Ken Kam, Marketocracy: So far in our search for the next Warren Buffett we’ve looked at Justin Uyehara, a swing trader, and Kai Petainen, a quant. This time we are going to look at Mike Koza, a civil engineer in California who has an investment style similar to Buffett's. Over the past 10 years, Mike’s Marketocracy track record shows an annualized return of 17%. Berkshire Hathaway and the S&P 500 both show annualized total returns just short of 9% during the same period. Like Justin and Kai, Mike is having a great year, up 34% so far, and he is also profiled in the book "The Warren Buffetts Next Door" by Forbes Investment Editor Matt Schifrin. Could Mike Koza be the next Warren Buffett?
For many value investors, the “holy grail” is to find stocks that are about to start growing while they are still trading at low valuations. This is exceptionally hard to do.
One way Buffett has succeeded in the past is by buying companies that have major assets that accountants won’t allow on their balance sheets. A good example of this kind of asset is a consumer brand name.
Even today, the Coca Cola brand, which is arguably the company’s most valuable asset, does not appear as a major asset on the company’s balance sheet. If you create the brand yourself, accountants will make you expense almost all of the cost allowing next to nothing on the balance sheet. If you buy a brand name, there is a tremendous incentive to assign the purchase price to assets that can be depreciated rather than to the brand name.
Whether you create the brand yourself or buy it, brand names are assets that tend to be severely undervalued on company balance sheets. Buffett’s insight allowed him to feel comfortable valuing a company at more than the market price because there were assets that the market was not valuing properly that provided a cushion of intrinsic value should his judgement about the company’s business prove wrong.
Accountants are generally conservative. However, a conservative financial statement is not the same as an accurate one. If you owned the company, or were thinking about buying it, you need to adjust the financials to give you a more accurate sense of the strength and value of the business. This is what Mike excels at.
Mike looks at a company’s financial statements as if he owned the business. An important metric for him is the company’s intrinsic value which he defines as the present value of the cash flow the company generates that is not needed to run the business. Mike pays particular attention to non-cash expenses such as depreciation and amortization, trying to distinguish between the ones that are required to run the business (depreciation of plant and equipment), and the ones that are not (amortization of goodwill). Doing this work requires a close reading of a company’s financials including all the footnotes and appendices over many years. Mike is one of the few people I’ve ever met who enjoys reading financial statements in his free time.
A Great Stock Picker
Over the past 10 years, Mike has invested in a total of 333 stocks at one time or another, and made money on 205 (62%) of those stocks — a pretty good batting average in my view.
Not So Much A Trader
Mike’s average gain to loss ratio is 0.95. This ratio tells me that on average he makes less when he is right about a stock than he loses when he is wrong. A common problem I see among value investors is that when a stock they like goes down, they tend to buy more believing that the lower price makes the stock an even better investment. It’s a good thing Mike is right 62% of the time on the stocks he picks or his track record would be terrible.
Sweet Spots And Blind Spots
This table shows which sectors and market caps accounted for Mike’s gains and losses over the past 10 years. Mike’s investment style does not work equally well across all sectors. As is true of just about all value investors I’ve looked at, Mike has sweet spots and blind spots.
A common problem among value investors is that you often don’t know where your blind spots are until you make a mistake. Buffett, for example, has famously sworn off investing in airlines after making an investment in US Airways that didn’t work out as he expected. In Mike’s case, it was an investment in China Media Express that exposed his blind spot.
When Mike first bought China Media Express, it had reported revenue growth of 100% from the previous year, was trading on the NASDAQ with a price/earnings ratio of 8 (one-half the market’s PE), and Hank Greenberg (the former CEO of AIG), had just made an investment after putting the company through four months of intensive due diligence. The company’s auditors were Deloitte Touche Tohmatsu Hong Kong, a subsidiary of the one of the largest audit firms in the world. Showing a value investor a stock with these characteristics is like dangling a pork chop in front of a dog. To make a long story short, the company fooled everyone because it turned out to be a fraud. When the dust settled, the financial statements that Mike relied on for his analysis did not reflect reality.
The fact that Mike made a mistake with China Media Express does not, in my view, eliminate him from consideration as the next Warren Buffett. After all, even Warren Buffett has made mistakes. If we eliminate everyone who has ever made an investment mistake we would quickly eliminate just about everyone.
What I find remarkable is that even after this mistake, Mike’s track record is outstanding. In my view, Mike is an excellent value investor. When he is investing in his sweet spots, as he is now, I am willing to follow.
Current Top Five Stocks
1. Genworth Financial Inc. (GNW, Earnings, Analysts, Financials): Provides insurance, wealth management, investment, and financial solutions in the United States and internationally. Market cap at $5.5B, most recent closing price at $11.16.
2. GenCorp Inc. (GY, Earnings, Analysts, Financials): Engages in the manufacture and sale of aerospace and defense products and systems in the United States. Market cap at $954.73M, most recent closing price at $16.10.
3. Research In Motion Limited (BBRY, Earnings, Analysts, Financials): Operates as an automotive retailer in the United States. Market cap at $7.82B, most recent closing price at $14.91.
4. Hewlett-Packard Company (HPQ, Earnings, Analysts, Financials): Offers various products, technologies, software, solutions, and services to individual consumers and small- and medium-sized businesses (SMBs), as well as to the government, health, and education sectors worldwide. Market cap at $46.46B, most recent closing price at $24.01.
5. MetLife, Inc. (MET, Earnings, Analysts, Financials): Provides insurance, annuities, and employee benefit programs primarily in the United States, Japan, Latin America, the Asia Pacific, Europe, and the Middle East. Market cap at $49.8B, most recent closing price at $45.40.
You Make The Call
Does Mike’s 10 year track record give you enough confidence to stick with him for an entire market cycle? If you think Mike Koza might be this generation’s Warren Buffett, email me at email@example.com to let me know.
If you don’t think so, there are still 395 Marketocracy managers and 61 mutual fund mangers to review, all of whom passed our first cut by outperforming the S&P500 by at least 600 basis points, or 6%, per year for the last 5 years.
In the next article, we’ll look at the mutual fund managers who passed our first cut. To be notified when it is posted, click on the link next to my picture labeled “Follow” or join Ken Kam’s Investment Masters Roundtable group on LinkedIn.
The first article in this series is “Finding The Next Warren Buffett.”
Disclosure: Ken Kam is the portfolio manager for mutual and hedge funds advised by Marketocracy Capital Management, an SEC registered investment advisor. Before relying on the opinions expressed in this article, you should assume that Marketocracy, its affiliates, clients, and Ken Kam have material financial interests in these stocks and may hold or trade them contrary to these opinions when, in our view, market conditions change.
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Dig Deeper: Access Company Snapshots, Charts, FilingsGenworth Financial Inc. (GNW, Chart, Download SEC Filings) GenCorp Inc. (GY, Chart, Download SEC Filings) Research In Motion Limited (BBRY, Chart, Download SEC Filings) Hewlett-Packard Company (HPQ, Chart, Download SEC Filings) MetLife, Inc. (MET, Chart, Download SEC Filings)