Perspective on Investing: Maxims that Guide Our Work

There’s more than one way to succeed at investing, but we have our own clear perspective on what works for Nixon Capital. There’s a consistency of thought that pervades our work, and the maxims below offer insight into how we think about the significant advantages of our opportunistic philosophy. These maxims are simplifying principles we have developed or observed over many years; we’ll repeat them to ourselves (and add to them) for the next 20 years.

1. Volatility + changes in investor psychology = opportunity: A big advantage of buying businesses in public markets is that market forces can at times help you purchase a business at prices far lower than you could ever negotiate with a private owner of such a business. By the same token, you can sell companies at high prices during periods of market ebullience.
2. Identify firms that are beneficiaries of major industry change: Long-term compounding is the goal, so it’s ideal to identify undervalued firms in the midst of a long, positive industry transformation. Consider the air-conditioning industry. It’s a consolidating and regulated sector dominated by a handful of players. They’re shaping an industry that is increasingly sophisticated in technology and selling methods. We’ve identified four solid investments in the sector over the last five years. We’re scouting for more such snowballing-trend industries ahead.
3. Lens placement—everybody’s got a microscope; the key is what it’s focused on: There’s a tendency to over-use brain power and time on fact-gathering about investment ideas, as if amassing the most facts about a company ensures winning the game. (It doesn’t.) The value in the investment process occurs only when the scope is focused on the right material — the business model, the cash flow, the people, the valuation. We also focus our lens on overlooked pools of value, such as spin-offs.
4. To find value, seek innovation in mundane places: Why seek innovative companies? Because innovation creates value. Why seek it in mundane places? Because that’s where the bargains are. A basic apparel company like HanesBrands has been rewarded for innovations made in a seemingly mundane industry – globalizing its supply chain and launching Hanes and Champion product platforms.
5. There’s no extra credit for degree of difficulty: Rather than concoct complicated investment ideas based on uncertain future events, it’s better to patiently wait for big fat values staring us in the face: like a non-cyclical company producing all-time high profitability while carrying a trough valuation. That’s the situation we found in 2010 with life-science tools companies, when we bought industry leaders Sigma-Aldrich, Millipore Corp., Waters Corp., and Becton Dickinson — all deeply discounted despite record profits.
6. Be a long-term investor in a short-term world: Profitable situations arise when we can think long-term while others are constrained short-term.
7. Exploit financial-industry trends: Positive trends for us as active managers are recent increases in popularity of index-product strategies, hedge strategies and algorithmic strategies based on computer programs. A few times a year, robotic market participants will create helpful dislocations in prices on businesses we can buy at a discount or sell on excess mechanical euphoria. It’s another reason to be encouraged about opportunities in the next 5-10 years.
8. If we’re not looking for value, we won’t find it: We will get intermittent shots at the purchase of dominant, innovative companies as long as we never give up the hunt. An unwavering commitment to the search for bargains makes discovery possible. As poet Ralph Hodgson wrote, “Some things have to be believed to be seen.”
9. Mistakes are part of the process: Over the 5-year period, we made money on approximately 75% of the investments we made — a decent hit rate, but far from perfect. So you could say we were wrong 25% of the time. But being wrong on a percentage of investment decisions is part and parcel of the investing endeavor. While it’s appropriate to work toward mistake reduction through constant improvement, mistake elimination is impossible without draining an investment system of its potential for gains.
10. Let the companies do the work: “Don’t confuse activity with progress” is a key concept. Impatiently trading in and out of holdings isn’t a strategy for long-term compounding. We know we won’t get the benefits of ownership (dividends, stock-price growth, takeovers) if constantly trading in and out of a company’s shares.
11. Control risk by saying “I don’t know” often: There’s a reason we discriminate against cyclical companies with weak balance sheets — their business models have too many variables to create predictable cash flow. That makes the valuation question harder. We can stay out of trouble by saying, “I don’t know” — and then move on.
12. Be flexible. Don’t get stuck with a stale playbook: One of the fun, challenging parts of this business is responding to the situational potholes and roadblocks we confront as investors each year. Here’s how 3M CEO Inge Thulin describes the need to stay practical in changing conditions: “If you go to the forest with a map, and you get there and they don’t match, throw away your map! The forest is right. Some people stick with the map, thinking that the map is right. But the forest is right.”
13. Identify investment themes from within: We can identify themes from within our existing investments by listening to CEOs describe the changing growth and profitability of their segments. In 2010-11, we noted that mature companies 3M and Becton Dickinson were reporting extraordinarily high growth rates and profit margins in their emerging-market healthcare businesses—a budding trend. This observation led us to a large 2013 investment in spin-off company Covidien.

Information contained herein has been obtained from sources believed reliable but is not necessarily complete. Accuracy is not guaranteed. Any views expressed are subject to change at any time, and Nixon Capital disclaims any responsibility to update such views. References to specific securities are not intended and should not be relied upon as the basis for anyone to buy, sell or hold any security. Portfolio holdings and sector allocations may not be representative of the portfolio manager’s current or future investment and are subject to change at any time. This information is not to be reproduced or redistributed to any other person without the prior consent of Nixon Capital LLC. This document has been updated to comply with Rule 206(4)-1(a)(5). Investors may have been provided additional information at the time of publication.