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My full interview with Gaelen Morphet originally appeared in my national bestselling book, Market Masters, which is available at Chapters, Indigo, and Coles as well as Costco and Amazon.ca.
It was through a story in Canadian Business that I became aware of Gaelen Morphet. The magazine featured one of Gaelen’s largest and most successful holdings: Alimentation Couche-Tard. It’s a stock that she continues to hold today. Alimentation Couche-Tard has been such a high-flying stock that Gaelen’s been forced to sell portions of it over time, taking profits off the table, and reducing its position size in her portfolio.
In her role as chief investment officer at Empire Life Investments, Gaelen oversees a number of funds. The flagship, Elite Equity Fund, has returned 9.8% since its inception. The other funds comprise Empire Life’s “first family of mutual funds.” In total, Gaelen is responsible for approximately $9 billion in assets.
On top of having a knack for picking the right stocks, Gaelen has also been known to make superb calls on the direction of the market. One such call in 2012 turned out to be right on the money, so to speak. In a June 2012 article in the Morningstar Manager Monitor, Gaelen said, “We’re actually in a sweet spot right now. As a value investor, you try and capitalize on the emotionalism of the market to buy names when they’re cheap and sell them when they’re expensive. Almost every stock out there is a value stock right now.” And sure enough, after a broad market decline that started in 2011 and was perpetuated by the Euro Crisis, the TSX finally started to turn up in 2012, and continued to rally all the way into late 2014.
How does Gaelen make such bang-on calls? The answer is that she employs her margin of safety model. Gaelen scans the market on a weekly basis and measures the margin of safety (the difference between intrinsic value and market value) in individual stocks based on Graham and Dodd’s teachings about fundamental value investing. Gaelen then invests in stocks that are below their long-term or intrinsic value. She’s refined Graham and Dodd’s framework and models intrinsic value using a combination of current book value, return on equity, earnings per share for the next two years, projected book value, normalized return on equity, normalized earnings per share, and relative P/E ratio. She uses that information to determine the net present value of a company — in a similar way to the discounted cash flow model. You’ll learn more when you read through our conversation.
Gaelen was relaxed, composed, and open to sharing her stories with me. She removed her thick-rimmed glasses when she wanted to emphasize a point. We met in a large room at Empire Life that could probably have accommodated 20 people.
16 Investing Lessons From Gaelen Morphet:
1) “The markets run on a combination of finance and emotion. [But] investing is largely emotional. In order to get really good at it, you need to understand how you feel when your stock goes down 20% and what your reaction will be.”
2) “I follow the theory that all companies have an intrinsic value, and that stock prices fluctuate around that intrinsic value. I look for companies that build their intrinsic value over time. I . . . compare the intrinsic value to the current stock price and record the difference. I want stocks that are trading below their long-term or intrinsic value.”
3) “If . . . a problem emerges, investors tend to assume the worst and often move to something that isn’t having problems. Value managers often look at this as an opportunity to purchase the stock with the view that the stock will recover when the problem is solved.”
4) “If I know the company really well, I can make a judgment call on whether there’s permanent value destruction.”
5) “Before you know it, everybody’s piling in. That is the way the market works. It is dynamic and relative. It is not black and white.”
6) “You need to stay invested to build wealth over time. If you trade in and out of the market, you’ll miss the best moves. You need to buy high quality companies and let them appreciate in value over time.”
7) “When the market becomes more pessimistic I take advantage of that pessimism and add to my positions. Likewise, when markets become overly optimistic I will pare back.”
8) “I look at return on equity as a measure of profitability. It is important to look at ROE on a historical basis because it indicates how well that company has been run and the return it has delivered over time.”
9) “A longer time period allows you to evaluate the company’s performance over different economic periods, giving you a better indication of how the stock will react, regardless of the macro-economic picture.”
10) “I’m very focused on identifying value traps. Those are stocks that look cheap but are going to stay cheap forever. Some of the reasons a stock may be a value trap is because it has too much debt, doesn’t have good management, or lacks good corporate governance.”
11) “To create a successful portfolio, you need different types of stocks — some that deliver today and some that’ll deliver in the future. The portfolio should be a combination of stocks that are reaching their intrinsic value, trading below their intrinsic value, and some that are going through their intrinsic value.”
12) “My goal is have the portfolio appreciate while always protecting the downside. I do this through diversification and having exposure to many different industries and stocks. And by focusing on stocks that pay dividends.”
13) “If you’re always building wealth with a portfolio that’s less expensive than the market, when the market rolls over, you’ll have that margin of safety that other investors do not have.”
14) “To be a good investor you must go through some very difficult times where you really do question your abilities and your resolve.”
15) “As a value manager, I prefer stocks that have limited downside and plenty of upside.”
16) “When everybody’s playing the same stocks and the expectations are there, it’s difficult for companies to always meet investors’ expectations, and that’s where the volatility comes from. A great deal of investing is about meeting or exceeding expectations.”
Robin Speziale is the national bestselling author of Market Masters, which is available at Chapters, Indigo, and Coles as well as Costco and Amazon.ca. He lives in Toronto, Ontario. Learn more about Market Masters.