Wednesday, April 27, 2011

Best Passages from Peter Lynch's Beating the Street: Part 1

I just finished Peter Lynch's Beating the Street. While the stock picks are dated and not useful anymore, the insights into Lynch's stock thought process were invaluable. I'd like to share some of them with you by recording some of the passages I underlined:
  • [On retirement] there comes a point at which you have to decide wheter to become a slave to your net worth by devoting the rest of your life to increasing it or let what you've accumulated begin to serve you.
  • Unfortunately, buying stocks on ignorance is still a popular American pastime...When people discover they are no good at baseball or hockey, they put away their bats and their skates and they take up amateur golf or stamp collecting or gardening. But when people discover they are no good at picking stocks, they are likely to continue to do it anyway.
  • The stock market is the one place where the high achiever is routinely shown up.
  • A retired fund manager is qualified to give only investment advice, not spiritual advice.
  • Peter's Principle #3: Never invest in any idea you can't illustrate with a crayon.
  • IBM is an approved stock that everybody knows and a fund manager can't get into trouble for losing money on.
  • The key to making money in stocks is not to get scared out of them.
  • In dieting and in stocks, it is the gut and not the head that determines the results.
  • A successful investor does not let weekend worrying dictate his or her strategy.
  • Peter's Principle #4: You can't see the future through a rearview mirror.
  • [Successful investors] somehow manage to develop a disciplined approach to investing that enables us to block out our own distress signals.
  • If you don't buy stocks with the discipline of adding so much money a month to your holdings, you've got to find some other way to keep the faith.
  • Whenever I am confronted with doubts and despair about the current Big Picture, I try to concentrate on the Even Bigger Picture.
  • The Even Bigger Picture tells us that over the last 70 years, stocks have provided their owners with gains of 11 percent a year, on average, whereas Treasury bills, bonds, and CDs have returned less than half that amounts.
  • A successful stockpicker has the same relationship with a drop in the market as a Minnesotan has with freezing weather. You know it's coming, and you're ready to ride it out, and when your favorite stocks go down with the rest, you jump at the chance to buy more.
  • Whereas companies routinely reward their shareholders with higher dividends, no company in the history of finance, going back as far as the Medicis, has rewarded its bondholders by raising the interest rate on a bond. Bondholders aren't invited to annual meetings to see the slide shows, eat hors d'oeuvres, and get their questions answered, and they don't get bonuses when the issuers of the bonds have a good year. The most a bondholder can expect to get is his or her principal back, after its value has been shrunk by inflation.
  • People who sleep better at night because they own bonds and not stocks are susceptible to rude awakenings.
  • Here's a good strategy for convertible investing: buy into convertible funds when the spread between convertible and corporate bonds is narrow (say, 2 percent or less) and cut back when that spread widens.
  • Fund managers and athletes have this in common: they may do better in the long run if they're brough along slowly.
  • Peter's Principle #7: The extravagance of any corporate office is directly proportional to management's reluctance to reward the shareholders.
  • Flexibility is the key. There are always undervalued companies to be found somewhere.
  • I always ended these discussions [with company's management or investor relations] by asking: which of your competitors do you respect the most?
  • Small [caps] is not only beautiful, it also can be lucrative.
I think that's long enough for one post.

Friday, April 15, 2011

Haiku - You deserve some time off

I used to love work,
Ran hard after the carrot.
Where has my life gone?

Thursday, April 14, 2011

Bobby Fischer is a badass

Two of my favorite quotes so far in the book "Endgame", a biography of Bobby Fischer:
"But why would Geller expect Fischer to take a quick draw? Fischer's entire record as a player shows his abhorrence of quick draws and his wish at every reasonable (and sometimes unreasonable) occassion to play until there is absolutely no chance of winning. No draws in under 40 moves is an essential part of his philosophy."
"Taking nothing for grandted was one of the key's to Fischer's success."
 The whole book is worth a read and is easily accessible for the chess outsider like me. I love reading biographies. The more you read the more you realize there is a pattern of success: hard work bordering on obsession. For instance, it was estimated that between his ninth and eleventh birthdays Bobby played a thousand games a year. Between his eleventh and fourteenth birthdays he played 12,000 games a year. Another example: in 1970, Fischer left NYC to go to the Catskill mountains to prepare for the World Championship match against Spassky. In the four months that he trained there he spent 12 hours a day 7 days a week reading, thinking, and preparing for one match.

I'll have more on this book after I finish it.

Tuesday, April 12, 2011

Notable and Quotable from Alex Berenson's "The Number"

I just finished The Number: How the Drive for Quarterly Earnings Corrupted Wall Street and Corporate America. What a fantastic read. Alex Berenson is a captivating writer who masterfully wove together many different narratives - accounting, government regulatory, and stock market history as well as the stories of corporate misdoings by Computer Associates, Enron, Tyco, and Worldcom. It was a great read.

As I've written before, I like to underline as I go along. Here are some of my favorite passages, which will give you an idea of how good a writer Berenson is. All of the points are attributable to him unless otherwise specified.
  • "It is difficult to get a man to understand something when his salary depends on his not understanding it." -Upton Sinclair
  • On Wall Street, not all numbers are created equal.
  • Earnings per share is the ultimate benchmark of a company's success or failure.
  • Earnings per share is the number for which all the other numbers are sacrificed. It is the distilled truth of a company's health. Earnings per share is the number that counts.
  • But the trouble with bubbles...the trouble with bubbles is they don't last.
  • Accountants are the plumbers of capitalism, unappreciated but vital to the system.
  • Bear markets have villains. Bull markets have heroes.
  • A conglomerateur who runs out of acquisitions is a very unhappy conglomerateur. He's stuck managing the companies he has already bought, which are all too often third-rate companies in slow-growth industries. Winners buy; losers manage. Worse, the skills that make a successful conglomerateur-salesmanship, impatience with details, and a huge ego-are more or less the opposite of the skills needed to successfully manage a company.
  • Diversification is no protection against loss if that diversification consists of owning a diverse group of second-rate stocks.
  • If Wall Street's history proves anything, it is that investors of all sizes examine financial statements much less closely when stocks are rising.
  • In Wall Street's version of heaven, the strip clubs don't have covers and every month is January. In hell, on the other hand, the calendar always reads October.
  • "You start as an analyst, but you end as an ambassador."
  • Bill Barnhart of the Chicago Tribune: "When you boil down the entirety of a corporate enterprise to a few pennies, the chances for error, misunderstanding and mischief are immense."
  • [Stock] options are worth something even when they're not worth anything. They are as close as Wall Street comes to believing in an afterlife.
  • Roger Lowenstein on executive compensation, specifically the abuse of stock options: "By turns, a system designed to motivate became one to simply enrich."
  • The clash between longs and shorts is about more than money; it is the eternal battle of hope and realism.
  • Short-sellers are the little voice in the middle of the night, the voice a CEO cannot allow himself to hear: Your numbers are crap. Your new product is way behind schedule. You're booking sales for which you'll never get paid. You're burning cash. The competition is ruinous. You don't have a chance. That $200 million you raised last year, it's gone. What now? To executives, that voice is death, so the shorts are killers.
  • During the worst panics, the market does not make even a halfhearted attempt to rally. It closes at the day's lows, and one has the sense that if not for the 4 P.M. bell, prices would fall until the Dow and the S&P 500 and every stock in them all hit zero, and even then traders would try to sell short. The very concept of a bottom is laughable. Only a night's rest can bring sanity back to the world...But the worst crashes do not last just one day.
  • After the first day of a crash, no one can know where it will end. It is a force of nature as much as any hurricane or earthquake.
  • Michael Lewis on the 1990s: "A boom without crooks is like a dog without fleas...A healthy free-market economy must tempt a certain number of people to behave corruptly."
  • It's time for all of us, investors and executive and managers and employees, to admit what we already know: Just because a company hits its earnings targets doesn't mean it is flourishing; just because it misses for a quarter or two doesn't mean that it is failing. Just because a company has grown 15 percent a year for a couple of years in a row doesn't mean it can grow 15 percent a year forever. Only a handful of companies has earnings that can be smoothly plotted more than a few months in advance. Business doesn't work that way. Life doesn't work that way. [Emphasis my own] Planes run late; meetings go badly; contracts don't get signed when they're supposed to. Hire good people is hard; making good acquisitions is harder. Even well-run companies have a tough time keeping decent financial controls, figuring out where to invest research dollars, and satisfying investors and the media. And not ever investment pays off in three months. Sometimes smaller profits now can mean a better business and bigger profits later.
  • The number is a lie. We need it; we can't avoid it. But it's still a lie.
Hush thee, my babe, Granny's bought some new shares,
Daddy's gone out to play with the bulls and the bears,
Mommy's buying on tips, and she simply can't lose,
And baby shall have some expensive new shoes!
-September 1929 in the Saturday Evening Post

Monday, April 11, 2011

Notes from Seth Klarman's Youtube Videos

I came across some videos of successful money manager Seth Klarman of the Baupost Group. Klarman is the author of the $900 book, Margin of Safety: Risk-Averse Value Investing Strategies for the Thoughtful Investor. When I was watching I was blown away with the rapid-fire investment truisms. So I decided to jot them down:
  • value investing is a risk averse approach - focus on risk before return
  • Ben Graham's net working capital test - if you can buy a stock for less than 2/3 its networking capital (working capital - all liabilities) then that's a bargain. You are buying a company for less than you could liquidate the business for.
  • three underlying pillars:
    • Focus on risk before return. Focus on multiple scenarios, i.e. what can go wrong, what's the worst thing that can happen. Create a range of possible outcomes, don't rely on single point estimates. Volatility isn't risk, volatility creates opportunities.
    • The world is oriented toward relative performance. People who are risk averse should be focused on absolute returns. If you are focused on absolute returns, the idea of losing other people's money is abhorent. If you're focused on relative performance then you're OK with that.
    • The importance of being bottom-up and not top-down. Interest rate and the stock market direction forecasting are incredibly difficult to perform well.
  • Baupost. When they set it up they wanted to have flexibility - a wide mandate - in order to have as large an opportunity set as possible. The more weapons available in your mandate  the better chances you will have to take chances of mispricings. They also set it up to have capital alongside their clients. They don't allow people to have significant holdings outside the firm. The firm is highly collaborative; people are able to make an impact even at a junior level. Capital isn't siloed or allocated to specific people; it is able to move to different opportunities as they arise. Baupost's edge is in complicated situations.
  • To invest in something you need an edge. They need to have a reason that they will outperform. The biggest edge someone can have is a long-term orientation. It's easy to say you do, but harder to implement it. Also, you need a catalyst: what is going to cause a mispricing to correct itself. Or a supply/demand imbalance like distressed debt where, as a bond is down-graded, there is forced selling.
  • Spin-offs and index inclusion/exclusion are both good sources for deals.
  • Relationships are important. They work hard to have the best clients and the best brokers. Trust. The team has worked together for a long time.
  • Pharmaceutical company that invented a number of drugs - PDL Biopharma 30% IRR on the likely collections from drug patents.
  • Risk vs. Return:
    • Intensive sensitivity analyses on everything they do. A whole variety of assumptions. E.g. what if defaults are 5%, 10%. If a security, even with Depression-like scenarios, passes these tests then it is a good buy.
  • Easy to find things that aren't efficiently priced.
  • Baupost never uses modern finance, i.e. WACC or ROIC. Instead, use a range of values.
  • Often the greatest opportunities are around the peripheries of things. If people are looking at
    the S&P 500, you should look at the 501st company. Where do we earn enough to buy and hold this entire company?
  • Which value managers do you admire?
    Buffett and Munger for one.
    FPA Crescent team. Southeastern Asset Management. Tweedy Brown.
    Paul Singer. David Abrams. Perry Capital. Jeff Hallis. Michael Lowenstein. Steve Mandel.
  • Looking for egregious mispricings. Looking for low-risk, high-return situations.
  • Never believe that something will go well beyond fair value. We don't hold on for the last nickel. Don't fall in love with a stock because it acts well.
  • One of the biggest mistakes that investors make is overdiversification. This presupposes that losses will be one-off events rather than the entire market moving against you. This limits your return and doesn't really limit your risk that much.
  • You need to be able to tell a great idea from a good idea.

Thursday, April 7, 2011

What I Learned from Phillip Fisher's Common Stocks

I would not recommend the book Common Stocks and Uncommon Profits and Other Writings (Wiley Investment Classics) for anyone. However, my displeasure with it didn't deter me from finishing it once I picked it up. I don't quit on things. My philosophy is: power through. These are my general feelings on the book, written as part of a review on the Amazon reading list app of LinkedIn:
"My expectations for this book were high. I was severely disappointed. The best part of this book is that it's over. The worst part of this book is that Phillip's son Kenneth owns the rights to the book. He took that privilege, ran with it, and abused the hell out of it. Kenneth, a billionaire investor, droned on for a dozen pages of prologue before writing another 27 for the introduction. If you happen to pick up this copy, and I suggest that you don't, skip all of Kenneth's writing. It's horriblely egotistical, monotonous, and empty of any informational value whatsoever.
Phillip writes like I hope that I don't: overly verbose with too complicated a sentence structure. His writing also has too many references to previous statements so quoting him is very difficult. In my view, the best investment writers drop little nuggets of wisdom that are highly quotable. Because of the way Fisher writes, you won't get much of that from this book. The other problem with the writing is that there are too many examples so the book doesn't stand up historically. I don't want to read about Dow Chemical in the '50s or Motorola in the '70s. Both of these stocks are also written about because Fisher owned them which I also found annoying.
I did find bits and pieces that I believe was adopted by other investment managers, e.g. three year rule, buying something when it is priced well and not haggling over 1/8ths.
However, I recommend that you skip this book."
Not enjoying the book also didn't prevent me from learning. I keep a journal of ideas that I want to keep when I read. I want to share with you those ideas that I came away with from this book. [I cleaned up his gratuitously elongated speech for my own records.]
  • In the case of really outstanding companies, the information is so crystal clear that even a moderately experienced in vestor who knows what he is seeking will be able to tell which companies are likely to be of enough interest to him to warrant taking the next step.
  • You need to have patience if you want to make big profits from an investment. Put another way, it is often easier to tell what will happen to the price of a stock than how much time will elapse before it happens.
  • Doing what everybody else is doing at the moment, and therefore what you have an almost irresistable urge to do yourself, is often the wrong thing to do at all.
  • Just as even the best professional baseball players cannot expect to get a hit more than one out of every three times he comes to bat, so a sizable number of stocks are bound to produce nothing profitable at all.
  • If you want to gauge a management's orientation towards profits (short- vs. long-term) then look to the treatment of customers and vendors. It provides a very good indicator.
  • Stocks should not be bought where the dividend payout is so emphasized that it restricts realizable growth.
  • Practical investors usually learn their problem is finding enough outstanding investments, rather than choosing among too many.
  • Usually a very long list of securities is not a sign of a brilliant investor, but of one who is unsure of himself.
  • To make big money on investments it is unnecessary to get some answer to every investment that might be considered. What is necessary is to get the right answer a large proportion of the very small number of times actual purchases are made.
  • His three principle, two I's and an H: integrity, ingenuity, and hard work.
  • A good place to start with a conservative investment is with an industry's lowest cost producer, because:
    • the higher margin allows the company to weather poor business conditions better
    • the margin also allows the company to earn enough that they won't need to seek additional financing
  • The largest profits in the investment field go to those who are capable of correctly zigging when the financial community is zagging.
  • Contrary opinion is not enough, however. When you do go contrary to the general trend of investment thinking, you must be very, very sure that you are right.
  • Three year rule: each investment should be given three years in order to draw a conclusion from the investment thesis.
  • "If you can't do a thing better than others are doing it, don't do it at all."