Ted Williams was arguably the greatest pure baseball hitter who ever lived and the last one to break the magic 0.400 average barrier (which means he hit 40% of the balls pitched at him – baseball is not easy). One of the drivers of his success was that he analysed in great depth what makes a great hitter and importantly knew his own strengths and weaknesses. He developed a number of tenets which are equally applicable to long term investing as they are to baseball. In the game, the pitcher has to throw to pass through an imaginary rectangle beside the hitter. The hitter has three attempts or ‘strikes’ to hit the ball if it is passing through the square. William plotted out on this square where he could easily hit the pitch and where he found it more difficult. He would only attempt to hit the easy pitches. The analogy for a fund manager is that some investment propositions play to his or her strengths and are therefore easier whereas others are more difficult. The advantage a fund manager has is that there are numerous pitches – there are over 50,000 quoted companies globally. The difficulty is that easy pitches in investment are rare.
One factor in this assessment, which is analogous to the decision company management make when allocating capital, is the price of the investment, which in this case will be set by the market. Generally, quoted market prices tend to be lower than company acquisition prices as in the latter, a premium is paid for full control. When a fund manager is deciding whether to acquire a minority portion of a quoted company, the decision carries some inherent risk. In order to counter this risk, and render the pitch easier, the fund manager should build in a margin of error into the price he is prepared to pay. Therefore an estimation should be made of the current value of the company’s operations and compared to the market price. The manager should then aim to acquire below this level so that there is a ‘margin of safety’.
The fund manager should aim to invest in those areas he or she is most capable and there is a margin of safety – the easy pitches – and discard those that are too hard.