Bill Nygren Market Commentary | 1Q11
March 31, 2011
“Making mistakes was acceptable. Failure to learn from them was not." -Jonah Keri, The Extra 2%
I enjoy reading books about successful organizations. I like to see how their methods overlap with ours and the companies we have investments in. I also like seeing what they do differently than we do to get ideas for how we can improve. While we have learned some things from studying other successful investment firms, I find we learn more from comparisons to non-investment companies. And given my non-work interests, I especially enjoy the comparisons to successful sports organizations. Several years ago I wrote about one such book, Moneyball by Michael Lewis, that examined how baseball’s Oakland A’s had applied a value-investing discipline to their investments in baseball players. Developing a better understanding of how some obscure statistics translated into runs scored allowed a small-market team like the A’s to play competitively against teams that had payrolls multiples of their size.
Another successful small-market MLB team, the Tampa Bay Rays, is the subject of Jonah Keri’s new book, The Extra 2% - How Wall Street Strategies Took a Major League Baseball Team from Worst to First. The book chronicles events leading up to Tampa Bay getting a major-league team in 1998. It then examines a decade of frustration as Tampa finished in last place in nine of its first 10 seasons. Following the sale of the franchise to new owners, the team went from last place in 2007 to American League champions in 2008, and in 2010 the team again beat the Yankees and Red Sox to win the AL East Division. Though the Rays were not as forthcoming with the baseball particulars that led to their success as the A’s had been, I found the comments about organizational management to be especially insightful.
The original owner of the Tampa Bay Rays was a businessman who profited handsomely from leading several successful turnarounds of industrial companies. He made companies run much more efficiently by cutting expenses while boosting productivity. That skill proved less than helpful in launching a baseball team, which is effectively an entertainment company. In the Oakmark Fund we own ITW Industries, an industrial conglomerate. I think the management of ITW is as good as any industrial company management. We also own Discovery Communications, a cable-TV networks company. I think the Discovery management is as good as any management in the entertainment industry. However, if we switched the management teams and put the ITW managers in charge of Discovery and vice-versa, I’m not sure either management would succeed.
At various times, maximizing the value of a company might mean acquiring or disposing of business segments, improving profit margins, boosting sales or maximizing the value of the cash it generates. Often it is some combination. I think the failing of the original Tampa Bay management is a good reminder that when we refer to a company as having “good management,” we really mean that we believe the managers have the skills needed for the challenges their specific company faces. For all of our holdings, we have made the judgment that the current management teams are suited to the current needs of each respective business.
After nearly a decade of disappointing results, Tampa Bay’s team was sold to—and run by—a trio of ex-Wall Street guys who had no experience in managing professional sports teams. What they did have was an extensive background in statistical analysis. As Keri explains in The Extra 2%: “Sternberg, Silverman, and Friedman made a commitment from the start to track the effectiveness of their decision making. Draft picks would need to be scrutinized several years out, to see how the scouting staff could have done better. Ditto for trades, business partnerships, ticket sales strategies, and other decisions. Making mistakes was acceptable. Failure to learn from those mistakes was not.” It is surprising to me how few companies rigorously analyze the results of their past decisions. Through that analysis, good companies can learn from their mistakes and constantly improve their processes. At Oakmark, we try to invest only with managements that we believe will be that self-reflective, and we strive to be equally thoughtful when we review our past investment decisions.
The Rays’ new manager, Joe Maddon, was also key to the turnaround. Like his bosses, Maddon was a hard worker and an analyst of statistics. He toiled for 30 years as a minor-league manager and major-league assistant before getting the Rays prize. Given the track record of the Rays to that point, one wondered whether or not it was a prize worth winning. Maddon told the press, “When it comes down to individual effort, it takes absolutely zero talent, zero, to try hard and play hard every day. I’m okay with physical mistakes, with mental mistakes, I’m accepting of all that. The part I’m not accepting of is that part you can control. And that’s your effort. You just can’t pick and choose when you put your effort out there. It has to be all the time.” (I hope the Cubs’ new manager demands the same!)
One of the reasons I enjoy comparing baseball to investing is because of their similarities. In baseball, the best teams lose more than a third of their games and endure extended losing streaks. The best hitters generate far more outs than hits. Applying high levels of talent and effort doesn’t eliminate all the bad outcomes in baseball. Similar to the Rays, we always expect a high level of effort from our analysts, regardless of how the stock market is behaving. But that alone doesn’t guarantee success. I’ve said before that investing is an endeavor where lack of effort or talent will eventually lead to disappointing results, but even consistently high levels of effort and talent will fail to produce consistently good short-term results. There is no magic formula that allows for winning every day. As I wrote in last quarter’s report, despite achieving very good performance in the past decade, the Oakmark Fund either lost money or failed to outperform up markets by more than a percentage point in 80% of the quarters. We know what it’s like to play the game hard but still go hitless.
In both baseball and investing, even the best performers experience bad short-term outcomes, and that invites second-guessing. And in both cases, long-term success requires having the discipline to stick with a good process even as it produces bad day-to-day results over a short period. The Rays EVP of baseball operations, Andrew Friedman, said of the turnaround season, “People ask all the time what our expectations were. We don’t get caught up in those things because we are so caught up in process. We believe, with the right process, good things will happen. I felt like we would score more runs than we allowed. What that meant, we weren’t really sure.” I think I’ve used almost those same words. “At Oakmark we believe we have a process in place that will result in us choosing more stocks that go up than down, and the magnitude of our winners should exceed that of our losers. What that means for any given quarter, I don’t know.”
The author Keri writes, “When self-confidence, an even-keeled personality, a nose for analysis, and job security come together, you get coaches and managers willing to make decisions that fly in the face of conventional wisdom.” I believe that success in almost any endeavor requires having the freedom to think differently than others do. Like the Rays, we encourage unconventional thinking. “Trust the process,” Maddon told himself, “and success will never be a surprise.” At Oakmark we strive to maintain an environment where our investment professionals trust our process. Our analysts know that they won’t be rewarded or penalized based just on short-term stock price movements, but rather on how well they followed our process. When we make mistakes, we try to identify them as quickly as possible in order to limit their damage and then we go back to see if we can improve our process to reduce the chance of a recurrence.
Just like the Tampa Bay Rays, we strive to get the right investment professionals on our team. We believe that self-confidence and an even-keeled personality are requirements for success in sports and in investing. So is passion. In investing, that passion has to be for analysis. We hire team-oriented individuals, and we especially like team-sports participants who didn’t have the talent to fully quench their drive for success through sports. We believe the Oakmark process and our team of analysts give us an important competitive advantage. Several of our analysts compete quite successfully in fantasy baseball and football leagues. Our shareholders are fortunate that those analysts didn’t have the talent to play those sports for real.
William C. Nygren, CFA
As of 3/31/11, Illinois Tool Works Inc. represented 1.4% of The Oakmark Fund’s total net assets and Discovery Communications Inc. Class C represented 1.4%. Portfolio holdings are subject to change without notice and are not intended as recommendations of individual stocks.
As of 3/31/11, Illinois Tool Works Inc. represented 0% of The Oakmark Select Fund’s total net assets and Discovery Communications Inc. Class C represented 7.9%. Portfolio holdings are subject to change without notice and are not intended as recommendations of individual stocks.
Keri, Jonah. The Extra 2% - How Wall Street Strategies Took a Major League Baseball Team from Worst to First. ESPN, March 8, 2011.
The discussion of the Funds’ investments and investment strategy (including current investment themes, the portfolio managers' research and investment process, and portfolio characteristics) represents the Funds’ investments and the views of the portfolio managers and Harris Associates L.P., the Funds' investment adviser, at the time of this letter, and are subject to change without notice.