Last week we explored Bill Ackman’s approach to picking winning stocks.
As we mentioned in last week’s post, Ackman’s performance has been very impressive, but he has had some blunders. We want to explore those blunders and see what we can learn from them.
Ackman's Investing Style
Ackman identifies as an activist investor. Activism is when an investor purchases a large number of shares and tries to influence the decisions of the company.
He started out as a passive value investor, but then realised that it suited his personality better to try and improve the companies he invested in. He found it to be more fun and meaningful to be an activist.
Herbalife and Valeant
He initially had a lot of success with this investment style, but in 2012 he waded into somewhat uncharted territory.
He sold short Herbalife, a nutrition company, which means he bet the stock price would go down.
He accused Herbalife of being a multi level marketing scheme. He said they were convincing low income people to buy their products and resell them, however these low income people were not able to resell the products they had bought, being left with large personal losses. This is otherwise known as a pyramid scheme.
After several years of campaigning, and a reported loss of $1bn, he finally exited the position. He was not able to convince the market that Herbalife was a fraud. He still believes the company is fraudulent, and is doing tremendous harm, but he has no position in it.
Another blunder was Valeant, a drug company that came under fire for boosting drug prices and pushing them through using questionable methods. Prosecutors and regulators started investigating the company, and the CEO, who had piled on large amounts of debt, was ousted.
Investors lost faith in the company, and the share price fell more than 95% from the top. We are not certain how much Ackman lost, but it’s reported to be around $3 billion, give or take.
Mistakes Made and Lessons Learned
So, what was his mistake with these two investments?
Last week we mentioned that Ackman follows 8 investing principles; he invests in companies that:
Are simple and predictable
Generate a lot of free cash
Are dominant and operating in industries with large barriers to entry
Earn high returns on capital
Have limited exposures to extrinsic risks
Have strong balance sheets, so they don’t need access to capital to survive
Have excellent management teams, and
Have good governance (systems, practices and processes directing the firm)
His mistake was to not follow his tried and tested principles.
As an activist he tries to influence the management team by buying a large chunk of shares and getting a seat on the board.
With Herbalife he went in the opposite direction, by shorting a low-quality company. Also, shorting is very tough because, as he has said, everyone hates you - the shareholders hate you, the management team hates you, the employees hate you. He says that the “return on invested brain damage” is not worth it.
With Valeant he says he made the mistake of being a passive investor. He was not on the board and could therefore not see what was going on. Ackman had previously worked with Valeant on a deal where they tried to acquire a company called Allergan. He subsequently invested in Valeant and seems to have mistaken it for a high quality company. In reality it was a low quality company that used highly questionable tactics.
These two investments were huge mistakes, both from the perspective of losing money, and losing reputation.
It’s only over the last year or two that Ackman has started to come back from these two mistakes.
But everyone makes mistakes, and as investors we can learn a lot from studying the mistakes of others.
The main lesson for us is that Ackman veered from his tried and tested principles, and paid dearly as a result.
But he seems to have learned his lesson, and is currently back on track. All the best, Lars and Roshni P.S. for people interested in hearing about Ackman’s principles, and his mistakes, we suggest watching this 3.5 minute video: