This conversation is part of our “Wisdom in Books” series and podcast. Every week we inspire your reading with an exclusive author interview or John’s takeaways from an influential book on investing, business, or life.
Control what types of emails you receive from us.
I had the pleasure of speaking with Lauren C. Templeton about her book, Investing the Templeton Way: The Market-Beating Strategies of Value Investing’s Legendary Bargain Hunter.
Lauren is the founder and CEO of Templeton & Phillips Capital Management. She also serves on the Board of Directors of Fairfax Financial Holdings, Fairfax India, and Canadian Solar. Lauren is active in the non-profit community, serving as Chair for the Board of Trustees of the John Templeton Foundation and as a member of the Board of Trustees for the Baylor School.
The following transcript has been edited for space and clarity. (MOI Global members, access all features, including ways to follow up with Lauren.)
John Mihaljevic: What inspired you to write Investing the Templeton Way?
Lauren Templeton: I had an unusual relationship with my great-uncle in that he seeded my first fund to the tune of $30 million when I was 24 years old, and I had the opportunity to work with him up until he died. I decided I would write a book describing his most well-known trades and the historical context around them. As investors, it’s very easy for us to look back on some of these trades and think, “Oh, that was just common sense. I would have done the same thing.” However, we all know we have behavioral biases and other behavioral aspects which prevent us from doing it. I wanted to describe the historical context in which he made these trades so that we could better imagine ourselves in the same position, to give thoughtful analysis on whether or not we could have placed the same trade, and if you would have, how to position ourselves better going forward.
Mihaljevic: How would you summarize the core message of the book?
Templeton: It is definitely that if you want better performance than the crowd, you must do things differently from the crowd. Every single chapter talks about a specific trade of his that was very contrarian in nature. His contrarian trait is what helped distinguish his investment returns, in my view. I think it is very important. There are only two ways to get a bargain. One is to buy when there are no other buyers left and only sellers, and the other is to focus on neglected stocks, but it’s that behavioral aspect we find to be the easiest to take advantage of. At our firm, we are focused on buying at points of maximum pessimism, as my uncle called it. We believe this is to be a very easy way to pick up a bargain-price security.
Mihaljevic: What was it about Sir John Templeton that allowed him to pursue such a contrarian approach?
Templeton: He was a strongly disciplined person and liked discipline in all areas of his life. I think it helped him have this value bias and execute his strategy well. He also had a unique childhood and upbringing, as well as some personal experiences which taught him about buying at the point of maximum pessimism. His father was a lawyer and had an office facing the town square in Tennessee. In the Great Depression, when farms came up for auction, he would look down across the town square. If he saw that the auction produced no buyers, he would go there and buy the farm for cents on the dollar. Uncle John witnessed this over and over again, and he saw the accumulation of wealth.
That’s a highly specific experience for a child to witness, and I think that’s where he learned the art of buying a bargain and buying at the point of maximum pessimism. His investment discipline helped him execute that strategy. When you interview the greatest value investors out there, you find they are all strongly disciplined people. An investment discipline to adhere to is important for saving you from yourself. It’s extremely hard to go in and buy at the bottom of the market when no one else is buying, be it in a stock, a country, or an industry. We’ve learned to anticipate these bouts of maximum pessimism, but there are times when we get nervous, too. If you rely on investment discipline, it allows you to easily execute your strategy.
Mihaljevic: How did Sir John get started in investing? Tell us about his first forays or give us an example of an investment he made at the point of maximum pessimism early on.
Templeton: Uncle John attended Yale University, which he graduated in 1934. He remarked that a lot of the wealthier students at Yale had investments, but their families were invested in US companies only. He decided very early on that he would have a global outlook. After Yale, he received a Rhodes Scholarship and went to Oxford, where he attended Balliol College. When he graduated from Balliol, he left with a roommate on a round-the-world trip where they would visit 35 countries.
He exercised strict discipline with his expenditures as well. He had budgeted £200 for the trip and even went so far as to divide the money and mail it to himself at different points in the itinerary so that he would maintain financial discipline. This is remarkable when you think of a young person doing it back then, what coordination and thought this would have taken. When he finished the trip, he came back to the United States and entered the investment business in 1937.
His first trade in maximum pessimism occurred in 1939, when the world was on the brink of a full-blown war. The Nazis invaded Poland, which was going to lead Europe into World War II. Uncle John anticipated that the US would be dragged into it, and he thought that US industrial firms would be pushed to supply commodities and goods to support the country’s entry into the war. What’s really interesting about the whole thing is that he was correct, but he didn’t focus on the most profitable firms. He was a student of history – he had studied the civil war and World War I, and he knew there was a tendency for governments to instigate excess profit taxes. Those taxes were levied on profitable businesses before the war, so if a company was profitable prior to World War II, its excess profits coming out of the war were taxed at 85.5%. Uncle John did not want to focus on those companies; instead, he focused on the bottom of the barrel because he correctly anticipated that the war would lift all companies.
On the eve of World War II, he borrowed $10,000 from a previous employer, which is also remarkable, and bought 104 companies, 37 of which were already in bankruptcy. He held those positions for a number of years, turning the $10,000 into $40,000. Out of the 104 companies, only four investments did not work out. One of his most notable investments from that trade was the Missouri Pacific Railroad, which he purchased for 12.5 cents per share. When he sold the stock, it was trading at $5 per share, which is a 3,900% return. He had some amazing returns coming out of that, but this was what we call his first trade in maximum pessimism.
Mihaljevic: Tel us a little more about that trade. What was it that attracted him to it?
Templeton: Stocks were already depressed. If I recall correctly, the stock market was down about 49% in 12 months in 1939, so people already had a deeply pessimistic view of it. His careful analysis of history, including the civil war and World War I, led him to believe that the activities surrounding the US entrance into World War II would benefit all companies, particularly companies like railroads and specifically companies which would not be subject to the excess profit tax of 85.5%. What is common in many of the trades you’ll read about in the book, Investing the Templeton Way, is that they all have a historical component to them. He was a great student of history and liked to read a lot about it. I think in all of his trades, there was a component where he was taking something from the past and applying it to the present. That’s probably a good thing for investors to remember. History doesn’t exactly repeat itself, but it does rhyme, so there is a tendency to have quite similar events happen over and over again.
Mihaljevic: It seems quite prescient that even though he had interest in global investing, he opted for US-listed companies just before the full outbreak of World War II. I assume he branched out into global markets after the war was over. Is that correct?
Templeton: He did. He’s known as the pioneer of global and international investing. He always remarked to me that he found the students at Yale, their families that only invested in US companies, to have a very arrogant way of looking at the world. Why not have a larger universe of stocks to choose from? When you think about the time he was investing internationally, it was amazing because even now, international markets are less efficient, and emerging or frontier markets are even more inefficient. It’s harder to get information, and when he was doing it, it was exceptionally hard to get information.
He was well-known for being an early investor in Japan. He was allocating personal capital to Japan in the 1950s, and then he was investing clients’ capital in the country in the 1960s. Of course, he reached those returns in the 1970s. During the 1970s, the Templeton Growth Fund was compounding at 22% versus, I think, 4% or thereabout for the Dow. He had three bad years (1970, 1971, and 1975), but he did a good job of outperforming the market during that period because he was investing in these Japanese companies a decade before that. He recognized that these firms were low-priced based on the P/E ratio, but by being a good student of accounting, he also realized there was an anomaly and that the Japanese firms were not consolidating their subsidiaries on the balance sheet. He was able to buy companies like Hitachi, which appeared to be trading at around 16x earnings, but when you consolidated the subsidiaries, it was trading at 6x earnings. Of course, some of the things he saw in Japan in the 1960s would have been that it was growing at about 10% per year, or about 2.5x faster than the US at that time. The stocks in Japan cost 80% less than the stocks in the US, and they were trading at around 4x P/E versus 19.5x or something like that for the US.
Very often, people think of my uncle as this great macro investor, and that’s probably because he used to come on shows like Wall Street Week with Louis Rukeyser. He would make a broad call like, “I’m investing in the US. I’m investing in Japan or South Korea,” but he was so bottoms-up focused. He allowed the valuation of stocks to show him where to invest. He invested in Japan in the 1950s, 1960s, and the 1970s. Then in 1979, around the same time that Newsweek magazine proclaimed the death of equities and nobody would go near the US stock market, he transitioned from Japan into the US and put over 60% of his capital in the US around 1980. He’s well-known for going on Wall Street Week in about 1982 and predicting that the Dow would reach 3,000 in the next 10 years. The Dow was trading at 800 at the time, and by 1991, it had hit 3,000. Everybody thought he was crazy. I actually remember him going on that show and declaring so. People did think he’d lost his mind, but people usually say things like that when good investors come out and do stuff like that, so it’s fun to watch.
Mihaljevic: What do we know about his analysis of businesses? Did he prefer certain industries over others?
Templeton: He did not like heavily regulated industries, and there are some industries which are hard to value, for example, biotech. Other than that, he was pretty agnostic to industry and country. When I was investing for him, he had a rule that I could have no more than 50% in any industry, country, or currency. He had broad risk constraints on portfolios.
Mihaljevic: Did he also short securities?
Templeton: He did. It’s so funny. He would often tell people not to use leverage and not to short securities, but he did both personally. He never did it for other investors, and he always advised against using leverage and shorting securities, but I certainly knew him to do both. It’s been 12 years since my husband and I wrote the book on our honeymoon, and when I was preparing for this interview, I thought I wasn’t going to remember any of these details, but I was reminded of his strategy and the tech boom of the late 1990s, early 2000s where he was shorting IPO stocks. I graduated from college in 1998, so I remember this clearly because that is the environment I went to work in. I remember the tech boom and investors saying Julian Robertson, Warren Buffett, and Sir John Templeton had lost their touch.
Uncle John had devised a strategy where he was shorting tech stocks about 11 days prior to their IPO lockup expiration. The crazy thing is that he was covering the stocks if they fell by 95% or below historical P/E ratio at 30x. Those were the measures he used during that period, and he put $2.2 million in 84 stocks, so he had about $185 million invested in that trade. The NASDAQ would have reached an all-time high in March of 2000, and during that period, NASDAQ stocks were trading at about 151x next year’s earnings. They had incredible valuation, and there were lots of IPOs coming to market. I think there was something like $78 billion worth of IPOs hitting the market in the first quarter of 2000, and there was more than that in initial public offerings where the lock-up expiration was occurring. He knew these insiders were aware that their companies were not worth what the stocks were trading for in the market and that they would be the first to run to the exits. He found out when their IPO lock-up expirations where and shorted the stocks about 10 days before that, covering them when they fell 95% or started trading at less than 20x, which is simply remarkable. He made a gob of money doing it.
Mihaljevic: That certainly sounds like a high-conviction trade when you want to wait until they drop 95%…
Templeton: I know. Also, if you remember what the market was like back then, being short $185 million of tech stocks would have been like standing in front of a train going straight towards you. My father, who is a great investor himself and has taught me a lot, received a letter from uncle John advising him to do the same thing. Dad put on some of these short positions, and he ended up covering on them. He said, “I just can’t handle it. This isn’t for me. It’s too stressful.” It wasn’t worth it to him, but uncle John stood pat and believed in the strategy, and it worked well for him.
Mihaljevic: That’s probably why it works – it’s really hard to invest at the point of maximum pessimism or, in this case, to short at the point of maximum optimism.
Templeton: True, and he also would have had large margin calls that most investors probably couldn’t have handled because few have that much excess capital around to meet those margin calls. That was a unique trade. There are websites which track this IPO lock-up expiration, and I’ve recently pulled up one just to see the companies whose lock-ups expire this quarter. I didn’t see anything I was particularly interested in, but it’s something for investors to remember. The data’s out there. You can see which companies have their lock-ups expiring, and if they’re overvalued, it’s not unreasonable to believe the insiders will take the first opportunity to sell.
