Hi, Welcome to the 4th Special Edition
Brief Overview of What We will cover in this Issue
Detailed Key Takeaways from the book I am reading Currently
Key Takeaways from Investing Articles and Blogs
Asset Allocation Framework (+3 Articles)
Small Important Investing Video Clips
How to find multi-bagger
How Cycles Works in Market
Interesting Case Study of One Sector and Company (+ Many Clips)
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Having a Sense for Where We Stand
A lot of people know more than the consensus about the timing and extent of future cycles.
“Those who cannot remember the past are condemned to repeat
Ask yourself: Are investors optimistic or pessimistic? Do the media talking heads say the markets should be piled into or avoided? Are novel investment schemes readily accepted or dismissed out of hand? Are securities offerings and fund openings being treated as opportunities to get rich or possible pitfalls? Has the credit cycle rendered capital readily available or impossible to obtain? Are price/ earnings ratios high or low in the context of history, and are yield spreads tight or generous?
All of these things are important, and yet none of them entails forecasting.
We can make excellent investment decisions on the basis of present observations, with no need to make guesses about the future.
The seven scariest words in the world for the thoughtful investor—too much money chasing too few deals
Why NO to Commodities
They’re goods where no seller’s offering is much different from any other. They tend to trade on price alone, and each buyer is likely to take the offering at the lowest delivered price. Thus, if you deal in a commodity and want to sell more of it, there’s generally one way to do so: cut your price.
When the Interest rate goes down
One way to lower the price of your money is by reducing the interest rate you charge on loans. A slightly more subtle way is to agree to a higher price for the thing you’re buying, Such as by paying a higher price/ earnings ratio for a common stock or a higher total transaction price when you’re buying a company. Any way you slice it, you’re settling for a lower prospective return.
Appreciating the Role of Luck
Every once in a while, someone makes a risky bet on an improbable or uncertain outcome and ends up looking like a genius. But we should recognize that it happened because of luck and boldness, not skill.
The truth is, much in investing is ruled by luck. Some may prefer to call it chance or randomness.
A great deal of the success of everything we do as investors will be heavily influenced by the roll of the dice.
Thus, when considering whether an investment record is likely to be repeated, it is essential to think about the role of randomness in the manager’s results, and whether the performance resulted from skill or simply being lucky.
10 million earned through Russian roulette does not have the same value as $ 10 million earned through the diligent and artful practice of dentistry. They are the same, can buy the same goods, except that one’s dependence on randomness is greater than the other.
Someone who has enough aggressiveness at the right time doesn’t need much skill.
The easy way to see this is that in boom times, the highest returns often go to those who take the most risk. That doesn’t say anything about their being the best investors.
We all know that when things go right, luck looks like skill. Coincidence looks like causality. A“ luckyidiot” looks like a skilled investor.
Investors are right (and wrong) all the time for the “wrong reason.”Someone buys a stock because he or she expects a certain development; it doesn’t occur; the market takes the stock up anyway; the investor looks good (and invariably accepts credit).
The correctness of a decision can’t be judged from the outcome. Nevertheless, that’s how people assess it. A good decision is one that’s optimal at the time it’s made when the future is by definition unknown. Thus, correct decisions are often unsuccessful, and vice versa.
For these reasons, Investors often receive the credit they don’t deserve. One good coup can be enough to build a reputation, but clearly, a coup can arise out of randomness alone. Few of these “geniuses” are right more than once or twice in a row.
Most people acknowledge the uncertainty that surrounds the future, but they feel that at least the past is known and fixed. After all, the past is history, absolute and unchanging. But Taleb points out that the things that happened are only a small subset of the things that could have happened. Thus, the fact that a stratagem or action worked— under the circumstances that unfolded— doesn’t necessarily prove the decision behind it was wise.
Maybe what ultimately made the decision a success was a completely unlikely event, something that was just a matter of luck. In that case, that decision— as successful as it turned out to be— may have been unwise, and the many other histories that could have happened would have shown the error of the decision.
Quality of a decision is not determined by the outcome.
A good decision is one that a logical, intelligent and informed person would have made under the circumstances as they appeared at the time before the outcome was known.
Even after the fact, it can be hard to be sure who made a good decision based on solid analysis but was penalized by a freak occurrence, and who benefited from taking a flier. Thus, it can be hard to know who made the best decision
Investors of the “I don’t know” school understand that the outcome is largely up to the gods, and thus that the credit or blame accorded the investors— especially in the short run— should be appropriately limited.
One year with a great return can overstate the manager’s skill and obscure the risk he or she took.
Investment performance is what happens to a portfolio when events unfold.
Taleb’s ideas are novel and provocative. Once you realize the vast extent to which randomness can affect investment outcomes, you look at everything in a very different light.
We should spend our time trying to find value among the knowable— industries, companies, and securities—rather than base our decisions on what we expect from the less-knowable macro world of economies and broad market performance.
A healthy respect for risk; awareness that we don’t know what the future holds; an understanding that the best we can do is view the future as a probability distribution and invest accordingly; insistence on defensive investing; and emphasis on avoiding pitfalls. (Thoughtful Investing)
Investing Defensively
There are old investors, and there are bold investors, but there are no old bold investors.
Asking for investment advice without specifying that is like asking a doctor for a good medicine without telling him or her what ails you.
So Howard Marks asks, “Which do you care about more, making money or avoiding losses?” The answer is invariably the same: both.
The workings of economies and markets are highly imprecise and variable, and the thinking and behavior of the other players constantly alter the environment. Even if you do everything right, other investors can ignore your favorite stock; management can squander the company’s opportunities; government can change the rules, or nature can serve up a catastrophe.
Investment results are only partly within the investors’ control,
The bottom line is that even highly skilled investors can be guilty of mis-hits, and the overaggressive shot can easily lose them the match. Thus, defense—significant emphasis on keeping things from going wrong—is an important part of every great investor’sgame.
Similarities between Investing and Sports
• It’scompetitive—some succeed and some fail, and the distinction is clear.
• It’s quantitative—you can see the results in black and white.
• It’s a meritocracy —in the long term, the better returns go to the superior investors.
• It’s team-oriented—an effective group can accomplish more than one person.
• It’s satisfying and enjoyable—but much more so when you win.
There are lots of forms of financial activity that reasonably can be expected to work on average, but they might give you one bad day on which you meltdown because of a precarious structure or excess leverage.
The amount of risk you’ll bear is a function of the extent to which you choose to pursue the return. The amount of safety you build into your portfolio should be based on how much potential return you’re willing to forgo.
The critical element in defensive investing is what Warren Buffett calls “margin of safety” or “margin for error.” It’s not hard to make investments that will be successful if the future unfolds as expected.
Tightly targeted investments can be highly successful if the future turns out as you hope. But you might want to give some thought to how you’ll fare if the future doesn’t oblige. In short, what is it that makes outcomes tolerable even when the future doesn’t live up to your expectations? The answer is margin for error.
The aggressive lender will look smarter than the prudent lender (and make more money) as long as the environment remains salutary. The prudent lender’s reward comes only in bad times, in the form of reduced credit losses. The lender who insists on margin for error won’t enjoy the highest highs but will also avoid the lowest lows. That’s what happens to those who emphasize defense.
Low price is the ultimate source of margin for error. So the choice is simple: try to maximize returns through aggressive tactics, or build in protection through margin for error. You can’t have both in full measure. Will it be offense, defense, or a mix of the two
Achieving gains usually has something to do with being right about events that are on the come, whereas losses can be minimized by ascertaining that tangible value is present, the herd’s expectations are moderate and prices are low.
Investing is a testosterone-laden world where too many people think about how good they are and how much they’ll make if they swing for the fences and connect.
HM: I don’t think many investment managers’ careers end because they fail to hit home runs. Rather, they end up out of the game because they strike out too often— not because they don’t have enough winners, but because they have too many losers. And yet, lots of managers keep swinging for the fences.
• They bet too much when they think they have a winning idea or a correct view of the future, concentrating their portfolios rather than diversifying.
• They incur excessive transaction costs by changing their holdings too often or attempting to time the market.
• And they position their portfolios for favorable scenarios and hoped-for outcomes, rather than ensuring that they’ll be able to survive the inevitable miscalculation or stroke of bad luck.
“If we avoid the losers, the winners will take care of themselves.”
Investing defensively can cause you to miss out on things that are hot and get hotter, and it can leave you with your bat on your shoulder on a trip after a trip to the plate.
Defensive investing
Worry about the possibility of loss. Worry that there’s something you don’t know. Worry that you can make high-quality decisions but still be hit by bad luck or surprise events.
Avoiding Pitfalls
An investor needs to do very few things right as long as he avoids big mistakes.
- WARREN BUFFETT
To avoid losses, we need to understand and avoid the pitfalls that create them.
Financial memory tends to be extremely short.
If you Assumed Double sixes should come up once in every 36 rolls of the dice. But they can come up five times in a row— and never again in the next 175 rolls— and in the long run, have occurred as often as they’re supposed to.
In many ways, psychological forces are some of the most interesting sources of investment error. They can greatly influence security prices.
When greed goes to excess, security prices tend to be too high. That makes prospective returns low and risk high.
The desire to make money causes you to buy even though the price is too high, in the hope that the asset will continue appreciating or the tactic will keep working, you’re setting yourself up for disappointment.
Hindsight shows everyone what went wrong: that expectations were unrealistic and risks were ignored. But learning about pitfalls through painful experiences is of only limited help. The key is to try to anticipate them. To illustrate, I turn to the recent credit crisis. The markets are a classroom where lessons are taught every day. The keys to investment success lie in observing and learning.
Too much capital availability makes money flow to the wrong places. When capital is scarce and in demand, investors are faced with allocation choices regarding the best use for their capital, and they get to make their decisions with patience and discipline. But when there’s too much capital chasing too few ideas, investments will be made that do not deserve to be made.
•When capital goes where it shouldn’t, bad things happen. when money’s everywhere, unqualified borrowers are offered money on a silver platter. The inevitable results include delinquencies, bankruptcies, and losses.
•When capital is in oversupply, investors compete for deals by accepting low returns and a slender margin for error. When people want to buy something, their competition takes the form of an auction in which they bid higher and higher. When you think about it, bidding more for something is the same as saying you’ll take less for your money. Thus, the bids for investments can be viewed as a statement of how little return investors demand and how much risk they’re willing to accept.
•Widespread disregard for risk creates great risk.“Nothing can go wrong.” “No price is too high.” “Someone will always pay me more for it.” “If I don’t move quickly, someone else will buy it.” Statements like these indicate that risk is being given short shrift. This cycle’s version saw people think that because they were buying better companies or financing with more borrower-friendly debt, buyout transactions could support larger and larger amounts of leverage. This caused them to ignore the risk of untoward developments and the danger inherent in highly leveraged capital structures.
•Inadequate due diligence leads to investment losses.
•In heady times, capital is devoted to innovative investments, many of which fail the test of time. Bullish investors focus on what might work, not what might go wrong. Eagerness takes over from prudence, causing people to accept new investment products they don’t understand. Later, they wonder what they could have been thinking.
•Hidden fault lines running through portfolios can make the prices of seemingly unrelated assets move in tandem. A portfolio may appear to be diversified as to asset class, industry, and geography, but in tough times, nonfundamental factors such as margin calls, frozen markets, and a general rise in risk aversion can become dominant, affecting everything similarly.
•Psychological and technical factors can swamp fundamentals. In the long run, value creation and destruction are driven by fundamentals. But in the short run, markets are highly responsive to investor psychology and the technical factors that influence the supply and demand for assets.
•Leverage magnifies outcomes butdoesn’’t add value. When Assets are fully priced or overpriced. It makes little sense to use leverage to try to turn inadequate returns into adequate returns.
•When investor psychology is extremely rosy and markets are “priced for perfection”—based on an assumption that things will always be good—the scene is set for capital destruction. It may happen because investors’ assumptions turn out to be too optimistic, because negative events occur, or simply because too-high prices collapse of their own weight.
The declines had a maximum psychological impact.
The loss of confidence prevented many from doing the right thing at the right time.
There are times when the investing errors are of omission: the things you should have done but didn’t. Today I think the errors are probably of commission: the things you shouldn’t have done but did. There are times for aggressiveness. I think this is a time for caution. - October, 2007 (Risk and Return Today)
Adding Value
It’s not hard to perform in line with the market in terms of risk and return. The trick is to do better than the market: to add value. This calls for superior investment skills, superior insight.
A manager who earned 18 percent with a risky portfolio isn’t necessarily superior to one who earned 15 percent with a lower-risk portfolio.
In a bad year, defensive investors lose less than aggressive investors. Did they add value? Not necessarily. In a good year, aggressive investors make more than defensive investors.
The real question is how they do in the long run and in climates for which their style is ill-suited.
Everyone makes money in the good years,
The relationship between price and value holds the ultimate key to investment success. Buying below value is the most dependable route to profit. Paying above value rarely works out as well.
But while we never know where we’re going, we ought to know where we are. We can infer where markets stand in their cycle from the behavior of those around us.
Risk control and margin for error should be present in your portfolio at all times. But you must remember that they’re “hidden assets.” Most years in the markets are good years, but it’s only in the bad years— when the tide goes out— that the value of defense becomes evident. Thus, in the good years, defensive investors have to be content with the knowledge that their gains, although perhaps less than maximal, were achieved with risk protection in place . . . even though it turned out not to be needed.
Excerpts and Learning from Articles/Blogs
A Good Filter For Finding Winners
“Debt is a great way to fund growth and goose return on equity, but it also puts the company at risk during the inevitable downturns in the economy. Family businesses last longer because they are able to pay the price that longevity requires.”
Family businesses tend to use less leverage than their peers.
Most people can’t dedicate the time and resources it takes to study businesses. So if you can’t do that, then you maybe shouldn’t buy individual stocks at all – at least not with serious money. You may be better off in a fund - Joel Greenblatt
Why there is only one Warren Buffett?
1. His approach is too boring
He can buy for decades and we most of the time don’t even have patience for months – especially when our friend’s stocks are performing better than ours.
We love to predict and show our intelligence. E.g., I know that market is going to correct in the short term – so let me sell currently and I will buy back when it corrects. Result – long term investing remains on paper.
2. He buys businesses, we buy stocks
He is least bothered about something that is not going to impact his ‘underlying business’ whereas we are bothered about everything and anything that will impact the ‘stock prices
3. His annual average returns are ‘only’ 20%
The only advantage of WB is – “WB knows what he is doing and why.”
The impact of behavioral traits on our financial decisions (Pratap Snacks Brief Analysis)
Our minds have been wired in such a way that we always want to be in the top position in all our endeavors. Hence, we want the best of the deals and the highest ROI especially when it comes to finance management and investing our savings. Due to this very reason we often churn our portfolio frequently
In financial matters, patience can be a good behavioral antidote to envy!
Towards an asset allocation framework (Worth reading the full post)
What works for Warren Buffet need not work perfectly well for you. Not everyone can bat like Sachin Tendulkar, even if many model themselves on his style and technique.
Some people aren’t comfortable with volatility by nature, concentration doesn’t work for them unless they have some operational control on the business too.
Some people aren’t comfortable with volatility by nature, concentration doesn’t work for them unless they have some operational control on the business too.
Those who are already wealthy often trade a bit of alpha generation for peace of mind, the incremental 4-5% return does not move the needle for them. If you are worth 100 Cr and have 30% invested in equity, an incremental 5% return on the equity component is 1.5 Cr per year. But the fixed income component already throws out ~4 Cr per year in a steady manner. For this very reason rich folks prioritize balance sheets over P&L. When you have something worth losing, the incremental return doesn’t look all that appealing if it leads to higher balance sheet risk.
Closer to the bottom of the market you are just a liquidity provider, you aren’t really a stock picker or a fund manager. When chase an unknown small-cap stock when you can pick up Kotak Bank at a 40% discount?
what is optimal for you is rarely optimal for the CEO of your company. In investing your individual context determines a lot of things.
Small Video Clips
https://abalone-honeycup-c0d.notion.site/Small-Video-Clips-with-Timestamps-4th-Issue-83236b11afc8425588b359a3f29a9488
Go to the above URL, You will find clips on the Notion page which will start at a specific time as usual if that does not works Click Here to download a Clickable PDF for the same
Thank you for reading! see you at the next one.