Foster Friess was the founder of The Brandywine Fund, a top performing mutual fund for decades. Friess was interviewed for the 1997 edition of Investment Gurus by Peter Tanous.
In the book, it was revealed that in the 10 years since inception, The Brandywine Fund earned an average annualized return of 18.4% (by December 31, 1995). It grew its Assets Under Management from $100,000 to $4.2 billion in that time.
While the actual net worth for Foster Friess is not publicly disclosed, we can make a few estimates. In 2001, Friess sold 51% of his company for $247 million (source). He had about a 61% stake. However, Friess was also a political donor. He was probably still worth hundreds of millions by his passing in 2021.
What led to his phenomenal 10-year track record in the market?
After reading his interview, I saw 4 interesting points about the life of this great investor:
- The “pigs in a trough” mental model
- Companies to avoid
- Thoughts on the efficient market
- Team building and time management
At the time of the interview, The Brandywine Fund had a portfolio of 220 stocks and 180% average annual turnover. Each of those two components were a result of his very intentional process.
Pigs in a Trough
Foster Friess had a philosophy of never being content with a stock pick.
What that meant to him was that there could always be a better stock to be in. So rather than hold on with stocks that are doing pretty well, he always wanted to be in the stocks that were doing the best.
As Friess mentioned in the book, that could mean selling a stock with a 20-30% upside for a stock which they see with a 60-70% upside.
Predictably, this led to huge portfolio turnover, which averaged about 180%. That equates to an average holding period of less than 6 months.
The logic behind this approach was that some companies can get “fat and happy.”
For instance, when you look at a pig trough, there might be 15 pigs feeding at a time. When a hungry 16th pig forces its way into the trough, one pig gets pushed out. Presumably, it’s usually a pig that’s already fully fed, fat and happy.
Companies can also get fat and happy, and rest on their laurels. They might take their great profits and squander too much of it through excessive dividends and stock buybacks rather than reinvesting for future growth.
That can be a slow death sentence for a stock, especially in technology companies.
Also, Friess instilled a strict discipline with regards to the price paid for a stock. By sticking to lower Price to Earnings ratios, The Brandywine Fund benefited from much of the short-term mean reversion many underappreciated stocks see. Then, if all of that upside has already been fulfilled, the fund can move on to the next great mean reversion opportunity and avoid “dead money” periods.
The Benefits of the Pigs in a Trough Approach
By forcing a decent company out of a portfolio and replacing it with a better company, the fund is greatly reducing its risk of seeing its returns limited by a fat and happy company (or stock).
Friess calls it a forced displacement idea.
Every new stock pick for the portfolio must displace an old holding.
It forces the employees working in the fund to constantly assess and re-assess how the companies in the portfolio are doing. This can help the fund be among the first investors to sell at a time where a company might be peaking, or starting a decline.
The second benefit to the forced displacement approach is in how it engages the fund’s employees.
By forcing (no pun intended) employees to constantly assess the companies in the portfolio, they naturally must do more work in the industries they cover. This can help them become first movers on an exciting stock they might come across in the process of re-evaluating their owned positions.
Executing a “pigs in a trough” strategy can help fan the flames of insatiable curiosity in an investor, which helps in finding new opportunities.
Companies to Avoid
Foster Friess had some very strong opinions on the types of companies he tells his employees to avoid.
The reason for each of these might be slightly different, but each have their own logic.
- Speculative biotech companies
- Utility companies
- Companies with unfavorable positions in the value chain
- Some financial stocks
Speculative biotech companies
Biotechnology is notorious for being a very boom or bust business. Many companies rely on just a handful of drugs to drive the majority of their revenues. That can make for a very uncertain environment especially in an industry with constant disruption.
Many drugs that go through clinical trials don’t make it to FDA approval, which also contributes to the boom and bust nature of the business. If a very successful drug goes through and becomes a blockbuster, the profits are usually enormous. However, most drugs don’t amount to anything, and become a waste of capital.
Despite this, investors will pile into what Friess called “concept companies,” which includes biotech stocks that haven’t gotten final approval on a major drug or drugs.
That’s usually a recipe for disaster.
Utility companies are affected by local politics, especially around pricing and profits.
Though a utility company providing electricity has a monopoly on its area, its upside potential is essentially capped. Since local authorities set prices on the energy sold, they can prevent a utility from making outsized profits at the expense of its customers.
Also, as Friess pointed out, the organic growth is limited to the area’s demographics combined with the limited pricing power. If a utility company is stuck in a low population growth area, it can mean very dissatisfied investors and meandering growth for a long time.
This was not mentioned in the book, but utility companies also have to instill massive amounts of capital to keep their plants running. It usually does not leave much free cash flow to investors for future growth and buybacks.
Companies with unfavorable positions in the value chain
The value chain can be thought of as a business’s place in its ecosystem.
Professor Michael Porter came up with Five Forces which affect every business, and should be considered by investors looking for the best stocks to own for the long term.
Basically, every company will have customers they generate revenue from, but also suppliers (or “vendors”), competitors, potential competitors (“new entrants”), and alternative products or services.
An unfavorable position in this value chain can mean having very few suppliers, or very few customers.
When you rely on just a few vendors or customers, they have enormous bargaining power on you. A company with great bargaining power will usually exercise it, meaning less favorable terms for the business on the other side of that. It can take many forms—including prices, payment terms, and other concessions.
Friess used the example of an IT manufacturer who sells to IBM and just a few other customers. Today’s equivalent could be small business owners who sell most of their products through Amazon.
It’s risky to investors because those large profits could quickly and unexpectedly be taken away, and those profits are usually much lower than if the company was not fighting against bargaining powers.
Some financial stocks
Friess was keen to the opaque nature of accounting in the financial industry.
In a way, many financial companies are bean counters and money movers; they hold money, pay back money, and use money to make more money. Most banks and insurance companies fit this mold exactly.
Risk management plays a critical component in these types of businesses, as they must constantly assess how much of the money to hold close in case they have to pay it back, and how much to invest for more profits. It is then accounted for in financial statements as reserves, and is constantly adjusted leading to swings in a company’s profitability (which can be greatly altered by reserve adjustments).
Friess used the example of an insurance policy where the payout is unknown (must be estimated), and commission to the insurance agent is spread out (must be estimated). There can be a brush of creativity in these calculations which can be criminally miscalculated.
However, Friess also said “we don’t want to be so dogmatic that we aren’t open to shooting fish in a barrel” in regards to financial stocks.
He said viable and very conservative operations can be fantastic investments; so there’s that.
Thoughts on the Efficient Market
Peter Tanous, the interviewer for the book, brought up the Efficient Market Hypothesis and how many people in finance subscribe to the idea.
Tanous brought up their argument that the market in aggregate will respond to all new information about a stock and price the stock accordingly. It implies that stock pickers have little chance in beating the market, because over the long term the value of stocks are correctly priced.
Friess had reservations about this mindset, particularly around the timing of new information.
He basically made the counter argument that people closer to the business might recognize fundamental shifts faster than others. This can make the market slower to react to certain information that’s already been released that is indicative of bigger trends for an underlying business.
It does make sense when you think about it.
Analyzing information can be so subjective, and certainly some information is regarded as more or less important depending on who you talk to. So there can be leading indicators which the whole market doesn’t pick up on, which can led to fantastic opportunities in the short term.
Also, it is interesting how much power “the young folks over at Standard & Poors” have on the market as a whole. It’s even more so in today’s times than it was when Friess made that statement.
The S&P 500 is one of the most widely held index funds in the world, and yet it is actively selected by a committee.
Some of the biggest or best businesses in the world will not be part of the index, which can create fundamental divides between any stock’s price and the underlying business’s true value.
Team Building and Time Management
Foster Friess was perhaps just as passionate about team building and time management as he was about portfolio selection and strategy.
He related that most people will probably dedicate around 22% of their life for working, if you do the math over a year’s worth of hours. He said that 22% should be used as efficiently as possible.
At Friess Associates, he encouraged this in unconventional ways. He tried to have employees take part in a minimal number of meetings, and even went as far as to remove chairs from meeting rooms so too much time is not spent there. Friess preferred that his team communicate logistics through email, where everything is recorded and can be referred back to.
However, Freiss had his team take the opposite approach when gathering information for their investments.
Employees were encouraged to meet face-to-face when researching investment ideas, and used a “scuttlebutt approach” to gathering information about a company and industry by interviewing people throughout the value chain—often getting good information from a company’s suppliers and competitors rather than from the company itself.
Friess delegated The Brandywine Fund’s portfolio to a team where a leader was responsible for about 25 or 30 companies.
He established intentional checks and balances, and resisted a hierarchical process for decision making as much as possible. He thought that some of the best insights can come from people “in the trenches” of the research, and that they should have a hand in the decision making. This is in contrast to traditional money management firms, where the analysts just present research and portfolio managers think about and make the decisions themselves.
Friess also shared how teachings in the Bible have shown him that everybody has weaknesses. Rather than try and change the people on his team (which he has tried to do unsuccessfully), he instead accepted their weaknesses and worked around them. Show love by forgiving. I admire that greatly.
I think all investors can learn a valuable lesson or two from Foster Friess and his great success over his life, as shared by his interview in Investment Gurus.
Perhaps the most impressive takeaway for the author was how The Brandywine Fund was the #1 fund picked by Morningstar employees for their 401K’s. If you didn’t know, Morningstar has famously ranked mutual funds and examined their performances deeply; that fact says a lot.
Whether you want to build a big investment team with very active management or simply want to build your own portfolio, using Friess’s philosophies can help you be a better investor.
My biggest takeaway, which I will also strive for: Stay curious. Do the work. Be grateful.
Andrew has always believed that average investors have so much potential to build wealth, through the power of patience, a long-term mindset, and compound interest.