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You Can't Become Rich In Your Pocket Until You Become Rich In Your Mind | ||||
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Driehaus discovered that his trading ideas were even better in practice than he dared to believeRichard Driehaus: The Art of Bottom-UpInvesting Richard H. Driehaus got hooked on the stock market as a kid, and JAJlis enthusiasm for the market has never flagged since. While still in his early teens, Driehaus discovered the folly of following the recommendations of financial columnists. As a result, he decided to educate himself by devouring all the stock newsletters and financial magazines he could find at the local branch library. It was during those childhood years that he began to develop me basic market philosophy that would serve as the core of his approach in his later years as a securities analyst and portfolio manager. Upon college graduation, Driehaus set out to find a market-related job and landed a slot as a research analyst. Although he liked the job, he was frustrated by seeing his best recommendations ignored by the sales force. Driehaus got his first chance to manage money in 1970 while working in the institutional trading department at A. G. Becker. To his pleasant surprise, Driehaus discovered that his trading ideas were even better in practice than he dared to believe. In his three years as a manager at A. G. Becker, he was rated in the top 1 percent of all portfolio managers surveyed by Beckers Fund Evaluation Service, the largest fund rating service at the time. After leaving A. G. Becker, Driehaus worked as a director of research for Mullaney, Wells and Company, and then Jessup and Lam-ount, before starting his own firm in 1980. For the twelve-year period since 1980, Driehaus averaged an annual return in excess of 30 percent (net of brokerage and management fees), nearly double the S&P 500 return of 16.7 percent during the same period. The S&P 500, however, is not the appropriate benchmark, as Driehaus focuses on small cap (capitalization) stocks. In case you think that Driehauss superior performance is related to the better performance of the low cap stocks, note that the Russell 2000 index, which tracks the performance of the 1,001st through 3,000th largest U.S. companies (a group representative of the stocks in Driehauss portfolio), was up only 13.5 percent, compounded annually, during the same twelve-year period. One dollar invested in the Russell index in 1980 would have been worth $4.56 at the end of 1991; one dollar invested in Driehauss Small Cap Fund would have grown to $24.65 during the same time frame. Although Driehauss flagship investment vehicle has been small cap stocks, he has broadened his scope to include other types of funds as well. He is particularly fond of the concept mat underlies his Bull and Bear Partnership Fund. This fund seeks to remove the impact of the general stock market trend by approximately balancing long and short positions on an ongoing basis. In other words, the funds market directional exposure is near zero at all times, with performance entirely dependent on individual stock selection. In its first two years of operation, 1990 and 1991, this fund realized back-to-back annual returns of 67 percent and 62 percent (before a 20 percent profit incentive fee payout), with only three out of twenty-four months registering a loss (the largest being a mere 4 percent). Over the years, philanthropy has become an increasingly important force in Driehauss life. In 1984, he started the Richard H. Driehaus Foundation with a $1 million contribution of TCBY (The Countrys Best Yogurt, originally This Cant Be Yogurt) stock. He manages the foundations funds, distributing 5 percent of the total equity annually to a variety of charities. By the end of 1991, the foundations capitalization had grown to approximately $20 million. I met Driehaus on one of his periodic jaunts to New York City for an art auction. The interview was conducted over a leisurely breakfast (apparently far too leisurely as far as the staff was concerned) in the cavernous dining room of a midtown hotel. Eventually, we moved on to continue the interview at a quiet lounge at a nearby hotel, where the dark, floor-to-ceiling wood-paneled walls and antique fixtures provided a century-old atmosphere. ==== When did you first become interested in the stock market? ==== When I was thirteen years old I decided to invest $ 1,000 saved up from my newspaper route in the stock market. My early investments, which were guided by financial columnist and broker recommendations, fared poorly. I had thought that if I followed the advice of professionals, I would make money. I found the experience very disheartening. I decided to try to figure out what made stock prices move. I started going down to the local library on a regular basis and reading a variety of financial periodicals and newsletters. One letter that had a particularly strong impact on me was John Herolds Americas Fastest Growing Companies. ==== What appealed to you about that letter? ==== It was my favorite letter for two reasons. First, it showed me the success that could be achieved by buying growth stocks. Herold had stocks in his newsletter that he had recommended ten years earlier that were up tenfold and twentyfold. These were incredible moves to me. Second, Herolds approach of focusing on earnings growth made a lot of sense to me. It seemed logical that if a companys earnings were growing over a long period of time, its stock price had to go in the same direction. In his newsletter, Herold displayed charts that superimposed a stocks price and its earnings over a ten-year period, with both graphs showing dramatic growth. These charts, which basically demonstrated that a stocks price was in harmony with its long-term earnings growth, became a very powerful image to me. ==== Was your first job market related? ==== Yes. After college, I landed a job as a securities analyst for a small Midwestern brokerage firm. To my dismay, I discovered that many of my recommendations were never implemented in the customers portfolios. ==== Why was that? ==== Because the P/E multiples [the ratios of prices to earnings] were too high. Many of the best growth stocks have high multiples and are psychologically difficult to buy. If the brokers werent turned off by the high P/Es, their clients were. Also, I realized that many brokers werent portfolio managers but were primarily sales oriented. I found it very discouraging that many of my best recommendations were not being utilized. After about two years, I left this company to join the institutional trading department of A. G. Becker, which at the time was a very strong force in the Midwestern brokerage business. I published my own inhouse recommendation letter for the customers of that department. The company management began to notice that my recommendations were significantly outperforming the stocks in their other portfolios, as well as their own research recommendations. At the beginning of 1970, they gave me approximately $400,000 of the A. G. Becker Profit-Sharing Fund to personally manage. This was my first opportunity to implement my investment philosophy. I was elated. ==== Did you find that there were differences between actually managing money and simply making recommendations? ==== No, not really. However, the period when I started managing this account coincided with a bear market in stocks. Consequently, I had to suffer through some early, large losses. This is a good example of why you have to have faith in your approach in order to succeed. For example, one of the first stocks 1 bought was Bandag, which I purchased at $37. The stock first went down to $22, but then in the ensuing 1971-72 bull market, it went up tenfold. ==== Did you hold on to the stock for that entire move? ==== No, unfortunately, I didnt. About a year later, I was on a business trip and I called my office to check on my stocks. I found out that Bandag was up $5 that day, reaching a new high of $47- I decided to take my profits, with the idea of buying the stock back later. Bandag then proceeded to continue to go straight up to a high of $240 over the next year. That experience taught me that its not that easy to buy back a good stock once youve sold it. It reinforced the idea that theres great advantage and comfort to being a long-term investor. ==== Yet I understand that your average holding period tends to be significantly shorter than that of most other money managers. Why is that? ==== Although many of the equities in our portfolios are held for a very long period if theyre doing well, you have to be willing to turn over your portfolio more frequently than the conventional norm to get superior performance. I always look for the best potential performance at the current time. Even if I think that a stock I hold will go higher, if I believe another stock will do significantly better in the interim, Ill switch. ==== In other words, you want the fastest horse, even if your first horse is still trotting in the right direction. ==== Yes, but even more importantly, I want to make sure I get off the horse if it starts heading in the wrong direction. Most people believe high turnover is risky, but I think just the opposite. High turnover reduces risk when its the result of taking a series of small losses in order to avoid larger losses. I dont hold on to stocks with deteriorating fundamentals or price patterns. For me, this kind of turnover makes sense. It reduces risk; it doesnt increase it. ==== How long did you stay with A. G. Becker? ==== I left in the fall of1973 to become the research director for Mullaney, Wells and Company, a smallregional brokerage firm. ==== Did they give you money to manage? ==== No, but A. G. Becker let me continue to manage the account I had traded for them. In addition to that, the woman who reconciled the trades in the A. G. Becker office had seen that I was good at picking stocks. She gave me $104,000 of her own money to manage, which constituted most of her liquid assets. ==== As I recall, late 1973 would have been a particularly poor time to start a stock account. ==== Thats right. The 1973-74 bear market was the worst decline since the 1930s. ==== Were you fully invested? ==== Yes. Then I assume the account must have taken a fairly large hit At the worst point, I believe the $104,000 went down to under $60,000. ==== Did your clients confidence ever flag? ==== Thats the beauty of it. Her confidence never wavered. She had the strength to stay in. In fact, shes still with me today. Ill always be grateful to her for sticking with me when I was young and unproven. ==== What is her account worth today? ==== The account is now up to $5.8 million-and thats after taxes. This stuff really works! ==== Any trades stand out in your long trading history? ==== My largest position ever was Home Shopping Network [HSN], which I purchased in 1986. I heard about the stock from one of my analysts whom I had sent to a cable television conference several weeks before the company went public. As you probably know. Home Shopping Network sells low-priced merchandise-clothes, jewelry, and so on-over cable television. They had started this venture about a year before the offering, and in their first six months they had sold $64 million in merchandise and earned $7 million fully taxed. These were about the best results I had ever seen for a new company. Even better, the company still had incredible potential. At the time of the offering, they were reaching only a limited number of subscribers but were adding new subscribers very quickly. The cable systems liked the service because they got part of the profits, so it was easy for HSN to get picked up by new cable networks. ==== Did you buy the stock on the initial offering? ==== I wish I could have, but it was very hard to get stock on the deal. I believe we got only one hundred shares. The offering price was $18 per share and the first trade was in the low $40s. I bought most of my position in a range between the low $40s and low $50s. ==== Wasn`t it hard to buy the stock when it was up so much? ==== No, because the growth was tremendous, the company was making lots of money, and the potential at the time seemed open-ended. I actually felt very good buying stock at those levels. Within five months, the stock was at $100. During this time, the company continued to build its subscriber base and even purchased television stations to reach more viewers. The revenues and earnings remained very strong. ==== How long did you hold the stock? ==== By early 1987, the stock had reached $200.I sent my analyst down to Florida to an investor meeting hosted by the company. Although the management was very optimistic, at the meeting they admitted that almost aU the growth was coming from new subscribers and that the growth in order rates from customers on existing cable systems was not that great. About this time, the stock had also started to break down technically. That was all I needed. I sold the stock aggressively and eliminated my entire position over the next few weeks. |
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