Top financial blogger turned ETF manager: Keep investing simple

Published Thu, Nov 17 20163:05 PM EST

Financial blogger Eddy Elfenbein, whose annual list of 20 stocks has outperformed the S & P 500 in eight of the last nine years, spoke with CNBC PRO about the simple investment principles he uses to select winning stocks. "I think too often investors get too buried in the numbers and P/E ratios. What all those numbers reflect is, is this an outstanding company? Is this a company that has a consistent track record of growing their earnings, growing their sales? Do they have their balance sheet under control? That's really what you want to get to," Elfenbein said during the in-depth conversation with CNBC's Mike Santoli . Because of his strong track record, Elfenbein was able to launch his investment approach as an exchange-traded fund in September, the AdvisorShares Focused Equity ETF . His blog is Crossing Wall Street . Elfenbein also discusses: Why he decided to peg his fee structure to his performance. His career path outside of Wall Street. Some of his favorite long-term investments. Why "buy and hold" works. Timeless investment lessons for every market participant. PRO subscribers can also read the entire transcript of the exclusive interview below. (Editor's note: The content below is from a third-party service and there may be some minor transcription errors. Watch the video for the exact quotes.) MIKE SANTOLI: Eddy Elfenbein is the portfolio manager of the AdvisorShares Focused Equity ETF, an exchange traded fund that's based on his philosophy to investing. The key to doing well on Wall Street is actually very simple, he says. Buy and hold shares of outstanding companies. He's also the editor of Crossing Wall Street, a website dedicated to helping investors make sense of the market. Eddy's buy list, which is published yearly on his website and consists of 20 of his top picks, has outperformed the market for eight of the last nine years. He joins us now here at the NASDAQ to share ideas about his investment approach and market outlook, and about that exchange traded fund. So, Eddy, thanks a lot for bein' here. EDDY ELFENBEIN: Thanks for having me. MIKE SANTOLI: So it's great, like a lot of people, you and I know one another through Twitter, never much in person. But it's been great to follow what you've done, both with the newsletter, your buy list, and now converting it into an exchange traded fund. I thought we could kind of broaden out just to start and talk about just how you got into investing, I mean where you kind of came from before you even had all that. I know you invested on your own, but how did that all develop for you? EDDY ELFENBEIN: Let me see, well after college, I didn't know exactly what I wanted to do. So, like a lot of people, I went to grad school. I put off reality for a few more years. I got my MBA from the University of Connecticut. After that, I went to a brokerage firm. I don't want to call it the wolf of Wall Street, but it was a bit higher than that. I didn't see as much sex and drugs, but it was a very low level firm. But it gives you an introduction into the world of investing. And after that, I got hooked up with a more upscale, respectable broker and I worked with him. Then I launched my own newsletter. And this was back in the day when you actually wrote them on paper. And I specialized in microcap stocks. The newsletter wasn't successful, but a great learning experience. And then after that, I hooked with Phillips Publishing, which is a very large newsletter publisher, and they publish many dozens of newsletters. So I worked with them for a number of years, really learned a lot and got to see the industry from that end. And then about 11 years ago, I started to go off on my own. I've been doing some consulting work, but for the most part, it's been blogging. And then about six years ago, I started the newsletter along with the blog. And then Twitter came along and so I've sort of implemented all those aspects of social media and over the years have been able to gather a nice following. MIKE SANTOLI: And how would you describe the investment approach, itself? How do you isolate what you consider these outstanding companies? EDDY ELFENBEIN: What I do is I have what I call a watch list. This is a list of about 70 names of companies that I consider very high quality companies. I think too often investors get too buried in the numbers and P-E ratios. What all those numbers reflect is, is this an outstanding company? Is this a company that has a consistent track record of growing their earnings, growing their sales? They have their balance sheet under control? That's really what you want to get. That's the aspect. I think there's a tendency that people overuse stock screeners and that can only tell you so much. What you want to know is, a good example, Aflac, a company I own, a company I like a lot. I remember when the earthquake happened in Japan, a horrible, horrible event. And they asked Aflac, are you ready? And they said, absolutely, we're prepared. This is what we do. MIKE SANTOLI: Japan, a very big business for Aflac. EDDY ELFENBEIN: Exactly. Exactly. And they said sort of this is what we do. And that's the ultimate test for a company. You understand the management, they're prepared. They can deal with issues that come their way. I think a lot of people and investors sort of don't focus on that so much and they sort of over-stress the numbers. So I get a list of about a few down names which I consider very high quality and then once a year I have a list of 20 which make it onto the buy list. MIKE SANTOLI: Okay. And so what kind of gets it from the watch list to the buy list? Is it some kind of valuation measure or is the some kind of opportunity presented to you by the market, itself? EDDY ELFENBEIN: Yeah, I would say more of the latter, if I see something fall for a transient reason. There are issues sort of internal to the company and external to the company. Actually, keeping with Aflac, I think, is a good example, is that they're strongly influenced, their bottom line, by the Dollar-Yen exchange rate. But here's the thing about the exchange rate, is that's gonna help you and that's gonna hurt you. It comes and goes. But being a solid business, that stays for you. So when you see these problems in a-- they miss earnings-- with a company that I follow, I'm not terribly bothered if they miss earnings by a penny or two. Day traders, sure, they're upset by that. Me, not so much be I wanna see is the problem endemic to them? Is it something that affects the entire industry? The key is that you want to see at the core of the business, inside those walls, are things going well. MIKE SANTOLI: And it's interesting because your buy list is built to be held for at least a year. It stays static for a year, which for a lot of people might seem like a long time. But on the other hand, you really want to own them for much longer than that, right? So how do you, I guess, get the comfort level with a business that in fact it is something that you could potentially hold forever? EDDY ELFENBEIN: I always think of it that if the stock market were shut down, would you be fine with owning that, and the market were to reopen a year from now. With my stocks, I'm absolutely fine about that. Now remember, people also do that with their home and their car. Those aren't so liquid. And you know, they buy those things as well. And then on top of that, I think there's a standard sort of cycle, an economic cycle and an investing cycle. So even a stock can go down right after you buy it, that doesn't mean you're wrong. In fact, a lot of times the best investments I've made has been in year three of an investment. It can just sit there for a while and then suddenly it blossoms. So really, I mean the saying, time is on your side, with good investments. MIKE SANTOLI: Interesting story about how this approach and this buy list got converted into now an exchange traded fund based on your philosophy. Talk about exactly how that is and how the fun discover built. EDDY ELFENBEIN: Yeah. Well basically I had people come up to me, you know, over the last several years and they'd say, "I love your buy list. It's had great returns. I really like what you do. Twenty stocks is a lot and, you know, I can buy here and there, but I can't buy the whole thing." So they said, "Do you manage money? Do you have a hedge fund?" And I'd say no and no. And I guess at some point you're asked this question so many times, you realize, well, maybe there is an investment vehicle. So I was able to partner with AdvisorShares and they actively manage ETF's. And in fact, there are a lot of people who know a lot about investing in ETF's and they don't know that there are actively managed ETF's. They assume those are all indexes, but they are out there. And so we got together and we said, maybe there's a market for this. So we sort of got together and our idea was to get the ETF to replicate the buy list as much as possible outside of just the operational. You have to some level of cash, but basically transferring the buy list as much as possible to an investment vehicle. And the blog is Crossing Wall Street and we looked for a ticker symbol. I've never done that before, trying to get a ticker symbol. And we found out that CWS was available and we were able to reserve that. And then in September, the fund launched. MIKE SANTOLI: I guess if the Chicago White Sox ever want to go public-- EDDY ELFENBEIN: I know. I'm willing to sell-- MIKE SANTOLI: Along with the Braves. EDDY ELFENBEIN: to Reinsdorf. You know, $10 million, no problem. MIKE SANTOLI: There you go. So it was initially set up with those 20 stocks on the buy list. After a year, what happens? Or at the end of the year? EDDY ELFENBEIN: So wit's rebalance, but we only change five of the 20. That's sort of how confident we are in the buy list. And I figure four years is a good enough average time period for a rollover, to see has this investment worked out, has the thesis held up, is the company still what you thought it was. MIKE SANTOLI: Gotcha. EDDY ELFENBEIN: Which even from my understanding is the actual turnover of the S & P 500, it's not that far away from it. I think that's about 5 to 7 percent each year. MIKE SANTOLI: And so what are the criteria? So you get to the end of the year, you're gonna have five potentially that you take out, five more you put in. What are you gonna be looking at? EDDY ELFENBEIN: Basically from my watch list, something that's down for a dumb reason, a story I just like, I think it's a strong franchise, has a good value, really something that I think is appropriate. It's some combination of those factors. For things that go off the buy list, sometimes there are buyouts and I'll get a company that maybe I don't really want to own the new parent of. Or there will be spin-offs. That happened last year with eBay and PayPal. Or, more troubling, is there can be an incident where my thesis hasn't held up. It's not the company I thought it was. I thought there would be a turnaround. They had some plans and it's not working out. And that's when I think it's a good time to sell a stock. MIKE SANTOLI: So you had owned eBay and then PayPal was spun out? EDDY ELFENBEIN: We got the PayPal spin-off for that, yeah. MIKE SANTOLI: Got it. And at that point you decide either you hold both, hold one, hold neither. EDDY ELFENBEIN: Yeah, last year we sold both. MIKE SANTOLI: Oh, you sold both. Gotcha. EDDY ELFENBEIN: We sold both, yeah. MIKE SANTOLI: Okay. Is there one in the portfolio right now that you would characterize as one of those-- down for a dumb reason and we just picked it up recently? EDDY ELFENBEIN: I like-- Signature Bank in New York City. Fascinating bank, not well known. You know, the banking industry is not very popular right now. These stocks are just sort of flat lining. They've had something like 26 straight quarters in a row of record earnings. Their bad loan rate is something like 1/10 of the industry average. And they've been hurt by-- they went into medallion loans. So a lot of people, when they say Signature Bank, oh, the medallion loan thing. MIKE SANTOLI: Taxi medallions. EDDY ELFENBEIN: Yeah, exactly. Exactly. And they got hurt, you know, because of Uber and Lyft. And so, yes, they've been hurt by that and that's brought the stock down. But that's a good example. You look at this problem, this is a manageable problem. This isn't going to sink them. They're gonna have some bad write-offs and it will take some time to get through that, but the stock has come down. I think it's a very good buy here. MIKE SANTOLI: Interesting. One stock that I always note is in the portfolio. And it went from being kind of a beloved growth stock to one that people worry that maybe long-term it doesn't really even have that viable a business, which is Bed Bath & Beyond. How long have you been involved in it? I mean they had a management team that's been in place really for a long time. And pretty much the same characters, but maybe a different business or not? EDDY ELFENBEIN: Yeah, that's one I have to say frankly I've been very frustrated with over the past few years. It was a very well-run company. If you just look on the return on equity and just the cash flow, they always had amazing cash flow. Bought back their stock at phenomenal rates. Also it was a very insular company. The management had been around for a long time. One of the companies that on their earnings call, they never took any questions. They just sort of announced it and you had to go from there. And I think they got into a problem, they were not strong on the web. That hurt them. And then they used their coupon strategy. And the thing is with a coupon strategy, is you have to be very sparing when you use that. That can help you out with a bad quarter and inventory management. That's what you can use it. And I think they went to that too often and they were hurt by it. Now they're trying to make some changes. They've done some purchases. It's a frustrating stock. I'm really gonna have to look at that one carefully. MIKE SANTOLI: Sure. What about one that's worked really well, up a lot, but no reason to sell it? I mean is there one that would come to mind for that? EDDY ELFENBEIN: Microsoft. MIKE SANTOLI: Yeah? EDDY ELFENBEIN: I look at the earnings results, I look at what the new management has done there, and it's great. And I'm fine with it. Just keep going. You know, by the way, here's some good advice for people. A lot of times a company will come out and they'll reiterate guidance. And a lot of investors, they play like that's a non-issue. To me, that's a good thing because a company's telling you, we're still on plan. You know, things are still going well. And that's how I see Microsoft. They're doing well. They're continuing to do well. I have no immediate plans to get rid of it. MIKE SANTOLI: Interesting. Just back to the genesis of the fund, but also the fee structure of it. So this was a little bit of a rapid education on your part in how you build an ETF and what the business of it is like. But you also have a relatively rare fee structure. Talk about that. EDDY ELFENBEIN: Yeah, I believe this is the first one. It's called a fulcrum fee. And basically the expensive ratio is dependent on how well the fund does versus a benchmark, the S & P 500. I think perhaps it's importing something from the hedge fund world into the ETF space. I think this is new. Perhaps it will grow. Maybe I'll be a pioneer in this. But basically if we beat the S & P 500 on a rolling basis, I get a little bonus. But if we fall short of the S & P 500, then the shareholders get a little discount. And so each month it's recalculated on a 12-month trailing basis. MIKE SANTOLI: Interesting. Okay, so it's essentially if on a trailing basis it falls a little bit short, it's sort of a rebate. EDDY ELFENBEIN: Exactly. Exactly. MIKE SANTOLI: A partial rebate. EDDY ELFENBEIN: Yeah. MIKE SANTOLI: Got it. And I mean was there a particular reason you felt like it fit for this structure? EDDY ELFENBEIN: Basically I thought it would be interesting to tell people, I think Nassim Taleb talks about skin in the game. So I wanted to tell people, you know, this is what I've been doing for 11 years now on the blog. I think we've had very good results. I stand behind this and I wanted to tell people I stand behind this so much, here is the length to which I'm going. I'm all in on that. MIKE SANTOLI: Yeah. I think some mutual funds maybe have had it over the years? EDDY ELFENBEIN: Fidelity does have that, yeah. MIKE SANTOLI: Yeah. But in general, you're right, it's usually how much can we change-- EDDY ELFENBEIN: Right. MIKE SANTOLI: --and have a viable product here. Are there other people in the industry that either you follow or that you've kind of read up on over the years that are really kind of standouts to you in terms of embodying a certain investment approach or that you feel like have, you know, wisdom that just lasts? EDDY ELFENBEIN: I mean what can I say, of course there's, you know, people like Warren Buffett. I always like Peter Lynch. I think he is somebody who is able to distill investing wisdom to its very simplest understanding. I think so many investors kind of over think this. Investing and Wall Street is one of those things, people want to make it far more complicated than it needs to be. It really gets down to is the business being run well? Are they serving their customers? Are they serving, you know, their clients? And is more money coming in than is going out? That's really all it gets down to. And I think a lot of the numbers and equations and formulas can be a smokescreen to that. MIKE SANTOLI: It's interesting, I certainly agree people over complicate it. They want to feel as if it's this real difficult formula to be cracked. On the other hand, I think they're opting out with index funds, right? So people are kind of, you know, whether it's fashion, whether it's just sort of learning that low costs matter more than anything else, this wave of just people saying I'll passively index, has been very strong. How do you interpret that? So is it basically people saying I'll just get exposure to the market? I'm not gonna worry about even these simple principles that you operate on. EDDY ELFENBEIN: Yeah. I mean I think there's a mindset where I think indexing is fine. If you're really not concerned about that and you just want to set money aside, there's nothing wrong with indexing. To me, investing is exciting. You're putting your wits, your judgment against the entire market and I find that thrilling. And of course, there's enormous bodies of research showing that things like momentum investing and value investing do work. I think Mark Hober (PH), a writer, described it very well, saying, you know, the market can be beat, but statement B, it's very, very hard. MIKE SANTOLI: Exactly. And just finally we like to ask everybody if there are particular lessons or, you know, common pitfalls that you've observed over the years that people make that you feel like should always be kept in mind. EDDY ELFENBEIN: I think one of the biggest mistakes that people do is they do what I call top-down investing. They talk about politics, but most of all they talk about the Federal Reserve, what the Fed will do. Or when they approach an investment, they say what's gonna be really big in the future? Biotechnology and solar energy and China. While these things are going to be very big, remember just talking about running a well-run business, a good example is Hormel Foods. These are the Spam people. Look at their chart over the last 25 years. It's an astounding growth story and it's creamed the huge majority of mutual funds. Another great one is Smucker's, the jelly people. This has been a tremendous winner over years. So people, you know, they miss the profit opportunities right in front of them. MIKE SANTOLI: Excellent. Eddy, thank you very much. EDDY ELFENBEIN: Thank you. MIKE SANTOLI: I appreciate your time. For CNBC PRO Talks, I'm Mike Santoli. Transcript by Transcript Associates, Inc.

"I think too often investors get too buried in the numbers and P/E ratios. What all those numbers reflect is, is this an outstanding company? Is this a company that has a consistent track record of growing their earnings, growing their sales? Do they have their balance sheet under control? That's really what you want to get to," Elfenbein said during the in-depth conversation with CNBC's Mike Santoli.

Because of his strong track record, Elfenbein was able to launch his investment approach as an exchange-traded fund in September, the AdvisorShares Focused Equity ETF. His blog is Crossing Wall Street.

Elfenbein also discusses:

Why he decided to peg his fee structure to his performance.
His career path outside of Wall Street.
Some of his favorite long-term investments.
Why "buy and hold" works.
Timeless investment lessons for every market participant.

PRO subscribers can also read the entire transcript of the exclusive interview below.