Thomas Howard’s name is not familiar to us. However, his credentials are that he is the CEO of Athena Investment Services which manages an AUM of about $150M (~Rs. 900 crore) and has an admirable track record of 25% CAGR for the past 12 years. In 2013, the portfolio generated an eye-popping 67% return.
Conventional wisdom dictates that we invest only in stocks whose businesses we understand and which score well on objective parameters such as ROE, P/E and which have low/nil debt. However, Thomas Howard has turned this wisdom over its head with his unique investment approach.
In an interview to CFA (credit: http://greenbackd.com), Thomas Howard makes the astonishing revelation that he makes investment decisions without even knowing the name of the stock or what the company does. He says that knowing the name of the stock and its business creates “emotional problems” which come in the way of making rational investment decisions.
Thomas Howard buys a stock if it meets five parameters:
(i) Dividends: Howard calls dividends a “powerful signal” that the company will have earnings in the foreseeable future;
(ii) Analyst earnings estimates: This is the second opinion used to back up the first (dividends) that there will be future earnings;
(iii) Debt: Surprisingly, Howard says that he likes companies “with as much debt as possible” and that he is “thrilled” with companies which have a negative net worth. His logic is that if the lender has advanced so much money, he must be convinced about the future earnings of the company. He adds that investors commit a “behavioural mistake” by overreacting to debt and running away from high debt companies. “I’m harnessing these behavioral mistakes” he says;
(iv) & (v): Price-to-sales ratio and a minimum sales threshold.
Interestingly, apart from not knowing the name of the company or its operations, Howard also pays no attention to any news (whether about the markets or about specific companies). He says that if you listen to news, you become prone to “availability bias” and that it “dominates your thinking”. You then make your investment decision based on the news and the information available. You react in an “emotional” way and not in an objective/ rational way.
Howard calls his method “ruthlessly driving emotion out of the decision process”. “As ruthlessly as I can, I drive everything out of the decision process that is emotionally driven and has nothing to do with my investment process”.
The other point that Howard makes is that in his method of stock picking, one can “never make an investment mistake” in the sense that at the time the decision was made, it was the best decision one could make. The fact that a stock pick may not work out is not a “mistake” but a decision that just did not work out.
There is merit in Thomas Howard’s theory that we should not make investment decisions on an “emotional” basis and that we should not be swayed by the constant deluge of news and information. However, the proposition that one should invest without knowing the business and the management of the company is too much to swallow. Also, the argument that a highly indebted company reflects the confidence of the lenders in the future earnings of the company is somewhat detached from reality.