Case StudiesInvestment QuotesOverall Stock MarketThink Differently

Michael Burry: Focus on Bargains and not Stock Market Valuations

Michael Burry’s story is captivating. And in fact so good of a story that excellent financial storytellers like Michael Lewis and Greg Zuckerman turned it into main portions of best-selling books on the financial crisis.

The story goes something like this: Burry was just a guy writing a blog (before people knew what a blog was). He was discussing his ideas in early internet chat rooms. He picked stocks. He was a value stock picker at a time when value investing couldn’t have been less popular—the late 1990’s. But Burry did well investing his own account, and he got a small following on these early message boards. One day, he posted that he had decided to leave medicine, and he was starting his own fund. Joel Greenblatt—who had been reading, and profiting, from Burry’s posts—promptly contacted Burry, offered him a million bucks for an equity stake in his new business, and help seed Burry’s tiny fund.

Burry gained success as a stock picker who preferred bargains over market darlings, but he became famous when Michael Lewis wrote a book about the famous subprime trade. Burry went from a complete unknown (but very successful) stock picker to a fund manager who brilliantly predicted and profited from the biggest bubble in decades. His trade became the focal point of the financial crisis books, and his name became known by the heaviest of hitters such as Warren Buffett and Alan Greenspan.

Burry’s story is often told as a Cinderella type story about “just a guy” who was a good stock picker, got discovered, and then made it big in a Soros-esque trade of a lifetime.

Not exactly… That is how the sequence of events unfolded, but I think the story of Burry’s success in the subprime trade actually downplays how talented a stock picker the guy really is. He deservedly gets attention for his investment in the credit default swaps that soared when housing crashed. But as he himself states in his investor letters, he’s a stock picker at the core. He is classic value investor, hunting for bargains in the nooks and crannies of the market. As he said of his own philosophy in an early post:

“My strategy isn’t very complex. I try to buy shares of unpopular companies when they look like road kill, and sell them when they’ve been polished up a bit.”

The thing I admire most about Burry is his ability to think independently. He studied Buffett, but realized Buffett couldn’t be cloned. His style was originally much closer to Ben Graham’s—he was a bargain hunter. But he didn’t clone Graham either. From what I can tell, he simply looked for bargain-priced stocks by turning over a lot of rocks. Many of his early investments were sort of special situation type bargains—some with catalysts that played out fairly quickly, others just unloved and neglected bargains selling for less than a private buyer would be willing to pay for the business.

This weekend, I happened across a link to a very nice write-up and summary of Burry’s original posts on the message board I referenced above. It prompted me to re-read the compilation of Burry’s original articles he wrote for MSN Money, as well as review a couple old letters that I printed off. Unfortunately, I don’t know if Burry’s original Scion Capital letters are still in the public domain, but if anyone would be willing to share them with me, I’d love to read them. I only have a few of them. As for the MSN articles, they were written for the lay-person investor, but they provide a glimpse into how Burry thought about his investments.

I thought I’d highlight just a few clips from the investor letters and the MSN letters. The first thing I thought was remarkable was the fact that Burry was very bearish on the stock market in 2001, yet he remained fully invested and produced incredible results from buying bargains: +36% annually for the first 2+ years of his fund, even as stocks were in an extreme bear market, with the S&P dropping 50% and the Nasdaq falling 80% from their 2000 highs.

He describes his pessimism on the overall stock market in an early investor letter:

Burry Scion Letter Bearish View

He describes a situation that could easily describe 2015. Established companies with durable products, competitive advantages, and stable long term prospects (but with no real hope of growing much faster than 7 or 8% annually) are priced at 20 to 30 times earnings in many cases (I’m referring to large, high quality stalwarts at these valuations. This isn’t to mention the ridiculous valuations of some of the more recent IPO’s). The popular argument for this seemingly pricy valuation among high quality companies rests on the fact that interest rates are so low—a dubious justification in my view.

But back to 2001… Despite Burry’s lack of enthusiasm for the overall stock market and general valuations, and despite his bearishness on the economy, he remained fully invested in stocks he thought were undervalued. This is a good lesson—his bearish assumptions were correct, but he still preserved capital and made remarkable returns by staying focused on identifying undervalued securities and not worrying about where the market will go next:

“So, I will go on record right now as saying that this is a time of tremendous uncertainty about market direction—but no more so than at any time in the past. I continue to believe the prudent view is no market view. Rather, I will remain content in the certainty that popular predictions are less likely to come to pass than is believed and the absurd individual stock values will come along every once in a while regardless of what the market does.”

Burry turned out to be correct in his assessment that the market was overvalued, even after a significant drop. But what’s interesting to me is that he still maintained a fully invested portfolio filled with bargain securities.

In his early letters he describes how he maintained his portfolio filled with cheap stocks, and despite his bearishness, was long bargain stocks that did extraordinarily well as the overall market dropped 50% from 2000-2002. Here are his early results (Burry started his fund in November 2000):

  • 2000: +8.2% (vs -7.5% S&P 500)
  • 2001: +55.4% (vs. -11.9% S&P 500)
  • 2002: +16.1% (vs. -22.0% S&P 500)

So for the first 2 years and 2 months of his fund, he had compounded at a rate of 36.1% per year vs. a CAGR of -18.8% for the S&P 500.

And it’s remarkable that this was done primarily being long stocks with basically no shorting. Burry said in his 2006 investor letter that:

“A Scion portfolio will be a concentrated portfolio, though, and I have generally thought that in any market environment I should be able to spot the handful of investments that will make all the difference.”

So I think it’s notable that although Burry was extremely bearish (as described in his letters and the MSN articles), but he still stuck to his knitting—looking for low risk bargains.

Buffett and Munger said something similar at the recent meeting about just looking for undervalued companies and let the macroeconomic tide take care of itself.

Burry eventually got much more interested in the macro tides, and profited from it, but I think his early results as a stock picker are a good reminder that regardless of how overvalued we think the market is, there are always opportunities to invest in low risk, high probability bargain situations.

As for the MSN articles, Burry’s value stock picks there also did very well, even as the broad stock market indexes got crushed. His picks returned +23% while the S&P 500 dropped 22% and the Nasdaq plummeted 58%—a testament that in most markets, good old fashioned value can in fact protect capital from permanent capital loss.

One other comment from Burry on why it’s more important to focus on bottom-up stock picking than to try and predict stock market movements:

“Regardless of what the future holds, intelligent investment in common stocks offer a solid route for a reasonable return on investment going forward. When I say this, I do not mean that the S&P 500, the Nasdaq Composite or the market broadly defined will necessarily do well. In fact, I leave the dogma on market direction to others. What I rather expect is that the out-of-favor and sometimes obscure common stock situations in which I choose to invest ought to do well. They will not generally track the market, but I view this as a favorable characteristic.”

Here are Scion’s returns over the life of his fund until he liquidated the partnership:

Michael Burry Scion Capital Returns

Here are a few other links of interest regarding Burry and the financial crisis:

33 thoughts on “Michael Burry: Focus on Bargains and not Stock Market Valuations

  1. Hi Mr. Huber:

    Thank you for service and thoughtful writing. If you do get copies of the Burry Letters, please make them available to your readers. I think your audience would be very keen to study them as well.


  2. Thanks for the review of Michael Burry’s career thus far. I’m glad he made a 5x return in his investment career and also made a pile of loot for himself in doing so. I’m always a little surprised at how much capital under management some of these folks acquire, whereas others have small amounts. I’m not sure if it’s marketing, connections, networking, or what have you — since I don’t work in that sector, I suppose it doesn’t much matter.

    I had seen some blogs talking about Burry but didn’t know much about him. I think financial journalists like to talk up the drama of situations like Burry’s short of subprime mortgages, as a selling point, but actually, many good investors all seem to be pretty anti-risk, anti-drama, stick-to-one’s knitting.

    1. Yeah I think Burry’s trade is the perfect type of trade that people get excited about. Kind of like the Soros and Druckenmiller trade. The reality is regarding the pound trade, it was an epic trade, but I think it added around 25% to their capital (or something around that number). Those guys were doing 30% a year so this wasn’t an unheard of amount. I think people get caught up in the notional value of the trade and the amount of money ($1 billion).

      As for Burry, he certainly never sought out the limelight–it just found him. I think he would have been perfectly happy picking his bargains and quietly compounding at 20% per year or so, but this was an idea that he found that he understood and was convicted on. The rest is history… but I don’t think he would prefer to be characterized as an investor who hunts out these crazy one-off opportunities. My guess is he’s happy to hunt for bargains. I think guys like Kyle Bass (who also got subprime right and made a fortune) get so caught up in trying to do another one of these epic trades that they force the issue. Bass may end up being right on Japan, but I do wonder if his position is influenced by what I’ll call “subprime nostalgia”.

      1. What makes you think Bass is going to be right on the Japan trade? He hasn’t been so far! Any bias on your side here?

        But even he is Burry*s story should have tought you that you can make a ton of money applying Graham and Dodd style investing meanwhile.

        I only invest in Japan following the G&D approach and it has been very lucrative so far.

        What makes you think people can not be successful doing the same in Japan?

        1. Hi Otto, Where did I say that I think Bass will be successful? And where did I say people can’t be successful investing in Japan?

          For the record, I don’t have any opinion on whether Bass will be successful in his Japan short trade. My comment in fact suggests he has (as I put it in the earlier comment) “subprime nostalgia”. And I never made any comment regarding the merits of investing in Japan.

          You may have misinterpreted my comments.

          1. Hi John,

            thanks for the clarification. Selective reading and misinterpretation on my part than. Was focussing on the “(…)Bass may end up being right on Japan(…)” too much.

            I apologize.

            Have a great sunday.

  3. Hi John,
    Big fan of your blog. I was just looking at an old post of yours on idea generation, and you mentioned that you read other fund letters.
    Is there a way that you find fund letters? I’ve been finding it difficult to source for them.


    1. Hi Lee,
      I don’t really have any secrets on finding the letters. Most of the ones I read I just happen across online.

  4. Evening John – I really enjoyed this post, and its timing was fortuitous because I happened to have come across Burry recently too. I’ve been taken by his story, in part because I think his approach is one that suits small investors (who presumably make up the majority of investors) rather better than the modern-day Buffett (i.e. a Graham-esque value approach versus a Buffett/Fisher buy-and-hold strategy). I wonder whether you agree? I think the latter puts an even greater premium on an investor’s skill than the former. I also think that techniques like ‘scuttlebutt’ are probably unrealistic for most investors. One final thing – I really admire how seriously Burry took independent thought. I like his comment on buy-and-hold being popular toward the end of bull markets, and talking about Berkshire’s annual report as a marketing tool is a reminder that Buffett is a great self-publicist as well as great investor…!

    1. Good points… thanks for reading. Yes, I noticed Burry’s comment regarding the late 90’s bull market, and fully agree. I think buy and hold becomes quite popular among the masses at exactly the time when the market begins getting frothy.

  5. So while it’s true he did a lot of bottom up stock picking, you’re cherry picking. The MSN and street capitalist profiles make it clear that Burry had a very large Technical analysis training and that he made sure to use it. He had rules like buying within a % of a new low, and he would short based on technical analysis. Rather than ignoring it b/c it’s outside of our comfort zone, it’s worth recognizing. The fact that a value investing genius used technical analysis is a rarity, should make everyone stop to question their beliefs.

  6. So while he didn’t focus on market movements, you’re cherry picking. The street capitalist and MSN profile and case studies make it clear he used a lot of technical analysis. He shorted stocks with TA, and he had a large training in technical analysis of futures. He used it successfully, at one point noting that “Effectively, you need to use technical analysis. My shorts, though fewer in number by far, have been more successful than my longs — what that says about me I don’t know.”…..he was constantly trying to find a more value-based strategy, but he found technical analysis effective. Rather than ignoring that because it doesn’t fit our beliefs, I think it’s worth recognizing him as a value investing prodigy and stopping to question our preconceived notions on trading and technical analysis.

    1. I think those old articles have to be put in context. They were posts written by Burry in the late 90’s before his time as a professional money manager. As I read through his letters from his fund, I think it becomes more clear that his philosophy evolved into mostly fundamental. I really don’t think he used much technical analysis. I have no way to confirm this (other than if I were able to talk with him), but my strong suspicion is that he evolved as he became a better investor. Nevertheless, these old posts are very interesting and they do provide valuable insight into his early thinking.

      The biggest takeaway for me is not specifically how he invested or if he used this or that style of investing, but rather how independently minded he was. I think that is a very valuable characteristic to have as an investor.

      1. I agree.

        When referring to “technical analysis”, I think that Burry was primarily trying to come up with a way to deal with a particular problem which all value investors face, that is, the clearly undervalued stock which keeps on getting cheaper.

        The orthodox approach, in this situation, is to buy when a stock looks cheap and try to leave some room in your portfolio to buy more if the stock gets cheaper. Over the years, I’ve seen things written by WEB, Klarman & others to the effect that that is the better way.

        Burry, however, thinks it’s best not to try to stand against the tide (as it were) but to wait for some indication that the tide has turned before wading in. That way, he hopes to avoid large unrealised losses which can distort the performance of his overall portfolio, especially were the portfolio is fairly concentrated.

        Viewed in this context, Burry’s references to “technical analysis” seem to me to be just one tactic in a game he plays according to the value investing playbook.

        1. Hi!

          I think it’s a bit like Walter Schloss, he liked to buy in low’s of past few years… He said something like this ” if a stock goes to 125 then decreases to 60 you may think is good to buy than but if a few years ago the stock traded at 20 there is some vulnerability in it… ”
          I think you are right nemo, it’s a way to try to deal with undervalued stock that keeps getting cheaper…

  7. There were bargains among small-caps and mid-caps in 2001. The bubble was relatively confined to technology stocks and then other large- and mega-cap stocks (Coca Cola and P&G trading at 40x earnings). Besides buying technology stocks, buying the S&P 500 was about the dumbest thing you could do in 2001. That was the time for small-caps, which had been totally neglected.

    It wasn’t so contradictory to be hunting for (and finding) value in small-caps and mid-caps, but despise the S&P 500 in 2001. the market was quite bifurcated on a valuation basis. Another way of saying that is “valuation spreads” were wide — lots of insanely expensive stocks, but lots of cheap ones too.

    The current situation is more characterized by nothing insanely priced, but nearly everything at least mildly expensive.. Valuation spreads are tight now, and things are generally expensive.

    1. I agree with that assessment John. And I would add that the 50% decline between 2000 and 2002 in the overall market was not a liquidity driven decline as much as it was in 2008. In 2008 everything declined, and it was a true panic. 2000 was certainly a bear market, but not driven by a liquidity crunch that forced all assets down at the same time.

  8. global top banks’ total derivatives is 10xglobal GDP (?), and concentrated to these exclusively. SPECTACULAR FIREWORKS are expected ?

  9. If you study long-term charts of Burry’s picks, it becomes apparent that Burry has a remarkable ability to identify businesses with extraordinary long-term returns, whereas most of his discussions of these businesses focus on short-term reasons why the stock is undervalued. You would incorrectly conclude from reading his articles on MSN that he was just good at finding temporary mispricings of otherwise ordinary stocks. Whether by intuition or by some explicit selection criteria like high five-year ROE, Burry in fact seems to have limited the universe under consideration to just those companies that would perform extraordinarily for the next 15 years.

    Given his background as a doctor and how easily he was able to transition to being a top-tier investor, you would have to say this is a uniquely brilliant guy, on par with a Warren Buffett.

    Does anyone here know if Burry still dialogs with other investors online? Since closing his fund, he seems to have distanced himself from regular conversation with others about stocks.

  10. Another thing I have noticed from reading Burry’s MSN picks is how well versed he is on comparable valuation metrics within the industry he is evaluating. Was that part of his initial selection criteria, or simply part of his checklist?

  11. That’s a good point that you can have your money make money. If you have savings it has the potential to be an investment instead. If you don’t do anything your money will lose value anyways because of inflation.

Leave a Reply to Connelly Barnes Cancel reply

Your email address will not be published. Required fields are marked *