Tag Archives: Investing

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…

Investing: The Last Liberal Art by Robert Hagstrom

Summary
  1. Hagstrom walks the reader through why and how to incorporate fundamental principles from multiple fields to become a better thinker, decision maker, investor, etc.
Key Takeaways
  1. Worldly Wisdom
    1. Combine key ideas from all disciplines and then develop a latticework in head to ‘hang’ all mental models on
    2. Chances of good decisions improve when many, disparate models yield the same conclusion
    3. Educate self and then train to see problems by seeing/thinking differently
      1. Learn big ideas so well that they are always with you
    4. Key is finding linkages and connecting one idea to another
      1. Connectionism – we learn by analogy, more connections leads to more intelligence
      2. Massive number of connections more efficient than raw speed (small world networks are everywhere)
    5. Two keys to innovative thinking – understand basic disciplines we draw knowledge from and be aware of the benefits and uses of metaphors
      1. Concise, memorable, colorful way to depict thought, action, ideas and more importantly translate ideas into models – stimulating understanding and new ideas
  2. Physics
    1. The bridge between equilibrium in physics, economics and the stock market
    2. Equilibrium – state of balance between two opposing forces, powers or influences
      1. Static vs. dynamic
      2. Rational actions lead to stock market equilibrium – where the shadow price (intrinsic value) = stock price
        1. Now argue market is complex adaptive system – a network of many individual agents all acting in parallel and interacting with one another. The critical variable that makes a system both complex and adaptive is the idea that agents in the system accumulate experience by interacting with other agents and then change themselves to adapt to a changing environment
          1. Irrational, organic, not efficient
  3. Biology
    1. Evolution and natural selection to law of economic selection
    2. After crashes, market and economy best understood from a biological perspective as equilibrium could not account for them
    3. Struggle between species and individuals of same species leads to natural selection and evolution
    4. Schumpter – economics essentially an evolutionary process of continuous and creative destruction
      1. Innovation, a visionary and action-oriented entrepreneur and access to credit are all necessary
      2. Innovation leads to periods of punctuated equilibria – creative destruction
    5. 4 distinct features of economy
      1. Dispersed interaction – what happens in the economy is determined by the interactions of a great number of individual agents all acting in parallel
      2. No global controller
      3. Continual adaptation (co-evolution)
      4. Out of equilibrium dynamics – constant change leads to a system constantly out of equilibrium
    6. Evolution takes place sin stock market via economic selection and capital allocation
    7. Living systems make themselves up as they go along
    8. Efficiency and evolutionary / behavioral not necessarily exclusive – times of less emotions leads to more efficient market
  4. Sociology
    1. Study of how individuals function in society and ultimate goal is predicting group behavior
    2. Relationship between individual investor and stock market a profound puzzle
    3. All human interactions and systems are complex adaptive – can’t separate part from the whole and behavior constantly changes as agents and therefore system adapts
    4. Self-organization and self-reinforcement found in physics, biology, economics, etc.
    5. Emergence – larger entities arise out of interactions of simpler, smaller entities and have characteristics that the smaller entities do not exhibit
      1. Crowds can be collectively intelligent IF diverse and independent
      2. Smart and dumb agents lead to better outcomes than a group of just smart people
      3. Information cascades, which lead to diversity breakdowns happen when people make decisions based on others rather than private information and leads to inefficient system
        1. Can even happen with small groups if have a very dominant leader
      4. Self-organized criticality – market one example where instability is inherent, unpredictable and small fluctuations lead to big changes
        1. Different meta-models of reality (quant vs. fundamentally oriented…) leads to instability
      5. Complex adaptive, self-organization leads to emergence which leads to instability, unpredictability, criticality
  5. Psychology
    1. Anchoring, framing, overreaction, overconfidence, mental accounting, loss aversion key biases
    2. Equity risk premium is puzzling – people hold bonds because of loss aversion and mental accounting
    3. Loss aversion makes people short-term focused
    4. Longer investor holds an asset, the more attractive it becomes IF not evaluated frequently – advises checking prices only once per year!
    5. Information overload can lead to illusion of knowledge
    6. Don’t be  Walter Mitty investor – feed during difficult times!
    7. Decisions we make based on skill lead to higher risk taking and luck to lower
    8. Mental models are imprecise ways of modeling reality but very helpful and simplify life
      1. Mistakes – believe models equiprobable, focus on  few or one, ignore what is not easily seen
    9. Innate pattern seeking leads to magical thinking and superstitions by people trying to explain the unexplainable
      1. In this case, beliefs precede reasoning, beliefs dictate what you see
        1. Why people listen to forecasters – quells anxiety we hate to live with even if we rationally know how stupid it is
    10. Reduce noise via accurate communication of information makes for better rational decisions
      1. Correction device – get information from first-hand sources and then do your best to remove prejudices and biases
  6. Philosophy
    1. Forces us to think and can’t be transferred intact from one mind to another
    2. Metaphysics – ideas independent of space and time (God, afterlife)
    3. Aesthetics / ethics / politics three main branches
    4. Epistemology – study of the nature/limits of knowledge; thinking about thinking
      1. Develop rigorous, cohesive epistemological routines
    5. Failure to explain caused by failure to describe – Mandelbrot 
    6. Disorder simply order misunderstood
    7. Wittgenstein – world we see is defined and given meaning by the words we choose
      1. Reality is shaped by the words we select
      2. Stories very powerful description tools – beware of the overconfidence they can deliver
    8. Pragmatism – true belief defined by actions and habits it produces (William James)
      1. Idea or action is real, good, true if it makes a meaningful difference
        1. Our understanding of truth evolves as it is based on results
        2. No absolutes
  7. Literature
    1. Read selectively but analytically
    2. Always evaluate its worth in the larger picture and then either reject or incorporate what you learn into your mental models – the importance of reflection!
    3. Improves understanding (over fact collecting) and critical thinking
    4. Critical mindsets evaluate the facts and separate facts from opinion
    5. Fiction important because it helps us learn from others’ experiences
    6. Detectives best practices
      1. Develop a skeptic’s mindset; don’t automatically accept conventional wisdom
      2. Conduct a thorough investigation
      3. Begin an investigation with an objective and unemotional viewpoint
      4. Pay attention to the tiniest details
      5. Remain open-minded to new, even contrary, information
      6. Apply a process of logical reasoning to all you learn
      7. Become a student of psychology
      8. Have faith in your intuition
      9. Seek alternative explanations and redescriptions
  8. Mathematics
    1. Bayes’ Theorem – updating initial beliefs with new information leads to new and improved belief
      1. AKA Decision Tree Theory
    2. Probability theory – analysis of random phenomena
    3. Kelly Criterion – how to size bets
      1. 2p – 1 = x (p = probability of winning)
      2. To compensate people not having an infinite bankroll or time horizon, halve (or take some fraction) of the Kelly Criterion
    4. Never fail to take variation into account – trends of system vs. trends in system (individual winners even during sideways overall market)
    5. Never fail to take into account regression to the mean
  9. Decision Making
    1. Intuition helpful when situation is reliable enough to be predictable and when can learn regularities through prolonged practice (mostly linear systems)
      1. Intuition nothing more than recognition – increase store of knowledge and connections leads to improved intuition
    2. How you think more important than what you think
    3. Humans cognitive misers and stop thinking the minute they’re satisfied with an answer
    4. Building blocks from many disciplines used to form mental models must be dynamic and updated with new information
What I got out of it
  1. A fascinating read which was helpful to get a good, broad understanding of what it means to be a multi-disciplinary learner

The Manual of Ideas: The Proven Framework for Finding the Best Value Investments by John Mihaljevic

Summary
  1. Describes some of the world’s most respected investors’ proven, proprietary frameworks for finding, researching, analyzing, and implementing the best value investing opportunities
Key Takeaways
  1. Each investor must carve out a personal way to invest in order to succeed
  2. a share of a stock is a share in the ownership of a business
  3. investors tend to buy after a period of good performance and withdraw after a period of bad performance, which is bad for the funds results
  4. Those considering an investment in a hedge fund may first wish to convince themselves that their prospective fund manager can beat Buffett. Doing this on a prefee basis is hard enough; on an afterfee basis, the odds diminish considerably.
  5. Becoming a smart asset allocator is key to managerial success
  6. believe that our investment decisions affects the world
  7. Losses have a perverse impact on long-term capital appreciation, 20% drop in book value requires a 25% subsequent gain in order to offset the loss
  8. Increase in size makes it increasingly difficult to maintain same level of success
  9. thinking like a capital allocator is coupled with thinking like an owner. looking to the business rather than the market for return on investment
  10. Graham-style investing starts with price of a stock.  If it does not look like a bargain based on tangible metrics, Graham-style investors are not interested.
  11. Eugene Fama and Kenneth French have found through their studies that equities with high book-to-market ratios outperform those with low ratios.
  12. Uncovering equities that provide both asset protection on balance sheet and own businesses with high returns on capital are treasures.  This is hard to find unless the business has experienced a steep near-term profit decline.
  13. by prioritizing return of cash to shareholders, low-return businesses can assist investors in earning a strong investment return, assuming the equity purchase price was favorable.
  14. Investors may overestimate liquidation values, as the reality of a dying business tends to hide some nasty surprises
  15. Acceptance of discomfort can be rewarding in investing, as fearful equities frequently trade at exceptionally low valuations.
  16. investing in asset-rich but low return business, time may be working against you.  As long as management can hold on to the assets and keep reinvesting at low returns, shareholders may earn unimpressive returns despite a bargain purchase price. As result, catalysts become a relevant consideration.
  17. businesses trading at deep value prices are among those most likely to be creatively destroyed. It seems unwise to allocate a large portion of investable capital to any one deep value opportunity, even if it promises a large expected return
  18. Several considerations may augment the likelihood that a Graham-style screen yields a list of market-beating investment candidates.  Share re-purchases, insider buying, and cash generated through working capital shrinkage may be used as screening factors.
  19. When we value a company based solely on readily ascertainable balance sheet values, we run the risk that those values erode over time, negatively impacting future equity value.
  20. Many companies can be appraised most accurately by analyzing each of their distinct businesses or assets separately and then adding up those components of value to arrive at an estimate of overall enterprise or equity value.
  21. A reason for the market’s occasional mispricing of companies with multiple sources of value may be investors’ unwillingness to value assets that differ materially from a company’s core assets.
  22. Companies with distinct components of value often enjoy greater strategic flexibility, as they may divest a fairly valued asset to improve the balance sheet, repurchase undervalued shares, or reinvest capital in a high-return business.
  23. Sometimes investors, in their zeal to create a sum-of-the-parts opportunity, slice a company into too many parts, creating an attractive investment thesis in theory but not in reality
  24. We normally do not require a catalyst, but we find that situations with multiple sources of value are more prone to becoming value traps in the absence of strategic action.
  25. It matters tremendously whether the offer is “buy one get one free” or if it is “buy ten get one free”.  As shoppers we recognize the former as a more compelling offer. As investors, we often overlook this important distinction.
  26. sum-of-the-parts opportunities come in a few different flavors, each of which demands a slightly different approach to screening. excess assets typically consist of cash and cash like assets, stakes in other businesses, real estate holdings, or a combination of these asset types.
  27. Some hidden asset stories are so compelling that they attract quite a few smart investors, potentially eliminating both the valuation discount and the hidden nature of the assets.  Investors may become patsies by failing to realize how many other smart investors have bought into the same story of hidden value.
  28. Whenever hidden assets motivate us to consider an equity security, the question of how the assets will cease to be hidden becomes important.  In this context, we are less interested in the speculative question of what will prompt other investors to see what we are seeing.  rather, we focus on the economically important issue of how the value inherent in the hidden assets will accrue to us as shareholders– and when.
  29. Buying good companies when they are cheap is invaluable advice, as demonstrated in Greenblatt’s “the Little Book That Beats the Market”.
  30. Higher return on capital employed indicates a good business.  Typically calculate capital employed as net working capital plus net fixed assets.
  31. Greenblatt’s use of operating income to enterprise value as the way of determining cheapness is congruent with his use of operating income to capital employed as the way of determining quality, as the effects of leverage and taxes are stripped from both calculations.
  32. Greenblatt’s magic formula suggests that it will keep outperforming markets over time despite the fact that its success, in theory, would attract a flock of investors and therefore eliminating its prospective attractiveness.
  33. Mr. Market makes two mistakes with some consistency: it over values high-return businesses whose returns on capital derive from explosive but ultimately transitory trends or fads. On the flip side, the market may undervalue unhyped quality businesses with sustainable high-return  reinvestment opportunities.
  34. The future is what counts in investing, and while historical data has the advantage of certainty, forward-looking estimates have the advantage of relevance.
  35. high returns on existing capital – the capital already employed in a business – are almost meaningless without the ability to invest new capital at above-average returns.  Returns on existing capital, whether high or low, are already reflected in a company’s operating income.
  36. Business executives can distinguish themselves in two ways: business value creation and smart capital allocation
  37. Distinguish between business performance and stock price.  Better management results generally mean better business outcomes, but in terms of the stock beating the market also depends on market quotation at time of investment.
  38. Eliminate the bad actors when it comes to finding better management, even when some are esteemed by the business establishment.
  39. Some factors that reflect CEO attitude towards owners
    1. communication with shareholders open and honest
    2. composition of board of directors
    3. what does financial leverage tell us about the management
  40. Determinations like shareholder friendliness, alignment of interests and the ability to run a business not only involve many variables but also an element of judgment.  while we cannot exactly screen for jockey stocks, we can use screens to move a step closer toward finding companies with good management
  41. Screening for close alignment involves two proxies, stock ownership and insider buying activity.
  42. Most capital allocators view reinvestment as a default option, giving little consideration to the alternatives.
  43. Making a list of great capital allocators represents a continuous process of discovery and curation.  Corporate executives come and go, and seemingly great managers may reveal themselves as not so great over time.
  44. Subjective assessment of management in a one on one meeting likely adds value to the investment process, assuming the investor is aware of the biases involved and judges correctly that awareness will render inconsequential any biases.
  45. in addition to selecting a proper focus for a meeting, investors may want to prioritize meetings likely to produce incremental, differentiated insights.
  46. hedgefundletters.com
  47. One of the best pieces of advice “Do your own work and do not trust the tips of others”. nonetheless, following the moves of super investors can be both smart and profitable, if done correctly.
  48. Common traits of super investors, Other than remarkable returns, are clear thinking, lucid communication, a visible passion for the process of investing and surprisingly humble attitude toward success.
  49. Even if we accept that super investors are likely to outperform the market, it is not entirely clear that copying superinvestors also leads to outperformance
  50. The problem is not that all investors make mistakes but also that our ability to stick with an investment is diminished if we have not done the research to give ourselves a certain level of conviction in an idea.
  51. Investors may invest in macro theme or political outcome that makes them invest in individual stocks that they may not be entirely sure about.  Viewing these stock purchases as endorsements from such investors would be a mistake
  52. Factors to track superinvestors: decide which type of investors to track, concentration of portfolio, average portfolio turnover, propensity to employ short selling, and congruence between one’s own investment approach and that of a superinvestor
  53. Turnover is important because as outside observers we receive only delayed notice of other investors’ buy-sell activity.  the higher the turnover, the higher the chance that an investors is considering selling a holding by the time we consider buying it.
  54. Context is paramount when assessing the purchase and sale activity of superinvestors.  imagine three investors, each of whom has invested five percent of their respective equity portfolios in Bank of America.  It would be wrong to infer that each investor’s position has comparable significance for our purposes.
  55. Several key developments have created opportunities for small stock investors, including an increase in the size of institutional portfolios, an escalation of compensation expectations, exclusion of small stocks from major market indices, and scant research coverage by sell-side firms.
  56. Major shareholders have more influence on small-company CEOs than they do on their large-company counterparts, as more investment firms can credibly put small companies in play.
  57. We find that small stocks outperform large stocks by a statistically significant margin over time.  while the results differ based on the time periods examined and the definitions used, the verdict is clearly in favor of small stocks.
  58. Even if small caps as a group stop outperforming large caps, the differential between top and bottom performers should continue to be greater in the case of smaller stocks, providing opportunities for research-driven investors.
  59. While underfollowed situations generally offer fertile ground for research-driven investors, it is not always necessary that many people analyze an investment for pricing inefficiency to be eliminated.
  60. In small cap arena, moving beyond quantitative screens is valuable because few professionals are willing to start at A and work through Z in their appraisal of qualitative value drivers of small companies.
  61. Small company executives are also generally more forthcoming than are corporate executives whose ability to communicate spontaneously has been lawyered into oblivion.  Ask a small company CEO how business is going and you might get an answer.
  62. one well-known drawback of small stock investing is the, at times, severely constrained trading liquidity of smaller companies.  Wider bid-ask spreads, greater market impact, and perhaps greater trading commissions conspire to make entering and exiting the equity of small companies a costly affair.
  63. Many of the best small stock opportunities elude discovery by quantitative screens.  the reasons include rapid change in company fundamentals, the disproportionate impact of management quality on value, and the tendency of small companies to lump nonrecurring items into financial reports.
  64. we may uncover hidden inflection points by scouring the small-cap landscape for companies with two or more businesses, one of which is typically a large, declining legacy business.  if the other business is a profitable growth business, we may have found a compelling opportunity.
  65. Special situations encompass equities whose near to medium term stock price performance is largely independent of the performance of equity markets.
  66. the flood of talent and capital has taken some areas of special situation investing from obscurity to popularity, reducing prospective investment returns.
  67. the more obscure a market niche, the higher the likelihood that diligent investors will generate market beating returns.
  68. in markets that exhibit informational inefficiency, rewards may accrue to those who make the effort to obtain timely, accurate and relevant information.
  69. Analytical inefficiencies may play an even greater role in driving outperformance in special situations. While information is generally available to investors willing to dig for it, many market participants struggle to overcome the analytical hurdles.
  70. Investing rules, as distinct from laws, need to be broken occasionally in the pursuit of investment excellence. In this context, rules include the financial formulas we have memorized along the ways.
  71. Some insights can be gained only if we launch the process of inquiry at the relevant point in time.  If we do so, we may enrich the process with new insights at a later date, but if we fail to launch the process, we may never capture the available insights.
  72. Special situations are one of the few investment areas in which it makes sense to pay at least as much attention to the time component of annualized return as to the absolute return expected in a particular situation.
  73. Special situations crystallize the meaning of value.  In a liquidation, value is determined solely by when and how much cash we will receive in exchange for the cash we give up today. When no terminal value remains, we cannot base the investment thesis on what other investors might pay for a business.
  74. In the absence of identifiable drivers of inefficiency, the probability may be higher that our appraisal of value contains an oversight or flaw.  If we can identify a non-fundamental factor that explains the low valuation, we gain confidence in an estimate of value that differs from the market price.
  75. Passive returns to investing in leveraged equities reveal little about the merits of such an approach.  On the other hand, the all-but-certain wide dispersion of returns strikes us as crucial.
  76. It would be difficult to overstate the importance of judgment in this area.  Even if all investors possessed comprehensive data on equity stubs, their investment decisions, and outcomes, would differ materially.
  77. We need to be careful not to overreach when our judgment turns out to be correct.  The payoffs in equity stubs may exert an intoxicating effect on the successful investor.
  78. Do to the lopsided payoff in leveraged equities, the probability of winning on any one investment may be well under 50 percent.  The low batting average increases the size of the sample required to estimate the ex ante likelihood of success with any confidence.
  79. It helps to commit our investment theses to paper, and then test and refine them over time. In leveraged equities, experience can be an investor’s key asset, it interpreted properly.  We add this qualification because a danger exists that we overlearn.
  80. The tendency of investors to think about the likely outcome rather than the range of possible outcomes represents a key stumbling block to success in leveraged equities.
  81. Assuming we wish to wade into treacherous but potentially rewarding equity stubs, one of the key considerations in each situation is the ownership of the debt on a company’s books.
  82. We distinguish between two types of equity stubs for screening purposes: first, we look for companies that have been designed as equity stubs, namely, private equity type investments available in the public market.  Second, we target companies that have become equity stubs due to some kind of stumble.
  83. Our experience suggests that industry- side sell-offs represent better hunting grounds for
What I got out of it
  1. Good overview of where to look for and how to look for value investments

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. Peter Bevelin lives in Malmo – visit when go to Sweden
  2. 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.”
  3. Learn from other’s mistakes
  4. Learn the big ideas that underlie reality and develop good thinking habits (namely, objectivity)
  5. This book is a compilation of what Bevelin has learned from reading some of the works of the world’s best thinkers
  6. 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

So You Want to Start a Hedge Fund by Ted Seides

Summary
  1. First book written by an insider that looks under the hood of the industry and offers thoughtful views on key success drivers and pitfalls – for asset allocators and managers alike
Key Takeaways
  1. Ted Seides is the guru of starting hedge funds and decided to write the book now as competition between hedge funds is at an all time high
  2. Lessons for Managers
    1. Attracting Capital
      1. Be thoughtful before speaking to prospects
      2. Reflect on how you want to present yourself
      3. Offer incentives to get all important early wins
      4. Dedicate resources to facilitate the marketing process
      5. Create a brand and leverage the buzz
      6. Be prepared in advance and strike while the iron is hot
      7. Diversify client base to build a great business
    2. Team
      1. Investing in people is the best decision you can make
      2. Your organization will evolve but your culture remains
      3. The two-headed portfolio manager is nearly extinct, so choose a structure more fit to survive (avoid co-portfolio managers)
      4. Put your destiny in your own hands
      5. Make the changes you need to thrive irrespective of external perception
      6. Stay connected to the drivers of your success
    3. Investment Strategy
      1. Be true to yourself
      2. When getting started, don’t let perfect be the enemy of good
      3. Communicate frequently with clients to sustain a flexible strategy
      4. Anticipate the inevitable ebb and flow of a focused strategy
      5. Pay attention to process and outcomes will follow
    4. Investment Performance
      1. Focusing on the short term is antithetical to achieving long-term success
      2. When you think you have arrived, your next adventure will just have begun
      3. If you fly too close to the sun, you’re apt to get burned
      4. Never underestimate the role of luck
    5. Allocator Relationships
      1. Mirror your potential partner to learn who he is
      2. Strive to give more for less
      3. Be frank about the challenges you face – teaching something of value may pay dividends down the road
      4. Share your honest assessment of the opportunity set in good times and bad
      5. When you strip away the label, an allocator’s job is a lot like your
  3. Lessons for Allocators
    1. Attracting Capital
      1. Your time is precious – manage it well
      2. The early bird gets the worm
      3. Putting yourself in your manager’s shoes may shed light on where others see darkness
      4. Timing matters, so separate your decision to invest with a manager from your timing of when to invest
      5. Hot managers may cause you to gloss over important issues; cold ones may offer opportunities glossed over by others
      6. Follow your own voice when exiting managers
    2. Team
      1. Prioritize talent development in your manager assessment
      2. Expect some ugliness inside the sausage factory
      3. Avoid marriages of convenience with a co-portfolio manager structure
      4. Don’t be alarmed by change in a nascent organization
      5. Scrutinize your assumptions regularly when a firm grows quickly
    3. Investment Strategy
      1. Write down your goals in advance, and make honest assessments of performance against those goals
      2. Investigate the quality of a manager’s early results – you may find that some babies are thrown out with the bathwater
      3. Communicate thoroughly and openly with managers to develop a shared understanding of expectations
      4. Pay attention to process, and outcomes will follow
    4. Investment Performance
      1. Your interactions may affect your manager’s behavior
      2. You will chase performance, so make sure it is for the right reasons
      3. Focus on what matters most
      4. Recognize the difference between luck and skill
    5. Allocator Relationships
      1. Be your best self in your relationships with managers
      2. Look to start ups to extract better terms without adverse selection
      3. Adjust your mental model for the particular circumstances at hand
      4. When you fall in love, take your time
      5. When managers call for the ball, listen; when they run for the hills, proceed with caution
      6. Learn from the best by applying your managers’ best practices to your investment process
  4. Successful hedge funds are driven by the passions of their founder(s)
  5. Calls out Randall Stutman and Carol Morley at the Imprint Group to help improve leadership and culture at firms
  6. A manager’s investment strategy touches every aspect of his business. The strategy reflects his experience and temperament and is a key driver of the firm’s performance. When clearly articulated, the strategy also sets the foundation for the firm’s common mission, organization and marketing story
What I got out of it
  1. Interesting read and a good resource for anybody looking to start their own hedge fund or for managers looking to deploy capital to a newly formed hedge fund

The Dhando Investor by Mohnish Pabrai

Summary
  1. Dhando investing is all about value investing – maximum rewards with minimal risk. Dhando = endeavors that create wealth. “Heads I win, tails I don’t lose much”
Key Takeaways
  1. Life is a journey and the journey is the destination
  2. Uses the Patel family from India as a case study. They first immigrated to the US in the 1970s and today own over half the motels in the US. They came from nothing but were able to buy distressed motels for little, get bank financing, live/work in these motels. Their downside was basically zero and upside was astronomical
  3. Dhando all about maximizing reward and minimizing risk
  4. Make few bets, big bets, infrequent bets (about 8-10 investments in your portfolio)
  5. 9 core Dhando Principles
    1. Focus on buying existing businesses
    2. Buy simple businesses with an ultra slow rate of change
    3. Buy distressed businesses in distressed industries
    4. Buy businesses with a durable competitive advantage (moat)
    5. Bet heavily when the odds are overwhelmingly in your favor
    6. Focus on arbitrage
    7. Buy businesses at big discounts to their underlying intrinsic value
    8. Look for low-risk, high-uncertainty businesses
    9. It’s better to be a copycat than an innovator
  6. “Our life is frittered away by detail…simplify, simplify.”
    1. “Everything about Dhando is simple, and therein lies its power. The psychological warfare begins after you buy stock. The most potent weapon to fight these forces is to buy painfully simple businesses with painfully simple theses for why you’re likely to make a great deal of money and unlikely to lose much. Always write the thesis down and if it takes more than a short paragraph, there is a fundamental problem”
  7. Moats are often mostly hidden
  8. High ROC, ROIC indicative of moats
  9. Kelly formula: edge / odds = fraction of your portfolio you invest in a company
  10. The spreads in arbitrage eventually close but the moat and time of spread very important
  11. Try not to sell anything, especially losers, within 3 years as this is typically the amount of time it takes for the price/value gap to close
    1. Any stock cannot be sold at a loss within two to three years unless you can say with a high degree of certainty that current intrinsic value is less than the current price the market is offering
  12. Most don’t understand the difference between risk and uncertainty, take advantage!
  13. Good management gives you upside options for free
  14. Screen – high dividend yield, low P/E, well off from highs
  15. All knowledge is cumulative. Read voraciously, wait patiently and swing big but infrequently
  16. Independence of thought is fundamental to sound investing
  17. Value investing fundamentally contrarian in nature
  18. Have a crystal clear exit plan when buying a stock. Pabrai typically begins selling some if market value comes to within 90% of intrinsic value and most of it if it reaches 100%
  19. Checklist
    1. Is it a business I understand very well – squarely within my circle of competence?
    2. Do I know the intrinsic value of the business today and, with a high degree of certainty, how it is likely to change over the next few years?
    3. Is the business priced at a large discount to intrinsic value today and in two to three years? Over 50%?
    4. Would I be willing to invest a large part of my net worth into this business?
    5. Is the downside minimal?
    6. Does the business have a moat?
    7. Is it run by able and honest managers?
  20. Idea Generation
    1. Value Investors Club – people do write ups on particular stocks and winners get $5,000 from Greenblatt
    2. Magic Formula Investing – put together by Greenblatt, compiles stocks with low P/E and ROIC
      1. Focusing on companies with a VIC write up and on MFI is an awesome place to focus
    3. Value Line – study their bottom lists (lost most value, trading at widest discounts to BV, lowest P/E, highest dividend yield)
    4. Look at companies at 52 week lows
    5. Outstanding Investor Digest – detailed interviews with great money managers
    6. Value Investor Insight – detailed interviews with great money managers
    7. Whale Wisdom – recent buying activity, 13Fs
    8. GuruFocus – recent buying activity, trends, interviews
    9. Super Investor Insight – 13F filings of the great investors
    10. Biannual Value Investing Congress – teach value investing and provide some potential opportunities
What I got out of it
  1. Really good, short read on how to think about investing

Damn Right! Behind the Scenes with Berkshire Hathaway Billionaire Charlie Munger by Janet Lowe

Summary
  1. Lowe details Charlie’s life through his early career as a lawyer, later partnership with Buffett to form Berkshire Hathaway, his family, his hobbies and outlook on life
Key Takeaways
  1. Warren, Charlie are very similar and make an amazing team. They are both from Omaha but didn’t meet until 1959
  2. Very eclectic reader – hundreds of biographies
  3. Wanted wealth because it grants independence
  4. Loves complex ideas and detailed analysis
  5. Credits his success to self-education, mental discipline, deeply understanding big ideas
  6. Always act as honorably as possible
  7. Star Island is his secluded family getaway
  8. Family was very smart, hard working and loving. Father taught him power of Tao – love of doing small things excellently
  9. Poker helps with business decisions – when to fold early and when to back heavily
  10. Somewhat arrogant but his opinions are not set in stone
  11. Divorced “Nancy 1” and soon after remarried to “Nancy 2”
  12. Tended to do a task himself or totally delegate it (usually delegated)
  13. Saw advantage of high quality businesses (easy decisions) early on and helped Buffett see the benefit of paying a fair price for high quality businesses
  14. Made first real money in real estate in California
  15. Able to look at facts and come up with new, insightful conclusions
  16. Great at analyzing businesses quickly and saying no if it falls outside his circle of competence
  17. Can zero in on what is truly important
  18. Must think correctly AND independently
  19. To become truly wealthy, need ownership in a business
  20. Simply easier to be ethical, rational and honest. Hard work and honesty gets you almost anything
  21. If Charlie trusts someone, he trusts them completely
  22. Blue Chip float lead to purchases in See’s Candy, Precision Steel
  23. Typically make one major decision every 3 years. Extreme patience with extreme decisiveness
  24. Must only deal with quality people
  25. Want to be in sectors that tend towards natural monopolies
  26. Bought Buffalo Evening News in 1977. At the time was nearly 25% of BRK net worth
  27. Foresaw savings and loan debacle and moved Wesco away from thrift
    1. “Our experience in shifting from savings and loan operation to ownership of Freddie Mac shares tends to confirm a long-held notion that being prepared, on a few occasions in a lifetime, to act promptly in scale, in doing simply and logical things, will often dramatically improve the financial results of that lifetime…A few major opportunities clearly recognizable as such, will usually come to one who continuously searches and waits, with a curious mind, loving diagnosis involving multiple variables. And then all that is required is a willingness to bet heavily when the odds are extremely favorable, using resources available as a result of prudence and patience in the past.”
  28. Remember the obvious rather than grasping the esoteric
    1. “Most geniuses—especially those who lead others—prosper not by deconstructing intricate complexities but by exploiting unrecognized simplicities.” — Andy Benoit
  29. “Our rule is pure opportunism”
  30. Look for integrity, intelligence, experience and dedication. Look to create the best business environment anywhere through evaluations without extensive meetings, capital access, focused compensation, and freedom to do one’s best
  31. Don’t confuse simplicity with ease
    1. “People underrate the importance of a few simple big ideas. And I think to the extent Berkshire Hathaway is a didactic enterprise teaching the right systems of thought, the chief lesson is that a few big ideas really work. I think these filters of ours have worked pretty well because they are so simple.”
  32. In the mid ’90s, BRK transitioned to owning more companies outright and became the buyer of first resort
  33. Munger admires Costco so much he violated his rule and joined their Board
  34. Avoid the mistake of not buying great, undervalued businesses when the stock has appreciated
  35. Tell the truth, tell it fully, tell it fast
  36. Giving time, talent, risking reputation as important as contributing money
  37. Many people specialize too early. Must deeply learn subjects you can’t live well without (psychology, math, physics, engineering)
  38. Paranoid self pity, the “victim mindset” is the most destructive frame of mind
    1. Every time you think about someone or something ruining your life, it’s in fact just you
  39. A few really big ideas carry most of the weight
  40. “To those whom much is given, much is expected. Always live below your financial means so that you will have money to invest. Invest in such a way so as to avoid the possibility of falling into a negative position – primarily, by limiting the amount of debt you use…If you want to get smart, the question you have to keep asking is “why, why, why?” And you have to relate the answers to a structure of deep theory. You’ve got to know the main theories. And it’s mildly laborious, but it’s also a lot of fun…From physics, Munger has learned to solve a problem by seeking the simplest, most direct answer. The easiest way invariably is the best way. From mathematics Munger learned to turn problems upside down or to look at them backward – invert, always invert.”
  41. If he taught finance, would look at about 100 companies who have thrived or failed
  42. Take a simple, basic idea and take it very seriously
  43. Truth is hard to assimilate in any mind when opposed by interest
  44. 5 best practices for thinking, problem solving, decision making
    1. Simplify by answering the big “no brainer” questions first
    2. Gain numerical fluency
    3. Invert problems
    4. Must use elementary and multidisciplinary thinking
    5. Lollapalooza effects come only from a combination of a large number of factors
  45. Pilot training should be implemented into different fields
    1. Formal education wide enough to cover practically everything useful
    2. Wide base of knowledge raised to practical fluency
    3. Ability to think forwards and backwards (concentrate on what you want to avoid as much as what you want to happen)
    4. What is most important gets the most attention
    5. Checklist routines are always used
    6. Forced into a special knowledge maintenance routine
What I got out of it
  1. Interesting read on Charlie Munger’s life, career, though process. Multidisciplinary thinking, inverting problems, always act honestly key topics, take a simple, basic idea and take it very seriously