Circle Of Competence Issue #16
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This week, I read through the compendium (link above) of Michael Burry's quarterly letters, testimonies, interviews, and articles so wonderfully compiled by the gentlemen at Austin Value Capital (www.austinvaluecapital.com). I had previously heard of Burry's wonderful record and interesting approach to value investing, but after reading the document, I had a newfound respect for his uncanny ability to perform DEEP research.
So, let's start with a little intro. Michael Burry graduated from UCLA with a degree in economics in 1993 and went on to Vandirbilt's school of medicine. Despite studying medicine, he worked hard on his investments, often late into the night after long days during his schooling and residency. In fact, he studied so hard one night that he fell asleep during a surgery during his residency at Stanford and was promptly removed from the operating room. He left behind Stanford's neurology residency program and started his own hedge fund, Scion Capital. Interestingly, while he worked at nights on his investment theses and wrote about them on the then-budding internet forums, he drew the attention of well-known investors such as Joel Greenblatt and White Mountains Insurance CEO John Byrne (previous CEO of Geico and mentioned numerous times in Buffett's annual letters). They provided seed capital on the amount of a few million dollars for Burry to start Scion, and a budding investment legend was born.
Burry's investment record is superb. He returned roughly 21% compounded annually from 2000-2008 while the S&P 500 returned just over 3% including dividends. This period included the internet bubble bursting, during which he not only avoided losses in popular stocks but also generated significant returns. Burry was turning away money by the end of 2004.
I would describe Burry's strategy to be similar to Seth Klarman's in the sense that he hunts for value in literally any place, any industry, any company, at any time. His strategy seems to be straight out of Klarman's "Margin of Safety," likely the most well-regarded value investment strategy book ever written. He does not time markets or macroeconomic events, but invests with a large margin of safety based on underlying asset values or business fundamentals. In one of the articles in the compendium above, he describes his process more in depth. He screens for low enterprise value (market capitalization plus net debt) to EBIT (earnings before interest and taxes) multiple stocks (essentially the acquirer's multiple after depreciation and amortization) as a starting point. He starts with the lowest multiple stocks and looks for hidden assets, catalysts that will help propel the stock to a more fair value, as well as plain old dirt cheap stocks that have been thrown out by larger institutions for no fundamental reasons (spinoffs, delisting from an index, etc.). And occasionally, he will find a wonderful business at a wonderful price (what I like to call a compounder, a business that is able to reinvest profits at high rates of return on capital). So, as you can see, he was not solely a deep value investor, or a high growth high quality investor, or a special situation investor. He was all of those things, but only when the price was right.
Despite his great returns in general, his magnum opus was calling the housing bust in 2008. I would encourage people interested in the mechanics of his research and short on the subprime mortgage pools beginning in 2005/20006 to scroll through the compendium above and find his quarterly letter discussing the derivatives he used to short subprime mortgage pools (which were the riskiest of all mortgages issued in the real estate credit bubble). These types of mortgages included pay-as-you-go mortgages where people could simply choose not to pay anything on a monthly basis and interest would accrue and add to the principal. This, as Burry describe