haus: We put positive surprises in a larger context of the group,the market, and the portfolio. A lot of people have electronics now,but not a lot of people have the same judgment and experience. Thereare plenty of systems that try to do what we do but don’t producethe results.
Tanous: You’re saying it’s not just a matter of being there first?
Driehaus: Most people just can’t do it. Everyone has the informa-tion, but we seem to make money at it. We look at a bigger perspect-ive: Are these groups in favor? Where is the stock? What’s our posi-tion? And so forth. It’s knowledge, understanding, and wisdom. It’salso a belief in my philosophy. It’s not mechanical.
Tanous:How does your philosophy apply to large-cap investing?
Driehaus: We have a small amount of money in large-cap alreadyand we've beaten the S&P 500 by several hundred basis points. [A
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basis point is one one-hundredth of a percent.] We would look to beatthe S&P 500 by 300 to 500 basis points over a full market cycle.
Tanous:! presume your volatility is not all that high in the large-cap stocks.
Driehaus: [ don’t think it has been, but avoiding volatility is notone of our objectives. Edmund Burke said that selection is the ultimateeconomy. But we do concentrate our portfolios, and we are moreactive than most managers. We take bigger bets. Like Soros recently- he had a hunch and bet a bunch!
[George Soros, the renowned hedge fund manager, reportedly madea $10 billion bet against the British Pound in September 1992 andnetted a profit of $2 billion when the British currency was devalued.Another big bet in early 1994 was less successful - Soros bet wrongon the Japanese markets and lost $600 million.]
Tanous:To sum up this part, Richard, what are you buying now?
Driehaus: We’re buying networking stocks, internet companies,and specialized chip manufacturers.
Tanous:Bottom line. What is it that you do that future RichardDriehauses can profit from?
Driehaus: Time, effort and commitment. Everybody wants to berich but few want to work for it. It’s a lot of work and effort. It’s a24-hour-a-day commitment. I’m always observing. I look for newcompanies that show the type of growth that the Avons, the Baxters,the Abbott Labs did in the 50s. Earnings are the fountainhead of futurestock prices. When these future giants were recommended in the earlyfifties they were much smaller companies. I want to find new compan-ies with that kind of growth. That’s why I focus on small- and mid-cap names.
Then I focus on positive earnings surprises. | remember whenAmerican Motors reported a positive earnings surprise and the stockwent up 15% in one day, from 8 5/8 to 10 1/8 on record volume. Orwhen Chrysler reported a positive earnings surprise in the early ’60s,and that stock took off. At that time, the electronic revolution wasjust beginning. I concentrated on technology names since they wereshowing the most dynamic growth. The ’50s were a decade of growthof established companies. The ’60s were a decade of growth of newcompanies - new names and new ideas, the beginning of a new entre-preneurial era for America, not only in technology but in other areasas well.
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Tanous:I think you mentioned earlier that you first started investingnot in stocks, but in coins.
Driehaus: True. But when I was buying coins, I looked not for whatdealers were trying to sell, but what they were trying to buy! I wouldignore the big display ads showing what they had to sell, and I wouldlook at the bottom of the ad where they listed what they wanted tobuy. [ remember that American proof sets were very profitable, so Ifigured this would spill over to Canada and I bought Canadian proofsets. Since the Canadian market was much smaller, it took little de-mand to move the prices.
Tanous:Did you make money doing this?
Driehaus: Oh, yeah. I made a lot of money at age 14. I still havesome proof sets from that era.
Tanous: There is a story that keeps surfacing, which I'd like you toconfirm. It’s about a clerk at A.G. Becker who gave you $104,000when you started managing money at that firm. What’s the true story?
Driehaus: It’s true, and I'll share the facts with you. The most inter-esting thing about it is that this happened just before the worst bearmarket (1973-1974) in years, and the value of her portfolio sank toabout $65,000. It recovered a year and a half later, but the noteworthypart of the story is that this woman didn’t get cold feet. She stayedwith me while the professionals all ran for cover! In the late seventies,I felt that the market was going toward the smaller ideas, and I askedher if she wanted to take the risk. She said, “Fine.”
Tanous: What is her account worth today?
Driehaus: It was worth $7.8 million at the end of 1995. And she’smade some withdrawals over the years for taxes and other things. Ithink she’s 71 now, and her mother is 104. By the way, her motheris still invested! So is her sister. You know, everybody says old peoplecan’t take risk. But the real risk is being in all those so-called conser-vative investments! People think the definition of risk is volatility.We're getting the returns we get because our volatility is on the upside.More up than down, and when we’re up, we’re up a lot more thanwe're down.
Tanous:Let’s get a little personal. You’re a very generous man.There is a Richard Driehaus Foundation. What does it do?
Driehaus: It started with a million dollar commitment I made in1985. That consisted of 40,000 shares of TCBY. My cost on the stockwas less than $1 and it was up to $25. I contributed another $2.7
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million in the next several years. Now the Foundation is over $30million.
Tanous:Tell us about your giving philosophy.
Driehaus: It’s partly entrepreneurial. We’ve invested in start-upsand plain good causes where we can make an impact. We don’t gen-erally contribute to the big organized charities, instead favoring somecultural things, and also education. I contribute to my high school,St. Ignatius. [A building there has been named after Driehaus.] In1982, the school had only a couple hundred thousand dollars in en-dowment and was in bad shape. Now the school has a $20 millionendowment. I am also involved in a project called “Opportunities In-ternational” which makes small loans in third world countries. WhatI like about it is that they require the borrowers to pay interest andthere’s a 93% payback, so the money gets recycled and helps others.The giving keeps on giving.
Tanous:If you are agreeable, Richard, I would like to continue theinterview upstairs in your trading room. I'll keep the recorder runningwhile we tour the activities. I’d like to create a picture for the readerthat will show them how you work in your own environment.
Driehaus: Okay, we can show you what we’re doing today. Here’sone example: we took a 200,000 share position in one company andwe're adding to our positions in the internet companies.
[Richard Driehaus, Bob Buchen and I leave the Louis XVI surround-ings and make our way upstairs in the mansion. Upstairs, the decorflows consistently, antique originals and copies, heavily influencedby a combination of Victorian and French, complete with electricsconces, Tiffany lamps, and rich fabrics throughout.
The stark contrast in the trading room is remarkable. Amid the or-nate furnishings, young traders work at desks replete with the latest,and, in some cases, proprietary, communications apparatus andcomputers. Huge screens display myriad data on a single page, afeature unique to Driehaus - whose programmers have figured out away to get all of the information on one screen in real time.]
Tanous: Where are we now?
Driehaus: This is the trading room [points at a large TV screen onone of the desks in the trading area]. This is our small-cap portfolio.It’s up 1.5% today. Mid-caps are up 0.6%. As you can see we haveprice charts here. These are stocks we are buying. So when the traders
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are executing orders, they can look at these price and volume chartswhich help their judgment.
Buchen: They also get some fundamental information. Quarter byquarter earnings for the last four years, for example. [Buchen pointsto that information on the screen.] Also cash flow numbers on anabsolute and relative basis, so you can track momentum.
Tanous: [I point at one stock position on the screen.] Tell me aboutC-Cube. You told me earlier, it was up 2 3/4 points today.
Driehaus: That was the price when we started talking downstairs.Now look at it [Driehaus finds it on the screen]. It’s up 6 1/2.
Tanous:Maybe your buying is running it up.
Driehaus: [Laughs] No. It’s not us! We've got a full position. Otherbuyers are coming in now.
Buchen: That's the largest position in our mid-cap portfolio. [Wewalk to another screen.]
Driehaus: Here’s the C-Cube. Here’s what happened. On a positiveearnings surprise, the stock moved from 42 to around 48. We boughtit here [points to the chart on the screen]. We owned it when peoplewere getting scared away. Now look at it. [We move to a series of oldfashioned news printers clacking away against a wall.]
Tanous:This hardly seems state of the art.
Buchen: You're right. In fact, you can’t buy these anymore. Theydon’t sell Dow tape machines anymore. We had to buy old machinesand re-program them. The new machines no longer furnish print-outs.But Richard likes to come out here and browse through the informa-tion as it prints off the machine. We have 14 news wires on-line - 7domestic and 7 international. So we see the news as fast as anybodyin the country or even in the world. It’s no big deal. Anybody canbuy them. It’s what you do with them. But Richard still likes to readthe news on the tape. He was raised on the tape. [We go back to oneof the screens.]
Tanous:Let’s look at C-Cube again.
Driehaus: Here’s where the positive earnings surprise occurred. [Heis pointing at the price chart.] Note the huge gain both sequentially[compared to the previous quarter’s earnings] and versus the estimate[what the Wall Street research analysts expected the earnings to be].Here. They were supposed to earn 27 cents. They reported 48. Unbe-lievable. This was due to strong revenue growth. So the estimateswere raised pretty dramatically. The three year growth rate is estimated
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at about 45% [per year]. Lehman raised their numbers from $0.87 to$1.01 and from $1.05 to $1.70. [Here he points to the informationwhich refers to Lehman Brothers’ estimate of earnings for the nexttwo years.] This is classic. Here are the other estimates. RobertsonStephens, Alex. Brown...
Buchen: Richard has a very short attention span. When his analystscome to him, they can’t come to him with a half-hour story. They getdown to key points. He doesn’t sit in his office very often. He’s alwaystalking to traders, or to analysts, just like we’re doing now.
Driehaus:/He is still focused on the data on the screen. His eyesnever left it during our side conversations.] Here it is. Results werevery much better than expected as a result of very strong revenuegrowth for this video process. This is it. All our small cap stocks aremaking new highs today! Look at Oak. I told you about it downstairs.It’s in a similar area. Now we've got to look at what’s down. [Pointsat a stock on the screen.] This one is down because somebody down-graded its evaluation, but we like it a lot.
Tanous:Let’s talk about that. Somebody downgraded that stock be-cause they thought the price earnings ratio was too high?
Driehaus: We often found that they are too early in the downgrad-ing. They are too conservative and we should let things play out. Inother words, this stock is up about 50%, but it’s up because of verystrong underlying fundamentals. But they’re saying it is too highshort term. Short term they may be right, but over the intermediateterm, it’s going higher. They are trying to be too cute by saying it’snot going to work. It is going to work over the long term based onthe information we have.
Tanous: [Pointing at the bottom of the screen] What’s this downhere that looks like it is down four points. Davidson & Associates.
Driehaus: Davidson? Down four? That’s one we're selling!
Tanous:A technical point. Because you’re so well known in thebusiness, do you disguise your trading?
Driehaus: We try to be anonymous, but it’s not perfect. Here’s theOxford. We sold most of that yesterday and sold a little more today.This is a typical day.
Tanous:! notice that the holdings that are down are down fraction-ally, but the ones that are up are up dramatically.
Driehaus: That’s how we make our extra return. We’re adding toBay Networks. Sun Microsystems is up to a full position...Notice that
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the red numbers are those that are down. Wait a minute...this one isnot acting well. Altera. [Driehaus focuses intently on the screen, obli-vious to everything else momentarily.]
Tanous:Now, you say, it is not acting well. Do you mean in the lastfew days, or hours?
Driehaus: It’s a combination of things. Here’s another one that isn’tacting well. MU is Micron Technology. Everybody says it’s a big stock.[We move back to the trading desk. Traders are monitoring screensand barking orders into the telephone. An analyst joins us. He givesRichard a list of stocks he thinks ought to be sold, and explains thereasons why. But Richard is still obsessed with what he saw earlier.]
Driehaus: The only trouble is I’m more concerned about Altera,that’s A-L-T-R. It’s selling off again. The Macromedia I think is stillokay. How much are we over?
Analyst: We need to raise $20 million in cash.
Driehaus: We’re being forced into a situation here.
Tanous: Why?
Driehaus: Because of other Buy ideas. [Driehaus turns to the traderon the phone.] I'll tell you what I want to sell today. Altera A-L-T-Rfrom the small-cap fund.
Trader: All of it?
Driehaus: Yeah.
Trader: Okay. Altera is trading well. It just traded over a million.
Driehaus: See, the Macromedia looks to me like it could break outon the upside. [Driehaus points at the chart.]
Tanous: Interesting chart.
Driehaus: It’s got a 100% growth rate. And the market is goingtoward heavy growth. Now look at this, Mark [Genovise]. That’s theXilinx again. That doesn’t look so great either. I think we shouldlighten here, too, in the mid-caps. This is our day-to-day work. Here’sthe U.S. Robotics. There should be a positive surprise here. Note thatthe local area networking companies are doing better as a group.We'd rather find a company that has less powerful numbers, but isin a better group, where the industry estimates of the growth rate areincreasing, than buy something with very strong earnings but wherethe group is going down. See, one of the most important things is,we want to buy stocks that are going...up! [Laughter all around.]
Buchen: Richard does focus heavily on the group. Fifty-three per-
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cent of our portfolio is in the four top performing groups - out of 195groups.
Tanous:The CIA would probably be envious of these data banks.At the end of the day, where do you get your best ideas?
Driehaus: Actually, I get my best ideas from The Wall StreetJournal and Investor’s Business Daily.
Well, maybe. But several recurring themes in our day with RichardDriehaus provide very valuable clues to his success. Remember howoften the phrase “positive earnings surprise” reoccurred in our conver-sation? That is clearly the single most important criterion thatDriehaus looks for. He also likes accelerating earnings trends. Likemany other managers, Driehaus subscribes to First Call, a sophisticatedand expensive service that provides on-line research information froma variety of sources. If an earnings estimate comes out that beatsmost, or even all, of the Wall Street estimates, that’s a positive earn-ings surprise. Driehaus looks not just for surprises, but dramaticsurprises.
But perhaps the most important personal trait that he brings to theprocess is his personal dedication. His comment about the pianoplayer stuck with me long after our conversation. How many peoplewho like to play the piano ever become virtuosos? Not many. Butthose that do have something in common - they practice a whole lot.That is precisely what Richard Driehaus does. He practices a greatdeal. He is consumed by his business and he is totally immersed init. For those who do not plan to spend upwards of 15 hours a day atthis craft, we may do well to remember the discipline that RichardDriehaus brings to his successful strategy. And for investors who areprepared to accept the volatility of small-cap stocks, the notion ofaccelerating earnings trends and positive earnings surprises is some-thing to keep in mind.
Postscript:Six months after our initial interview, we asked BobBuchen for an update on the stocks that were mentioned during ourvisit. Buchen reported that every stock holding mentioned at the timehad been sold during the following six months, with one exception,Ascend. Driehaus bought 3 million shares between July and Octoberof 1994. The average cost was $3. At this writing, the stock is tradingin the mid-60s.
69MARIO GABELLI
They call him “Super Mario,” and why not? He is one of the mostvisible, ubiquitous figures on Wall Street. A legendary stock-pickerwho must now divide his time between managing his rather largeempire and doing what he loves most, managing money, Mario Gabellidoes not appear poised to slow down. Ask him about leadership andhe'll give you an interesting analogy. He doesn’t see himself as a dark-suited corporate president, or even the coach of a basketball team.Rather, Mario visualizes himself as a jet fighter pilot at the controlsof his plane, hands on the stick, ready to blast off - which sayssomething about the dynamic nature of this high-powered individual.A perennial member of the prestigious Barron’s roundtable, Gabelli’sinvestment style has always been value. But he has modified the tra-ditional value approach with some interesting wrinkles of his own,including a “catalyst” dimension which we discuss in the interview.I think you will find that twist quite compelling.
Gabelli’s firm is divided into three activities. One is an institutionalbrokerage firm, which also has some specialized arbitrage and venturecapital funds; the second is the mutual fund management company,which oversees a dozen separate funds including the flagship GabelliAsset Fund which Gabelli personally manages; and third is the moneymanagement business, which caters to institutions and well-heeledprivate investors. Add it all up, and you quickly come to a total undermanagement that exceeds $10 billion. Not bad for a nice Italian kidfrom the Bronx. Okay, this was a real smart kid.
Mario Gabelli moved his headquarters to suburban Rye, New York,a few years ago, but we met in his New York City office and continuedour conversation in his car as we were driven down to Wall Streetwhere he headed to a board meeting of the American Stock Exchange.
Tanous:How did you first get interested in stocks?
Gabelli: My first investment experience was somewhere around1956. I was working in the Catskill mountains as a waiter and theywere financing the ski resort. I looked at the offering, but I was nota qualified investor. So I didn’t invest in it. The ski resort then wentbust, which was kind of fascinating. I must have been between 13and 15, | forget. Also, I used to caddy at Sunningdale Country Club.INVESTMENT GURUS
I shared in the enthusiasm for investing that the floor brokers I workedfor had.
Tanous:That ski resort experience does not seem to be an experiencethat would lead to a career in investments.
Gabelli: I think if you look at Warren Buffett, Peter Lynch, andMario Gabelli, we all caddied, and we all invested in the stock marketvery early in life. There must be something about caddying.
Tanous:As a matter of fact, I discussed the caddie experience withPeter Lynch [page 113]. Like Peter, you certainly qualify as one of thebest known and visible fund managers out there.
Gabelli: I’ve been doing it a long time. It’s called survivability.
Tanous:But the other thing I find interesting about you is probablynot as well known. I’m referring to your academic credentials. You’rea CFA [Chartered Financial Analyst, a designation earned by takinga series of 3 qualifying exams]. Not many of the fund managers I'vespoken to are, and it’s an important discipline. You also have anMBA from Columbia. You’re obviously smart.
Gabelli: A lot of people are smart. I was summa cum laude fromFordham. I went to a Jesuit undergraduate high school and a parochialgrammar school. But it’s tough to get into this business these dayswithout an MBA. There have been gaps in talent coming into WallStreet, like in the ’50s due to the lackluster market. There was also agap in the seventies, predictably, given the market at the time. ’'mon the board at the Columbia Graduate School of Business, so we’reactively involved in the curriculum and how we mentor students.Obviously this is a part of America that is important to money man-agers. The competitive advantage we have is entrepreneurialism andingenuity. Education is an important springboard to that.
Tanous: There are, of course, lots of different approaches to invest-ing. What is there in your background that led you to choose the valuestyle?
Gabelli: Very simple. I was at Columbia in 1965. Roger Murraytaught security analysis. | wanted to take security analysis, and I tookhis course because he was the best. He basically is an extension ofGraham and Dodd and actually co-authored the fifth edition of theGraham and Dodd book, Security Analysis. [The value style of invest-ment is sometimes called “Graham and Dodd” because of their pion-eering role articulating it.]
Professor Murray, who is 85 today, is wonderfully focused and still
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talks about stocks in more than just an academic way. About fouryears ago, our firm, in part to create a living legend, asked RogerMurray to give lectures on value investing. He gave four lectures, 120minutes each, non-stop, at the Museum of Television and Radio. Weinvited Columbia Business School to participate. Dean Meyer Feldbergjoined Professor Greenwald. Based on that, Professor Greenwaldbrought back to the curriculum a value investing course.
I think if I trace the roots of Gabelli, Cooperman, Samberg, and awhole array of mid-’60s-vintage investors, you'll find that many ofthem have one thing in common, and that is value investing. It wasa fundamental approach to the investment process driven by a Grahamand Dodd academic background. We were not University of Chicago,we were not University of Pennsylvania, or Harvard. We were driveninto this style by virtue of the discipline that we learned in graduateschool.
Tanous:One of the things we’re doing in this book that I think you'llappreciate is bringing academics into the discussion. The academicsdon’t think that people like you are predictable. You’re the luckyorangutans.
Gabelli: I think your selection of academics is the problem. Youshould have Roger Murray. [I decided to take Mario Gabelli’s advice;you'll find my conversation with Roger Murray on page 301.]
Tanous:Let’s talk about your investment strategy. The Gabelli ValueFund is structured to allow you to take big bets by buying substantialpositions in companies. How do you justify that amount of concentra-tion since, with more concentration, you have potentially more risk?
Gabelli: Within the framework of concentration, if you readBerkshire Hathaway’s annual report for the last 20 years, you'll findthat, if you understand a business, buying the business has less risk.So your assumption is not valid. It goes to the notion of what you’redoing. Are we buying a piece of paper? Concentration in a portfoliocould be 33 stocks at 3% each as opposed to 100 stocks at 1%. But Isuppose somebody would also argue that that gives you diversification.
We're buying a business and a business has certain attributes. We’renot buying a piece of paper and we’re not buying soybeans. As sur-rogate owners, there are certain characteristics with regard to thevalue of the franchise, the cash generating capabilities of the franchise,and the quality of the management. So you have quantitative andqualitative measures. You also have a notion of price. Where are you
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buying that stock within the context of what I call “private marketvalue”- what others might call intrinsic value? And within thatframework, Mr. Market gives you opportunities to buy above thatprice and below that price, that intrinsic value. So risk can come inbecause you're buying a great franchise, a great business, run bywonderful people, but at too high a price. It’s kind of the blending ofa series of judgments with some mechanical and arithmetic exercises.
Tanous:So clearly you’re not an efficient market proponent.
Gabelli: There are lots of ways to make money. I don’t think funda-mental analysts, who do disciplined bottom-up research, believe thereare no bargains. The harder you look, the more you find them. Theyare uncovered in strange ways.
Tanous:Could we talk a bit more about private market value andsome of the criteria you use to zero in on companies that you ulti-mately buy?
Gabelli: The “private market value” approach is the terminology Icoined in the late 1970s coming out of the bear market of 1973-74.We went back to fundamentals to determine what a business is worth.If it’s selling on the stock market for $10 a share, I will look for theprivate market value, the summation of the pieces of its business, bylooking at cash, receivables, inventory, off-balance sheet assets likegoodwill, franchise values, earnings power. Then I'll ask: what wouldan informed industrialist pay to own this enterprise? What is thevalue of the company if it were privately owned? What would some-body pay and why? Of course, private market value multiples change.They are a function of interest rates, capitalization structures, taxes,all of which have an indirect impact on the value of the franchise.So private market value investing does change over time.
I developed this approach in the mid-1970s for a practical reason.I wanted to convince people that it was okay to buy stocks. I actuallytook an ad out in The Wall Street Journal congratulating my friendsat Houdaille, and to Kohlberg, Kravis and Roberts for doing theHoudaille transaction. I believe it was in 1979. It was the second LBO[leveraged buyout] that was done by KKR. It was a perfect exampleof the private market value principle, since the LBO took Houdailleprivate. As a result of my knowledge of how to do these “privatemarket value” transactions, | became the leading guru in the earlyeighties on the leveraged buyout business.
Tanous:So, is the idea that you’re putting these stocks into your
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funds and accounts, and then anticipating that something is going tohappen?
Gabelli: No, that’s backwards. What you do is identify a companyin the public markets that is selling well below a channel called “in-trinsic private market value.” That gives you a margin of safety, andhelps protect the downside by providing a cushion, because it is sellingat a significant discount to the underlying value.
The other element that I added to the investment process was aneed for a rate of return and a definable time period. So I added theelement called the “catalyst.” What would be the element that wouldhelp narrow the spread between “the private market value” and thestock price? That catalyst was important. It could be a 13D filing, itcould be a split-up of a company. All the things I talked about in1979 are back in 1996. Nothing changes. Plus ca change, plus c’estla méme chose.
Tanous: What are some of the other examples of catalysts, Mario?
Gabelli: A divorce of a founder, the death of a founder, a familyblock that wants a change in their tax situation. A change in regula-tion. For example, right now, in 1996, you have a major structuralchange in the way the telephone industry is being regulated. That isthe new Telecom act. That is a major catalyst for certain industries.
Tanous:The identification of the catalyst is important as part ofthe process of identifying the companies.
Gabelli: The first thing you do is examine 100 companies, andyou'll find 15 of them that fit your criteria regarding price, cost,margin of safety. The second element, before you buy them for theportfolio, is that you want to have a catalyst.
Tanous:So the catalyst is part of the investment process?
Gabelli: It’s not part of the research process, but it is part of thetotal investment process - including pulling the investment trigger.
Tanous: Most managers who are identified with a style, as you arewith value, stay wedded to it. But your firm has expanded beyond thevalue style and has been very successful. You’ve grown a lot.
Gabelli: You’re getting confused. But it’s not you alone; it’s theStreet, too. | wear two hats. Mario Gabelli, the fighter pilot; that is,the person at the throttles running the value style of investment ourfirm has. Secondly, Mario Gabelli, the Ned Johnson [Fidelity], theJohn Bogle [Vanguard]- I'm Bogle and Johnson put together. That is,I’m the business guy running a firm, who has a moral responsibility
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to his professional staff to make sure that their business of investingstays healthy in all markets at all times, and, also, gives them a con-tinuing challenge. As a result, the Gabelli brand is preeminent invalue and has certain other niches - we think we do a marvelous jobin arbitrage; we think we do