When I look for investment opportunities in the stock market, I look for cases of pessimism if not extreme. Each stock market crash provides me with a moment of great opportunity where the stock prices have dropped to such an extent that there is no more risk involved. This perspective pushes me to look for an opportunity to take advantage of the fear in the market and to look for ideas, under the condition to have sufficient cash at hand.
In most cases, I try to understand the nature of the problem with the price of the stock and the company itself and I put it into mathematical terms what these problems are. One of them is to determine the impact of the financial disaster upon the company and to quantify it. And then, I try to see if the problems have been reflected properly upon the stock price itself.
If you want to be a contrarian, you ought to do what other people are not going to do or will not dare to undertake. But one must not be a contrarian for the sake of being a contrarian. I always try to understand the issue and get some insights as to why people are not doing certain things and what are the elements that they do not take into consideration in terms of valuation.
When a stock has dropped significantly, just because it is cheap that one should invest into it right away has some reserves. Most of these drops are event driven and this requires an event driven analysis. When an event has impacted negatively upon a stock, one should look into it in order to see whether there's an opportunity. I can say that at least half of my investment ideas come from this understanding.
Any major financial crisis pushes down extensively the stock prices and thus creates an opportunity for me to buy a stock at a big discount. There isn't necessary a catalyst to turn around the stock and when a catalyst drives the prices down, I react to it by buying it. Frequently, the Turkish stock market had severe drops in the marketplace during the financial crisis, reaching more than 50% drops. All I had to do was to start to look for beaten stocks once the drop went further than 50%.
What I was trying to understand was what I was paying for the company and what was it doing. If it is a cement company, what is the value of the company in the marketplace, the enterprise value per produced cement unit? It is more interesting to me than just to look at the book value of the company or the earnings stream of it. I am trying to figure out what I am paying for this company per unit of whatever it does. And this in turn gives a better sense of "is it affordable?"
One must understand what it means to buy a company. It is not just the market value of the company but it also means assuming the liabilities in terms of balance sheet. Due to this, I do a lot of stock screenings. I look for problems that push down the stocks dramatically. Such stocks come to my screening because they have a lot of problems. Therefore, I do a number of screens in terms of valuation and attractiveness criterias such as a formula that I had developed to evaluate the private market value of the stocks.
I am very mindful of the famous phrase of Warren Buffett: "diversification is a protection against ignorance." I don't turn much the portfolio and in fact I avoid it as much as possible and accordingly, I hold 10 stocks at a time in the portfolio and my holding period is quite long, at least until the next extreme optimism in which case I sell the entire portfolio without a second thought.
One of the things that one must do as far as the investment style is concerned is to change the investment style over time. I maintain a list of stock selection methods but I must always have 10 different ways of looking at a stock. I do a lot of future earnings projections and discounting them to today's stock price and also, I look at the dividend streams over a long period of time. But had I kept doing the same thing that I had done 10 years ago, it wouldn't have worked. The dynamics in the marketplace change over time and consequently, I am constantly trying to improve what I am doing. When the market is offering me something, I have to identify what is cheap on the market. At some point, growth stocks might be cheap; in other times, value stocks might be cheap. Consequently, I have to find what is cheap in the market or what it is offering to me and I try to understand why it is cheap and what is the rationale behind that price. Flexibility in the investment approach is very important. And changing my investment approach according to what the market is accommodating to me is very important as well.
Over a long period of time. I have been trying to find a normalized earnings over a full business cycle. Many investors concentrate on what the company will do this quarter or next year but the more efficient part of the market is further out because people are not willing to look to that further out, they are not comfortable of holding securities that long. Thus, the shorter term is less efficient that the longer term; so, I concentrate on the longer term. I believe that the normal business cycle is five years. So I can figure out what a company can earn both in recession and in expansion periods over that five years period. Then I discount it back to the current stock price.
One part of my job is to manage risk. I want to know how much money I can lose in every single stock that I have invested and how much money I can make. I hold in the portfolio a certain number of names for the upside and I may be wrong a third of the time despite running the numbers on a constant fashion. For example, I may think that the bottom price is 10 but it may go to 8. Then the management sits with me around the table and discuss with me about it by saying that why I was wrong and is it temporary in terms of stock prices, etc (especially when I bought the Turkish Airlines at 800 TL (0.11 USD) in 1991 at 50% to its book value and in early 1993, the stock dropped to 400 TL (0.035 USD) at 20% to its book value before jumping to 24000 TL (0.40 USD) in 1995).
The most important thing for me when I am wrong is that I try to understand why I am wrong and I try to determine whether I am comfortable with that or not and whether the longer term thesis of the stock is still in place or not. When the price of a stock goes down and I don't understand why it went down, it will be wrong for me to maintain that position.
I believe that people are wasting time in thinking too much about the overall risk than the company's specific risk. And their asset allocation decisions based on risk trade totally ignore the company's specific valuations and this provides me with investment opportunities.
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