Blue Ridge Capital was founded by John Griffin in 1996 in New York City and currently manages 5.3 billion dollars. Although they returned an impressive (and their best) 65% to their investors in 2007 and weathered the financial crisis with an impressively minor 8% loss in 2008, in the last few years the fund has been underperforming the S&P 500 index.
With over 5 billion dollars under management, Mr. Griffin is one of the more prominent Tiger Cubs (for the uninitiated, this refers to hedge fund managers who worked at Tiger Management founded by the long-short proponent Julian Robertson). Prior to his crucial tutelage at Tiger Management, Mr. Griffin earned his undergraduate degree from the University of Virginia and an MBA from Stanford Graduate School of Business. He launched his investment career as an analyst at Morgan Stanley in the Merchant Banking group.
As many others who sprouted from Tiger Management, Mr. Griffin’s investment method is long/short with a long bias. The long positions are usually in large cap and high performance stocks, (such as Morgan Stanley or McDonald’s), while the shorts tend to be in lesser known entities with fundamental problems. In accordance with the Tiger Cubs’ philosophy, the fund’s investment decisions are based on bottom-up in-depth research of the fundamentals to determine the long term perspectives of each individual company, with some consideration given to the general prevailing environment.
Mr. Griffin brings his own nuance to the long/short strategy by filtering all the generated investment ideas through an exhaustive checklist (similar to the procedure espoused by Mr. Mohnish Pabrai to screen his value ideas in Pabrai Funds. ) Mr. Griffin’s Checklist is not much talked about in public, but was jotted down by a zealous student attending a lecture on stock analysis given by Mr. Griffin (an adjunct professor at Columbia Business School) at the University of Virginia in 2000. It is said that the lecture was so remarkable that the student went on to pursue finance over biology and is a hedge fund manager himself today.
As mentioned earlier, Mr. Griffin normally focuses on individual corporations rather than the sector, but in the checklist methodology benchmarking against well and badly performing peers is important, as is the whole industry’s outlook. Industry is assessed on some basic factors such as relative power of stakeholders, barriers of entry, core competencies for success, opportunities and how they are addressed by competitors, but most importantly whether a high performer can differentiate itself effectively from the bad ones in that particular market.
Moving along on the checklist and onto the chosen entity, an extensive number of questions must be answered by the analysts in the following areas: business model, management, financial measures, risks and some miscellaneous topics. Finally a detailed time line must be made.
In the case of business model, analysts must look at the very basic activities: is the company offering products/services etc., the basic economics of the operation, and how it fares, when compared with competitors. What are the main reasons of success, and whether it’s sustainable, what’s the growth strategy and finally how is the sales process from order to final delivery.
As to management, the evaluation is based on peer review, past track record, compensation scheme, and changes in their holdings of their own company’s stocks.
While conducting the above scrutiny, analysts must constantly look at the long term perspective and ask themselves whether they would invest in this stock for the long haul, how would the chosen stock compete with and survive against the well-performing competitors, and also compare it with a weak competitor.
Having subjected the investment idea to this systematic non-quant fundamental analysis, now the stock’s analysis is geared towards financial indicators. A good starting place according to Mr. Griffin is Howard Schilit’s book “Financial Shenanigans: How to Detect Accounting Gimmicks & Fraud in Financial Reports”.
First, the balance sheet is stress-tested against the following criteria: capital structure, inventory and interest coverage. At the cash flow statement capital requirements and investments are reviewed along with the regularity of access to capital markets.
Second, profitability is investigated based on how visible earnings are on a quarterly and yearly basis, whether fixed or variable costs dominate, and whether earnings growth is determined by unit sales, price or margin changes.
Third, the company’s true value estimation is derived from an amalgam of earnings, EBITDA, Sales, and Free Cash Flow Yield, taking into consideration the accounting policies applied by the entity.
Fourth, risks are covered by creating various worst case scenarios. (Note that many of the risks have already been addressed incrementally by the fundamental and quantitative analysis so far, the latter especially with an eye towards Financial Shenanigans.)
Additionally, a timeline is required at Blue Ridge, which emphasizes trigger events for the proper valuation to be realized, possible future news affecting the price and finally the possible position building and the circumstances influencing it.
Choosing corporations for short positions is partly similar to the long ones, but with a different angle: the needed reinvestment to keep the company working, the major risks, misconceptions by management and the market, and an extensive media research is prescribed. As of the financial indicators differences can be noted: EBIT/EV, (EBITDA-CAPEX)/EV, inventory alterations and especially any recent changes in accounting guidelines are mainly covered. (Note that EV, enterprise value, is more important in M&A or other liquidation situations.)
Further to short selections, the so called “fantasy- transition-reality” paradigm determines the timing of opening a short position, helped by earnings excuses, insider sale and the stockholders’ investment time span (long/short term, momentum investors).
Whether initiating a long or short position, a noteworthy and common-sense benchmark of whether an analyst has understood the big picture or not, is if they can explain the business model to a ten year old. This is reminiscent of Mr. Mignone who wants his analysts to be able to sum up an investment thesis in one sentence … of course, Mr. Mignone worked under Mr. Griffin before founding Bridger Management. The lineage of the non-common sense of the Tiger is far reaching indeed.