Tag Archives: Finance

On Howard Marks’ Memos

I spent a couple of months reading Howard Marks’ memos and have attempted to make a distilled “teacher’s reference guide” which (hopefully) describes his investing philosophy in a clear, effective, and concise manner. His focus on simple and truly important ideas throughout these nearly 30 years of memos was amazing to read about and I hope this comes across!

*The vast majority of the content is from Howard’s memos and not my own words. I’ve simply distilled, compiled, and added a few notes and references.

Business Adventures by John Brooks

Summary

  1. Brooks discusses 12 classic financial cases 

Key Takeaways

  1. The Ford Edsel disaster – Ford spent $250m in designing and selling the car but it was an absolute flop. 
  2. The Saunders’ story about how the founder of Piggly Wiggly tried to corner the market. 

What I got out of it

  1. I’ve heard so much about this book and was a bit disappointed. Some fun stories, but overall wouldn’t recommend

The Hour Between Dog and Wolf: Risk Taking, Gut Feelings, and the Biology of Boom and Bust by John Coates

Summary

  1. The story about traders on Wall Street, how the body and mind react to stressful moments, and how the mind does it so quickly that we aren’t consciously aware of it. It is the biology of stress and risk that the author will analyze and explain

Key Takeaways

  1. When there is a bull market or potentially a bubble, there are excess profits and this tends to lead to excessive risk taking, overconfidence, and general mania for those who are benefiting from it. 
  2. Some fascinating questions have been raised whether the increased use of anti-depressants and other drugs could have been so widely and regularly used in the early 2000’s that it changed the brains and risk-aversion tendencies of the traders who used them, exacerbating the dot com bubble
  3. Women were relatively unaffected during the dot com boom and the author argues it is because of their lower levels of testosterone which leads to lower risk taking and more independent thinking when everyone else around them is losing it
  4. Mistakes are made when we artificially separate and silo systems which are truly united. This happens in economics when we assume a perfectly rational human and, in this case, the author argues that the mind and body should be considered one – what happens in the mind affects the body and what happens in the body affects the mind
  5. The feelings we experience during stress comes about because our body is changing, preparing itself for physical movement
  6. There is a hypothesis that when fuel is running low our bodies and minds function by a last in first out methodology meaning that the things that evolve last such a self-control are the first to go when food is scarce
  7. Importantly, novelty, uncertainty, and situations which are out of our control can have as big of an effect on our bodies and minds as real danger does
  8. Goes deeply into the effects that cortisol and testosterone have on the body. Too little and we’re lethargic but too much leaves to overly risky behavior. Have to find the happy medium, flow
  9. The best traders, like the best athletes, are able to toggle between high stress moments and deep relaxation. The more amateur are in a consistent level of stress, never able to relax. The different physiological changes is also manifested in higher HRV in the higher level traders and athletes 
  10. Physical exercise, especially very intense and short spurts and cold exposure, can help us train our physical and emotional toughness 

What I got out of it

  1. Some decently fun stories about finance, risk taking, intuition. I’d recommend Sapolsky’s Why Zebra’s Get Ulcers if you’re interested in this

How Asia Works: Success and Failure in the World’s Most Dynamic Regions by Joe Studwell

Summary

  1. This book is about how fast or not economic transformation is achieved. It argues there are 3 interventions the government can take to influence this process: maximize output from agriculture with highly intensive household farming (pushing up yields and outputs to its highest level which primes demands for goods and services), direct investment and entrepreneurs towards export-oriented manufacturing as it makes use of the limited skills of labor by working with machines and technology (subsidies should incentivize spending in technology and manufacturing), and interventions in the financial sector to focus capital on intensive small scale agriculture and manufacturing development. The state’s role is to keep money targeted at a development strategy which gets the highest rate of technological learning, giving the highest rate of return, and helping the country grow as sustainably as possible, improving the lives and outcomes of everyone .

Key Takeaways

  1. Agricultural
    1. Agriculture is the place to start with up-and-coming countries because the vast majority of their people are tied to the land. Structuring incentives so that these people can prosper creates the foundation for further economic success 
    2. By approximately evenly dividing up the land amongst the peasants and incentivizing a maximization of output (rather than profit), yields go through the roof which helped pay and feed these families. It allowed everyone to compete on an approximately equal footing and everyone believed they had a chance st success – which they did. This “gardening” approach is the most appropriate way to think about and structure agricultural societies early on as it can make full use of all the available labor. Surprisingly, these smaller plots owned by the farmers had far greater yields than many plantations – busting the myth of efficiency in large scale agricultural operations
    3. The political elite tend to be out of touch with the agricultural peasants and therefore undervalue and under-appreciate their power and ability to help the economy 
    4. If you want industrialization, first fix agriculture
    5. Even a total outsider can tell the difference between a plot of land tended by an owner vs. a tenant
    6. A consistent application of these policies across different cultures and regions is a stark reminder that geography is not destiny 
    7. Farmers laid the foundation for industrialization and their household savings provided the base to build factories and later the market for the goods these factories made. Taiwan is the prime example in this case as many factories were built in rural areas and many farmers became industrial entrepreneurs. Indonesia and the Philippines are the negative examples – they nationalized land before the farmers could build up wealth and plantation inefficiency took hold. In addition, loopholes in policies so the rich could amass massive land holdings, put the poor at a disadvantage and worsened conditions
    8. Besides owning the small fields, the farmers need the extension, marketing, and credit to progress 
    9. As rural laborers begin moving into higher paying industrial and service jobs, farming needs to rebalance from productivity towards profitability – shifting towards more mechanized farms away from gardening plots. The countries will need to specialize at this point, moving away from farm protection and subsidies and to a niche they can compete in. This shifts money to this area and gives other poor countries the chance to follow the same playbook 
  2. Manufacturing 
    1. If there is one thing economic history can teach us is that there are no economic policies or laws which are sound forever 
    2. Manufacturing helps local people learn skills and to leverage the machines which they initially import, increasing productivity. Local entrepreneurs know the local market but they must compete with international firms in order to continue improving and to survive long-term without protection 
    3. Government must incentivize – through protection and subsidy – their rural entrepreneurs so they can get into large scale manufacturing rather than service industries at this phase. They must have export discipline – proving that their goods are competitive on a global stage and thus merit subsidies to grow.
    4. The government shouldn’t pick winners as much as weed out losers. South Korea did this which is why they ended up with one or two massive companies in each sector without explicit state investment or control. Protectionism hurts in the short term but helps economies evolve and it’s people learn useful skills and in the long term is beneficial
    5. Growing economies typically start industrialization with textiles later moving on to steel, shipbuilding, food stuffs, petro-chemicals, and eventually cars other heavy industry
    6. While Taiwan what is the exemplar in land redistribution, South Korea took over as the exemplar of industrialization – setting up their entrepreneurs to have to compete with international markets and companies by providing enough subsidy and protection to let them grow, learn, and thrive
    7. It is interesting to look in hindsight that Taiwan, South Korea, and Japan accomplish their amazing feats with no, or at least very few, trained economists. They simply followed the model of early America and later Germany 
    8. Government must not ask entrepreneurs to innovate for moral reasons. Rather they must accept and incentivize their animal spirits so that they can innovate, industrialize, and develop the country as is needed for their own benefit and for the benefit of all
    9. More than ever, firms are able to flourish if they have the right state industrialization policies in place. Hyundai was able to flourish and become one of the world’s most successful car manufacturers from an unpromising start and a family with no automotive experience thanks to the favorable Korean policies 
    10. The goal is technological learning which hopefully leads to internal, domestic innovation. While land reform and infant industry regulations are difficult, there are no better options. Technical and technological progress equates to economic progress and history has shown that these difficult but necessary steps must be taken 
    11. Big business is incredibly important. There are smaller countries with big firms which have gotten rich but never the other way around. However, government must continuously restrain their entrepreneurs or else you end up with oligarchs like in Russia or SE Asia
  3. Financial
    1. Bank deregulation and removal of capital controls too early hurt developing economies such as Thailand or Indonesia. The agricultural and industrial sectors must be ready before these financial policies are enacted. Several different monetary and fiscal policy approaches have led to success but they all had the right policies, pointing at the right targets 
    2. In the Philippines, private banks would lend to the rich entrepreneurs at favorable terms which of course help them but didn’t help the country develop at all. However, ultimately what led to the downfall of economic collapse of the Philippines was their lack of export discipline which would have provided them with export loop feedback so that they could continuously improve and better compete on a global stage – improving their technical know-how across the country
    3. Korea and the Philippines both borrowed extremely heavily and were in a lot of debt but Korea used that money to improve the technology and scale to a global level where the Philippines did not
    4. Malaysia pumped too much money into real estate and the stock market instead of directing it towards industry. They tried to skip a step in order to compete and out do Singapore but this eventually led to an economic collapse and stagnated technological progress 
    5. Capital allocation must be tied to industrial policy and export performance or else capital will be deployed in low return investments. Government must incentivize and cajole entrepreneurs towards manufacturing and international markets. The financier is not the economic savior some suggest but responds to the environment around him which the government helps create. Foreign funds must not be allowed in too early and deregulation can only happen once manufacturing is humming and technological progress is underway 
    6. Banking systems are so effective because they respond to central bank policy which is controlled by government policy. It is a simple and effective method, easier to to control than bond and stock markets
    7. There is no good understanding today of when a country should deregulate 
  4. China 
    1. China first tried the mass scale agriculture approach but soon realized it was ineffective so they transitioned to the gardening approach which greatly helped feed and put to work hundreds of millions. They also abandoned an approach where they would try to come up with everything internally and opened up trade to buy, borrow, and steal the best inventions and processes rather than trying to come up with everything internally
    2. Chinese government has always been paranoid of being at the mercy of necessary food stuff importers. They have taken away a lot of farmland dedicated to these grains in the past decade and may soon change the policy so they secure enough food to be continue to be independent 
    3. It is yet to be seen if China’s close control of oligopolies can help the economy long term. So far they have been able to strike a balance between control and allowing the entrepreneurs and employees to profit 
    4. China has a heavy bias to public and state owned enterprises rather than private companies. 
    5. People worry about shadow banking systems which lend to wealthy citizens outside the direct view of the government in order to seek higher returns but this has existed in one form or another in every developing country. Whenever government policy favors agriculture and industry over finance, shadow finances will pop up
    6. China’s financial policies are not as loose as many think if taken into context of Japan and Korea in similar stages, the size of their economy and the make up of their assets, and the fact that little money is owed externally. They are making great technological progress with the money they’ve borrowed but the best days of industrial-led policy development have passed so they will need to be more efficient moving forward. It is China’s size and not necessarily their innovative policies which have shaken the world. It does not yet have any world renowned firms and, if it is to take the next step developmentally, must improve its institutional policies 
  5. Other
  1. One of the key lessons when analyzing failed states is that they are isolated, closed off, and do not trade or interact with external countries. It has shown to be very hard, if not impossible to thrive if you are not open and trade with other countries 
  2. There is a weaker than expected correlation between education and rise in GDP. Most education occurs on the job and within firms rather than in school settings making industrial focus extremely important. If there is no industry to serve as a vehicle for learning, formal education may go to waste 
  3. Demographics, political pluralism / democracy are very important but is not touched on at length in this book 
  4. Rule of law is not one of the pillars for economic development but it is for overall development 
  5. Broadly, there are two types of economics. The first is akin to an education for developing countries in which the people require the skills needed to compete with their global peers. It requires nurture, protection, and competition. The second is more focused on efficiency and is applicable for more developed countries which needs less state intervention, more deregulation, freer markets and a larger focus on profits. The question is not if there are two but when they meet and how to best transition between the two. Where certain economically developed countries have fallen flat is that they fail to continue to evolve and develop. No policy is good forever and things must change. In addition, economic development is only one leg of the stool. Freedom, rule of law, environmental health, and individual autonomy are equally important and are needed for any country to prosper
  6. There is no significant economy who has evolved successfully out of policies of free trade and deregulation from the get go. They require proactive interventions – namely in agriculture and industry that foster early accumulation of capital and skill 

What I got out of it

  1. For developing countries, the best way to prosper is to first redistribute land so the people can use gardening style agriculture to feed themselves and save some money, then government’s must create subsidies and protective policies so that internal industry can grow and flourish with the goal of increasing skill and technological know-how so that future innovation can happen, then finance comes into the picture and must be used to further direct these two areas effectively and sustainably

Essays of Warren Buffett: Lessons for Corporate America by Lawrence Cunningham

Summary
  1. An organized compilation of Warren Buffett’s annual letters, broken down by concept. “By arranging these writings as thematic essays, this collection presents a synthesis of the overall business and investment philosophy intended for dissemination to a wide general audience.”
Key Takeaways
  1. Focus on the business with outstanding economic characteristics (favorable and durable moats) and management
  2. People are everything – partner with CEOs who will act well even if they could cheat, who act as if they’re the sole owner, as if it’s the only asset they hold, as if they can’t sell or merge for 100 years
  3. Performance should be the basis for executive pay decisions, as measured by profitability, after profits are reduced by a charge for the capital employed in the relevant business or earnings retained by. If stock options are used, it should be related to individual rather than corporate performance, and priced based on business value
  4. True risk is not volatility but permanent loss of capital
  5. Rather be approximately right than precisely wrong
  6. Put eggs in one basket and watch that basket
  7. Price is what you pay, value is what you get
  8. The 3 legs of the investing stool – Mr. Market, margin of safety, circle of competence
  9. Value investing is a redundancy – aim for focused or intelligent investing
  10. Deploying cash requires evaluating 4 commonsense questions based on information rather than rumor
    1. the probability of the event occurring
    2. The time the funds will be tied up
    3. The opportunity cost
    4. The downside if the event does not occur
  11. Guard against the institutional imperative – CEOs herd-like behavior, producing resistance to change, inertia, and blindness
  12. If you aren’t happy owning business when exchange is closed, you aren’t happy owning it when open
  13. Create the business and environment that attracts the people, management, shareholders that you want
  14. Useful financial statements must enable a user to answer 3 basic questions about a business
    1. Approximately how much a company is worth
    2. Its likely ability to meet its future obligations
    3. How good a job its managers are doing in operating the business
  15. Owner earnings –> cash flow = operating earnings + depreciation expense and other non-cash charges – required reinvestment in the business (average amount of capitalized expenditures for PPE that the business requires to fully maintain its long-term competitive position and its unit volume)
  16. Intrinsic value = the discounted value of the cash that can be taken out of a business during its remaining life
  17. Don’t risk what you have and need for what you don’t have and don’t need
  18. Beware weak accounting (EBITDA), unintelligible foot notes, those who trumpet projections
  19. Directors must be independent, business savvy, shareholder oriented, have a genuine interest in the business
  20. Really only 2 jobs – capital allocation, attract and keep outside management
  21. Choose a cold sink (weaker competition) than best management
  22. Conventionality often overpowers rationality
  23. Risk – we continually search for large business with understandable, enduring and mouth-watering economics that are run by able and shareholder-oriented managements
    1. The certainty with which the long-term economic characteristics of the business can be evaluated
    2. The certainty with which management can be evaluated, both as to its ability to realize the full potential of the business and to wisely employ its cash flows
    3. The certainty with which management can be counted on to channel the reward from the business to the shareholders rather than to itself
    4. The purchase price of the business
    5. The levels of taxation and inflation that will be experienced and that will determine the degree by which an investor’s purchasing-power return is reduced from his gross return
  24. When dumb money acknowledges its limitations, it ceases to be dumb
  25. Need to do very few things right if you avoid big mistakes
  26. Changing styles often is a recipe for disaster
  27. Worry most about management losing focus
  28. If you won’t own a business for 10 years, don’t own it for 10 minutes – materially higher earnings in 5-10 years is what you’re looking for
  29. Time is the friend of the wonderful business, the enemy of the mediocre
  30. Have not learned how to solve difficult business problems, but have learned to avoid them
  31. Never in a hurry – enjoy the process more than the proceeds
  32. “Expert error” – falling in love and acting on theory, not reality
  33. You don’t have to make it back the way you lost it
  34. In commodity-type businesses, it’s almost impossible to be a lot smarter than your dumbest competitor
  35. 4th Law of Motion – for investors as a whole, returns decrease as motion increases. a hyperactive market is the pickpocket of enterprise
  36. Attract proper inventors through clear, consistent communications of business philosophy
  37. It pays to be active, interested, and open-minded, never in a hurry
  38. Avoid small commitments – if something is not worth doing at all, it’s not worth doing well
  39. Deals often fail in practice but never in projections
  40. In a trade, what you give is as important as what you get
  41. The goal of each investor should be to create a portfolio (in effect, a “company”) that will deliver him other the highest possible look-through earnings a decade or so from now. An approach of this kind will force the investor to think about long-term business prospects rather than short-term market prospects, a perspective likely to improve results. It’s true, of course, that, in the long run, the scoreboard for investment decisions is market price. But prices will be determined by future earnings. In investing, just as in baseball, to put runs on the scoreboard one must watch the playing field, not the scoreboard
  42. The primary test of managerial economic performance is the achievement of a high ROE employed and not the achievement of consistent gains in earnings per share
  43. The difficulty lies not in the new ideas but in escaping the old ones.
  44. Ultimately, business experience, direct and vicarious, produced my present strong preference of businesses that possess large amounts of enduring Goodwill and that utilize a minimum of tangible assets.
  45. Nothing sedates rationality like large doses of effortless money
  46. Speculation most dangerous when it looks easiest
  47. Fear is the foe of the faddist but the friend of the fundamentalist
  48. Take into account exposure, not experience
  49. Noah Rule – predicting rain doesn’t count, building arks does
  50. Tolerance for huge losses is a major competitive advantage
  51. Berkshire’s next CEO – temperament is important, independent thinking, emotional stability, and a keen understanding of both human and institutional behavior is vital to long-term investing success.
What I got out of it
  1. An amazing collection of investing, finance, accounting, and management ideas

The Most Important Thing: Uncommon Sense for the Thoughtful Investor by Howard Marks

Summary
  1. Not a how to guide for investing but Howard’s investing philosophy, his guideposts
Key Takeaways
  1. Focus on risk over returns
  2. Goal is to have people say, “huh, I never thought of it like that before”
  3. Experience is what you got when you didn’t get what you wanted. The most powerful lessons come in tough times
  4. No idea can be any better than the action taken on it
  5. Some influencers and mentors: Galbraith, Buffett, Taleb, Munger, Greenblatt, Rothschild
  6. Getting average results is easy, simply invest in an index fund. But, to be successful and best the market and other investors, it takes a deep commitment. To understand business models, psychology, history and a whole host of other disciplines
  7. Second level thinking requires you to see past the short term, see how other are thinking and see the effects of that, takes into account second order consequences, it is deep, complex, convoluted, uses probabilities to see future outcomes, takes many things into account, knows the consensus opinion
  8. Do you have the confidence to be above average? Can you use second order thinking? In order to be successful, you have to hold on consensus views and be correct
  9. Second most important thing is understanding market efficiency and its limitations. Howard’s take us that markets are efficient in that they quickly incorporate new information but they are not necessarily right
  10. Everything moves in cycles, including accepted wisdom
  11. When you have a great idea or thesis on an investment, ask “and who doesn’t know that?”
  12. The starting point and foundation for all investing is an accurate calculation of intrinsic value. Easier said than done
  13. Understanding risk is key. Risk is not volatility but the fact that more things can happen than will happen. He three steps are understanding it, knowing when its high and then controlling it. Risk is different for every investor so creating a broad stroke for it is not possible but the Sharpe ratio may be the best alternative
  14. The greatest investors are subject to some of the greatest periods of underperformance because of their unconsensus views and methods
  15. Improbable things happen and probably things don’t happen all the time
  16. People expect the future to resemble the past which sometimes it does but it leads to be people expecting change to be less impactful than it often is
  17. The most dire and negative situations can in fact be the most riskless as all optimism has been drive out of the price. Quality is not tied to risk. A high quality company can be very risky above a certain price
  18. “This time is different” should cause you to pay extreme attention
  19. Combative negative influences such as desire for more, desire for a sure thing, biases, fear of missing out, greed, fear, comparing self to others, ego and poor psychology is vital. This may be one of the greatest sources of advantage one can achieve
  20. It is essential to find bargains by being willing to invest in what others are seemingly over pessimistic about. Boil it all down in order to find bargains perception house sitter of work in reality for whatever number of
  21. Investing is the discipline of relative selection
  22. Should not go out and try to find out investments – let them find you
  23. Most people, although they have many holdings, are not truly diversified. Own is only diversified if you can expect the holdings to perform differently in changing environments. It is the rare investor who understands these correlations
What I got out of it
  1. One of my favorite investing books – focus on risk rather than return, understand how difficult the game is if you decide to play, must be a second/third level thinker…

Seeking Wisdom: From Darwin to Munger by Peter Bevelin

Summary

  1. Through real life examples, many of them centered around Warren Buffett and Charlie Munger, Peter Bevelin helps the reader learn how to think better, make fewer poor decisions  understand ourselves and others better. Discusses mental models, human fallibilities, heuristics, instincts, human psychology, biology and more.

Key Takeaways

  1. Main goal is to understand why people behave the way they do. “This book focuses on how our thoughts are influenced, why we make misjudgments and tools to improve our thinking. If we understand what influences us, we might avoid certain traps and understand why others act like they do. And if we learn and understand what works and doesn’t work and find some framework for reasoning, we will make better judgments. We can’t eliminate mistakes, but we can prevent those that can really hurt us.”
  2. Learn from other’s mistakes
  3. Learn the big ideas that underlie reality and develop good thinking habits (namely, objectivity)
  4. This book is a compilation of what Bevelin has learned from reading some of the works of the world’s best thinkers
  5. Book is broken down into 4 parts – what influences our thinking, examples of psychological reasons for misjudgments, reasons for misjudgments caused by both psychology and a lack of considering some basic ideas from physics and mathematics and lastly describes tools for better thinking
What I got out of it
  1. Seriously good read if you’re at all interested in understanding how and why we make decisions (both bad and good) and how we can go about improving our thought processes and tools. Fantastic read and couldn’t recommend more highly
Part 1 – What Influences Our Thinking?
 
  • Brain communicates through neurochemicals and genes are the recipe for how we are made
  • Behavior is influenced by genetic and environmental factors
  • The flexibility of the brain is amazing as it can change due to our thoughts and experiences
  • Mental state (situation and experience) and physical state are intimately connected – beliefs have biological consequences, both good and bad
  • World is not fixed but evolving – evolution has no goal
  • Pain (punishment) and reward (pleasure) have evolutionary benefits with pain avoidance being our primary driver
  • Hunter-gatherer environments have formed our basic nature – competitive, access to limited resources, many dangers, self-interest, ostracism = death
  • Cooperation leads to trust, especially amongst relatives
  • Fear is our most basic emotion and it guides almost everything we do. Repeated exposure lessens instinctual reactions
  • Novelty is always sought out
  • Reputation, reciprocation and fairness are big human motivators
  • Very painful to lose anything, especially status, once obtained. Higher status linked to higher health and well being
  • People learn their behavior from their culture
  • Assume people will act in their self-interest
  • Don’t blindly imitate/trust others – think rationally and form your own opinions
Part 2 – The Psychology of Misjudgments
  • Outlines 28 reasons for misjudgment. These are never exclusive or independent of each other. Many of these echo similar sentiments to Cialdini’s Influence
    1. Bias from mere association
    2. Underestimating the power of rewards and punishment
    3. Underestimating bias from own self-interest and incentives
    4. Self-serving bias
    5. Self-deception and denial
    6. Bias from consistency tendency (only see things that confirm our already formed beliefs)
    7. Bias from deprival syndrome (strongly reacting when something is taken away)
    8. Status quo bias and do-nothing syndrome
    9. Impatience
    10. Bias from envy and jealousy
    11. Distortion by contrast comparison
    12. Bias from anchoring
    13. Over-influence by vivid or the most recent information
    14. Omission and abstract blindness
    15. Bias from reciprocation tendency
    16. Bias from over-influence by liking tendency
    17. Bias from over-influence by social proof
    18. Bias from over-influence by authority
    19. Sensemaking
    20. Reason-respecting
    21. Believing first and doubting later
    22. Memory limitations
    23. Do-something syndrome
    24. Mental confusion from say-something syndrome
    25. Emotional arousal
    26. Mental confusion from stress
    27. mental confusion from physical/psychological pain, the influence of chemicals or diseases
    28. Bias from over-influence by the combined effect of many psychological tendencies working tougher
  • Behavior can’t be seen as rational/irrational alone – must have context
  • People can take bad news, but we don’t like it late
  • Evaluate things, people and situations by their own merits
  • Past experiences are often context dependent. Just because some stimulus caused you earlier pain, doesn’t mean that is still the case today
  • Create a negative emotion if you want to end a certain behavior
  • Good consequences don’t necessarily mean you made a good decision and bad consequences don’t necessarily mean you made a bad one
  • Frequent rewards, even if smaller, feels better than one large reward
  • The more “precise” people’s projections about the future are, the more wary you should be
  • Munger looks for a handful of things in people – integrity, intelligence, experience and dedication
  • Recognize your limits. How well do you know what you don’t know/ Don’t let your ego determine what you should do
  • Bad news that is true is better than good news that is false
  • People associate being wrong as a threat to their self-interest 
  • Labeling technique – when somebody labels you, whether you agree or not, you are more likely to comply and behave in ways consistent with that label
  • Avoid ideology at all costs
  • “There is nothing wrong with changing a plan when the situation has changed.” – Seneca
  • Base decisions on current situations and future consequences
  • Don’t fall in love with any particular point of view
  • Know your goals and options
  • Remember that people respond to immediate crisis and threats
  • People favor routine behavior over innovative behavior and similarly, people feel worse when they fail as a result of taking action than when they fail from doing nothing
  • Deciding to do nothing is also a decision. And the cost of doing nothing could be greater than the cost of taking an action
  • People give more weight to the present than to the future. We seek pleasure today at a cost of what may be better in the future
  • “We envy those who are near us in time, place, age or reputation.” – Aristotle
  • “The best way to avoid envy is the deserve the success you get.” – Aristotle
  • How we value things depends on what we compare them with
  • Sometimes it is the small, invisible changes that harm us the most
  • Accurate information is better than dramatic information. Back up vivid stories with facts and numbers
  • We see only what we have names for
  • Always look for alternative explanations
  • We see available information. We don’t see what isn’t reported. Missing information doesn’t draw our attention
  • A favor or gift is most effective when it is personal, significant and unexpected
  • Always try to see situations and people from their POV
  • People tend to like their kin, romantic partners and people similar to them more as well as those who are physically attractive. We also like and trust anything familiar
  • Concentrate on the issue and what you want to achieve
  • The vast majority of people would rather be wrong in a group than right in isolation
  • “It is easy in the world to live after the world’s opinion; it is easy in solitude to live after our own; but the great man is he who in the midst of the crowd keeps with perfect sweetness the independence of solitude.” – Ralph Waldo Emerson
  • When all are accountable, nobody is accountable
  • Being famous doesn’t give anybody special expertise – beware ads with celebrity endorsements
  • “We don’t like uncertainty. We have a need to understand and make sense of events. We refuse to accept the unknown. We don’t like the unpredictability and meaninglessness. We therefore seek explanations for why things happen. Especially if they are novel, puzzling or frightening. By finding patterns and causal relationships we get comfort and learn for the future.”
    • Consider how other possible outcomes might have happened. Don’t underestimate chance
  • Any reason, no matter how flimsy, often helps persuade others
  • 5 W’s – A rule for communication – must tell who was going to do what, where, when and why.
  • Memory is very selective and fallible – keep records of important events
  • Don’t confuse activity with results. There is no reason to do a good job with something you shouldn’t do in the first place
  • “Wise men talk because they have something to say; fools, because they have to say something.” – Plato
  • Awareness of ignorance is the beginning of wisdom
  • When we make big decisions, we could compare our expected feelings with those of people who have similar experiences today. In that sense, we are not as unique as we think we are
  • Understand your emotions and their influence on your behavior. Ask – Is there a reason behind my action?
  • Hold off on important decisions when you have just gone through an emotional experience
  • Cooling-off periods help us think things through
  • Stress increases our suggestibility
  • Stress is neither good nor bad in itself. It depends on the situation and our interpretation
  • “I’ve suffered a great many catastrophes in my life. Most of them never happened.” – Mark Twain
  • People tend to overestimate personal characteristics and motives when we explain the behavior of others and underestimate situational factors like social pressure, roles or things over which there are no control
  • The less knowledgeable we are about an issue, the more influenced we are by how it is framed
  • Advice from Munger – can learn to make fewer mistakes than others and how to fix your mistakes faster when you do make them. Were the factors that really govern the interests involved, rationally considered and what are the subconscious influences where the brain at a subconscious level is automatically doing these things – which by and large are useful, but which often mis function. And, take all the main models from psychology and use them as a checklist in reviewing outcomes in complex systems
Part 3 – The Physics and mathematics of Misjudgments
  • 9 Causes of Misjudgment/Mistakes
    1. Systems Thinking
      • Failing to consider that actions have both intended and unintended consequences. Includes failing to consider secondary and higher order consequences and inevitable implications
      • Failing to consider the likely reactions of others
      • Overestimating predictive ability or using unknowable factors in making predictions
    2. Scale and limits
      • Failing to consider that changes in size or time influence form, function and behavior
      • Failing to consider breakpoints, critical thresholds or limits
      • Failing to consider constraints – system’s performance constrained by its weakest link
    3. Causes
      • Not understanding what causes desired results
      • Believing cause resembles its effect – a big effect must have a big, complicated cause
      • Underestimating the influence of randomness in good or bad outcomes
      • Mistaking an effect for its cause
      • Attributing an outcome to a single cause when there are multiple
      • Mistaking correlation for cause
      • Drawing conclusions about causes from selective data
      • Invert, always invert! – look at problems backwards
    4. Numbers and their meaning
      • Looking at isolated numbers – failing to consider relationships and magnitudes. Not differentiating between absolute and relative risk
      • Underestimating the effect of exponential growth
      • Underestimating the time value of money
    5. Probabilities and number of possible outcomes
      • Underestimating the number of possible outcomes for unwanted events. Includes underestimating the probability and severity of rare or extreme events
      • Underestimating the chance of common but not publicized events
      • Believing one can control the outcome of events where chance is involved
      • Judging financial decisions by evaluating gains and losses instead of final state of wealth and personal value
      • Failing to consider the consequences of being wrong
    6. Scenarios
      • Overestimating the probability of scenarios where all of a series of steps must be achieved for a wanted outcome. Also, underestimating the opportunities for failure and what normally happens in similar situations
      • Underestimating the probability of system failure
      • Not adding a factor of safety for known and unknown risks
      • Invest a lot of time into researching and understanding your mistakes
    7. Coincidences and miracles
      • Underestimating that surprises and improbable events happen, somewhere, sometime to someone, if they have enough opportunities (large enough or time) to happen
      • Looking for meaning, searching for causes and making up patterns for chance events, especially events that have emotional implications
      • Failing to consider cases involving the absence of a cause or effect
    8. Reliability of case evidence
      • Overweighing individual case evidence and under-weighing the prior probability considering the base rate or evidence from many similar cases, random match, false positive or false negative and failing to consider relevant comparison population
    9. Misrepresentative evidence
      • Failing to consider changes in factors, context or conditions when using past evidence to predict likely future outcomes. Not searching for explanations to why past outcome happened, what is required to make past record continue and what forces change it
      • Overestimating evidence from a single case or small or unrepresentative samples
      • Underestimating the influence of chance in performance (success and failure)
      • Only seeing positive outcomes and paying little or no attention to negative outcomes and prior probabilities
      • Failing to consider variability of outcomes and their frequency
      • Failing to consider regression – in any series of events where chance is involved unique outcomes tends to regress back to the average outcome
      • Postmortems – Record your mistakes! Instead of forgetting about them, they should be highlighted
        • What was my original reason for doing something?
        • What were my assumptions?
        • How did reality work out relative to my original guess? What worked and what didn’t?
        • What worked well? What should I do differently? What did I fail to do? What did I miss? What must I learn? What must I stop doing?
Part 4 – Guidelines to Better Thinking
  • This section helps provide tools which create a foundation for rational thinking
  • 12 Tools for rational thinking
    1. Models of reality
      • A model is an idea that helps us better understand how the world works. Helps explain “why” and predict “how” people are likely to behave in certain situations
      • Ask yourself, “Is there anything I can do to make my whole mental process work better? And I [Munger] would say that the habit of mastering multiple models which underlie reality is the best thing you can do…It’s just so much fun – and it works so well.”
      • A valuable model produces meaningful explanations and predictions of likely future consequences where the cost of being wrong is high
      • Considering many ideas help us achieve a holistic view. No single discipline has all the answers – need to consider mathematics, physics, chemistry, engineering, biology, psychology and rank and use them in order of their reliability
      • Must understand how different ideas interact and combine
      • Can build your own mental models by looking around you and asking why things are happening (or why things are not happening).
    2. Meaning
      • Truly understand something when “without using the new word which you have just learned, try to rephrase what you have just learned in your own language.”
      • Meaning of words, events, causes, implications, purpose, reason, usefulness
      • “Never express yourself more clearly than you are able to think.” – Niels Bohr
      • Use ideas and terms people understand, that they are familiar with and can relate to
      • We shouldn’t engage in false precision
    3. Simplification
      • “If something is too hard, we move on to something else. What could be more simple than that?” – Charlie Munger
      • Make problems easier to solve. Eliminate everything except the essentials – break down a problem into its components but look at the problem holistically – first dispose of the easy questions
      • Make fewer but better decisions
      • Dealing with what’s important forces us to prioritize. There are only a few decisions of real importance. Don’t bother trying to get too much information of no use to explain or predict
      • Deal with the situations in live by knowing what to avoid. Reducing mistakes by learning what areas, situations and people to avoid is often a better use of time than seeking out new ways of succeeding. Also, it is often simpler to prevent something than to solve it
      • Shifting mental attention between tasks hugely inefficient. Actions and decisions are simpler when we focus on one thing at a time
      • Some important things we can’t know. Other things we can know but they are not important
      • Activity does not correlate with achievement
    4. Rules and filters
      • Gain more success from avoiding stupid decisions rather than making brilliant ones
      • Filters help us prioritize and figure out what makes sense. When we know what we want, we need criteria to evaluate alternatives. Try to use as few criteria as necessary to make your judgment. Then rank them in order of their importance and use them as filters
      • More information does not mean you are better off
      • Warren Buffet uses 4 criteria as filters
        • Can I understand it? If it passes this filter then,
          • Understanding for Buffett means thinking that he will have a reasonable probability of being able to assess where the business will be in 10 years
        • Does it look like it has some kind of sustainable advantage? If it passes this filter,
        • Is the management composed of able and honest people? If it passes this filter,
        • Is the price right? If it passes this filter, we write a check
      • Elimination – look for certain things that narrow down the possibilities
      • Checklist procedures – help reduce the chances of harm (pair with Gawande’s The Checklist Manifesto)
        • Should think about – different issues need different checklists, a checklist must include each critical item necessary for “safety” and avoiding “accidents” so we don’t need to rely on memory for items to be checked, readily usable and easy to use, agree with reality
        • Avoid excessive reliance on checklists as this can lead to a false sense of security
    5. Goals
      • How can we make the right decision if we don’t know what we want to achieve? Even if we don’t know what we want, we often know what we don’t want, meaning that our goal can be to avoid certain things
      • Goals should be – clearly defined, focused on results, concrete, realistic and logical, measurable, tailored to individual needs and subject to change
      • Goals need target dates and controls stations measuring the degree to which the goal is achieved
      • Always ask – What end result do I want? What causes that? What factors have a major impact on the outcome? What single factor has the most impact? Do I have the variable(s) needed for the goal to be achieved? What is the best way to achieve my goal? Have I considered what other effects my actions will have that will influence the final outcome?
    6. Alternatives
      • Opportunity cost – every minute we choose to spend on one thing is a minute unavailable to spend on other things. Every dollar we invest is a dollar unavailable for other available investments
      • When we decide whether to change something, we should measure it against the best of what we already have
    7. Consequences
      • Consider secondary and long-term effects of an action
      • Whenever we install a policy, take an action or evaluate statements, we must trace the consequences – remember four key things:
        • Pay attention to the whole system, direct and indirect effects
        • Consequences have implications or more consequences, some which may be unwanted. We can’t estimate all possible consequences but there is at least one unwanted consequence we should look out for,
        • Consider the effects of feedback, time, scale, repetition, critical thresholds and limits
        • Different alternatives have different consequences in terms of costs and benefits. Estimate the net effects over time and how desirable these are compared to what we want to achieve
    8. Quantification
      • How can you evaluate if a decision is intelligent or not if you can’t measure it against a relevant and important yardstick?
      • We need to understand what is behind the numbers
        • Buffett says that return on beginning equity capital is the most appropriate measure of single-year managerial performance
    9. Evidence
      • Evidence helps us prove what is likely to happen or likely to be true or false. Evidence comes from facts, observations, experiences, comparisons and experiments
      • Occam’s Razor – if we face two possible explanations which make the same predictions, the one based on the least number of unproven assumptions is preferable, until more evidence comes along
      • Past record is the single best guide
      • The following questions help decide if past evidence is representative of the future – observation (will past/present behavior continue?), explanation (why did it happen in the past or why does it happen now?), predictability (how representative is the past/present evidence for what is likely to happen in the future?), continuation and change (what is required to make the past/present record continue or to achieve the goal?), certainty and consequences (how certain am I?)
      • Falsify and disprove – a single piece of evidence against something will show that it is false
      • Look for evidence that disproves your explanation and don’t spend time on already disproved ideas or arguments or those that can’t be disproved
      • Engage in self-criticism and question your assumptions
      • Find your mistakes early and correct them quickly before they cause harm
      • The mental habit of thinking backward forces objectivity – because one way  to think a thing through backward is by taking your initial assumption and say, “let’s try and disprove it.” That is not what most people do with their initial assumption. They try and confirm it.
    10. Backward thinking
      • Avoid what causes the opposite of what you want to achieve and thinking backwards can help determine what these actions are
        • Should also make explicitly clear what we want to achieve
      • “Wise men profit more from fools than fools from wise men; for the wise men shun the mistakes of the fools, but fools do not imitate the successes of the wise.” – Cato
    11. Risk
      • Reflect on what can go wrong and ask what may cause this to turn into a catastrophe?
      • Being wrong causes both an actual loss and an opportunity cost
      • To protect us from all unknowns that lie ahead we can either avoid certain situations, make decisions that work for a wide range of outcomes, have backups or a huge margin of safety
    12. Attitudes
      • “Life is long if we know how to use it.” – Seneca
      • Know what you want and don’t want
      • Determine your abilities and limitations. Need to know what we don’t know or are not capable of knowing and avoid those areas
      • Ask – what is my nature? what motivates me? what is my tolerance for pain and risk? what has given me happiness in the past? what are my talents and skills? what are my limitations?
      • Be honest – act with integrity and individuality
      • Trusting people is efficient
      • Act as an exemplar
      • Treat people fairly – must be lovable
      • Don’t take life too seriously – have perspective, a positive attitude, enthusiasm and do what you enjoy
      • Have reasonable expectations – expect adversity
      • Live in the present – don’t emphasize the destination so much that you miss the journey. Stay in the present and enjoy life today
      • Be curious and open minded and always ask “why?”
Appendix
 
Munger Harvard School Commencement Speech 1986
  • Avoid drugs, envy, resentment, being unreliable, not learning from other’s mistakes, not standing on shoulders of giants, giving up, not looking at problems from different POVs, only reading/paying attention to information that confirms your own beliefs
  • Be objective
  • “Disraeli…learned to give up vengeance as a motivation for action, but he did retain some outlet for resentment by putting the names of people who wronged him on a piece of paper in a drawer. Then, from time to time, he reviewed these names and took pleasure in nothing the way the world had taken his enemies down without his assistance.”
Wisdom from Charles Munger and Warren Buffett
  • Appeal to other people’s interests over your own
  • Institutional imperative – tendency to resist change, make less than optimal capital deployment decisions, support foolish initiatives and imitate the actions of peer companies
  • Board of directors have few incentives (unless large owners) to replace CEO
  • Type of people to work with – need intellectual honesty and business owners must care who they sell to
  • Need role models early on
  • Emulate what you admire in others but also be aware of what you don’t like
  • Know your circle of competence
  • Use all available mental models, not just what you’re comfortable with
  • Scale extremely important – efficiencies, information (recognition), psychology (fit in), and in some industries leads to monopolies and specialization
    • Disadvantages of scale – specialization often leads to bureaucracy
  • On what something really means – ask “and then what?” to truly get at somethings core
  • There is a certain natural tendency to overlook anything that is simple and important
  • Avoid commodity businesses
  • Deal only with great people and you will avoid 99% of life’s headaches

Buffett and Munger: A Study in Simplicity and Uncommon, Common Sense by Peter Bevelin

Summary
  1. A very interesting dialogue between Warren Buffett, Charlie Munger, the “librarian” and the “seeker” of knowledge. The dialogue discusses how to live a successful, happy and fulfilling life, what to avoid in life and in business and how to improve mental biases and heuristics in order to make better decisions
Key Takeaways
  1. On fatal mistakes, prevention and simplicity
    1. Mistakes are a fact of life
    2. Don’t bother about mistakes that don’t actually matter
    3. Avoiding problems is better than being forced to solve them
    4. If we understand what works and not, we know what to do
    5. It is better to try to be consistently not stupid than to be very intelligent
    6. Thinking backwards is a great tool for solving problems
    7. Keep it simple and make it easy for yourself
    8. The secret is ignorance removal
  2. On what doesn’t work and what does
    1. Find and marry a lousy person
    2. Turn our body and mind into a wreck
    3. Only learn from your own terrible experiences
    4. Use a hammer as your only tool and approach every complex problem as if it was a nail
    5. Go through life with unreasonable expectations
    6. Only take care of your own interest
    7. Blindly trust and follow the recommendations of advisors and salesmen
    8. Mindlessly imitate the latest fads and fashions
    9. Overly care what other people think about you
    10. Let other people set your agenda in life
    11. Live above your means
    12. Go heavily into debt
    13. Go down and stay down when bad things happen
    14. When in trouble, feel sorry for yourself
    15. Be envious
    16. Be unreliable and unethical
    17. Be a jerk and treat people really badly
    18. Have a job that makes you feel miserable
    19. Work with something that goes against your nature and talent
    20. Believe you know everything about everything
    21. Associate with assholes
    22. Distort your problems so they fit your wishes
    23. Stick to, justify and rationalize your actions no matter how dumb they are
    24. Be an extreme ideologue
    25. Make it easy for people to cheat, steal and behave badly
    26. Risk what you have and need, to get what you don’t need
    27. Only look at the sunny upside (over stress the downside)
  3. On what else doesn’t work and what does in business and investing
    1. Invest your money in overpriced assets – preferably businesses without any competitive advantages or future and with lousy and crooked management
    2. If you are a businessman think like an investor and if you’re an investor, think like a businessman
    3. Investing is about where to allocate your capital
    4. Buy “wrongly” cheap productive assets you understand
    5. Things are often cheapest when people are fearful and pessimistic
    6. Be opportunistic and adapt and change when the facts and circumstances change
    7. Stick to businesses where you can assess that their economics is good and getting better
    8. Buy assets protected with a durable competitive advantage run by able and honest people
    9. Understand why it has a moat – the key factors and their permanence
    10. One test of the strength of a moat is essentiality and pricing power
    11. Go in a field, in which you have no interest, not any competence or talent for, no edge in and where the competition is huge
    12. Think about where the business is going to be in the future – not the macro factors
    13. Common sense is better than advanced math and computer models
  4. On filters and rules
    1. The right filters conserve thought and simplify life
    2. Never lose sight of what you’re trying to achieve or avoid
    3. The tune out “folly” filter
    4. The important and knowable filter
    5. The circle of competence filter
    6. The too tough filter
    7. The opportunity cost filter
    8. The “and then what?” filter
    9. The “compared to what?” filter
    10. Checklists help – assuming of we are competent enough to pick the key factors and evaluate them
    11. Have some avoid-rules
    12. Learning never stops
What I got out of it
  1. An incredible book on heuristics, mental biases, how to live, how to not live, what to avoid, the importance of thinking backwards. Highly recommend and will re-read many times moving forward
  • Buffett and Munger have an amazing ability to eliminate folly, simplify things and boil down issues to their essence and get right to the point and focus on simple and timeless truths. Succeed because rational and very seldom let extraneous factors interfere with their thoughts
  • Making better decisions helps avoid a lot of misery
  • Start out with failure and then engineer out its removal
  • Einstein’s razor – things should be made as simple as possible, but no simpler
  • The more basic knowledge you have, the less new knowledge you have to get
  • Seeking Synthesis – always putting things in context and having a latticework mindset, linking the largest areas and using/always adding to your toolbox
  • The very successful say no to almost everything – you must keep control of your time
  • Consistently rub your nose in your own mistakes
  • Best way to avoid envy is to plainly deserve the success you get
  • Set up a system and environment which plays to strengths and minimizes weaknesses
  • Ignorance more often begets confidence than does knowledge
  • There is enormous efficiency in good character. If crooks knew how profitable being honest is, they would be
  • Knowing what you ultimately want to accomplish makes it easier for you to decide what is and is not important
  • Good question for field you know little about – “can you give me a very simple example and explanation for what you’re talking about?”
  • To speak/write clearly is to think clearly – orangutan test
  • Iron rule of nature is you get what you reward for
  • No need for extra analysis – just know what you need to know
  • Attractive opportunities come from capitalizing on human behavior (fear, pessimism, greed)
  • Understanding a business should always be filter #1
  • Best way to understand moats and their key factors and permanence is to study companies who have achieved them
  • Almost always easier to figure out who loses (short horses rather than long autos)
  • Franchise – another word for moats, a product or service that: is needed or desired; is thought by its customers to have no close substitute and; is not subject to price regulation. These three allow a company to regularly price its product or service to earn high ROC. The test of a franchise is what a smart guy with a lot of money could do it if he tried. The real test of a business is how much damage a competitor can do, even if he is stupid about returns
  • Share of mind matters more than share of market
  • Best business by far has high ROC with little need of incremental capital to grow at high rates
  • If you had $1b, could you compete? – silver bullet question (ask CEOs if they could kill one competitor, who would it be and why?)
    • When speaking with management ask “If roles reversed, what would you ask if I were running your business?
  • Northern Pike Model – if you introduce a dominant species, they will soon take over (as WalMart did early on)
  • You don’t have to make money back the same way you lost it
  • It’s simple, to be a winner, work with winners – get great management and let them do their thing
  • if you can detach yourself temperamentally from the crowd, you’ll end up being very successful
  • What is important and knowable? Ignore the rest
  • Wall of Shame for things / investments that have been mistakes (don’t forget to include omissions!)
  • Always consider higher order effects and the implications 

A Few Lessons for Investors and Managers by Peter Bevelin

Summary
  1. Bevelin compiles Buffett’s investor letters as well as other good sources of value investing into a quick and easy-to-read investing manual
Key Takeaways
  1. What investing in financial assets is all about – laying out cash today in order to get more cash back in the future
  2. Valuation – follow the cash as it’s the only thing you can spend; rough approximations are enough
  3. The value of a business – beware optimistic predictions, accounting jargon
  4. Return on Tangible Invested Capital reflects the cash flow generating characteristics of the business – should be able to generate substantially more than $1 for every $1 invested
  5. Business characteristics
    1. The great – high returns, a sustainable moat and obstacles that make it tough for new companies to enter
    2. The good – earn good returns on tangible invested capital
    3. The gruesome – require a lot of capital at a low return business; I have to be smart every day businesses; fast changing industries;
  6. Past results as a guide – sometimes useful and sometimes dangerous
  7. The importance of trustworthy and talented management – integrity, talent and passion
  8. The importance of clear yardsticks to judge management performance
  9. Corporate governance – board’s most important job is to pick the right person to run the business and evaluate their performance
  10. Owners and management – just follow the golden rule; decentralization and trust and loyalty all pay off in multiples
  11. Management compensation – you get what you reward for. Incentives are a superpower
  12. M&A – dumb acquisitions cost owners far more than most other things
  13. A few management issues –  be honest and trustworthy and select people you can trust; look for companies with low HQ costs; clear communication
  14. How to reduce risk – prevention is much better than cure – keep it simple; know when you have an edge and buy with a margin of safety (fewer but larger bets); be conservative with debt; distrust biased advice; avoid mindless imitation and don’t be caught up in the latest fads and fashions; pay no attention to forecasting; have the right mental attitude towards market fluctuations
  15. Sometimes mistakes are made – do postmortems on dumb decisions; learn from others mistakes; see the world as it truly is
What I got out of it
  1. Incredible overview of Buffett’s investor letters and line of thinking. Highly recommend for anybody remotely interested in investing and how to properly manage a company

Capital Account: A Money Manager’s Reports on a Turbulent Decade by Marathon Asset Management

Summary
  1. Relates the story of the 2001 TMT bubble from the perspective of Marathon Asset Management
Key Takeaways
  1. Capital cycle theory – when companies trade at a premium in the stock market to their replacement cost, new investment is stimulated; that demand forecasts are inherently unreliable; that when competition is increasing, there is a great danger of supply exceeding demand; that investment bankers will promote excesses and that investors will capitulate to these developments. After the boom has turned to bust, capital cycle analysis that a period of consolidation in the industry is necessary before returns improve
    1. High returns will attract excess competition, which will in turn lower excess returns
    2. May not be great at spotting rewarding sectors but it will help you spot bubbles and overvaluation; must take a global perspective
    3. Analyze industries within the Capital Cycle framework and quality of management
    4. Reversion to the mean occurs only in the long run
    5. Before taking a position in out of favor sectors which have failed historically to earn their cost of capital, investors should first ascertain whether capital or capacity is actually being removed from the industry
    6. Capital cycle analysis must always be accompanied by a parallel analysis of management reinvestment discipline
  2. The sectors Marathon looks at are characterized by corporate restructuring, industrial consolidation, a focus on the core business and a history of underinvestment – may not be fashionable or exciting but often lead to good results
  3. Take the view that a strong relationship exists between stock prices and replacement cost and furthermore, that the best investment returns are achieved when shares sell at a material discount to their replacement cost (Cemex)
  4. Investment experience shows that the range of investment outcomes is not normally distributed but is characterized by fat tails – shares spend relatively little time at fair value (highest quality companies can be undervalued for decades – WalMart)
  5. Business executives and gate keepers (lawyers, auditors, etc.) are mostly to blame for bubble
  6. Investors who ignore the noise generated by investment banks are likely to be winners
  7. Goodhart’s law – When any single measure of corporate profitability becomes a target for investors and business managers, it becomes useless
  8. EBITDA was popularized during this time as it stripped all “bad stuff” (aka costs) from earnings
  9. Folly of short termism – quarterly figures inherently unreliable, profits generated by a company over a three month period are tiny in comparison to the total value of the business, changes in competitive position cannot be measured over such a brief period of time, earnings can be manipulated
  10. Avoid IPOs, really anything that is being sold to you – most new issues are poor investments or else they wouldn’t take place at all
  11. Ability to allocate capital efficiently is the biggest predictor of share price performance.
  12. Profitability is determined primarily by the competitive environment, or the supply side, rather than by revenue growth trends. It is better to invest in a mature industry where competition is declining than in a growing industry where competition is expanding
  13. The winners are those who make fewer mistakes
  14. Overvaluation (Tobin’s Q = market cap / replacement cost) leads to over expansion which leads to too much supply which lowers profitability
  15. Distinction between innovation and adoption is critical
  16. Over the long run, it is a company’s ROC, not changes in quarterly earnings, which primarily determines the direction of its share price. The ROC of any company is largely subject to the state of competition within its industry.
  17. When shares are priced on the assumption that existing returns are likely to be maintained or even improved, then a rapid increase in industry capacity should serve as a red light. Unfortunately, business people have a tendency to extrapolate from recent trends. The ‘animal spirits’ of the corporate world tend towards optimism and overconfidence. CEOs frequently assume their competitive position is stronger than it is and that currently favorable conditions will continue indefinitely. As a result, they are frequently surprised by their unfavorable consequences of capital expansion in their industry. And professional investors, who mostly take their cue from what management tells them, are also liable to be wrong-footed.
  18. Growth company framework
  19. As one moves down the growth stock decision tree, business risk tends to decline as management has the operating model more under its control. The failure rate of stocks is therefore lower
  20. Substitutionary locomotion model the best – efficiency is at the heart of the model but a substantial amount of ‘savings’ are redeployed either for advertising, to generate new demand, or for innovation, to create more products. Because accelerated advertising or research goes through the profit and loss account, these companies often do not appear to be growing earnings as fast as they might be. In the race of fable, they resemble the tortoise rather than the hare. Management of such companies understand that not all costs are equally bad. They have a rising quality of costs as well as earnings (Colgate, Wrigley prime examples). JNJ, GSK, and Merck raising R&D budgets and might appear to be part of this elite but the issue  is complicated by growing competition in the pharma sector which is shortening life cycles of new drugs
  21. Rising advertising budgets show three things – underlying earnings growth rate that these companies have declared is sufficiently robust to allow for increased expenditure; providing these businesses have not been permanently damaged by the prior decline in advertising outlays, revenue growth should be reasonably robust; since there is little point in promoting a tired product, the rise in advertising spend also implies an increase in product innovation
  22. A successful product must make a consumer’s life easier (razor blades) or more pleasurable (Coca Cola)
  23. Efficiency based model – a key criterion for success is that the company should be profitable enough to expand but not so profitable that competitors are attracted into the field (WalMart, Home Depot)
  24. Price-based growth model – Has pricing power and can increase margins and profits through raising its selling price or reducing input costs (Kellogg, PM)
  25. Growth due to overvaluation – when a company’s shares are trading at many times the replacement cost of the business, there is a great incentive to grow the business
  26. Growth by acquisition – Source of value add is either merger synergies or a valuation arbitrage between share prices of the lowly valued target company and the highly valued predator
  27. Seeing quantum increase in mispricings and it often takes years to revert
  28. Low inflation doesn’t have the magical power to prep markets like many believe
  29. Believes passive investing is dumb as index construction is inherently flawed
  30. One of primary cures for poor returns is consolidation – economies of scale
  31. Capitalism works efficiently only under conditions of genuine competition
  32. 2 handled pump – management talks up the stock, sells at all time highs, sees stock tumble and buys again at lows (Silver Kings)
  33. MacGuffin – something which is just believable enough without being either understandable or clearly measurable
  34. EVA – Economic Value Add; spread between ROIC and cost of capital – bigger –> higher valuation
  35. Leads to some poor incentives – short-term, cut good expenses such as R&D and advertising to momentarily boost earnings
  36. Buybacks becoming increasingly popular but improperly implemented
  37. Turnarounds
  38. Most important criteria for easier turnarounds – intellectually honest management, good capital allocation (declining levels of investment preferred), robust core business, long product lives/loyal customer base, constrained supply side, good balance sheet, constructive fellow investors (bond and equity), properly constructed management incentives
  39. More difficult turnarounds – management in denial, more investment needed, core business troubled, short product lives/disloyal customer base, supply side out of control, bad balance sheet, stubborn investment constituencies, counter-productive incentives
  40. Smooth, incremental growth impossible but market penalizes if can’t deliver
  41. Importance of meeting management – by personally meeting can get to know management on a deeper level by observing tendencies, body language, lifestyle, see if they keep their promises, make sure they’re not formerly investment bankers, encourage a cultish personality, are self-promotion; like some ruthlessness in their managers as well as loyalty, intelligence, flexibility and honesty
  42. Richemont, Bunzl, Reckitt Benckiser, Heineken, Nokia, Intertek, Svenska Handelsbanken
  43. The more overvalued the market is, the more likely acquisitions will be made via shares
  44. What I got out of it
    1. Really great perspective on how Marathon analyzed the bubble in real time, how they kept their patience and viewed the situation in real time and how they avoided the mania and eventual losses