3 Top Managers on Their Biggest Mistakes and How They Pick Great Stocks

Investors are always eager to share their investing victories, relating how they bought an otherwise-overlooked stock at a cheap price which subsequently soared. They’re less likely to trumpet their failures. That’s human nature, perhaps, but a trio of successful mutual fund managers bucked the trend on Wednesday evening when they shared some of their own biggest investment mistakes at a Morningstar Investment Conference session.

In a session called "Ahead of the Curve" moderated by Janet Yang of Morningstar, Chris Davis of Davis Funds, Will Danoff of Fidelity Investments and Dennis Lynch of Morgan Stanley Investment Management began by answering Yang’s first question. Since all three men are constantly looking to invest in companies that have strong competitive advantages, what, she asked, is common among the best corporate managers? Since as fund managers they constantly meet with company CEOs, what, she asked, “are you trying to suss out in those meetings?”

Danoff recalled that he once talked to Warren Buffett about this very topic, and that Buffett told him “don’t listen to any CEOs.” Rather, he counseled that Danoff could find what he wanted elsewhere, because “it’s all in the numbers.”

Since managers “give us updates because we may be their largest shareholders,” Danoff said, what he’s trying to learn about the management team is “Do they think long term? Do they think about their customers?”

“If you see 80 companies a month, a couple will stand out” from the rest, he said. The other managers agreed.

Davis said what he looks for is whether management “has the ability to adapt … the nature of capitalism is that high returns attract competition,” but such outperformance “is a temporal thing.”

The three, all of whom have been Morningstar Managers of the Year, also cautioned against portfolio managers who might be so focused on their specific areas that they miss the bigger issues around those areas. “If you have a portfolio manager or analyst who wears blinders,” said Davis, “it doesn’t make sense ... the best PMs resist being put in a box.”

It’s not just money managers and analysts who can miss the big picture. Danoff said that corporate managers “don’t always realize what’s happening in their own industry,” using the example of how EOG Resources (EOG) was the first company to monetize the shale oil business.

“Why didn’t Exxon figure it out first?” Danoff asked, arguing that “entrepreneurs can see something others don’t and make a lot of money for themselves and their shareholders” in the process, especially in the U.S.

As for the mistakes these top managers have made, Davis said that Davis Funds has a “mistake wall,” where they display stocks they “missed on” along with the lessons learned from their mistakes. But Davis said, and the others agreed, that just because you miss the first big rise in a given stock that doesn’t mean you shouldn’t buy it then.

“Stocks follow earnings,” Danoff said, adding that “stocks don’t know where they’ve been” and that their current price “says nothing about where they’re going,” before admitting that “anchoring on those prices—it’s hard to overcome that bias.”

Lynch discussed Facebook (FB) as a business and a stock, saying that from a competitive-threat viewpoint, with “over a billion people interacting on one platform, it will be hard to move them onto another” similar platform. “Most of what they’re providingis free, so why would people change?” he argued.

However, he still wonders whether Facebook’s “economics will be affected by something new that attracts people’s time,” such as some kind of “virtual reality” platform. Danoff said CEO Mark Zuckerberg has learned from his own mistakes, specifically when he “bet on HTML” on the desktop when he “should have bet on Android and iOS” as areas of growth for the company. However, Facebook then “moved all engineering onto the smartphone,” and subsequently “they’ve executed very well; revenues are through the roof; and engagement remains strong, so they can continue to grow.”

Davis said that Facebook was one of those investments that he passed on, because “the one difficulty was around monetization. You go onto Google and you’re searching for information, so serving up ads might be useful to you. People on Facebook were communicating with each other,” and might resent being “served up an ad when they were writing about” taking a trip to Bermuda with their friends.

He admitted that Facebook has “done a good job” monetizing its platform, and then reported a conversation years ago with a Facebook executive who said, “our goal is to monetize the trust you have in your friend.” Wisely, said Davis, “they’ve never repeated that” goal, at least in public.

-- Check out ThinkAdvisor’s special coverage of the Morningstar Investment Conference.

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