John Bay: Investing is All About the Margin of Safety
How I failed, learned, and excelled in my investing game
Early this year, we had a chance to chat with one of Keel’s Pro investors, John Bay.
John worked for two years at US Trust in their proprietary equity strategies group, a year in Bank of America’s workout group, and two years at Merrill Lynch. John is a CFA charterholder and an MBA candidate at UCLA. He is currently beating the S&P 500 benchmark in the 11 months since he started managing his own money, using a hybrid strategy which incorporates value investing and ETFs.
John talked about what motivated him to start investing, his investment style, and the lessons he has learned along the journey. Here’s John Bay’s interview:
How did you start investing, what interested you in the first place?
John: When I was in college, I read this academic paper, called The Cross-Section of Expected Stock Returns. The paper was written by Eugene Fama, Professor at the University of Chicago. (note: Eugene Fama is also the Founder of Dimensional Fund Advisors, an investment advising firm with $251 billion under management)
The paper showed me the fact that if you invest in the three dimensions of risk, you have a better chance to outperform the index. Reading that paper got me first interested in investing.
Meanwhile, during my senior year in college, my parents had sold a lot of the assets at the bottom of the market under the advice of the financial advisor. I kind of watched this happen.
Keel: It’s interesting that you mentioned this. We’ve spoken with a few other seasoned investors. Watching their parents getting crushed in the stock market also motivated them to study investing and to avoid the same mistake.
John: Yeah. While I didn’t know too much about stocks, graduating from college, I knew I wanted to figure out how the stock market works. Ever since then, I became really involved in investing and spent five years working in the investment management industry.
As you know, working in the investing industry with many regulations involved, I never had a chance to invest my own money. Now that I am at business school, I finally have a chance to take control of my own investing actively. It’s been really great that I got to take a lot of actions on my investments.
Although investing can be kind of like riding a roller coaster sometimes, but I’ve learned to take my emotion out of it over time.
What’s your investment style and strategy?
John: I am a long-term, value-driven investor. That entails that I look at the bottom of the barrel in terms of the price-to-earnings ratio or price-to-book ratio. I then sort through a bucket of the companies, figuring out which ones are temporarily mispriced. I read a book called Margin of Safety by the hedge fund manager, Seth Klarman. The major takeaway from this book is that the only thing you can control is the margin of safety, which he defines as the difference between the intrinsic stock value and the stock price. I believe that, unless you are an institutional manager, there’s nothing else you can control. You’d better maximize your margin of safety. That’s why I am a firm believer of value investing, thus, my investment strategy.
What are the sectors you invest?
John: Sector-wise, I invest in financials and healthcare because of my prior experience in these two sectors. I also invest in tech a lot, just because I am bullish about the future of technology sector.
Keel: Could you briefly comment on these three sectors?
John: Sure! Regarding financials, the value has been low for so long. You see some of the market value started to pull towards to their intrinsic value. Healthcare wise, the sector has been beaten up pretty badly, particularly in the biotech space. I think a lot of them have been over-sold, hence, I am looking for value there.
I tend to over-weigh tech simply because I believe that these are the companies that are truly transforming the world right now.
Could you share with us your biggest success?
John: My biggest success has to go to Apple ($AAPL). I bought Apple around March 2016. While it may seem like a very logical bet now, back to last March, there were a lot of noises on the street about Apple’s products and directions. A lot of analysts were concerned about Apple’s performance. Some were talking about Apple becoming another Blackberry. I held a contrary view on this. If you look at the amount of cash Apple held, around 200 billion of cash, Apple could have easily bought other companies, say GoPro, that could have really built a barrier for other tech companies to catch up. Combined the fact that Apple’s fastest growing source of revenue was services instead of products. To me, that was a compelling story. Going back to the “Margin of Safety” and how I make sure that I maximize it for each investment. At that time, Apple was trading around 9 times of P/E, half of what S&P 500 was.
If you put all these facts together, high margin, growing profit, growing revenue, lots of cash, and low P/E ratio, Apple seemed pretty undervalued. On top of that, Apple also paid 2% dividend. To me, Apple was kind of a no-brainer.
Keel: And Warrant Buffet also made his first investment in Apple during the first quarter 2016.
John: Yes. That happened after I had bought Apple. Warren Buffet is known to not like tech stocks traditionally. Warrant Buffet’s investment in Apple definitely reinsured my point of view.
We also asked John about things he would have done differently. Here is what he shared:
You can access to John’s portfolios and follow his actual trades side by side here.
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Originally published at keel.io.
