Review

Book Synopsis: Think like Graham, Invest like Buffett and Buffettology

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thinklikegrahamA few days back I read a book with a title similar to this – Think Like Graham, Invest Like Buffett. While I had great expectations from it, honestly, beyond the title, there was not much in terms of depth in it. Of course, the title is a great message in itself, so I thought there would be examples of that and other stuff like that in the book. But there was not much of it in there. Lawrence Cunningham’s other book which is essentially a great collection of excerpts from Buffett’s letters to his shareholders is so much better. So while the thought of having this book and the title were great, the overall execution did not seem to make it as great a reading as I had expected.

But there was one small section in it which was absolutely like a flash of brilliance in an otherwise ordinary and repetitive book. It is a metaphorical story about a person who wants to sell his apple tree, and how he goes about evaluating various offers that people make for the apple tree. The story takes us through various stages of valuing the apple tree, starting with offers so low that they basically account for the cost of the wood one would get if the tree were cut down – something akin to scrap value. And then goes on to give examples of how one could arrive at various subjective ‘intrinsic values’ for the tree, methods based on the cost that went into planting the tree, or the value of fruits one gets from it today, or the value one could arrive if one could grow fruit yield in the future, as well as how it is important to take into account the cost of maintaining the tree farm and replanting the seeds from the fruits. Essentially taking us from the Graham thinking of ‘paying to avoid losses’ to the Buffett approach of ‘paying for high returns from predictable earnings’ in the form of a wonderful set of conversations between the tree owner and various bidders. So that was quite a nice section in the book to get the point across – Think like Graham, Invest like Buffett.

buffettology-previously-unexplained-techniques-that-have-made-warren-mary-buffett-paperback-cover-artLater, a few days back, I chanced upon another book named ‘Buffettology’ – written by his daughter-in-law. Honestly I did not have great expectations from that book, specially from the investing techniques point of view. I thought it would be more a general essay on Buffett as a person, and his style from a personal view. But surprisingly, it turned out to be a good set of writings on investing techniques. While there are a lot of writings in layman terms – but the message and detail on the source of Buffett’s success are quite surprisingly crisp. The examples on what forms a great business, how to identify great businesses, and how to value them in a manner where you don’t pay too much make quite decent reading. And the details on how Buffett started with Graham’s methods, and then graduated to a combination of Fisher’s and Munger’s techniques with Graham’s soul behind them are quite a treat to read. There are also a set of writings around how he gathered exceptional wealth primarily due to combining his acute investing acumen with an access to long-term insurance float over long periods of time. It may not be news for a serious investor, but nevertheless not bad for the layman.

So two books mostly around the same topics, both trying to distil some learning from past masters, two books with different levels of good reading.  But both of them with essentially a similar message – Think like Graham, Invest like Buffett.

Book Synopsis: Common Stocks and Uncommon Profits by Philip Fisher

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Over the past few days, I was privileged to have read another masterpiece of a book – “Common Stocks and Uncommon Profits” by the legendary investor Philip Fisher – the father of growth investing. A complete opposite of Graham and the theory of value investment, Fisher proposes a set of 15 ‘scuttlebutt’ principles that work as a checklist for investors to evaluate companies for growth investing. There are very few companies that consistently meet the criteria of being growth companies over the long-term, and his 15 criteria act as the guide for qualifying them.

commonstocksfisherFisher’s way of investing is to identify great growth companies and hold them forever or for as long as possible. His basic premise is that the best long term investments are companies that have products and services with large markets, a strong research function to keep coming up with newer products from time to time, an effective sales engine, high profit margins, and are run by happy employees and leaders of integrity. In case one is able to identify such companies, how much you pay for it does not matter so much as long as it is not completely unreasonable, as per Fisher. Of course, such a lethal combination is tough to find. Therefore, his view is – if one finds them, hold them forever. One is more likely to find companies with these qualities and such stature in the large cap end of the market – and if one is fortunate enough to identify something like this when it is not large enough, it will multiply investments many times over. Texas Instruments and Motorola were two such investments that worked well for Fisher – both of which he bought in the early 1950’s and held on almost till his death.  Obviously if you could find it, the young growth company is the best bet for superlative gains. But such scenarios are rare and also impractical.

Hence, in what to buy, Fisher says it is best if small as well as large investors stick to relatively large growth companies. On when to buy, Fisher has an unusual recommendation. His premise is that the best time to buy a growth company is when its new product development is going into production. That is when a fairly large growth is in store, which most people are unaware of. So he does not get into pricing or valuation of companies as the basis for purchase, but relies more on the stage within the company for timing purchase.

On when to sell, Fisher says – almost never. Investors make a number of mistakes which come in the way of uncommon profits, like selling too soon, or selling when it has gone up quite a bit – or selling in the expectation of overall market downtrend. All of which are mistakes with heavy penalties as per Fisher. When thinking of selling a growth stock, think of yourself on your graduation day from college. Let’s say you are to choose only 3 classmates who you will ‘buy’ by paying them what they would earn in the first twelve months of working, in return for which they would give you quarter of their earnings thereafter for the rest of their lives. Think of growth stocks like that is what Fisher says. It would be foolish for an investor to sell a growth stock either because it is going through a tough time, or if it has given stupendous returns. The only reasons why a growth stock should be sold is if one realizes one has made a mistake, or if the company does not qualify on one or more of the 15 scuttlebutt criteria, or if you find a relatively better growth stock. Basically if the choice is correctly made, it means that one should sell almost never.

Some of Fisher’s views on buying cheap companies and dividends are completely in contrast with Graham’s quantitative approach to value investing. Most of Fisher’s assessment is qualitative. A pure value investor may not agree with his theories, perhaps find them outrageous too, but he has consistently used them over 70 years and with great results. His complete disregard to value metrics such as low price earnings or low price to book value as the basis of stock selection, and strong emphasis on growth as the only basis for long term profits is full of conviction. Both value and growth approaches have been equally effective in their own ways and, Fisher and Graham, have been legends on their own. It is, therefore, testimony that there is no single way to successful investing. The father of growth investing – in the end – summarizes his philosophy by a very succinct quotation from Julius Caesar which I reproduce here – “There is a tide in the affairs of men which, taken at the flood, leads on to fortune.” That is perhaps Fisher’s formula for uncommon profits from common stocks.

Book Synopsis: The Upside of Irrationality, and How we are victims of ‘My Ideas are better than Yours’

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Another weekend another book. This time it was about irrationality and actually how it helps being irrational – The Upside of Irrationality! We are an irrational species, and that was amply demonstrated through a set of experiments that the author conducted over time.

the-upside-of-irrationalityOne of our irrationalities has to do with lack of acceptance of new ideas because “it is not made here”. Even when we know that it is rational to choose something that is better even if not made here, the irrational part of us often says – not good as it is not made here or it is not mine! There is a set of experiments that the author describes to demonstrate that – but that is besides the point. The point really is that most of us are victims of the “My ideas are better than Yours” syndrome.

That’s the reason a lot of us fall in love with the cars we buy, the houses we own and perhaps even the stocks we have – even though there might be better ones around! Well – I am not getting into whether that is good or bad, because like so many other things, it depends! But it is quite true that better ideas, products or offerings that come from outside our own definition or context of our set up are not easily accepted by us – very often till it is inevitable to accept them. And this applies, I think, not just to individuals, but to any groups of people where a sense of ownership is established – so it applies to families, communities, cities or countries on the one hand; and perhaps even to departments, functions, companies, business groups on the other. So Sony does not see that IPOD was a better idea than the CD Walkman – perhaps because it was not made here.  Or Microsoft does not see that Google was a great idea till it had to take notice. Our first reaction is – my idea is better than yours. It has its advantages and disadvantages – but the fact remains that in taking this position, we are not rational, mostly irrational.

The same applies sometimes to stocks, bonds, funds and all types of investments too. Often we fall in love with our investments – not because they are great investments, but because we made them. That is also, perhaps, one of the reasons most investors end up choosing their own stocks rather than invest via mutual funds or index funds. The irrational logic (if anything like that exists!) being –  my ideas of choosing a stock are better than yours. While most data suggests that majority of the people cannot beat the market, and the rational thing for most individual investors is to participate in equity through funds, so many people continue to buy their own stocks. That is also one of the reasons, perhaps, why we hold on to our losing investments, simply because we made them.

And finally, on a lighter note, that is, perhaps, also the reason why you may not agree with me on the point of this article. Many of you may tend to think – well this does not apply to me. Because it is not your idea that we are all victims of the “My Ideas are better than Yours” syndrome!

Book Synopsis: Blink, and Why we get confused between Correctness and Confidence

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I read a book titled “Blink: The Power of Thinking without Thinking” over the weekend. It is about the unconscious, intuitive power of our mind in making decisions in a flash. Something that can work both ways – good and bad – depending on the situation; and how to harness its power, as well as how to take steps to avoid bias due to it.

blink_malcom_gladwellOne of the examples that the author provided was of doctors or medical staff taking a decision on the seriousness of an incoming patient’s illness, based on which the patient will be admitted to the appropriate ward or ICU. And the contention here was that most doctors know within the first minute or so, and have generally taken the decision by that time, at least at an unconscious level. A lot of time is lost in the multiple tests that they pursue later, essentially to collect data and add confidence to their decision. But in the process either it leads to excessive costs or wasted time and delays, which in a resource-hungry environment can be unaffordable.

That just set me thinking on whether an individual investor’s stock purchase decisions are also like that. Very often, I have realised that the buy or sell decisions are quite instinctive – after looking at the data – and mostly happen within a few minutes or hours of looking at the company and its core data metrics. Post that, one spends a lot of time, sometimes days, trying to validate that decision – which may not necessarily be bad. But quite often, the analysis does not change the earlier decision – whatever it is – whether to buy, to sell or to not buy, or to not sell also. So what one is essentially trying to do is to add levels of certainty or confidence to a decision that your mind already tells you within the first few minutes. One is trying to add confidence to something one believes to be correct quite early. Eventually, it is a different matter whether that decision turns out to be right or wrong. But the decision is generally taken quickly, and then layers of analysis is added to add confidence to it.

Some of the best decisions have been when I have taken both the decision and the action in a flash. It may seem contrary to the detailed analysis approach to investing.  It is perhaps also the case, that what earlier used to take a day of analysis now takes only an hour at best. Warren Buffett has been known to say that if he knows a business available at a price, he generally takes less than 5 minutes to decide yes or no. The decisions that have turned out to be the best have often been those where apart from the cold data analysis, one’s mind has a lot of conviction and intuitive gut that pushes one to take action, and which eventually comes into play when one is required to hold it when the numbers do not look good during downturns. Some bad decisions have also been when a detailed analysis of data seems to suggest a buy, but the intuition is not fully convinced of some aspect of the company – like management quality, ethics, business model or anything else.

So I am not quite sure what is the best recipe for decision-making in the field of investing – whether a cold rational approach is better or an intuitive approach works best – and this may be something that will have no clear answer as such. I guess the same conclusion that “Blink…” seemed to suggest towards the end may work in the area of investing too – keep working and practicing the approach that works in your area for you, and over time you will develop a strong intuition in the area – enabling you to take decisions in a blink.

Book Synopsis: The Intelligent Investor by Benjamin Graham

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Have read “The Intelligent Investor” by Benjamin Graham many times, and every time I read it fully or even in part – I am amazed by the depth, clarity and advice laid out in the book, and relevant every bit today, irrespective of the fact that it was written in the 1940’s. Such a piece of Investment Advice is available nowhere else in such crisp form for the individual investor. It is almost like financial philosophy, akin to the ‘Bhagavad Gita’ of investing and finance for the individual investor – whenever you pick it, you learn a new piece of investment wisdom every time.

TheIntelligentInvestorIt is difficult to pick up the best parts from such a book which is so all-encompassing – it covers everything from definition of investment to specific criteria for stock selection. Here are some of the key takeaways from the book that are invaluable for the individual investor – many of which are well discussed, but still worth repeating and re-reading.

1. Investment versus Speculation: Graham presents a very clear definition of investing, which in his view, means any operation that on thorough analysis promises safety of principal and an adequate return. Anything not meeting these – i.e. there must be thorough analysis, must promise principal (he does not use ‘guarantees’ but promises), it must have adequate return (which he goes on to elaborate later), and finally, it must be like an ‘operation’ – business-like.

2. Bonds versus Stocks in Asset Allocation: He presents a simplistic 50:50 formula of allocation between fixed income bonds and stocks that works for most investors – giving a leeway of 25% on either side. i.e. at no time should the allocation of either stocks or bonds fall below 25%. The guiding rule is to keep re-adjusting this allocation when one component increases above a certain defined limit, like 60%, by selling the additional 10% of the increased component and buying the other. This does not guarantee the highest returns – but is a mechanical program that is most likely to practically work – simply because it advises selling and buying when it is counter intuitive, and “chiefly because it gives the investor something to do”.

3. Defensive versus Enterprising Investors: Graham makes a distinction between types of investors not based on risk taking abilities or age – as was traditionally thought. Return is not dependent on risk, but rather on the amount of intelligent effort that is put into an investment operation. The Defensive investor will place emphasis on avoidance of serious mistakes and losses, and seeks freedom from effort, annoyance and the need to make frequent decisions. The Enterprising investor will be able and willing to put in time and effort in the selection and tracking of securities that may appear to be better valued than the general market from time to time – which may help him achieve better returns than the market over long periods of time. Majority of investors would fall into the Defensive category. To achieve satisfactory results available to the defensive investor is easier than most people realize, to achieve superior results sought by the enterprising investor is harder than it looks.

4. The famous Mr.Market: This is perhaps the most valuable part of the book – on how to approach the widely fluctuating markets that an investor will face number of times in his investing life. Treat the market as an obliging, emotional partner in your businesses – i.e. the securities of which you own.  Every day, he tells you what he thinks of the value of the share of business that you own, and offers to buy your share at a price or sell you his share at a price. Sometimes his fears overtake him offering you rock bottom prices, while sometimes he is too excited about the future offering you great prices. The best part is he does not mind being neglected – he will come back again tomorrow if you neglect him. Your best interests are then served if you only transact with him if and when you agree with his prices – the rest of the time, it is best for you to neglect him and focus on the operations of your business.

In the book, Graham goes on to provide clear stock selection criteria for defensive and enterprising investors – with great examples to help stock evaluation practically. But more than those, the clear framework based on the above – definition of investment, asset allocation, the decision on type of investor, and the attitude towards market fluctuations – are most valuable for an individual investor to go about his investment operations.

Graham’s advice and wisdom are unlikely to make anyone rich in a hurry – perhaps only when one gets old. But the principles are timeless and practical, and unlikely to be available in such fullness anywhere else in today’s financial clutter. That alone makes it a case for the ‘best book about investing ever written’ in Warren Buffett’s words, to be a guiding light on your desk throughout your investing lifetime.

The psychology of happiness: Why money has little to do with it

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It is unusual for a large global investment bank to present research on the psychology of happiness as part of their Global Equity Research. But that is exactly what I found in this attached document from Dresdner Kleinwort Wasserstein.

If you are looking for investment related advice, read no further. Also, if you invest in the hope of being financially well-off – so that you will be happy one day – you perhaps will learn from a reading of this piece of rational financial philosophy. Because according to them (and well – no surprise perhaps for a lot of Indians or followers of Eastern Life Philosophy), Money is not the source of happiness – beyond the point of lifting you out of poverty and giving you the basic means of a decent life.

MoneyHappinessAnd the source of happiness (or as they say – the contributors of happiness) revolve around three factors. First – your genetic make-up which you inherit from your parents or family is a 50% contributor to your happiness. Some people are just genetically pre-disposed to being happier than others. Second – your life circumstances – things like demographics, marital status, income, health, religious affiliations – are only a 10% contributor to your happiness. And Thirdly – the remaining 40% is determined by intentional activities that you do to increase your happiness by focusing on your happiness one day at a time.  These activities include 3 types: behavioural i.e. habits like exercising; cognitive i.e. mind-related like consciously focusing on living in the moment; and volitional i.e. discretionary activities like devoting yourself to serving a cause.  Basically – you make 40% your own happiness by doing activities that increase them!

So there it is – the writing on the wall – from people who advise other people on how to make more money – telling their clients that, after all, it won’t make them happy. Happy Reading!

Happiness

Book Synopsis: The Millionaire Next Door

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This is the title of a famous book that was a result of multi-year studies and research done by Dr Stanley and Dr Danko to discover the profile, lifestyle and habits of America’s wealthy households and how they became wealthy. The title is intriguing as they say, because initially they started their research by surveying people in upscale neighborhoods across the United States, and in time, discovered something odd. That many people who live in expensive homes and drive luxury cars do not actually have a lot of wealth. And then they discovered something even odder: many people who have a lot of wealth do not even live in upscale neighborhoods.  A lot of people with high incomes who live there actually have a lot less wealth than they should. And a lot of people who are really wealthy – do not look like they are, hence the name – the Millionaire Next Door.

the-millionaire-next-door-book-reviewThe definition of wealthy for the purpose of this research is important to understand. Obviously one criteria is the actual net worth number. The nominal cutoff was households with a minimum wealth of 1 million USD. But their intention was to research not the mega rich, so they dropped the ones with households of wealth greater than 10 million USD. About 95% of millionaire households in the United States had a net worth between 1 and 10 Million USD (in the mid 1990’s when this was published), and that was the focus of this survey. This is typically the level of wealth that, in their view, could be attained by many working class regular Americans at that time. I am sure something like this can be extrapolated to other countries too like India, with the nominal figures a bit different, but broadly similar distribution statistics between the “mega-rich” and the “ordinarily wealthy”, and perhaps, a similar set of findings.

Another way “being wealthy” was defined is one’s expected level of net worth, in comparison to one’s age and income. Multiple your age times your pretax household income from all sources except inheritance. Divide that by ten. This, less any inherited wealth, is what your net worth should be. To be comfortably well positioned as a prodigious accumulator of wealth, you should have twice the level of wealth expected.

So taking both the nominal (absolute) and relative definitions of wealth, this survey was done almost over a period of a decade from the late 80’s to the early 90’s.

So what were the key findings of America’s wealthy households? Is there a typical portrait of a millionaire household? Is there a set of factors that contribute to their being wealthy? The answer is Yes – there is a prototypical wealthy household, and a set of lifestyle patterns they follow that is conducive to building wealth. Here are a few of them:

1. Typically male lead earner of the household (>75% of income), became wealthy in his early fifties (i.e. when he could retire without income), Lived well below means throughout working life, Very frugal towards consumption

2. 65% either self employed professionals or own a small business, <25% from the high income employed group

3. 50% wives do not work (number one occupation of wives who work is a teacher, working wives contributed to 25% of household income), wives are meticulous planners and are prepared to live on a budget

4. Household income is 7-8% of current wealth (so lives on only 7-8% of net worth)

5. 97% are homeowners, and have lived in one or maximum two houses for the past twenty years or more

6. 87% are first generation affluent, their parents did not provide them with anything materially substantial in their adult life till they died (inheritance)

7. Change cars on an average once in 6-7 yrs (79% buy them without lease), Highest spend of income is on children and grand children education

8. Fastidious investors, invest 20% of income for over 10 yrs, 79% have 1 or 2 brokerage accounts, make own investment decisions, 25% of wealth in publicly traded securities and mutual funds, rarely sell (42% did not have any sell transaction in past 18 months, average holding period of 7 years), 21% of household wealth in their business

9. Save 35% of earned income, live in a neighborhood where they have typically 5 times the wealth of their neighbors (non-millionaire neighbors outnumber them three to one)

10. Their adult children are economically self sufficient, and they do not intend to provide any economic support to their adult children till they plan inheritance

11. Are proficient in identifying market opportunities, niches and chose the right profession, that they have been pursuing for long periods of time

In summary, 80% of the millionaire households are ordinary people who have accumulated their wealth over one generation. There is a set of patterns related to their lifestyle and habits that are conducive to wealth building. As they say, while there are a hundred paths to Nirvana, but if one adopts some of these, it is more likely than not, that one will find oneself being a Millionaire Next door – not in a hurry, but slowly and surely!

Buffett’s style can’t be implemented by Mutual funds fully, but it does not matter

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It is structurally not possible for mutual funds to implement value investing, in its completeness.

Mutual funds are essentially slaves of their investors and their temperament. Simply because of the structure of mutual funds and the need to beat an index on a monthly, quarterly, annual basis, it is almost impossible for mutual funds to replicate the ‘buy value and hold long term as long as the business stays great’ approach of Buffett in toto. And there is no reason honestly for individual investors to put their money in actively managed mutual funds if they cannot beat the index. That in itself is a structural constraint on why mutual funds will never be able to fully implement Buffett’s value investing style.

But nevertheless, I think individual investors may be in a position of advantage here, if they manage their portfolio well,  simply because of the situation that mutual funds find themselves structurally in.

One option for value oriented individual investors is clearly by not investing using mutual funds and doing value investing in a full fledged manner by directly buying stocks of great businesses at good prices and holding them, aka Buffett. But that may work for only a select few who want to do investing full-time, and may not be feasible for most individual investors. But even though most individual investors may not be able to do this, the second option for value-oriented individual investors may actually be to treat mutual funds as ‘diversified value buckets’, use them as useful stock selection mechanisms, and buy (more or less) mutual fund units based on their general assessment of value existing the market at various times.

That’s one way that individual investors can perhaps be value investors in a partial sense, without having to dabble directly in stocks – but by using funds as proxy value buckets. The need of funds to constantly beat indexes will make sure that they get at least reasonable performance (else use index funds), and treating funds as value buckets will ensure that investors can practice value investing, though to a lesser extent than Buffett, and buy general market value by timing their purchase of fund units.

Warren Buffett in India: The Wisdom and Simplicity

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Warren Buffett, the legendary investor and among the richest people on earth is in India – partly for his philanthropic activities, partly to assess investment ideas in India. But that’s not news. He is already more than a legend, and while his investing styles have been dissected and studied many times over, this being the first time he is in India – the whole business press is all into it.

[youtube=http://www.youtube.com/watch?v=4xinbuOPt7c]

But what is amazing when I see some of his interviews or interactions is that when it comes to investing tenets, he has basically the same things to say! That’s true – and I mean it in a truly appreciative sense, not derogatory. Most of it he has been sharing with his shareholders over the past 40 plus years in much detail, and is very much in the public domain. That’s because – the truth, perhaps, is – while one may try to dig into his investment gems and reasons for his stupendous investing success – he has more or less the same key things to say when it comes to investing success. They circle mostly around evaluating businesses that you understand and are confident have a great long lasting competitive advantage; and buying them at a reasonably low price and holding them for as long as that remains true. It is quite amazing that the entire business press asks him so many questions about world economy or India’s growth story or value of dollar and what not; and is looking for snippets on these topics, and he generally has nothing much to say, many times shies away from it or simply refuses to forecast the future. So you have this whole business press waiting for crystal ball advice, and what you get is basically buy great businesses at good prices and hold them! Luckily (for the press and audiences) he has an amazing honesty and sense of humor when he talks, which leaves opportunities for some quotes for the business press – things like Buffett would like to be reborn as Sophia Lauren’s boy friend and all that! Small mercies!

Anyway, it may actually be true that – perhaps that is all there is to investing success! Buy great businesses at good prices and hold on to them as long as those characteristics stay! Of course, you could spend a lifetime discussing what ‘great businesses’ are and how to identify them, or what is ‘good prices’, or what ‘hold as long as those characteristics stay’ means – but that is a different story. Beyond that – Everything else might perhaps be some shade of noise.

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