November 2013
Vol. 6 No. 10  
in this issue
The X-Men Go Bowling for Dollars

How Well Do You Know Your X-Men?"

logo - Daruma

Daruma Capital Management LLC
80 West 40th Street, 9th Floor
New York, NY 10018   

About Us

Founded in 1995, Daruma Capital Management invests in high-conviction portfolios of no more than 35 stocks.

Daruma manages $2.3 billion for public and corporate pension plans, endowments, foundations, and individuals. Our annualized Small-Cap return net of fees since inception is 13.3% vs. 8.7% for the Russell 2000 (7/28/95 to 9/30/13). Our annualized SMid-Cap performance net of fees since inception is 10.8% vs. 14.8% for the Russell 2500 (4/30/10 to 9/30/13).   


Notes to Performance

For more information about the work we do, please visit us here



You'd probably never expect to find investment process inspiration at a bowling alley. Me either.

And yet I did, just last week, while joining my fellow Darumites in a Halloween celebration.
Read on as I explain the parallels between "team bowling" and "team investing," the subject of this month's newsletter. 
(To listen to this month's newsletter, click here.)

All the best,
signature - Mariko 
Mariko O. Gordon, CFA
Founder, CEO and CIO
Daruma Capital Management LLC 
articleOne The X-Men Go Bowling for Dollars

Bowling, that dubious sport long associated with pre-teen birthday parties, stale beer and underachievement (hopefully, not all at the same time), has suddenly become tragically hip. Witness Daruma's recent Halloween bowling party, held at the Bowlmor in Times Square, a national chain with not one, but seven themed bowling areas. We took over "Chinatown," an area festooned with dragons and lanterns.

Our office manager, Kristen Smith, made costumes mandatory, which guaranteed that no one took themselves too seriously. There was even a minor celebrity spotting - retired NY Giants football player and current daytime TV talk show host, Michael Strahan.

Sadly, I won no awards - not for best costume and not for best bowler. Those went to Controller Robert Motch with his Popeye costume, and trader Ron Viener who, in his usual low-key way, proceeded to bowl everyone over (pun intended). I consoled myself with fried macaroni and cheese and chicken fingers and headed home.

Later that night, however, I had a giant, bowling-induced eureka moment, one that made me feel like the grand prize winner (not that I'm competitive or anything).

Here's what I realized...

We had three teams of five players and deciding which team won meant tallying up each person's score. And so while there was a cumulative effect, there was no interactive effect. With the possible exception of shouting unsolicited advice and/or performing the well documented, shoo-it-away-from-the-gutter dance, there was no way for one teammate to boost the score of another.

If someone had a lonely pin teetering in a corner, the teammate with the mean hook who could pick it off couldn't pitch in. If someone bowled a spare, the person most likely to bowl a strike wasn't able to step up and goose the score. If someone had a tricky split, their surgical-precision-bowler of a teammate couldn't help.

The score was a simple sum of everyone's game, an arrangement which resulted in a much lower total than if everyone were able to help out, if and when their particular skill was needed. From a pure, point maximization perspective, we may as well have been bowling in different countries.

Well guess what? ... (eureka moment coming) ... When it comes to picking stocks, we do the exact same thing with our investment teams. And I'm not sure that makes sense.

Think about it - put aside risk management of the portfolio for a moment and just focus on individual stock selection. We ask analysts to handle the entire investment process for a specific stock, from start to finish.

Of course, there is a base level of competency necessary to perform every step needed prior to hitting the buy or sell button. But no one is equally gifted at every step in the process; the skills, techniques and aptitude needed for each are vastly different. It's possible to be mediocre across the board, but it's im-possible to be truly excellent everywhere:
  • Some analysts are brilliant at spotting potentiality or imagining the future ... they always have more ideas than time. I call this "being able to hear the dog whistle."
  • Some analysts excel at translating the complex reality of a three-dimensional business into a two-dimensional financial model, and coming up with an accurate estimate of the earnings and cash flow a company is capable of under varying scenarios. I call this "being good at word problems," like knowing when the hypothetical train heading east at 100 mph will finally crash with a train heading west at 50 mph.
  • Some analysts can sniff out risks in an investment case better than an Irish Bloodhound. Given the same information, they can think of fifty ways the stock can go south, while you and I can only think of ten.
  • Some analysts have a knack for reading shifts in sentiment and anticipating what other investors will obsess over. They know when to jump on and when to jump off the carousel.
  • Some analysts excel at coming up with ranges of outcome that are probability weighted, something the human brain is not naturally wired to do.
The point is, while each of these steps is important, analysts are better at some than at others.

In our industry, though, it's normal to ask our analysts to dig up the clay, make the pot, paint the pot with glaze and fire it, expecting them to be equally brilliant at each stage. In short, the investment industry uses the craftsman model, rather than Henry Ford's assembly line approach.

And no, I am not about to suggest that we turn stock picking into widget building - that's impossible with such a complex and creative pursuit as analyzing a company for investment.

But I do think I am on to something. Why not have an investment team be more like Marvel Comics' X-men, where each member of the team has a superpower to bring to the battle? All X-men are competent fighters, however one of them usually gets in an impossible jam and can only be rescued by tapping into a teammate's unique skill.


... running a model's structure, assumptions and sensitivities by the Champion Modeler may create more conviction, or a better way to show the drivers to the range of outcomes.

... running through the valuation case and what's currently baked in the stock by the Sentiment Sniffer may make for more disciplined price targets.

... brainstorming with the Irish Bloodhound means no risk is left unflagged.

You get the picture. To be clear, I am not suggesting a handoff to another analyst at each step, or a group grope of a process. Rather, I am envisioning more of an expert consultation at key points along the way.

Because, as in a true team approach to bowling, the performance "score" that would result if each holding were subjected to all of the team's superpowers would no doubt be better than the sum of every analyst's solo efforts.

I bet a team using these techniques would win the grand prize in Mr. Market's bowling tournament (costume optional).

articleTwo How Well Do You Know Your X-Men?

Be one of the first three readers to match the X-Man in question, below, to his or her special super power and we'll send you a surprise superpower of your own (Hint: It probably won't be telekinesis.)  

Click "reply" to send us your answers!

1.Cyclops A.Telekinesis, Telepathy
2.Professor X B.Heightened senses, immobilizing cigar breath
3.Wolverine C.Absorb powers and memory through skin contact, flight
4.Rogue D.Healing factor, claws and fangs that can rend bone, heightened senses
5.Jean Grey E.Enhanced agility, nightvision, teleportation, prehensile tail
6.Nightcrawler F.The world's most powerful telepath (currently de-powered)
7.Storm G.High-intensity, continuous optic blast
8.Sabretooth H.Near total control of the weather, flight on gusts of wind

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