Taking a long-term approach, Azvalor Asset Management is known for investing in good businesses that offer sustainable competitive advantages over time, have high returns on capital employed, are led by a strong management team that oversees its shareholders’ interests and whose intrinsic value is not reflected in their share price.
The Spanish investment firm is led by Alvaro Guzmán de Lázaro, founding partner, CEO and co-chief investment officer, and Fernando Bernad, founding partner and co-CIO.
The two fund managers answered questions about investing and the market that GuruFocus readers asked recently. Read their responses in the interview below.
You can also check out some of the firm’s current portfolios here.
GuruFocus question: Can you tell us a bit about what sparked your interest in investing?
Alvaro Guzmán de Lázaro: I started using probabilities at the age of six while handicapping horse races. Then at 21, I started in an asset management company and I thought that there were important similarities. Then, I swallowed “The Intelligent Investor,” “One up in Wall Street” and “Common Stocks, Uncommon Profits” in a matter of days; after this, I knew I would do this for my entire lifetime.
Fernando Bernad: My very first real contact with the stock market was in 1997 as a junior analyst in Frankfurt, and I was soon fascinated by the “game.” I loved reading the hot debates in favor or against owning a stock. I was thrilled about the boom and bust nature of the market after going through the crash in the summer of 1998, and the phenomenal rally of 1999 that followed. And I really got hooked by the intellectual exercise of understanding and appraising the value of a business that one can, then, compare to a stock quote which experiences wild gyrations and can prove you right or wrong.
Question: Which investors inspired you the most at the beginning of your career? Are there any investors that continue to inspire you today?
AG: As I said, it was Warren Buffet and Peter Lynch. I have been fortunate to have met and talked briefly to Peter Lynch, Jean Marie Eveillard, Bill Miller, Howard Marks (Trades, Portfolio), the folks at Tweedy Browne (Trades, Portfolio), etc. All of them are immensely inspiring. I continue to read stuff from managers who I do not know personally, but who have a long-term track record. I also particularly enjoy receiving pitches from young investors with variant perceptions, as they’re hungry, fresh and want to achieve, which I think is massively important in investing. They also know more than me in fields like tech, software and biotech, for example.
FB: The first one was Peter Lynch and his book “One up on Wall Street,” and after it I devoured many books on or by the “usual suspects,” like Buffett and Charlie Munger (Trades, Portfolio), Phil Fisher and Ben Graham. Also during those early days, I very much enjoyed reading the Outstanding Investor Digest, and admired the various great investors featured during the late ‘90s and early 2000s.
Question: How do you generate your ideas? Do you run a screener?
AG:Well, not really. There are around 400 companies that we’ve visited and analyzed deeply over the last 25 years. This, plus the normal ebb and flow of market fluctuations, has allowed us to be fully invested in general. Sometimes we can also expand our circle of competence (provided it is doable by a generalist like us).
Our investment in uranium four years ago would be an example of that. It was hated, it was cheap and we thought Cameco (CCJ, Financial) had the best assets, a great team and an “OK-ish” balance sheet; we had close to 8% of it in the fund when the shares were under $7.
In general, the best screen is when a company praises a competitor, in my experience, or when the entire sell side hates a company in which the analysts were all burnt previously.
Question: What's a go-to resource for you when researching investment ideas, beyond typical business publications and websites?
AG: As I said, it is just our mental database in Europe accumulated over 25 years, and some cyclical businesses (steel, paper, oil, etc.) that we know well and are global in nature.
Question: What do you think are the most important factors to consider when building a portfolio?
AG: Value and price are by far the most important considerations. But valuing is an art. Otherwise, one would not find two smart investors, one long and one short, in the same stock. Yet this happens. So it is an art. Our portfolio is really built bottom up; it is the result of our individual convictions about price being way below our estimated value on a case-by-case basis.
Question: How do you allocate your portfolio’s international holdings in regard to position size? Do you allocate strictly from a bottom-up perspective or do you have a certain threshold for each geographic area that must be met (or limited) in terms of percentage of the portfolio?
FB:All is strictly bottom up. But there are limits, of course; those dictated by common sense. If Brazil is being forgotten by investors, we will definitely try to go there, but we won’t have 40% of the fund in Brazil. We normally have Europe as our preferred fishing ground, as one knows better what is closer to home. In cyclical sectors like paper, oil, etc., we would go global with relative ease, provided we really understand the incentives at work in the organization.
Question: How do you value businesses? Are asset-based or earnings-based valuations more useful?
AG: As I said, this is an art. Many disciplines are needed. Economics, history, psychology, game theory, complex systems understanding… all of this enters into our estimates of future earnings. Once we have a clear vision of how much the company will make three to five years from now, we do not spend a lot of time with the valuation. If an investment is a value investment, VALUE should be very easily calculated. Be it a simple P/E (with a well-thought “E”) or a DCF or an asset-based value, they all should show great undervaluation or else… danger!
Question: What are some of the key points you look at when assessing a company's balance sheet, how well (or poorly) it is utilizing debt and whether its leverage strategy is in the best interests of shareholders?
FB: We start ALWAYS with the balance sheet. This is what tells you if the option is long dated or not. We need long-dated options because we have a long-term horizon, and we are usually wrong before being proven right. So you need a strong balance sheet that allows the time needed for your view to materialize.
We analyze the balance sheet in great detail, almost with a private equity mentality. Are the fixed assets real or is there some capex capitalization without merit? What is their duration and how well reflected in the D&A line? What are the policies behind historic and current working capital levels? What are the assumptions underlying the different type of provisions? What is the value of the non-core assets? Is management hiding liabilities in JVs where there is effective control, yet they are accounted using the equity method? Scrutinize all forms of debt: type of creditor, maturity, cost, fixed versus variable, covenants, etc. We are very, very intense with accounting!
Question: How do you value the quality of the management team? What particular things do you objectively look into to assess how the administration is aligned with small shareholders?
AG: Well, I wish I could give a clear recipe. But it would be misleading.
The quality of a management team is very easy to ascertain when the track record is very long. It’s not difficult to say that Jack Welch was great, or Buffet or Sam Walton. But that is not the point. The point is to discover them ex-ante, as normally the stocks of great managers are well priced by the market (except in a market meltdown, where it is generally intelligent to pick the good managers).
Say you discover an $800 million market cap company selling for 6 times. Let us call it Company X. Completely unknown folks at the helm. What do we do? Well, first we try to talk to all the competitors. We ask them about their views on X’s history, on X’s main business decisions, on X’s CEO, CFO and mid-management. We then look at all the corporate transactions done in X’s history. We then look at organic growth rates, margins and return on capital versus its main competitors. This is long, surely tedious work for most, but we love it. We get excited as boxes are checked one after the other. Once done, we look at the compensation, the board and the other co-shareholders. We then call the company. And, in general, one gets a pretty good idea of who one is partnering with if you have done all this work.
FB: I do not want to convey the image, though, that this is easy or just a matter of will power, in the sense that “research can achieve everything.” Sometimes you get good things and bad things out of this scuttlebutt. Sometimes you cannot perform it entirely, as some competitors won’t tell you anything. Sometimes they tell you everything. It is fluid, though, and at the end of the day, one has to weight the important elements and separate them from the trivial.
AG: For us this boils down to: 1.) Who is the real ruler within the company, 2.) what does he want and 3.) does he have the means to achieve the objectives? At the end of the day, one wants to conclude if the ecosystem is one where the shareholder is the priority. We wish we could give an objective KPI for this, but for us it is more a combination of past behavior, incentives schemes and it goes down to individual human beings in the end. You have to go one by one, and it is not easy.
Question: How do you avoid value traps? How do you identify if you’ve invested in one, and how do you get out of it?
AG: Well, this is the only BIG question in value investing, isn’t it? Very good question.
A lot of the value traps come from some disruption going on. There is no protection beyond hard research, and even then, it is not always easy to find out 100% of what two bright, hungry guys are doing in a garage somewhere in the world. One protection here is to avoid names that can be disrupted by two guys in a garage, like owning two of the best uranium mines in the world with Cameco. But there are many more fluid situations where it is not that easy. In general, my advice is to be crazily obsessive about competition for this first category of value traps.
Then there are other instances where you still can be fooled. A dying business (newspapers at the 2007 multiples after having collapsed more than 50%...they were still value traps!) or a self-serving CEO with a weak board in a sector in which competition is just getting a little bit more intense. You can lose 70% in a situation like this before an activist comes in to rescue you as a shareholder (I prefer not to give examples, but there are really a lot here).
FB: Our recipe for avoiding it, in general, is to partner with companies in which there is an alignment between the management and the shareholders, a good balance sheet and a strong competitive position. Of course, getting all of the above CHEAPLY is why this is an art and only 5% to 6% of the managers tend to outperform in the long term. You have to be contrarian, and you have to be right, which is not easy by any means.
Read the second part of this interview here.
