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Monday, June 10, 2013 - 11:30

This Gold Powerhouse Hasn't Been This Cheap Since 2004

Monday, June 10, 2013 11:30 AM

As soon as I met Ryan O'Connor, I knew I wanted to get him on my team. He's an investing junkie like me, and we clicked immediately. Turns out it's all in his family... His grandfather was an old poker buddy of Warren Buffett's.

Back in the 1960s, Ryan's grandpa went all in with the future Oracle of Omaha into the original partnership.

The decision was bold. His grandparents -- with six kids -- had to part with their life savings to invest in the new partnership. Buffett was an unknown then. He was just a scruffy-looking, socially awkward 30-something with disheveled hair, fraying shirt cuffs and wrinkled, ill-fitting clothes. Upon hearing what Grandpa O'Connor wanted to do, Grandma burst into tears.

You can hardly blame her, but Grandpa was on the right track. "My grandpa said it was incredible when Buffett would get talking, the way he would make all kinds of brilliant connections and boil down abstract financial topics. My grandpa said he never saw anything like it."

The young Buffett's investing process satisfied Grandpa O'Connor: the concept of a margin of safety. The miracles of compound interest. The power of contrarian thinking. The ability to buy stakes in businesses for 25 cents when assets were worth $1-plus.

Of course, the investment worked out beautifully. "This is not exact," Ryan said, "and my grandparents aren't anywhere close to this wealthy, but an initial $10,000 invested in the original Buffett LP -- assuming every dollar continued to remain invested in the LP and rolled into Berkshire -- would be worth something like $300 million after tax. (Yeah, read that twice.)

"My grandpa's friends tease him about his decision to sell some stock 25 years ago," Ryan said, "and build a nice deck at our family's lake house. If you look at what that stock is worth today, his deck cost him about $10 million. I think that burned in my brain the concept of opportunity cost."

Today, Ryan has racked himself up honors. He managed funds that generated returns in the mid-20% range over the last six years, easily topping the market. He is also part of a number of fairly exclusive clubs -- the Value Investors Club, the Distressed Debt Investors Club and SumZero.

What really brings us two together is our love for owner-operators. We love to buy stocks where the guy in charge owns a bunch of stock. In today's weird marketplace, the presence of owner-operators can be a signal of a likely value. Over the long haul, owner-operators tend to outpace the broad stock market by a wide margin. Check out some of the research:

-- In 2012, Shulman and Noyes compared historical stock price performance of companies managed by the world's billionaires. Such companies outperformed the index by 700 basis points (or 7% annually).

-- In 2009, Fahlenbrach looked at founder-led CEOs, who invest more in research and development, and focus on building shareholder value -- not value-destroying acquisitions.

-- In 2005, McVey and Draho learned that companies controlled by families who avoid quarterly earnings guidance outperform their peers.

People with their own wealth at risk make better decisions as a group than those who are hired guns. The end result is that shareholders do better in these owner-operated firms. Horizon Kinetics' neat graphic illustrates the difference.

Bottom line: Stick with owner-operators.

With that, take a look at this mutual fund: the Virtus Wealth Masters Fund (VWMIX), managed by Murray Stahl and Matthew Houk. Its focus? Owner-operator companies. For a stock to get in the fund, management "must maintain a significant vested interest." Forget stock option grants, bonuses or salary increases resulting from meeting short-term financial targets... Those only look good to agent-operators.

Consider Colfax Corp. (NYSE: CFX), a manufacturing conglomerate. Brothers Steven and Mitchell Rales own 24% of the stock. They also own 15% of Danaher Corp. (NYSE: DHR), which, over the past 10 years, has rocketed from $17 to $62. "Colfax," they suggest, "is a reprise of Danaher, but at an earlier growth phase."

I think Virtus Wealth Masters Fund will be a winner.

Ryan and I also talked about Greenlight Re (Nasdaq: GLRE) (which you read about recently). And then we hit on AlarmForce Industries (TSX: AF) (or OTC: ARFCF), which is similar to ADT (NYSE: ADT), but there is an owner-operator here too. Joel Martin, the founder, owns 13% of the company. "The CEO is just awesome," Ryan said. "Read his annual letters. They tell you all you need to know."

It trades for only about 5 times steady-state cash flow. Cash flows are sticky, long-lived, high-margin and recurring -- all of which are like candy for investors.

Ryan thinks this under-$10 stock gets taken private -- a la Dell Computer -- at $15 a share. If not, there is an opportunity for a big return (8 to 10 times cash flow). Either way, you win.

Create your own mini-mutual fund using the owner-operator factor as your guide. Or consider some of the owner-operator gems in what I call my "Coffee Can Portfolio" -- an approach that beats just about every other method of investing -- and is good if you're a little lazy. Check out the five stocks here.

Chris Mayer does not personally hold positions in any securities mentioned in this article.
StreetAuthority LLC owns shares of GLRE in one or more of its “real money” portfolios.