A Dozen Things Ive Learned from

Dr. Michael Burry about Investing

2

Dr. Michael Burry is the founder of Scion Capital. He was recently made famous with the
general public as a character in the movie adaptation of Michael Lewis book The Big Short,
but even before then he was famous in investing circles for his astute investing during times
like the financial crisis of 2007. Michael Burry is portrayed in the movie by Christian Bale.
The real Michael Burry started out as a part time investor and blogger and built his
reputation and AUM with great results and original thinking. He is a physician by training and
has diagnosed himself as having Aspergers Syndrome. Burry is particularly interesting for
investors in that he has adapted value investing principles to his personality, skills and
nature. Like Charlie Munger did many years before, Burry found new ways for value
investing to evolve beyond using the system to find cigar butt stocks. Burrys approach
indicates that value investing can work for technology and other stocks that people like
Warren Buffet may invest in if circle of competence exists and the holding period is not as
long that used by someone like Warren Buffett. Technology changes too much to adopt the
same holding period as Munger and Buffett. What is Burry doing today? Michael Burry is
still managing a hedge fund named Scion and is still critical of the way the financial system
is being run, but now hes more interested in water than real estate wrote the author of a
New York magazine article who interviewed him in late 2015. Burrys story demonstrates
several important things. Most importantly, the power of being rational and the power of
fundamental bottoms up research. It also demonstrates the huge value that permanent
capital provides to a rational money manager since as Keynes once said: Markets can
remain irrational longer than you can remain solvent. Even as rational as Burry is, it took
courage to make and to hold on to the investments that made him famous. Being right, but
too early, is indistinguishable from being wrong.
1. My weapon of choice as a stock picker is research; its critical for me to
understand a companys value before laying down a dime. I really had no
choice in this matter, for when I first happened upon the writings of
Benjamin Graham, I felt as if I was born to play the role of value investor.
Investors in the habit of overturning the most stones will find the most
success. The late 90s almost forced me to identify myself as a value
investor, because I thought what everybody else was doing was
insane. Burry has not completely adopted the ideas of Warren Buffett or Ben
Graham and has instead developed his own approach that remains true to the
fundamental bedrock of value investing. Burrys example illustrates how it is possible
to follow the value investing system and yet have your own unique style. Again, he is
at his core a value investor. Burry makes clear in this set of quotes that he treats
shares of stock as a partial ownership of a real business and that understanding any
business requires research. You must genuinely understand of the underlying
business. A share of stock is not a piece of paper to be traded like a baseball card.
The movie version of The Big Short conveys that the style of Burry has a lot more
stress associated with it than a Buffett approach, but for Burry it has worked out well
financially.

2. All my stock picking is 100% based on the concept of a margin of safety, as

introduced to the world in the book Security Analysis, which Graham co-
 authored with David Dodd. By now I have my own version of their
techniques, but the net is that I want to protect my downside to prevent
permanent loss of capital. Specific, known catalysts are not necessary.
Sheer, outrageous value is enough. My firm opinion is that the best
hedge is buying an appropriately safe and cheap stock. It is a tenet of
my investment style that, on the subject of common stock investment,
maximizing the upside means first and foremost minimizing the
downside. Burry reveals in these statements that he keeps the core value
investing faith by always using a margin of safety approach. When Burry
says: Lost dollars are simply harder to replace than gained dollars are to
lose it is another way of saying what Warren Buffett has said many times: The first
rule of investing is: dont lose money; the second rule is dont forget Rule No. 1. Joel
Greenblatt agrees: Look down, not up, when making your initial investment
decision. If you dont lose money, most of the remaining alternatives are good ones.
Seth Klarman writes in his book of the same name: A margin of safety is achieved
when securities are purchased at prices sufficiently below underlying value to allow
for human error, bad luck, or extreme volatility in a complex, unpredictable and
rapidly changing world. An investor who purchases shares in a business at a price
that reflects a margin of safety can make a mistake and still do well financially. When
Burry refers to catalysts he is talking about the events that I wrote about in my
post on Mario Gabelli, who has said: A catalyst may take many forms and can be an
industry or company-specific event. Catalysts can be a regulatory change, industry
consolidation, a repurchase of shares, a sale or spin-off of a division, or a change in
management. Burry, Buffett, Greenblatt, Klarman, Gabelli all think about margin of
safety first. It is not an optional part of value investing.

3. I try to buy shares of unpopular companies when they look like road kill,
and sell them when theyve been polished up a bit. Fully aware that
wonderful businesses make wonderful investments only at wonderful
prices, I will continue to seek out the bargains amid the refuse. The third
bedrock value investing principle is: Mr. Market is your servant and not your master.
Howard Marks makes the same point Burry is making about the necessity of
sometime being contrarian: It is our job as contrarians to catch falling knives,
hopefully with care and skill. Thats why the concept of intrinsic value is so
important. If we hold a view of value that enables us to buy when everyone else is
selling and if our view turns out to be right thats the route to the greatest
rewards earned with the least risk. To achieve superior investment results, your
insight into value has to be superior. Thus you must learn things others dont, see
things differently or do a better job of analyzing them ideally all three. Adopting
the popular viewpoint will not result in market out-performance if the popular
forecast is also right. Some roadkill is really roadkill, and some refuse is really refuse.
Finding an out-of-favor business selling at a substantial bargain and then waiting is
the name of the value investing game. It is easier to say than do.

4. If you are going to be a great investor, you have to fit the style to who you
are. At one point I recognized that Warren Buffett, though he had every
advantage in learning from Ben Graham, did not copy Ben Graham, but
rather set out on his own path, and ran money his way, by his own rules. I
also immediately internalized the idea that no school could teach someone
how to be a great investor. If it were true, itd be the most popular school
in the world, with an impossibly high tuition. So it must not be true. Ick
investing means taking a special analytical interest in stocks that inspire a
first reaction of ick. I tend to become interested in stocks that by their
very names or circumstances inspire unwillingness and an ick
 accompanied by a wrinkle of the nose on the part of most investors to
delve any further. In his book The Big Short Michael Lewis describes Burrys view:
The lesson of Buffett is, to succeed in a spectacular fashion you have to be
spectacularly unusual. The movie version of The Big Shortcertainly portrays Burry
as a very usual character due to his Aspergers syndrome. Burry believes he has an
advantage in the investing process since Aspergers allows him to be more
rational/less emotional. There will be times when Mr. Market will offer up shares in a
business at a price that reflects a substantial margin of safety, and to find that
bargain wise investors try to find something that is out-of-fashion. Burry believes
there is no better place to look for something that is out-of-fashion than the ick
category.

5. I prefer to look at specific investments within the inefficient parts of the

market. The bulk of opportunities remain in undervalued, smaller, more
illiquid situations that often represent average or slightly above-average
businesses. In essence, the stock market represents three separate
categories of business. They are, adjusted for inflation, those with
shrinking intrinsic value, those with approximately stable intrinsic value,
and those with steadily growing intrinsic value. The preference, always,
would be to buy a long-term franchise at a substantial discount from
growing intrinsic value. Markets are often efficient but that does not mean that
they are always efficient. If you work hard at the research side of investing and are
diligent Burry believes that bargains can be found. The bargains may not always be
found within your circle of competence and may not be available for very, long but if
you are aggressive and willing to act quickly Burry believes there are big
opportunities for an investor.

6. It is Buffett, not Graham that espouses low turnover. Graham actually set
targets: 50% gain or 2 years. That actually ensures rather high
turnover. The actual Ben Graham quote from an interview is: If a stock hasnt met
your objective by the end of the second calendar year from the time of purchase, sell
it regardless of price. This statement by Graham is not consistent with Warren
Buffetts view of the world, but it is perfectly acceptable for a value investor to do as
long as the holding period is not so short that it falls within the definition of
speculation. Burry feels comfortable buying stocks and other assets that Buffett
would avoid. Both approaches are still value investing.

7. Credit-default swaps remedied the problem of open-ended risk for me. If I

bought a credit-default swap, my downside was defined and certain, and
the upside was many multiples of it. Burry is describing a classic example of
positive optionality that I discussed in my post on Nassim Taleb: Optionality is the
property of asymmetric upside (preferably unlimited) with correspondingly limited
downside (preferably tiny). If you can buy positive optionality at a bargain price that
investment can be very valuable. It is of course possible to overpay for optionality.

8. A Scion portfolio will be a concentrated portfolio. The Fund maintains a

high degree of concentration typically 15-25 stocks, or even less. Some or
 all of these stocks may be relatively illiquid. I like to hold 12 to 18 stocks
diversified among various depressed industries, and tend to be fully
invested. Burry is what Charlie Munger calls a focus investor since he
concentrates his bets. For Burry, owning a small number of stocks in various
depressed industries is enough diversification. This means he does not buy a dozen
health care stocks. In other words, Burry diversifies based on categories.

9. One hedges when one is unsure. I do not seek out investments of which I
am unsure. It is always wise to have what Charlie Munger calls a too hard pile
and avoid investment about which you are unsure. But this approach is especially
important if an investor has as few as 12 stocks in their investment portfolio like
Burry. One way to make peace with this approach and avoid hyperactive investor
syndrome is to realize that you can be a successful investor by making only one of
two sound decisions a year. Joel Greenblatt says: Even finding one good opportunity
a month is far more than you should need or want.

10. How do I determine the discount? I usually focus on free cash flow and
enterprise value (market capitalization less cash plus debt). I will screen
through large numbers of companies by looking at the enterprise
value/EBITDA ratio, though the ratio I am willing to accept tends to vary
with the industry and its position in the economic cycle. If a stock passes
this loose screen, Ill then look harder to determine a more specific price
and value for the company. I also invest in rare birds asset plays and, to
a lesser extent, arbitrage opportunities and companies selling at less than
two-thirds of net value (net working capital less liabilities). Ill happily mix
in the types of companies favored by Warren Buffett those with a
sustainable competitive advantage, as demonstrated by longstanding and
stable high returns on invested capital if they become available at good
prices. Burry is not like Buffett in every way and not like Graham either. Burry
shows how it is possible to follow the value investing system and yet have your own
unique style. But he is still a value investor since he buys at a price that reflects a
margin of safety, does not make Mr. Market his master and treats shares of stock as
a partial ownership of a real business. Burrys style is opportunistic and fits with who
is he is. You are not Michael Burry and neither am I. Most everyone is far better off
investing in a low cost portfolio of diversified index funds.

11. Volatility does not determine risk. I certainly view volatility as my

friend. Volatility is on sale because 99% of the institutions out there are
doing their best to avoid it. I will always choose the dollar bill carrying a
wildly fluctuating discount rather than the dollar bill selling for a quite
stable premium. Michael Mauboussin has a wonderful description of volatility that
I like a lot.

A lot of value investors shun concepts such as volatility, or standard deviation, as a

measure of risk and Im sympathetic to that point of view. That said, the notion of risk is
very time-dependent. For very short periods of time, volatility is a pretty good way to think
about risk. I have kids in college and I have to write a check for their tuition, so volatility is a
very important concept for me. I want to minimize my volatility so I can make sure I can
write that check. Or if you go out to an options desk and say, Options traders, were taking
away your measure of implied volatility, they would actually be very much hamstrung. But
if you take a long-term point of view, which most value investors do, then that idea of
volatility melts away and, in fact, volatility becomes your friend. Risk then becomes the loss
of permanent capital. You can bring these under the same tent by thinking about the
temporal dimension.

12. Innovation, especially in America, is continuing at a breakneck pace, even

in areas facing substantial political or regulatory headwinds. Anyone
involved in a real business or an occupation like medicine can see the pace of
innovation in increasing not decreasing. That people are not buying as much capital
equipment like machine tools is not evidence that innovation has slowed. That
software is replacing capital goods is obvious to anyone paying attention to the real
economy. Innovation is racing ahead, but not all innovation is profitable. A simple
way to think about disruption is to say that it happens when one business is able to
harm or eliminate the competitive advantage of another business. Its that simple.
Disruption happens when a business creates innovation which reduces the
competitive advantage of rival businesses. Innovation both creates and destroys
competitive advantage and therefore profit. Consumers always benefit from
innovation. Producers only sometimes benefit from innovation depending on whether
the innovation creates or harms a moat.