Interview: Larry Sarbit, Sarbit Asset Management

Despite the fact that you may not ever come close to catching up to Warren Buffett's wealth does not mean you shouldn't follow his investing style - which entails regularly purchasing or investing in excellent companies selling for less than they're worth. Oddly, many investors mistakenly believe that the only hope for securing life-changing wealth is to get in early on "the next big thing." Besides, how would one go about discovering this? It should come as no surprise that successful business-focused value-oriented investors seem to have historically had a lock on this outcome, often cornering the next big thing as a matter of practice, and not luck.

Nothing compares to the kinds of gains investors have enjoyed in "under-the-radar" stocks over the past decade. Disciplined, business-focused stock picking will get you far closer to your retirement goals than almost any other investment vehicle known to man.

With all the downside and volatility in markets both domestic and global, it may be time to allocate core assets to the "business-focused, value" column, given the substantially better margin of safety of buying great undervalued, but not so well known businesses with wonderful fundamentals.

One highly respected business-focused stockpicker in the industry with over 26 years under his belt, and the track record to go with it, is Larry Sarbit, of Sarbit Asset Management. We recently interviewed Mr. Sarbit, and here is the transcript in its entirety.

Larry Sarbit: "Business Owners Behave Differently"

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(companies featured in this interview - ITRN, STMP, CLCT, CSTR)

GLA: What are your thoughts on the current state of the markets?

Larry Sarbit: I’m not much of a market commentator. I don’t think it’s anything I can do particularly well nor do I think anybody can do it particularly well. Predicting moves in market and prices on a short- to mid-term basis is a waste of time and potentially hazardous to your financial health. If you’re putting money down on predictions, I think you’re taking a heck of a chance. And that’s not what investing is all about. Investing, in our view, is about finding opportunities where there is a very high probability that something productive is going to occur. And that’s usually dealing with individual businesses. I think we’re in a recession; this is a pure wild guess but it could last longer than people think. We’ve got oil at or near record prices and the demand for it is huge. Everybody knows that the price of food is going up and we know that the price of transportation and heating, and so on, are going up as well. And so, we’ve got inflation and we’ve got potential economic slowdown. Whether all the bad news is out on these financials remains a big question mark. I don’t try to answer them because I think it’s very difficult to handle.

GLA: Larry you’ve been described as a value / focused investment manager. How would you describe yourself?

Larry Sarbit: I’m a business owner - that’s how I describe my investment approach which is defined by the questions, “How do successful business people act and behave?” and, “How did they achieve what they have achieved?” Those are the questions I want answered. “How did they create so much wealth?” “What are they doing and is there anything I can learn from it?”

So, how does this lead to the stock market? The stock market is an opportunity to pick and choose individual businesses that we think are “wonderful businesses,” and to look for those that have those characteristics and that we can buy at terrific prices. That is more closely related to how rational business people act and think. Rational business people who own substantial portions of a company or a whole company aren’t sitting around worrying about the stock market and its movements every day.

They don’t own a business for 6 months and then sell it when the stocks moved up 10%. They own businesses for years, for decades, for generations. Sometimes in a lot of cases they never sell the business at all. So that’s very different from the behavior in professionally managed money. The average mutual fund in Canada turns over its portfolio at least once a year.

Contrast that with business people who own their business for 25 years. How different is that? One of the things that I constructed is a little book that I’ve put together called “Simply Sarbit” and in it there’s a table which contrasts the typical mutual fund investor versus the  successful business person. And I contrast them on business ideas. They aren’t just different, they’re opposites. Their behavior is completely different. Completely opposite.

They ask fundamentally different questions. Successful business people are always concerned about what can go wrong. “Where is the down side in an investment?”; “Where’s the down side in the investment in their own business?’ In buying somebody else’s business, where are the problems? Speculators are focused on the upside. They ask a fundamentally different question. They are focusing on the greed factor, which is, “How much am I going to make?”

The successful business owner is asking the question, “How much am I going to lose?” And they are fundamentally different. And from there, they just go of in completely different directions. Short term, long term.

To me it’s just something that I started working on as I was formulating my investment strategy. I realized how different people are in this business. The short-term view of the world, owning a stock for 3 weeks or 3 months versus, 30 years is, is about as fundamentally different as you can get. Successful business people own one business, the typical fund or professionally managed portfolio has at least 100 stocks.

GLA: What is it that gets you excited about what you do and when you’re sitting around with friends, what do you talk to them about when it comes to talking about what you do?

Larry Sarbit: Well, I usually end up talking about one company or another; why I think it’s a marvelous business; why it’s an exciting holding and why I think that its future is very bright, which is something that we need to happen. We look for what appear to be high probability events and what I mean is, there is a high probability that things are going to work out. We are not interested in 75% probability events.

We are looking for businesses, where we look at them and it just becomes obvious and apparent that this business is going to succeed, that it has all the characteristics of a terrific business and that we are buying it at a price where we are going to get what is called a double dip return.

GLA: Some of your holdings that you invested in during the last couple of years have come in very nicely for you and your unit-holders Can you comment on some of those?

Larry Sarbit: Some of them performed better than we would have liked. Typically we like them to stay lower for longer so that we can have more time to buy more… we don’t like paying more for a business  than we have to, and the stock market is the only place I know where people celebrate prices rising. When you go to the grocery store, you’re not celebrating because the price of a can of tuna is going up 50 cents a can; nobody does that; I don’t know what you’re paying there for gas, but  we’re paying almost a dollar forty a litre. I don’t see anybody, no rational consumer out there celebrating when they pull up to the pump and it’s now $1.35 or a $1.40. You’ve got to be a complete idiot to do that. And yet in the stock market, people celebrate paying more… it’s unbelievable.

For me, the flip side of things is me having an opportunity to buy something I like at a ridiculously cheap price, when people are panicking and upset or frightened. The other side of insanity is the way investors sell on the way down, as the price is getting lower, when they should in fact be buying…and they buy as the price goes up when they should be contemplating holding or selling.

In every other part of life they get it right, and in this part of life they’ve got it backwards. I call it the “frontal lobotomy” way of thinking. People buying whole businesses understand the concept about paying bargain price. They get it.

It’s an incredible mix-up or dichotomy, and still I don’t understand it, and I’ve read a lot of books on the market and psychology. I guess it’s one of those things where there are a lot of reasons for it.  Professionals sometimes get forced to do things that they don’t want to. In the wonderful world of professional money management, for example, you see a lot of funds that are 100% invested because that’s what they’re supposed to do, to be fully invested. It just doesn’t make sense.

GLA: What kind of cash position are you sitting on right now in your funds?

Larry Sarbit: We’re sitting on about a 35% and we’re buying things  carefully, slowly. When we see something we like we get busy and start buying if we’ve got cash. People often see staying in cash in the rising market is about the worst thing that you can have. On the other hand, I’ve often seen  markets do things that can turn very ugly. That’s a reality that we face as investors. Paying over 20 times earnings in the S&P 500 is not a price that I think is a good idea to pay. I don’t ever want to wait 20 years worth of current earnings to get my investment back. Rational business people don’t pay those kinds of prices, for a whole business.  You’ll see them paying 2 times, 3 times because they want to get their money back in a year or two.

In private transactions the price paid is much closer to getting your money back in, in a year or two or three. They’re not willing to wait 5 or 10 years, they just don’t do it, and never mind 20 times earnings. If you’re a business owner and you’re offered 20 times earnings, you ought to laugh out loud and say, “Where is the guy? Let’s get the lawyer, let’s get the papers signed, I’ll sell my business for 20 times earnings in a heartbeat. And yet with stocks,  the same people will go out and buy shares and pay 20 or 30 times the businesses earnings. I mean, what is wrong with them?

A guy goes into a pizzeria and he orders pizza and the baker says ‘How many slices would you like me to cut this into? 4 or 8?’ and the customer says ‘Oh you better cut it into 4 slices, there’s no way I can eat 8 slices of pizza’  That’s the way people think in the stock market?

GLA: Larry, once you’ve decided on a business that meets your criteria, how do you make your decision to buy?

Larry Sarbit: Rational business people  don’t just buy a business because it’s cheap, without looking at the quality of the business and they don’t just buy a business because it’s got wonderful characteristics without looking at the price. A rational business person buys with both of these ideas in mind and this ridiculous idea of whether you’re a value investor or a growth investor is a silly separation. Only stock market thinkers end up thinking this way.

Rational business people don’t think like that. If you’re gonna buy an entire business and own this business for the next 20 years, you look at what the business is; what the problems are in the business; whether there are barriers to entry; and whether it costs you a lot to be in that business longer term.

You’d spend more time looking at that, but you’d also not want to overpay for it. So business people have the right approach which is “I want to buy this business and I wanna pay a reasonable or a cheap price for it.” They don’t buy unless they have both. They don’t buy a piece-of-junk business because it’s trading at  half of its book value or something like that. On the other side, you can look at the business and say it’s a marvelous business but it’s trading at 30 or 40 times earnings.

How in hell am I going to make money if I have to wait 40 years of current earnings? And, what’s worse than that is the earnings must grow at 20 or 30 percent per year, otherwise you’re in for a negative surprise somewhere down the road and that’s the problem. The optimist’s price leaves absolutely no room for mistakes.

You reduce your risk by buying a great business, at a cheap price. There are a lot of businesses out there that can be had cheaply, but many of them turn out to not be cheap when you look at what they earn and what their requirements are. They’re not really good businesses at all. So, that’s why you must have both, and I didn’t invent this.

And that’s how we behave. Do we like this business? Is it a great business? Does it have operations that create real wealth? Do they have barriers to entry? Is there a sustainable competitive advantage in the business? What does it require in ongoing investment costs? We’re looking for companies that require very little in the way of capital today and on an on-going basis. They have high margins that are sustainable because they have barriers to entry. And we’re buying them at prices where we believe we’re paying 50, 60, 70 cents on the dollar.

GLA: Now, conversely, how do you decide when to sell?

Larry Sarbit: Well, it’s just the flip side. A business may still be great, but the price is now more than recognizing the quality and the future potential of the business. At these prices there’s no room for error. If things slip or even come in on target with their quarterly earnings or their yearly earnings, it’s already priced for perfection. And so, it’s got to do something even more spectacular in order to drive the price even higher. That gets harder and harder as the price gets higher and higher. We like to take our money off the table when the business price gets to or somewhat exceeds we think the value of that business is.

This, I can assure you, is not a science. I’ve sold stocks many times after making very nice returns and watched the stocks double after I sold it. So, that’s painful, but on the other hand if it doubles, it’s a price that makes no sense whatsoever relative to the underlying intrinsic value of the business. You’re in a very dangerous place if you still own that stock after we sold it and it doubles. A very dangerous place. We also sell when there’s a negative fundamental change in the business that will lead to a slow-down, or, it is no longer the business that we thought it was gong to be.

GLA:  You recently had some nice gains in Coinstar (CSTR) and a few other major holdings?

Larry Sarbit: Coinstar is a business that has all the characteristics that we are looking for. High barriers to entry, the coin-counting machines that they are manufacturing and installing; they are way out in front in the business.  They really don't have much of competition in North America. They have lost one customer that we are aware of in, in their 15 of 20 year history. It was a bank and they tried to do it themselves and they bailed out. So, the big thing with the entry barrier is that it requires a lot of capital because to place one of these machines costs about $15,000 each.

So  there’s a huge upfront expenditure for the machines, but each one generates $17,000 revenue a year on average. You don’t have to wait too long to get your money back. Recently, Wal-Mart announced they’re going to put them into all of their stores. They have about 13,500 machines in WalMart if I’ve got the number right, and at least another two or three large sign-ups. We are talking about huge growth in this business and nobody can get into it. They charge 8.90% to count your change. What a business.

GLA:  It’s a terrific business, because you can use the machines to get rid of coins. I used one of these machines and that’s when I realized that I was being fleeced.

Larry Sarbit: Yeah, all that loose change is a pain in the neck and they have a solution for it. Coinstar is a big business that’s growing, and it’s going to grow very rapidly during the next 2-5 years. We bought this thing in the low 30’s and it’s around $37. We’re happy…we think it’s a bargain and I’m not buying any more at these levels, but I’m very happy to own it and that single return of the long-term growth of this business. The other business they have is a 51% stake of a company called ‘Red Box’ which is DVD kiosks. Those are going into Wal-Mart; they’ve got about 8000 machines in total in the U.S already. They’re going into groceries stores. McDonalds is putting them into the restaurants, they’re going into drugs stores. It’s a cheap, alternative to Blockbuster or Rogers video and plunking down 4 or 5 bucks for a rental. Red Box charges a buck a night and they have 150 of the newest movies available and they have the people on the ground to support it. It’s very important to have the people in place to go around and collect the DVD’s and put them back in the right order, collect the money, and fix the machines when they break down.

GLA:  Larry, how many names (positions) do you have in your fund?

Larry Sarbit: 13 names. 13 names that account for roughly 60, 65%. Actually, invested capital has moved up a bit because we’ve been buying a couple of names (stocks) that I’m not going to talk about today. It’s a very eclectic group of companies but they all have the characteristics that I talked about. They all have a barrier to entry, they all require very little capital, and they all generate a ton of free cash flow and very high returns on invested capital and all have tremendous growth in front of them.

GLA:  How do you feel about Collector’s Universe (CLCT), which you’ve owned for some time?

Larry Sarbit: I’ve been in Collector’s Universe for a while. They’re going through growing pains in the diamonds and the colored gemstones evaluation business. What they do is they evaluate and authenticate precious objects like stamps, coins, baseball cards and autographs, and now they’re in the diamond business, precious diamonds and gemstones. They’re still losing money in that business, but they’re building a formidable barrier to entry into that business and they’re forming links with retailers across the United States who will use their authentication as a selling tool. We talk to them every quarter and find out when we get a break-even in the diamond business. The potential of the diamond and colored gemstone business is multiples of all the other businesses that they have, so they’re in a painful growing stage. We’re willing to wait, we’re patient people. In the meantime, we’re getting a 10% dividend yield on our stock. Unless I’m missing something, I think this is a business that will eventually, over the next 3 to 4 years, generate a huge amount of free cash flow in this business and I don’t think it will be a $10 stock 3 years from now. They dominate this business; they really are the leaders in the industry of evaluation. If you’re buying your wife a $10,000 diamond, is it worth a couple hundred of bucks to know that it is what you think its worth?

If I'm the owner I going to want to have it guaranteed and authenticated and warranteed so if it turns out that they screwed up on the evaluation they have to make good on it. They’ve screwed up on clients and they’ve come forward in the last quarter and they’ve paid the customer because they got the evaluation wrong.

GLA: You’ve got another very interesting company named Ituran (ITRN). What is it?

Larry Sarbit: Yeah Ituran; its a little Israeli company; they just reported their earnings today and things are ready to take off. They’ve got about 450,000 cars that have their location sensing devices on board and these are the best in the business and this is the best technology in their business that we’re aware of. There are other companies that have location devices that are installed on cars but [with others] you’re only going to find out when you go out your car is gone and then you have to phone them to try and track the thing down. With Ituran, the minute somebody tries to break into your car they’re notified. And 80 to 85% of the time they get your car back within 20 minutes.

This was a technology that they bought from the Israeli Air Force that they had to keep track of their jet fighters. They’re now in 450,000 cars right and the service costs around $12 a month. They’re dominant in Israel as you might expect, but they are becoming dominant in Brazil and Argentina. The reason they are going there is because a lot of new wealth is being created there and there’s also a great deal of theft in those countries. And they’re signing up new customers faster than originally projected.

GLA: I imagine that’s going to be a growth area. The emerging markets, automotive markets are going to be…

Larry Sarbit: It’s massive. The next place is to go into Eastern Europe. What do you think the potential of Russia and Ukraine and Poland and with guys driving around with  $100,000 cars where they get stolen all the time? So they’ve set their sights on these countries and, and  the turnover rate is pretty low in this business. Like once, if you’re a rich guy, and you’ve got this system in your car, you forget about it, right? You just get billed, 12 bucks a month on your credit card and that’s the end of it. You don’t even have to think about it until your car gets stolen and they get it back for you.

GLA:  How’s Ituran's stock doing?

Larry Sarbit: I think it’s cheap. I still think you can make a heap of money in it. If you’re comfortable with an Israeli company. Their earnings were excellent. They’ve had an increase of 20,000 subscribers in the quarter. Start doing the math and you realize how little it costs to put this technology in. Now they’re working with auto makers to try to get their units installed at the point of manufacture. To have them installed automatically. Also, they’re sitting on a ton of cash. They have $96.8-million in cash. Total assets are 211 million.

They sold a company and that’s why I think the cash is up.  They sold a company called Telematics. It’s no longer included in their revenue base. So they got $4.38 per share in cash and the stock’s trading at $12…Ituran has no debt.  It’s a cash machine. Once you get this thing in the car, it just spills out cash and they probably got pricing built into this. In other words,  if they increase the price of monitoring by a buck a year, do you think a guy who can afford a Mercedes in Argentina is going to give a damn?

GLA: When you investigate your investee companies do you go out and see them?

Larry Sarbit: As for the American companies I usually go and see them personally. It’s really easy to get down to the US and visit with management at the companies we have invested in or are looking at.

Another company we like is Stamps.com (STMP). What they do is sell postage online. It took them two and a half years of testing with the USPS in order to get them to okay the product and the service. There are only three licensees in the US, and there have been no applications in 7 years by any other companies to do this. What’s unique about Stamps.com is they do it online, and customers can process and create postage on their PC.

They’ve got almost $5 per share in cash, and they bought 12% of the stock last year and no debt, and there are no capital expenditures; I mean it’s a beautiful business. And do you think there’ll be around in 5 years? That’s when you look and you ask, “Is it a high probability event?” To me this business has the potential of being huge!

They’ve got South West Airlines as a client now, so how long will it be before they start capturing larger and larger companies? It’s a versatile tool for companies.

I don’t think it’s gonna be a long, long time. I think it’s a terrific business, and I think the management is terrific. It’s a huge holding for us. We’ve looked at this thing inside and out. Unless the technology turns out to not work, and I told you they spent 2½ years of working with the United States Postal Service.

GLA: Larry how do you uncover these eclectic not-so-well-known but great businesses?

Larry Sarbit: Well, first of all you have friends on the grounds that are helping you find these ideas. You talk to people who look for the same kind of thing that you’re looking for and then on top of that you run screens where you look for companies that have high margins, low capital expenditures over the last five years and have high returns on invested capital.

GLA: So that grabs your curiosity?

Larry Sarbit: Yeah and if it is a business that I’m comfortable with or I can live with: does it have a predictable future?; is the business going to go through massive changes over the next two years?; and does it have a sustainable competitive advantage?”

GLA: Your rational approach to what you do, I think it’s something that’s in short supply.

Larry Sarbit: Well, I hope so.

GLA: It’s your edge. You can talk openly about it till you’re blue in the face and most people will still not be able to grasp what’s required…

Larry Sarbit: Well, it’s called work. And a lot of people don’t want to do the work. I can’t help those people if they’re not comfortable with what we’re doing. And, what we’re looking for are people who are comfortable with our investment approach and are saying,”How do you find a good business to invest in?” That’s what we do. We’re this little niche of the investment business where we think we might be able to do a little better than the average guy, and go out and find these companies for them. And that’s what they pay us for.

GLA:  Well Larry, it’s been a distinct pleasure talking to you. Thank you.