What distinguishes an elite investor from a strong investor? In chapter five of How Life Imitates Chess Garry Kasparov explores Talent as a characteristic that separates elite chess players from the large pool of strong chess players who never break into the top ranks. Talent is described not as single attribute but a synthesis of natural aptitude and acquired skills. The author cites memory and fantasy as the characteristics common to the greatest chess players. However the most interesting message from this chapter for investors is the importance of recognizing patterns.

Grandmasters are walking storehouses of past games and positions, but they do not attain this by rote memorization. Researchers have measured the recall abilities of chess players by showing a series of chess positions to a pool of subjects and testing how well they could reproduce the positions. As expected, recall ability is correlated with chess ranking when testing memory using positions from real games. However when researchers show positions of pieces randomly placed on a chess board, the recall success of chess players is indistinguishable from non-chess players. Grandmasters exhibit aptitude in discerning meaningful patterns in the interlinking of chess pieces.

What are investors doing when we are searching for the "next Wal-Mart," the "next Apple," or the "next Google?" We search even when it is apparent the same story cannot be repeated as their success has eradicated the opportunity that enabled them in the first place. The pieces on the entrepreneurial chess board have moved. But the pieces were not randomly arrayed then and they are not random now. The interlinking of supply, demand, innovation, capital, and technology is under continuous change. The changes may be subtle or abrupt but change often follows a pattern. Though the business landscape continuously changes, meaningful patterns of opportunity and exploitation will repeat, and that is the elusive "next."

We can memorize the chronology of these companies' phenomenal growth or of their founders' biographies. We can watch in awe as Steve Jobs invents Apple, invents Pixar, reinvents Apple, and goes on to reinvent the way entertainment serves its market. A strong investor may invest in Jobs' ventures but remain unaware of the patterns in play with each of these successes. Ah but the elite investor. The elite investor recognizes patterns of opportunity and exploitation on the economic chessboard, searches out the emerging companies in those arenas, and invests accordingly.

Comments: View Comments |  Monday March 10, 2008

Chess requires participants to traverse a decision tree comprised of an ever increasing number of branches. At each branch the value of position, material, and threats must be calculated. Chapter 4 of Garry Kasparov's How Life Imitates Chess addresses the role of Calculation in playing chess. The author asserts calculations must be precise and ordered to be effective, but otherwise writes little on how to perform such calculations. Instead the author stresses the limitations of calculation. "It doesn't matter how far ahead you see if you don't understand what you are looking at."

As investors we routinely perform calculations of price per earnings, sharpe ratio, price per earnings growth, and various other ratios. We may also scour footnotes of SEC filings to make normalized computations of otherwise accepted release numbers. We may even go as far as to compute the net present value of a future stream of earnings. There is no shortage of calculations available to assign value to each branch of an investing decision tree but there is also value in knowing their limitations. No matter how precise and how well ordered our calculations may be, they are not a substitute for insight and we must recognize when there is a diminishing return in their pursuit.

Though highly regarded investors such as Warren Buffet, Bill Gross, Abby Joseph Cohen, or (insert name of your favorite prominent investor) and their staffs are no doubt highly skilled at calculation, I would posit that their success is because they are talented at understanding what they are looking at. The next chapter is devoted to role of talent in success.

Comments: View Comments |  Thursday March 6, 2008

Current conventional wisdom asserts the consumer is the economy's weak link and proposes avoidance of consumer discretionary stocks. This contrarian, believing that the consumer is not dead, holds one third of his SLO portfolio in consumer discretionary stocks. Current valuations in retail, restaurant, and resort industries make this an excellent time to buy good companies at good prices.

Kohls Corporation (KSS) is mid-way through an aggressive department store expansion. Compared to its peers JC Penny and Macy's, it has both higher operating margins and lower debt. Kohl's stores are well located and they are adept at promoting customer loyalty by dispensing "most valued customer" status via their credit card program.

Stein Mart (SMRT) is a much smaller retailer that Kohl's and its slowing sales and the recent suspension of its dividend has resulted in an extreme oversold position. Insiders appear to see better days ahead having bought nearly a million shares in the last couple of months.

The shoe retailer Collective Brands (PSS) is in the midst of a turnaround story offering considerably improved merchandise. Its Payless stores will soon have shelves stocked with exclusive designs from noted designers such as Laura Poretzky, Lela Rose Patricia Field, and Stacey Bendet. PSS' most recent earnings report confirms this strategy is beginning to pay-off.

As for restaurateurs, many appear to be quite oversold. For example the casual diner Ruby Tuesdays (RT) can be obtained for an incredible low value of 30% of sales. Insiders have doubled their holdings in the past six months.

As for resorts, it is inevitable that a measurable portion of the $160B of economic stimulus checks will find its way into casinos. Isle of Capri (ISLE) has many heartland properties within driving distance of people soon to have "found money" in their pockets. Las Vegas Sands (LVS) has the appeal of its Macao properties and visions of further growth in Asia.

In keeping with my three-unit buying tactic described in an earlier post, my SLO portfolio contains three units of PSS, two units each of KSS and SMRT, and one unit each of RT, ISLE, and LVS.

Comments: View Comments |  Sunday March 2, 2008