A Chess Master Scans the Market for a Checkmate; Grandmaster Capital’s Patrick Wolff discusses strategy, stocks he likes and dislikes, and his global outlook


A Chess Master Scans the Market for a Checkmate


Grandmaster Capital’s Patrick Wolff discusses strategy, stocks he likes and dislikes, and his global outlook.

Patrick Wolff’s résumé includes two U.S. chess championships, first in 1992 and again in 1995, when playing professionally during his time off from college. The Harvard-educated philosophy major earned the distinction of grandmaster, an elite level. Nowadays, Wolff, 46 years old, is running Grandmaster Capital Management, a hedge-fund firm in San Francisco overseeing about $230 million. And though he doesn’t play professionally any longer, he hasn’t stored his chessboard in the attic just yet. In recent years at Berkshire Hathaway’s annual meeting, Wolff, wearing a blindfold, has played multiple chess games simultaneously. “I win more than I lose,” he says, noting that he has to keep track of half a dozen games in his head. “But it is a good show.” Chess, with all of its complexity, served as good training for Wolff the portfolio manager. The long-short fund he runs had an annual return of 11% from Jan. 1, 2011, to Dec. 31 of 2013, versus an annualized total return of 16% over that time for the Standard & Poor’s 500 index. That, however, isn’t an apples-to-apples comparison, in part because Wolff’s fund also shorts stocks and because hedge funds don’t try to replicate the S&P 500’s performance.Barron’s met recently with Wolff, who offered several stock picks and observations about the global economy, among other topics.

Barron’s: Could you talk about how longevity treats elite chess players versus money managers?

Your peak years in chess are generally in your 30s. And once you hit somewhere in your late 30s to early 40s—it is different for different people—but around that age you start to decline. The person who lost the world chess championship last year, Viswanathan Anand, is a friend of mine. He is 44, and there is no question he peaked about five, six years ago. You could see it in the quality of his play and the result he got; that’s normal. The wonderful thing about investing is that Warren Buffett is going strong in his 80s. Investing is much more cumulative. So long as you’re sharp, you can do this for as long as you want to. In chess, you have both an analytic faculty and a judgment faculty, and the judgment gets better as you get older. But the analytic faculty begins to decay as you get beyond a certain age—just the ability to hold the board in your head and manipulate it. Well, I’m sure that Warren Buffett can’t do mental math at 83 the way he could when he was 33. But it doesn’t matter because he has a calculator. It’s the judgment faculty in investing that really matters, and that is what drives it as you accumulate more and more experience.


“Investing is far more cumulative [than chess]. So long as you’re sharp, you can do it for as long as you want.” — Patrick Wolff

How would you sum up your investing philosophy?

We think about buying stocks as if we owned a piece of a business. So the most important thing is you want to have a high conviction that you are getting more than what you are paying. First of all, you want a business that you can understand. And you want a good business that is durable, is going to maintain its economics indefinitely, and has good growth prospects. It doesn’t have to be hypergrowth. And then you want to make sure that it has good opportunities to reinvest capital for growth, or it is going to be able to give you capital in the form of buybacks or dividends. You also want to own a business that doesn’t need a lot of capital to keep going.

Does growth at a reasonable price apply?

No, it doesn’t. The problem with that approach is that not all growth is good. Sometimes, you can have very high growth, and then it will decline—but that’s not what you want in a business. I also don’t like what Warren Buffett calls cigar-butt investing– that is, finding a dollar bill for 70 cents. The problem is that maybe you get a dollar bill, but then it becomes worth 90 cents, and then it’s worth 80 cents, and pretty soon it’s worth less than what you paid for it. Those are value traps.

Last year, with the S&P 500 notching a total return of 32%, was tough for shorting stocks.

No question about it. But every market regime changes; you just never know when. We’ve been in a market regime for a while now. I like to call it miss and raise. Companies will miss their quarterly earnings estimates, and they’ll say, “But we are going to do better two quarters later,” and the stock will go up. In other words, people are rewarding hopes and promises, as opposed to actual results. That market regime will change, but who knows when.

What macro themes are you paying attention to?

Bubbles are real, and they can be understood, analyzed, and identified ahead of time. The most important thing is to stay away from them. So during the past decade, the bubble was housing in the U.S. and its overlevered financial system. Today it is China. It’s the commodities supercycle, which is over and done. It is emerging markets, which are no longer booming and which are now, as a group, in great danger. So I want to make sure I don’t own a business whose earnings power depends on the China boom, emerging markets, or high commodity prices. I do think—and we’ve been saying this since we launched more than three years ago, calling it Fortress America—that the U.S. is the safest place from a macroeconomic perspective.

What’s your assessment of the U.S. economy?

I don’t necessarily mean that it’s boom times in the U.S. It just means that it is the safest place and the most removed from the macroeconomic risks I see in the world. So if you are just looking for businesses to own, you can really concentrate on the business analysis and not worry about the macroeconomic shocks and dangers I see elsewhere, whereas if you are a company selling into China, the Middle East, or Latin America, it is much more precarious.

Let’s hear about a few of your holdings, starting on the long side.

We’ve been long-time admirers of the American Express [ticker: AXP] business model, which is extremely durable. So this really comes back to owning a business for a long period of time. I have very high conviction that, for several years and more, American Express is going to have the same quality business model, and it is just going to get bigger over time. It is the kind of business that sits on top of nominal gross domestic product—that is, the spending that people do. And that kind of a business model should trade at a premium to the market, as it has at times before. By my calculations, it trades at a slight discount to the market, which is cheap relative to where it deserves to trade.

So you have it trading at a discount to the S&P 500?

Yes, because when I think about the S&P, I look at GAAP [generally accepted accounting principles] earnings, not operating earnings. But with American Express, there are two other reasons to own it. One is they are getting really disciplined about holding the line on expenses. So there is operating leverage as revenues grow faster than expenses. Second, American Express is levered to a recovery in the consumer economy. So as people spend more and travel more, and you get a recovery in lodging and travel and spending, American Express benefits disproportionately.

There are some worries about competition in the card business, especially at the higher end.

Well, for many years, AmEx has taken share from its competitors. So the historical record is very clear that AmEx has been the winner, and their business model is highly advantaged. They have a great brand. They have tremendously strong relationships with merchants and consumers, and they have what they call this closed-loop economics, which means there is no intermediary between AmEx and its customers. They are able to provide more rewards to their customers, who value the rewards. The customers, in turn, use the cards more, which enables the wheel to keep turning.

What is the stock worth?

On normalized earnings, American Express deserves to trade at a modest premium to the market. Current earnings are depressed, though not massively. So if the earnings are depressed by, say, 15% to 20%, and the stock ought to trade at a 10% to 15% premium to the market, you can do the math. It may be cheap by about 30%. Obviously, that’s a guess, but that’s the kind of margin of safety that I like to own with a very high-quality business with good growth.

Wolff’s Picks…

Company Ticker Price
American Express AXP $93.52
NVR NVR 1,196.41
…And Pans
ADT ADT 30.93
Source: Bloomberg

Let’s move on to your next pick.

NVR [NVR] is a home builder. And we like being exposed to home building because new-home sales in the U.S. are still very depressed. If those sales got back to where they were in the middle of the past decade, which I’m not saying they will, you would have more than three times upside as far as the number of houses sold. If they just get back to the historical average over the past couple of decades, you’ve got two times upside, just in terms of the volume of homes being sold. So there is a recovery in the housing market, but most home builders are not good businesses.

Why not?

Because too often, all the money they make gets plowed into buying land. And they always end up buying land all the way to the top of a cycle. And then they are never able to give you back the cash when the cycle turns. So the home builders typically are valued on a price-to-book ratio, because you have to think about the tangible value they have. NVR is completely different, and it has a business model that is greatly superior to its peers. You can see it in the results and growth they’ve had over the past couple of decades.They do not tie up capital in the land. They use options, just to make sure they have the ability to get the land when they need it. But they only buy it when they build the house, which they turn around and sell along with the land. We believe NVR has dominant market share in many of the markets in which they operate, including the mid-Atlantic. So they get economies of scale in the local market, and they are able to get access to the land that they need. That strategy, with great discipline, has been executed over many years, and it has allowed them to build a stronger and stronger business. It is a cash-flow machine, and they have shrunk their float by nearly 50% over the last decade.

What kind of upside does NVR have?

Our bear case is that the stock is worth roughly what it is worth now. Our bull case has 50%-plus of upside, and it’s compounding its intrinsic value over time. So it is a bit of a wider range than American Express, but the chance that it succeeds is just as certain.

What’s an example of what you’re doing on the short side?

ADT [ADT], the security firm, is in very big trouble, in our view. The company is seeing higher attrition, for one thing.

What troubles you about their business model?

Home security used to be a fixed-line-based business. When that was the case, the barriers to entry were higher, and there were a lot of local companies that did this. But a lot of times, those companies had relationships with the home builders. However, because of wireless Internet, the technology has shifted. It has become a Wi-Fi-based business, reducing the barriers to entry. And crucially, the cable companies and the telcos are getting into this business. That’s because if Comcast or Time Warner or whoever is selling you Internet and TV and telephone—if they can also sell home security, that is one more product on the bundle, and it reduces the churn. So the problem for ADT is that it needs to make money selling you their product. Comcast does not need to make money on that product. Comcast can be break-even in selling you their product, just as long as they get one more product on the bundle and reduce the churn. So the lifetime value of you as a customer is greater for, say, Comcast than it is to ADT, which is to say ADT is facing a onslaught of very well-capitalized, new competitors with lower break-even economics. I’m not a genius, but that is a recipe for disaster.

But what would you say to a value investor who insists that the stock is cheap and that the company is taking the necessary steps to adapt?

The first thing I would say is the stock’s not that cheap. It used to be quite expensive, relative to current earnings power. It’s now more fairly valued, relative to its earnings power, but I think their earnings power is in trouble. So it trades around 16 times earnings with high leverage.

Thanks, Patrick.


About bambooinnovator
Kee Koon Boon (“KB”) is the co-founder and director of HERO Investment Management which provides specialized fund management and investment advisory services to the ARCHEA Asia HERO Innovators Fund (www.heroinnovator.com), the only Asian SMID-cap tech-focused fund in the industry. KB is an internationally featured investor rooted in the principles of value investing for over a decade as a fund manager and analyst in the Asian capital markets who started his career at a boutique hedge fund in Singapore where he was with the firm since 2002 and was also part of the core investment committee in significantly outperforming the index in the 10-year-plus-old flagship Asian fund. He was also the portfolio manager for Asia-Pacific equities at Korea’s largest mutual fund company. Prior to setting up the H.E.R.O. Innovators Fund, KB was the Chief Investment Officer & CEO of a Singapore Registered Fund Management Company (RFMC) where he is responsible for listed Asian equity investments. KB had taught accounting at the Singapore Management University (SMU) as a faculty member and also pioneered the 15-week course on Accounting Fraud in Asia as an official module at SMU. KB remains grateful and honored to be invited by Singapore’s financial regulator Monetary Authority of Singapore (MAS) to present to their top management team about implementing a world’s first fact-based forward-looking fraud detection framework to bring about benefits for the capital markets in Singapore and for the public and investment community. KB also served the community in sharing his insights in writing articles about value investing and corporate governance in the media that include Business Times, Straits Times, Jakarta Post, Manual of Ideas, Investopedia, TedXWallStreet. He had also presented in top investment, banking and finance conferences in America, Italy, Sydney, Cape Town, HK, China. He has trained CEOs, entrepreneurs, CFOs, management executives in business strategy & business model innovation in Singapore, HK and China.

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