’t be manipulated, according to star investor Simpson

Warren Buffett is without a doubt one of the greatest investors of all time. But there are many other hidden gems like him who have experienced extraordinary success in their investing careers. One of those names is Lou Simpson, who is largely unknown even among the investment community.

Simpson quietly racked up a balance sheet that improved the S&P 500 by 6.8%. Former GEICO chief investment officer Simpson delivered a 20.3% return for the company over 25 years. Upon his retirement in 2010, Buffett congratulated him in the Berkshire letter in 2010 and said: “Simply put, Lou is one of the greats in investing.”

At the time of his retirement from GEICO in 2010, Simpson managed a portfolio valued at over $ 4 billion. He has also served as a Senior Researcher and Assistant Professor of Finance at Kellogg, served on the Advisory Board of Kellogg’s Asset Management Practicum as well as on the Board of Trustees of Northwestern University.

Investment strategy
Simpson developed his approach to investing through trial and error and has continued to evolve over the decades. Earlier in his career, long before he was hired by GEICO, he was a growth investor, often failing to predict whether that growth was offered at a great price. His approach was to aim for spectacular returns from a few great performers. But after having had his share of ups and downs, he realized that good long-term results come from buying companies with high performance records set, which have low risk and are available at low. price.

Simpson shared the same investment philosophy as Buffett and Philip Fisher, which revolves around a few prime tenants and is best described as long-term concentrated bets in large companies with great management at reasonable prices.

He says there is no mystery about his success on the stock market. Simpson searches daily newspapers, magazines, annual reports and newsletters for clues that may spark investment ideas. He uses computer screens to identify stocks that, based on financial data, appear to be good deals.

Simpson left Geico in 2010 and started his own fund, SQ Advisers, in 2011. SQ Advisers, which now manages over $ 3 billion, developed and implemented a management strategy using the investment principles of Simpson as guidelines. Let’s look at some of these principles from this great investor.

Do your own analysis
Investors should get the information for themselves and do their own analysis before making an investment decision, he says. They shouldn’t let irrational behavior and emotions get the best of them. Investors must be willing to consider unpopular and unloved companies, as they often offer the best opportunities, says GEICO’s ex-CIO.

“We try to be skeptical of conventional wisdom and try to avoid the waves of irrational behavior and emotions that periodically engulf Wall Street. We don’t ignore unpopular businesses. On the contrary, such situations often present the greatest opportunities, ”he once said in an interview with a financial website.

Investing in high yield companies managed for shareholders
Simpson believes that, over the long term, the appreciation in stock prices is directly related to the return the company earns on the investment of its shareholders. He suggests that investors look at the rate of return on shareholder money used within the company to identify top companies. If it is high and sustainable, given the strategic position of the company and the quality of the management, then there is a good chance of long-term appreciation of the share price.

The return on cash flow, rather than the return on profits, can be a useful additional measure given that it is more difficult to manipulate than profit, says the assistant professor of finance. “We ask the following questions when evaluating management: Does management have a substantial stake in the shares of the company? Is the management simple in the relations with the owners? Is management prepared to sell unprofitable operations? Is management using excess cash to buy back shares? The last may be the most important. Managers who run a profitable business often use excess cash to engage in less profitable businesses. Buying back shares is in many cases a much more beneficial use of excess resources, ”he says.

Only pay a fair price, even for a great company
Once a top company has been identified, its stock should only be bought if the price is not excessive relative to its prospects, Simpson insists. “We try to be disciplined in the price we pay for property, even in a clearly superior business. Even the biggest company in the world is not a good investment if the price is too high.

Invest for the long term
Trying to guess short-term fluctuations in individual stocks, the stock market or the economy is unlikely to always produce good results, said the president of SQ Advisors. Therefore, investors should look to invest for the long term, as short term developments are too unpredictable.

Don’t diversify excessively.
Simpson, who was an economics professor at Princeton University earlier in his career, points out that investors are unlikely to outperform by buying a large sample of the market. The more investors try to diversify their portfolios, the more their performance is likely to be average at best. “We are concentrating our investments in a few companies that meet our investment criteria. Good investment ideas – that is, companies that meet our criteria – are hard to come by. When we think we’ve found one, we make a big commitment. Geico’s holdings represent more than 50 percent of the equity portfolio, ”he said.

One of the keys to a successful investment, Simpson says, is making a relatively small number of investments. “One lesson I learned is to make fewer decisions. Sometimes the best thing to do is do nothing. The hardest thing to do is sit down with money. It is really boring.

Read as much as possible
Simpson insists investors should have a voracious appetite for financial journals, annual reports and industry reports. They should generally read five to eight hours a day if they are to be successful.

Buy a quality business
Investors should be looking to buy quality companies below their intrinsic value, said Simpson, who has served as a director of several publicly traded companies. “The essence of my investment philosophy is simplicity. Identifying a significant difference between the market value of a security and the intrinsic value of that security is what defines an investment opportunity, ”he says.

Make wise decisions
Investors need to make decisions very wisely, because the more decisions they make, the more likely they are to make the wrong decision, says the former economics professor.

Investors make the mistake of selling their winners and keeping their losers, hoping that the losers will even come back. Instead, he says, sell the things that didn’t work and let the things that work run. “One thing that a lot of investors do is cut their flowers and water their weeds. In general, it is more efficient to cut your weeds and water your flowers. Mistake in investment management, this was selling companies really well too early on. Because, generally, if you made good investments, they will last a long time, ”he says.

Develop both quantitative and qualitative skills
A combination of quantitative and qualitative skills is required to be successful in investing. Investors have quantitative skills but need to develop qualitative skills over time, he says.

Be patient
Simpson points out that a lot of people don’t have the patience or the temperament to truly be investors. The stock market is like the weather and if investors don’t like the current conditions, they just have to wait a bit for things to improve. “If you can’t be patient, it’s impossible to be a successful value investor. While being patient is a key attribute, you also need to be able to be aggressive and seize an opportunity when the time is right. Patience and aggressiveness as desirable qualities for an investor may seem a little strange to some, but they are essential, ”he adds.

So, according to one of the greatest investors of our time, dealing in a circle of skills, dealing with companies that investors have the capacity to understand, being able to do a good analysis of the value and profitability of a business are fundamental to success as a value-driven investor.

(Disclaimer: this article is based on the various interviews with Lou Simpson)


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