Exploring how Michael Burry approached value investing and his early investment strategy.
While most investors know Michael Burry as the investor who predicted the 2008 subprime mortgage crisis he actually started by publishing his own investing private blog. This caught the eye of Microsoft who invested him to participate in the MSN Money Strategy Lab. As a result he published his investment picks on the MSN Money blog between 2000 and 2001.
This posts takes a deeper look at Burry‘s old MSN Money articles and analyzes his approach to investment. It will take a deeper dive at 7 key learnings from Michael Burry’s old blog posts.
Dr. Michael Burry is a famous value investor who is well known for predicting the 2008 housing market crisis and the resulting stock market bubble and financial crisis. The crash was caused from increasing default rates of subprime mortgages which led to huge losses for investors and investment banks. As a result of the crash companies like Lehman Brothers or Bears Stearns either ceased to exist or we’re acquired.
His story was later published in the book “The Big Short” by Michael Lewis. In it Christian Bale is playing the role of Michael Burry as the manager of Scion Capital.
However he actually started out by publishing his investment ideas on message boards like Silicon Investor and on his private website. This caught the eye of Microsoft who invited him to participate in the MSN Money Strategy Lab where he shared his investment picks in a virtual investing challenge.
His investment picks also attracted attention from well-known investors and companies like Vanguard and Joel Greenblatt from Gotham Capital. This eventually led to the founding of the Scion Capital hedge fund which offered extraordinary returns to investors. These returns mainly came from betting against tech companies during the dot-com bubble and betting agains the housing market during the 2008 financial crisis. Scion Capital was shut down in 2008 but was later reopened as Scion Asset Management in 2013.
Michael Burry identifies himself as a value investor who buys shares of unpopular companies with visible deficits and then sells them once the outlook is better. According to himself he was highly influenced by Benjamin Graham and his book “Security Analysis” as well as “Buffetology” which dives deeper into the investment approach of Warren Buffett.
“I really had no choice in this matter, for when I first happened upon the writings of Benjamin Graham, I felt as if I was born to play the role of value investor.”
Before investing into a company he always ensures to understand the value of potential investments and that the concept of margin of safety applies. Like most value investors he determines the value of a company through fundamental analysis.
He not only values the art of picking those companies but is equally focused on the portfolio management of his entire portfolio of 12-18 stocks. With relatively few concurrent investments Burry tends to have a diversified but concentrated portfolio.
As a contrarian Burry imposes only few to no restrictions onto his investments and tries to decouple them from the general market sentiment. No matter if he looks at large-cap stocks, small-cap, mid-cap, tech or non-tech stocks, as long as there is value to be found he is considering an investment. However according to him he finds the best investments in out-of-favor industries.
“So, I will go on record right now as saying that this is a time of tremendous uncertainty about market direction — but no more so than at any time in the past. I continue to believe the prudent view is no market view. Rather, I will remain content in the certainty that popular predictions are less likely to come to pass than is believed and that absurd individual stock values will come along every once in a while regardless of what the market does.”
Burry focuses on the enterprise value and cash flow of a company to determine the discount, and therefore the margin of safety, he gets on an investment. If possible Burry aims to buy close to the 52-week low of a company’s share price. He also picks the best time to buy based on some technical analysis of the stock price.
He uses the rate of enterprise value to EBITDA (earnings before interest, taxes, depreciation and amortization) to find suitable investment candidates although his preferred rate varies by industry and the company‘s position in the economic cycle. He avoids price to earnings ratios and makes sure to take off-balance sheet items and true free cash flow into account to avoid deceptive numbers reported by a company.
“In the end, investing is neither science nor art - it is a scientific art. Over time, the road of empiric discovery toward interesting stock ideas will lead to rewards and profits that go beyond mere money.”
One thing that makes Burry stand out from pure value investors is that he also seeks other opportunities once they arise. For example he will also invest in asset plays, arbitrage opportunities and companies selling less than two-thirds below net value. Similarly, like Warren Buffet, he invests into companies with a sustainable competitive advantage if they are available at a good price. These can include tech-companies if Burry is able to understand their business. As those investments are usually hard to find he generally considers them long-term investments.
Sometimes value can be found in industries which are largely avoided by other investors. But just because an industry is out-of-favor does not mean that companies within that industry are not attractive investments.
When Caterpillar stumbled in August 2000 amid a struggling construction industry Michael Burry took notice. While the situation looked bad on the surface he soon realized that the construction segment only made up about 10% of Caterpillar‘s sales. The company turned out to be quite diversified, not only by products but also by geographic areas. Since Caterpillar is a high-quality company which a sustainable future he invested And bought 200 shares.
“Whenever the stock of a company this significant starts to reel, I take notice.”
In August 2000 Burry also bought 800 shares of Clayton Homes. He considered it a great investment in the troubled manufactured housing industry. While competitors exposed themselves to high risk as a trade-off for short-term growth by handing out bad loans to poor-quality lenders Clayton Homes managed to grow without the added risk. Compared to competitors they had a very low delinquency rate and keep running profitable despite the cyclical downturn caused by its competitors aggressive over-expansion. In addition Burry also liked the conservative management, as well as the stock buy backs.
“As a value investor, one of my favorite places to look for value is among out-of-favor sectors in the market. In order to obtain maximum margin of safety, one must buy when irrational selling is at a peak. Ideally, illiquidity and disgust will pair up in tandem pugilism.”
One key factor Michael Burry looks into, when in investing into companies in out-of-favor industries, is the management of a company. He expects the management to use the chance to buy back shares for less than their worth when a company is undervalued as a result of avoidance by investors and the price falls below intrinsic value.
“Focusing on quarterly targets is not a method for removing undue risk. […] The competitive advantage therefore rests with those investors who can go where inefficiency reigns and risk is uncoupled from reward -- beyond the quarterly and/or yearly performance mandate.”
In his MSN Money article from August 7, 2000 Burry mentions that he previously received responses that he, as a then 29-year old, simply possesses a long-term investment horizon which other investors won‘t have. He strongly disagreed with this view as in his opinion many investors, even at a similar age, are too focused on short-term performance rather than the underlying value of future cash flows. In his opinion even older investors should consider a long-term perspective as the overall life-expectancy rate is increasing and they likely will live longer than expected.
“Cash seems quite conservative, quite boring. Yet the typical professional investor finds cash a little too hot to handle, and therefore high cash balances become the too-frequent prelude to forced investments and poor results.”
However in his post from August 8, 2000 he mentioned that he finds it hard to be fully invested in times when the markets rally and there’s not enough value opportunities available. During those times Burry tends to keep the cash in order to purchase value opportunities once they're back on the market. However keeping cash requires mental strength to withstand outside forces which lead to investments which are later regretted.
According to Burry most investors set themselves goals they intend to reach, for example to achieve a return of 20% or 30%. However once they loose some money they tend to lower their goals to instead break even. This however, ironically, requires a higher return than to achieve their original goal. For example if an investor looses 50% he requires a gain of 100% to break even.
As a result investors increase their risk tolerance and become more aggressive in order to achieve a higher goal than what the one set initially. The increased risk level then results in more losses which is being compensated with an even more aggressive strategy.
Rather than to increase these losses Michael Burry attempts to investigate the underlying reason instead. As it turns out in most cases they stem from straying too far from his investment method.
One part of risk management is to ensure that a company is able to survive on its own. So in the best case it should have as little debt as possible as it otherwise has to periodically lend money on the capital market. If the hope of paying those debts back is fading it will become harder for the company to get access to more capital which will eventually lead to bankruptcy.
“In a bankruptcy preceding, it is most likely that the common stock is canceled altogether. Therefore when assessing the safety of a common stock investment, one must also evaluate the probability of bankruptcy at some point in the future.”
This is a scenario that any investors should avoid. Shareholders usually last to receive little or no compensation in a bankruptcy which will result in a total loss of the investment. As a result Burry takes note of possible bankruptcy risk factors and strays away from an investment if he find any.
“Optimism […] and a wad of cash […] make for toxic twins in the world of investing.”
Another important strategy to reduce risks and avoid losses is diversification. Burry aims to diversify his portfolio into 12 to 18 stocks and tends to be fully invested.
However he is not afraid to sell stocks with a good gain of 40% to 50% when the opportunity arises and generally is not concerned about the possible implications on taxation. As he aims for a 50% portfolio turnover he explains that the tax benefits of a low turnover portfolio would mostly disappear and do not pose a risk.
One repeating topic in Michael Burry’s posts is the negative impact of employee options compensation onto companies and its shareholders, especially in the tech industry. In his opinion it increases costs for companies as they either have to issue new shares or buy back existing ones at the current price. These shares are then sold to employees at a discount and therefore increase costs for the company and its shareholders.
“Options repricing is one of the most blatant forms of theft from shareholders that corporate officers have at their disposal.”
Another issue he sees with the options compensation is that the options are not reflected on the income statement. He outlines this in one of his posts where he calculates the impact onto Adobe:
In its 2000 10K financial statements Adobe lists a $125 million tax benefit on stock options. This means the options which have been issued are worth $357 million based on a 35% tax rate. When reducing the $408 million operating income by the $357 million worth of stock options, shareholders end up with a gain of $33 million while the company has to pay out the majority of its earnings. For these $33 million earnings investors paid $8.7 billion but at a worse valuation than what is visible based on the financial reports.
“I of course still believe that companies, in the long run, will not be able to fool anyone. Either value is created, or it is not, and the share price ultimately reflects this.”
Now if the share price falls for whatever reason, including a bear market, the company either has to increase the salaries significantly or to reprice the options at a lower price. According to Burry this repricing and reissuing essentially means that employees are paid with items of near-limitless value.
Continue with the next lesson of our beginner-friendly guide “Popular Investors”.