Valuentum Exclusive Analysis for the Discerning Investor

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Image: SDM Investments' Kevin Truitt (left) and Valuentum's Brian Nelson (right) pause for a picture at the Chicago Chapter of the American Association of Individual Investors (December 2016).

Brian Nelson, CFA:

We’d like to introduce Kevin Truitt, manager in charge of the equity investments at SDM Investments, an investment management firm based in Merrillville, Indiana. 

Kevin and I have been friends for more than a decade now, and he’s even written an article about combining value and momentum investing in the AAII Journal a number of years ago, “Investing’s Odd Couple: Value and Momentum.” 

Kevin, thanks for sharing your knowledge, wisdom, and experience with us. With that said, let’s get right into the questions. Can you provide some background about yourself, your investment philosophy, and what got you first interested in investing?

Kevin Truitt:

Brian thank you for inviting me to do this interview. It’s a pleasure and an honor to be able to share my thoughts on investing with a friend who has contributed to my own education as an investor and whose intellectual prowess and firepower I hold in high regard.

You’ve asked me about my background, and wanted to know about my investment philosophy, and how I first got interested in investing.

The Cliff Notes on my background is this.

I was born and raised on the southside of Chicago. My father was a painter; he painted apartments, not works of art. My mother was mostly a stay-at-home mom whose job was to take care of six kids. We were not rich; we were working poor, and we struggled from time to time. During those periods when my father was unemployed, my mother grudgingly accepted public assistance just to be sure there was food on the table for her kids. Neither she nor my father were happy about this but they didn’t know what else they could do to be sure the kids got fed.

I was the second of six kids. I was baptized Catholic and was educated from grammar school through graduate schools at Catholic institutions. St. Clara Grammar School, Holy Name Catherdral, H.S., Loyola University undergraduate, and DePaul University MBA. I thought I got an excellent education at all these places because they all taught me to think critically and logically and challenge ideas where I thought there were holes in the logic.

My investment philosophy is deeply rooted in the principles of value investing that I’ve learned from reading Ben Graham’s book’s Security Analysis 4th Edition and The Intelligent Investor. The core principles of value investing can be found on pages 27 and 28 and 67 in Security Analysis 4th Ed. I gravitated to and embraced value investing because the principles are simple, based on sound logic. I understand them, and they have stood the test of time. I have also learned a great deal about value investing by reading and observing what great investors who’ve made money consistently over time have done and borrowed liberally from them. Discovering value investing opened up a whole new world of opportunities for me. It was as if I’d found a buried treasure or discovered the Rosetta Stone.

I became interested in business in high school when we were studying American History and we got to the “Industrial Revolution." I was fascinated and riveted by the stories of John D. Rockefeller, Andrew Carnegie, Cornelius Vanderbilt, Jay Gould and others. I thought, "Boy I’d like to be like one of these business titans, rich, powerful, and in control of your life." I knew I wanted to be in business, but I wasn’t sure what area of business I could go into and be successful.

It wasn’t until 1982 when the first edition of the Forbes 400 came out that I truly figured out that I wanted to be an investor. Given my modest childhood, I was always interested in money, not for its own sake, but, because having money gave you options and control over your life. I went through that Forbes 400 like Sherlock Holmes looking for clues to a murder mystery. What I was looking for were clues as to how the rich got rich. 

After reading the profiles of the Pritzkers, Warren Buffet, David Murdock, Larry Tisch and others who were described as “Graham and Dodd” investors, I believed I’d found the clues I'd been looking for. By then I had my MBA, but I’d never heard of “Graham and Dodd” investing before. I didn’t know who the other investors were in that issue of the Forbes 400, but I knew who the Pritzkers were, and I thought if it’s good enough for them and this is how they got rich I need to find out as much as I can about this “Graham and Dodd” stuff. That was the turning point in my life and I became a lifelong student of investing and more specifically “Value Investing.”

I realized early on that investing, and specifically value investing in the stock market was an endeavor that was completely objective, unbiased and that the stock market does not discriminate. The only thing you needed to succeed was brainpower, the right temperament, patience and a strategy that would work. To me “Value Investing” was that strategy. That’s how I got interested in investing. 

Brian Nelson, CFA: 

"Value Investing" is the core of what we do at Valuentum. In some ways, "Value Investing" is the foundation of all investment styles, or at least it should be. Quite simply, it seems very irresponsible if investors don't have some idea of what the companies they own are worth, or even how to calculate that worth.

Kevin, I recall that you had the opportunity to ask the Oracle of Omaha a great question at one of the Berkshire meetings. Is Warren Buffett your favorite investor? Do you like other investors as well, and if so, what have you learned from them, or how have they shaped your thinking?

Kevin Truitt: 

Warren Buffett is my north star as an investing role model. The other investors that have had a profound influence on my thinking as an investor were Ben Graham, Charlie Munger, Richard Rainwater, Cliff Asness and some youngster named Brian Nelson. 

I learned the basic principles of value investing by reading Ben Graham. Charlie Munger taught the lesson of investing in quality businesses. Richard Rainwater’s example taught me that great investors are made, not born, and if you’re willing to learn and study what other great investors have done, you can learn from them, borrow the best elements of their respective strategies and craft your own investment strategy that suits your personality and temperament.

Brian Nelson, CFA: 

Thanks Kevin. I have learned a great deal from you, too.

There’s a lot of talk now about the U.S. economy potentially heading into a recession given the recent inversion of the 2/10 Treasury yield curve and rising inflation expectations. Do macro indicators factor into your fundamental assessment of stock evaluations?

Kevin Truitt: 

To a degree yes, I pay attention to macro factors, but they don’t drive the investment decision. As an investor you have to be aware of what’s going on in the world around you. You have to make investments in a dynamic, rapidly changing world with imperfect information.

I want to be aware of what happening in the world and how what’s happening might affect our investments. You have to be able to understand and evaluate whether or not these changes that are going on in the world around you will fundamentally change your investment thesis. If you were invested in horse drawn carriages when Henry Ford created the Model T, and if you ignored that and dismissed what this meant to your business you ultimately got wiped out.

The people who held onto Wang Labs’ stock -- a computer company that at its peak in the mid-1980s had $3+ billion in revenue and employed 33,000 people only to go bankrupt in 1992 -- thinking personal computers were just toys did not fare well either. You don’t invest in a vacuum, and you have to be able to adapt to the world around you. You have to be a realist and invest in the world the way it is, not the way that you’d like it to be. The rapid pace of technological innovations has fundamentally changed the world, and value investors if they want to be relevant and successful must adapt to these changes.

I focus a great deal on trying to understand the underlying operating fundamentals of the business. What service or product does the business make? What drives demand for the product or service? Is the product or service “mission critical?’ Does the company have and identifiable and durable competitive advantages? Is management shareholder friendly and are their interest aligned with those of the shareholders? After I’ve answered these and other questions then I’ll look at macro events and indicators to try to evaluate what influence macro events or indicators might have on a potential investment.

But the first and most important thing is to know and understand the business first, then worry about macro factors. As Buffett has said, “you have to focus on those things you can control, and what’s knowable.”

Brian Nelson, CFA: 

I couldn't agree more.

Macro factors are important but only so much as they impact the intrinsic value of the equity. In many respects, macro traders and funds drive some of the biggest mispricings on the market as they are not looking at firm-specific considerations, but rather trading across large baskets of stocks that have varying exposures to macro dynamics.

Further, the intrinsic value of a company is based in large part on mid-cycle earnings and free cash flow expectations, and mid-cycle expectations capture both the upside of a potential boom and the downside of a potential recession. For example, if we do enter a recession in the next couple years, we won't see many large fair value estimate changes. The fair value is based on normalized fundamentals, not peak or trough numbers, and we always apply a fair value estimate range.

Now on to one of the hottest topics with respect to capital flows. With ESG investing becoming an increasingly more relevant consideration for investors of all types, what are your thoughts on how investors can consider more socially responsible investing into their investment frameworks?

Kevin Truitt:

If ESG is important to the investor, then you only need to ask yourself a few of questions.

Is the company’s product or service harmful to society? Is management honest and operating ethically? Are the company’s values consistent with my own? Does management treat its employees and stakeholders with respect and dignity? If I had the money to buy the entire company, is this a business I would be proud to own?

In short ESG can be summed up in a few words: good ethics, honesty, respect, and dignity.

Brian Nelson, CFA:

Great to-the-point answer Kevin. 

What are some valuable lessons you’ve learned through your own investing experiences? How might your experiences and takeaways have differed from some of the more traditional financial wisdom out there?

Kevin Truitt: 

Some valuable lessons I’ve learned are to be curious, be open minded, stay focused, be willing to learn from others, and be willing to admit when you’ve made a mistake or things have changed

Having spent the bulk of my career as a banker and credit analyst, I learned early on to focus on the downside risk. When I was a young banker, I learned that you have to look at cash flow, not earnings, because earnings can be manipulated. Cash is real, and cash is what repays a banker’s loan not earnings.

I also learned that in any deal or loan you should always consider your downside risk and build in a margin of safety. Bankers build in a margin of safety via their loan-to-value ratio. A value investor builds in a margin of safety based on the difference between the amount you invest and your estimate of intrinsic value.

A large number of investment analysts only talk about the upside potential of an investment. You don’t often see them evaluate what is the downside risk of a potential investment.

Brian Nelson, CFA: 

Well said. It's so important for investors to be cash-flow based, not earnings based. To a large degree, this dynamic was emphasized considerably in the book Value Trap: Theory of Universal Valuation, which warns against short-cut quantitative analysis that may only use simple ratios like the price-to-earnings ratio, for example.

Okay, now on to what everyone is waiting for. How about some investment ideas? What might be one or two of your favorite ESG related ideas, for example, and perhaps another one of your favorite ideas?

Kevin Truitt:

As you know, my focus is on quality businesseses. To me, the characteristics of a quality business are businesses that have:

1) Good consistent 'Return On Invested Capital.'

2) Have high and sustainable Gross Profit Margins.

3) Generate Consistent Cash Flow.

4) The business reasonably easy to understand.

5) The business has an identifiable competitive advantage.

6) Management are good capital allocators and good stewards of the shareholders money.

With that said, five names that I like a lot are as follows:

1) Veeva Systems (VEEV) -- [Highlighted in the November 2020 edition of the Exclusive publication and closed July 2021 for a solid "gain" -- Sample the November 2020 edition of the Exclusive here (pdf)]

2) Sherwin-Williams (SHW) >>

3) Cummins, Inc. (CMI)

4) Idexx Laboratories (IDXX)

5) Factset Data Systems (FDS)

Brian Nelson, CFA:

Kevin, thank you so much for talking with us today. I can't begin to tell you how much I appreciate your thoughts and perspectives on life, investing, and the markets.

Thank you again!

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Tickerized for VEEV, SHW, CMI, IDXX, FDS, ESGU, ESGV, EFIV, SAEF, RSPE, QQMG, QQJG, LRGE, WOMN, NACP, SUSL, SDG, ICLN, QQQ, XLU, ASML, TSM, RSG, AMRC, ALB, SOUHY, NEE

Brian Nelson owns shares in SPY, SCHG, QQQ, DIA, VOT, BITO, and IWM. Valuentum owns SPY, SCHG, QQQ, VOO, and DIA. Brian Nelson's household owns shares in HON, DIS, HAS, NKE. Some of the other securities written about in this article may be included in Valuentum's simulated newsletter portfolios. Contact Valuentum for more information about its editorial policies.  

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