Lessons From The Legends of Investing (11 Profile), How to use forensic accounting, The Art Of (Not) Selling

Premium Issue - 19

Sep 18, 2022

Hi, Welcome to the 19th Special Edition

Brief Overview of What We will cover in this Issue

Detailed Key Takeaways from the book I am reading Currently
3 Decent Articles to read and Key Takeaways from them.
Lessons From The Legends of Investing (11 Profile/Interview) (Detailed)
Concept of Opportunistic Loss/ Selling/ Switching (Video Clip)
How to use forensic accounting to avoid the most common pitfalls (Video Clip)
The Art of Business Valuation
The Art of (Not) Selling

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Invest Like A Dealmaker: Secrets from a Former Banking Insider (Part-3)

THE ART OF BUSINESS VALUATION

The first is that valuation is an art, not a science. There is no right answer, and there is no exact number. Right off the bat, purge your mind of the desire to find an exact value and a right answer. Keep an open mind and be prepared to deal with a lot of vagaries and a lot of gray areas.

None of these models are perfect, and different people work better with different tools, just like some artists are great with a paintbrush and others are better with a pencil. There is no perfect way to do any of this.

All the earnings, cash flows, and asset numbers you work with are themselves approximations put together by accountants adhering to a set of rules, assumptions, and guidelines. With different accounting treatments and different applications of guidelines, the same company could report very different results. So the basic tools themselves are not precise instruments. But that doesn’t make them useless. In fact, you can tell a person’s age and weight, and height with a fairly reasonable standard of accuracy just by looking at them, without any scales or measurements or personal information.

Valuing companies is not too different from that. Over time you’ll get better and better at it. Even when you do get good at valuing businesses, the fact is that the number itself changes over time. New information and ever-changing markets impact business valuations. This means you may have to revisit your assumptions every so often, depending on how important the new information is. And let’s face it: Forecasts are wrong. Things happen that we never expected.

No one could have factored in the impact of September 11 on American business, to take an extreme example. There are many unknowns and many unknowables.

Generally speaking, the less you can pay for one dollar of cash flow or one dollar of asset value the better. That’s a very broad statement because cash flows and asset values are difficult to determine.

So, as best as possible, you’re looking to pick up bargains based on conditions today, without relying too heavily on future growth to make your valuation work.

Even so, not all growth is created equally. Growth has many sources. “For any particular business,” Klarman writes earnings growth can stem from increased unit sales related to predictable increases in the general population to an increased usage of a product by consumers to increased market share, to greater penetration of a product into the population, or to price increases.

It’s helpful to think about what type of growth you’re betting on because different types of growth are more predictable than others. Growth based on population growth is a better bet, for example than growth based on taking business from competitors.

“The history of the stock market is the history of forgetting,” wrote that market sage F. J. Chu in his book The Mind of the Market. Anecdotal evidence is seen in how soon the 1937– 1938 collapse followed on the heels of its more famous cousin, the 1929– 1932 debacle. How quickly investors forget; how wicked is the bear market at work.

THE CRACKS AND CREVICES OF INVESTMENT WISDOM

More Than You Know by Michael Mauboussin includes lots of interesting chapters on how markets behave and how investors behave in them. It uses a multidisciplinary approach, drawing on insights from biology, physics, psychology, and a variety of other disciplines.

In the 1950s, the average turnover at a mutual fund was about 20 percent, meaning that the average mutual fund manager held on to his stocks for five years. Today that turnover ratio exceeds 100 percent— meaning that the average investor holds on to his stocks for less than one year.

It’s a different market today. Things happen fast. Some of the higher turnover is a rational response to quickly changing market dynamics. But most of it is just impatience and reflects the dominant speculative ethic.

Mauboussin also looks at those funds that beat the market over the decade ending in 2004. He finds that they share the following characteristics:

Low portfolio turnover.“ As a whole,” Mauboussin writes,“ this group of investors had about 27% turnover in 2004, which stands in stark contrast to turnover for all equity funds of 112%.”
Portfolio concentration. Bigger bets. You’re not likely to beat the market holding hundreds of stocks.
A value style.“ The vast majority of the above-market performers espouse an intrinsic value investment approach,” Mauboussin notes. Paying attention to price pays. It seems so simple.
Geographic location. This one was different. Basically, only a small fraction of these funds were located in East Coast financial hubs such as New York. Among the top locations: Omaha, Chicago, Salt Lake, Memphis, and Baltimore. I work out of my house in the suburbs of Washington, DC. The basic message: You have to break from the herd.
Limited time on macro forecasting. When your primary focus is a price to value, you can get a lot wrong on the big-picture side of things and still do very well.

Mauboussin also writes some good articles from time to time. In a recent piece titled “How Do You Compare?” he writes about how we think about and compares different investments.

REALLY BIG WINNERS AND BIG FAT ZEROES

few really big winners often make all the difference on your investment scorecard. To illustrate, let’s take a look at an experiment by Murray Stahl, a creative essayist and money manager for Horizon Asset Management.

Stahl began his research when the last great bull market began: 1982. He put together a portfolio of six troubled companies in which few sane people would have invested: Chrysler, General Public Utilities (GPU), Pan American, Massey Ferguson, International Harvester, and White Motor.

The surprising answer is that it beat the S& P 500 over the ensuing 10 years— a 19.2 percent annual return versus 17.6 percent for the S& P 500. The success of Stahl’s portfolio rested entirely on big home runs in Chrysler and GPU. Allowing these winners to run was the key. There was no rebalancing. So, at the end of the 10 years, Chrysler and GPU made up 93 percent of the portfolio.

Stahl concluded: “Thus, the arithmetic implication of success over a long period of time would be to possess an un-diversified portfolio.

The basic lesson behind Stahl’s research is threefold:

Your investment results can depend on only a few really big winners. Stahl’s experiment teaches us that a portfolio can suffer some grievous losses and still come out looking good. I’ve always preached avoiding the nasty big losses, but Stahl shows the arithmetic resilience of portfolio returns. Those really big winners cover even the worst sins— such as big fat zeroes.
And in order to have really big winners, you have to hold your winning stocks for a long, long time, which means….
You are not going to be able to maintain a fully diversified portfolio
with lots of stocks. Because these winners will overtake your laggards and assume an ever-larger share of your portfolio. Basically, expect to run a concentrated portfolio if you want to make big money in the stock market.

SEPTEMBER 1940: LESSONS FROM THE BRITISH WAR CABINET

More moves mean more chances of error.“ Intelligent inactivity is a rare virtue,”

Making a lot of moves in your portfolio gives you more opportunities to make a mistake.

In my personal investing and even in running my newsletter, there have been times when I thought I was smart in selling something, but it often turned out not to be the best decision. More often than not, it would have been better to just hold on.

If you do the upfront work well, picking good businesses and stuff you can hold for a while, then you can make time your ally. That’s where we want to be. I don’t always liveup to it, but it’s what I aspire to do.

MUHLENKAMP’S THREE-YEAR RULE

Ron Muhlenkamp runs the eponymous Muhlenkamp Fund, one of the best-performing mutual funds of the last 15 years. His recent book, Harvesting Profits on Wall Street, is a collection of essays he’s written over the years.

He writes: “The bottom line is that if you price your portfolio every day, you are going to get huge volatility. If you price it once a week, you’ll get less. If you price it once a quarter, you’ll get less.” You get the idea.

Stocks bounce around a lot in the short term, and that can eat away at your nerves and your patience if you watch them every day. But over the long term stock prices tend to follow value, and some of the volatility goes away. Most of it is gone after year three — hence Muhlenkamp’s rule

Worrying about your portfolio on even a monthly basis is like, in Muhlenkamp’s words, “ a farmer worrying about how much his crops grew in February. ”

ADVICE MORE IMPORTANT THAN ANY STOCK PICK

Warren Buffett has said that no one should expect to find more than 20 gems in a lifetime of stock picking. That statement tells you a lot. Again— you can’t be too active. Your big returns will come from a small number of stocks, and you have to sit on them to get the big gains.

Price and value don’t always move together. A stock can go down while the business still grows in value. Stocks can rise when the business is deteriorating. It happens all the time, and it is why we must divorce stock market prices from underlying value.

IF YOU WANT TO OUTPERFORM THE MARKET

Super - investor Anthony Bolton has said: “ If you want to outperform other people, you have got to hold something different from other people . . . . [T]he one thing you mustn’t hold is the market itself. ”

MARTY WHITMAN — SAFE AND CHEAP INVESTING

Marty Whitman, manager of the Third Avenue Value Fund, is one of my favorite investors. After more than 50 years in this business, he’s seen everything.

One of the best profiles of Whitman’s approach comes from my favorite newsletter, Grant’s Interest Rate Observer.

Look for high - quality assets and non burdensome liabilities. Seek out free cash flows from operations. Look for safety in the price you pay. Put not your trust in forecasts. Invest in what’s in front of you. Don’t shrink from investing in complex securities. Think two or three times before selling. Strive to understand the financial data under which an investor is fairly buried these days — that is, what the numbers mean, not just what they say.

Whitman looks at investing so differently than others do. Wiley just republished his book The Aggressive Conservative Investor as part of its “Investment Classics” series. There is a lot to the book, but some of the insights are too good not to be highlighted here.

Whitman also makes the important point that lower risk does not mean lower profits. In fact, one thesis of his book is that lowering risks actually enhances your return. This is counter to conventional investment wisdom, which says you must take bigger risks to make more money.

Quality of assets is frequently more important than earnings.

Conversely, overcapitalized banks and financial institutions can be a source of value. Let’s say that a $ 12 bank is earning 25 cents per share but has equity of $ 6 per share. On an earnings basis, it would look unattractive, trading for 48 times earnings. But the knowledge that banks typically earn 15 percent on equity, implying potential earnings of 90 cents per share, suddenly paints a different picture. The bank becomes a takeover target if it can’t deploy its assets to bolster its earnings by expanding the business, buying stock, or making other strategic alternatives. If the bank can’t do any of these things, someone else will relieve it of its cash.

Whitman’s basic approach to investing is pretty simple, though it is much more difficult to practice. He has four points that essentially describe his strategy: buy companies that have (1) strong financial positions, (2) reasonably honest management, (3) the ability to make reasonable disclosures, and (4) buy at prices below estimated net asset value. Therefore, you only buy stocks that are “good enough, based on the four essential elements.”

There is no aim for perfection. As Whitman says,“ The primary motivation for purchases is that values are good enough.”

RALPH WANGER— IN SEARCH OF ACORNS

During Wanger’s tenure at the head of Acorn, from 1970 to 2003, he averaged a robust 17.2 percent return. A mere $ 10,000 investment in 1970 was worth $ 174,059 by 1998. He handily beat the S & P 500 over that stretch and made his long - term shareholders rich. He is truly a legend in the industry.

Wanger had come to the conclusion that in order to minimize turnover, you have to hold stocks for a longer period of time. And in order to hold them for a longer period of time, you have to work with long-term themes and find companies you can live with for a while. In other words, you can’t focus your attention on what’s going to happen next quarter or next year (as most market participants do), but rather, you’ve got to look out further on the horizon.

As Wanger notes, if everyone is focusing on the short term, then long-term investing becomes an arbitrage between the long view and the short view. Working with themes is the result of making a decision to think long-term, avoid turnover, and lower transaction costs. That is what Wanger meant.

I’ll share some of the details of my interview with Wanger, including what many regards as the great secret to success in long-term investing. And I’ll introduce a strategy for selling stocks that you can use for every stock in your portfolio.

Investment Insight #1: Stray from the Herd

Wanger has long been associated with small-cap investing. His 1997 book A Zebra in Lion Country illustrates the virtues of staying with smaller, lesser-known companies. He believes that the small-cap investor can get the jump on the big-money pros, whose main attention usually is with the large-cap stocks— where they can take big positions.

But much of the big money in investing has been made with uncommon or unpopular ideas that later bore fruit.

Wanger advised, is to think long-term. Shorter-term thinking dominates the investment world.

“Growth fails because people cannot see the future,” Wanger said. Reality frequently disappoints; dreams are often just dreams. The basic metaphor behind Wanger’s book is conveyed in the title. The zebra, to get at the best grass— the grass untrodden by the herd— must selectively stray from the safety of the herd. Investors must do the same.

Investment Insight #2: Know When to Sell

Wanger articulated a bona fide strategy for deciding when to sell. It was the best advice on selling I have ever heard, and it is quite straightforward.

Wanger’s advice was simply to make the reason you buy a stock “specific enough so you know when it is no longer true.” That is, make it falsifiable or checkable. That way, you can keep checking back with your reason, and when it is no longer true, sell. Let me use a simple example to illustrate this powerful concept.

Say you buy a stock because you believe its business will turn around and you think it’s capable of expanding its profit margins from 3 percent to 8 percent over the next five years. Newer, more profitable products are coming on board. The company has lagged behind competitors, but you’ve identified some catalysts that are going to change that. Whatever the reason, you pencil in “8 percent” and buy the stock. Now you have a clear reason to sell. If the company doesn’t meet your expectations, your original reason for buying the stock is no longer valid.

Let’s say that after year five the company’s profit margin is only 6 percent. You were wrong, so you sell. It doesn’t matter what the stock price did. If in year three, the company seems to be making progress, you hold on. Your original premise is still valid. It could still work out. Conversely, the company may do much better than you expected. Maybe by year three, its profit margins have gone to 10 percent. Well, you still sell. Once again, your reason no longer applies, so you should sell the stock. Of course, you can revise and revisit your reasoning on a periodic basis. Just be sure to keep your reasons specific and checkable. Many investors complain about how difficult it is to decide when to sell. Even the great ones do. Make it easy on yourself. Be specific as to why you bought it in the first place.

Investment Insight #3: The Stock Market Is a Loser’s Game

Investors win only by exploiting the mistakes made by other investors. And this has profound effects on strategy— that is, on how an investor should approach the task of investing.

The way to win a loser’s game is to make fewer mistakes. You play not to lose. So the advice for amateur tennis players is to worry less about powerful serves and to focus more on just getting the ball back over the net and keeping it in play.

This means that the investors who make the fewest mistakes will be the winners.

The great secret of success in long-term investing is to avoid the serious losers.

Always think about the possibility of losses and how to limit them. If you remember nothing else from this book, the idea of the market as a loser’s game will serve you well over your investing career.

Investment Insight #4: Heed the Lessons of History

When you invest, you should think about climates, not the daily weather. Ellis advises, “ In choosing a climate in which to build a home, we would not be deflected by last week’s weather. Similarly, in choosing a long-term investment program, you don’t want to be deflected by temporary market conditions. ”

To understand the stock market’s “ climates, ” the investor has to understand history. As Ellis notes, the more the investor understands how markets behaved in the past, the better equipped he will be to deal with the present and future.

Investment Insight #5: People Get Paid for Doing Boring Things

This leaves plenty of boring companies in boring industries that make a little extra profit margin, and their stocks can be good investments.

Lots of companies that do very uninteresting things— like making window shades or door locks— get paid good money for doing it. The main reason is that they have little competition. Money flows to the exciting, lottery-style companies. Few venture capitalists or entrepreneurs wake up and say,“ Darn it! I’m going to open a gravel pit today.” Entrepreneurial money and energy are largely attracted by the potential big payoffs in high-growth industries. Investors feed this phenomenon.

BILL MILLER — EXPLOITING TIME ARBITRAGE

Value Investor Insight. Miller said, “In an environment with massive short-term data overload and with people concerned about minute-to-minute performance, the inefficiencies are likely to be out beyond, say, 12 months.”

That’s amazing. Miller says looking 12 months out can find inefficiencies. The investor’s short-term orientation has been one of the most profound changes in markets over the last 20 years.

lots of great investors have been preaching the virtues of long-term investing for years now.

Miller brought this point home for me in the Value Investor Insight interview:“ In markets, everyone tends to see the same things, read the same newspapers, and get the same data feed. The only way to arrive at a different answer from everybody else is to organize the data in different ways and to bring things to the analytic process that are not typically there.”

I think there is a lot in what Miller is saying. The basic idea is that if you are looking at the same stuff everybody else is, then the only way you are going to find great ideas before the herd does is to adopt a pattern of thought that is not shared by the herd.

As an aside, I find Bill Miller a fascinating guy who thinks very differently from just about everybody else. He recommended a book called Nature: An Economic History by Geerat Vermeij.

Vermeijis a paleoecologist. I didn’t know such a thing existed. What he’s done is take the history of evolution and apply it to economics, with interesting results. Vermeij draws insights from the natural world about how things relate, how they compete for resources, how they change and adapt, and much more.

Roy Neuberger led a remarkable life. As the co-founder of Neuberger & Berman, the multibillion-dollar investment management company, he had a long investing career.

In his memoir, he offers his principles of successful investing:

1. Know thyself.

2. Study the great investors: How great fortunes are lost can be even more informative than how they are won.

3. Beware of the sheep market. “ The sheep Get in and out in time. “Timing may not be everything, but it is a lot.” Neuberger is not recommending that you become a market timer, but he emphasizes the notion that no investment is good all the time. “Everything changes,” he notes. “I just don’t believe you can have confidence in any industry for an infinite length of time.” He also writes that it is important to recognize and close out your mistakes.

4. Keep a long-term perspective

5. Analyze the companies closely.

6. Don’t fall in love. “One should fall in love with ideas, with people, or with idealism based on the possibilities that exist in this adventuresome world.

7. Diversify, but don’t hedge alone. The basic advice here is to be flexible and maintain some balance so you can pull through the unexpected dips and swirls of the market.

8. Watch the environment. Neuberger maintains that investors should keep an eye on general market conditions. As he says, the joys of living and investing are enhanced by an appreciation for the shifting financial seasons.

9. Don’t follow the rules. “ At least not slavishly,” Neuberger adds to this last principle. Be willing to change your thinking and to challenge the thinking of others. Succeed in your own way, Neuberger advises.

MORE GOOD HABITS OF INVESTING

Mohnish Pabrai — The Dhandho Investor

Pabrai created a list of what he called the “Dhandho Framework,” which outlines the Patel philosophy. It is a nice little model for investors:

1. Invest in simple, unchanging businesses.
Focus on distressed businesses/ industries.
Invest in businesses with durable moats.
Make few bets, big bets, or infrequent bets.
Fixate on arbitrage.
Watcht he margin of safety— always!
Heads I win, tails I don’t lose much!
Copycats trump the innovators.

ANTHONY BOLTON— THE PETER LYNCH OF BRITAIN

Moreover, I have come to believe that there are core elements to successful long-term investing that run through all of these stories of great investors. It never hurts to revisit these core principles. Nor do I ever tire of learning from the experiences of investors who have been in the game a long time.

It was with these thoughts in mind that I recently picked up a book by Jonathan Davis titled Investing with Anthony Bolton: The Anatomy of a Stock Market Phenomenon.

Anthony Bolton is the investor behind that sterling track record. He runs the Fidelity Special Situations Fund (U.K.). In this slim volume, I found some simple— but enduring— insights that I would like to pass on to you.

His guiding philosophy is The beginning of investment wisdom. You can’t be afraid to stray from the herd, and you ought to relish turning over stones that the rest of the market may be missing. Also, don’t do a lot of“ dealing” (trading), as he says. Give your ideas time to work out. Think long-term, meaning years, not months. In these investment principles, Bolton is not very different from many of the greatest American investors.

Disasters seem an unavoidable part of the investor’s experience.

Play the game long enough and you are bound to make a serious mistake. Bolton has had his share of disasters, investing in companies that ultimately went bust.

Bolton writes: Investment is an odds game. No one gets it right all the time; we are all trying to make fewer mistakes than our competitors. In fact, the key to this business is as much to avoid losers as it is to pick winners. On the other hand, running money with a style that is so defensive that it avoids all losers is also, I believe, counterproductive to superior returns.

Investing takes some measure of courage. You can’t believe every flesh wound is mortal. Part of successful investing is the ability to stick to your discipline, even during stretches when it appears not to be working well. Bolton, like many great investors, does not switch horses midrace.

That doesn’t mean he is sure of everything he is doing. And this is an interesting psychological part of investing that you don’t hear all that much about.“ Conviction waxes and wanes,” Bolton writes,“ and a lot of the time, you’re uncertain about everything.” When a conviction is high, then you make big bets. When a conviction is low, you should sit on the sidelines or invest smaller amounts.

One misconception people have about great investors is that they are always sure of what they are doing. “Some seem to think people like myself are hugely sure of what they are doing all the time,” he says. “But this business is not like that. You are in a constant state of questioning your convictions.”

Bolton also does not spend much time on macro forecasting. He does not base his investment decisions on broad macroeconomic grounds alone. He instead works to understand individual companies. This is where you can build an edge. He invokes fellow Briton Jim Slater’s Zulu Principle—“ If you are expert on something, however small it may be in the broader context of things, you have an advantage over other people.”

Bolton also focuses on balance sheets, as I do. The balance sheet is a summary of a company’s assets and liabilities, a snapshot of financial strength. “One vital lesson I have learned,” Bolton writes, “is that when things go wrong, the companies I lost the most money on are those with weak balance sheets.” Most analysts and investors are not good at understanding balance sheets and assessing these risks. I’ve got 10 years of lending experience, which taught me a lot about risk and the meaning of financial strength. Most investors have little real-world business experience.

In addition to balance sheets, Bolton focuses on cash flow. Again, this has always been a hallmark of Capital & Crisis. I focus on cash-generating activities, not necessarily on pretty earnings pictures drawn up for the benefit of Wall Street.“ The ability to generate cash is a very attractive attribute,” Bolton says. “In fact, the most favorable of all attributes.”

Finally, it was refreshing to hear Bolton try to explain his investment style. What is it? What do you do? As an investment writer, I, too, often get this question, and it is never easy to answer in a soundbite sort of way. As Bolton answered, “Trying to explain what makes me buy one stock and not another is surprisingly difficult, even after all these years.” Further confirmation that the best investing philosophies cannot be packaged neatly in boxes for public consumption.

Investing is a qualitative art or skill honed over many years. In a similar way, a painter or woodcarver might master certain techniques over a lifetime, yet not be able to teach them easily to a newcomer. It is not easy to teach these ideas, and they are not always easily articulated.

BRUCE BERKOWITZ— BET THE JOCKEY, NOT THE HORSE

The Fairholme Fund is not familiar to most investors, I would guess. Bruce Berkowitz, the founder, and top dog is the kind of guy no one would recognize in a lineup as a top-performing investor. Yet, since its inception in 1999, investors in his fund have enjoyed a 19 percent annual return compared to a negative 1 percent return for the S& P 500 over that time.

Every great investor was once an unknown. That is not saying much.

“We stay away from faddish companies, industries, or trends and routinely shun companies that employ aggressive accounting or managers that are paid fortunes just to show up to work every day.”

If you go to Fairholme’s website (http:// www.fairholmefunds .com), you’ll see a section called “Fairholme’s Maxims: A Primer to Value Investing,” which I would encourage you to read.

Berkowitz may never achieve quite the fame or track record of Warren Buffett. But I’m betting that shareholders in his fund don’t mind. He’s doing quite all right for them.

CHARLES KOCH— HIS 100-BAGGER

Charles Koch is the 70 - year - old skipper (as I write) behind Koch Industries. The company is the largest privately held company in the world. The value of Koch Industries has increased 100 -fold in the 38 years he has been running the show, compared with a 13 - fold increase in the S & P 500 over that time span.

What makes his story so compelling is the manner in which his fortune grew

For instance, there were some tremendous failures along the way. Koch lost $ 50 million betting on supertankers and crude oil in the 1970s. He also lost $ 120 million trying to turn Purina— which would eventually go bankrupt— into an integrated agribusiness in the 1990s. The mistakes that investors make fascinate me. And I’m always struck by how even the best investors make big mistakes at times— yet still wind up with a fortune.

Koch says he gets burned a lot. If only we could all get burned like Koch. Despite these errors, Koch Industries has thrived, and Koch remains unafraid of making mistakes. Running a private company facilitates this attitude: He doesn’t have to answer to Wall Street and its focus on quarterly results. It’s hard to be contrarian in a fishbowl. Instead, Koch can make good decisions based on long-term thinking.

DAVID BABSON— INVESTMENT FOLK HERO

We all learn pretty fast that we can’t always get what we want. As investors, not every year can be 1982, when you could buy just about anything because just about everything was cheap. Every investor must make do with the market he finds himself in.

He started his firm in 1940. He was bullish then. Babson recommended buying growth stocks, a move that made him a radical in those days when the memories of the Great Depression were still fresh. He bought what seemed to be all the right stocks — 3M, Honeywell, Merck, Pfizer, Corning Glass, and others.

Herds, as a rule, make for poor investors.

Markets are notoriously hard to read. People see what they want to see. Bulls will find reasons why these stocks will go higher. Bears will find reasons for them to go lower. The seldom-admitted truth is that most of the time the market exists in some indeterminate state, like the muddled cherry of a whiskey sour.

The main lesson from Babson is that you cannot trust consensus. You cannot rely on “ the establishment. ” You can’t find refuge in the herd. And you must resist the urge to join the crowd

Recently, it published a letter describing five essential truths the firm follows, laid out by its founder years ago. They are:

Markets are unpredictable and ill-suited to forecasts.
Long-term fundamentals are key.
Investor emotion leads to volatility.
Valuation discipline should guide investment selection.
Perspective and patience are rewarded.

That’s not a bad set of self-explanatory truths. They are not sexy, but the best investment advice seldom is.

MAX GUNTHER — THE ZURICH AXIOMS

What Gunther says here may or may not be true. Readers, though, should forgive Gunther for his bias.

There were 12 major axioms and a host of lesser ones. Gunther, a witty writer, set out to codify these precepts in his book The Zurich Axioms , published in 1985

The axioms are entertaining and thought-provoking. And as Gunther writes, “ They are not just a philosophy of speculation; they are a guide - posts for successful living. They have made a lot of people rich

Gunther says may be the most important of all. It’s the fifth axiom: “On Patterns: Chaos is not dangerous until it begins to look orderly.” Put simply, this axiom emphasizes that the market is a world that does not adhere to any patterns or laws. “Arguing with it is like standing in a blizzard and howling that it wasn’t supposed to arrive until tomorrow.” The market is no respecter of logic or rational prediction.

Instead, the axiom acknowledges the role of chance and luck. “Any half-baked moneymaking scheme will work when you are lucky,” writes Gunther. “No scheme will work when you are unlucky.” He calls this “the axiom’s great, liberating truth.”

Knowing this, investors learn never to trust “ systems ” or rely on predictions about the future. Forecasts on oil, the economy, and interest rates — take it all and chuck it. Read for awareness and entertainment, but don’t bet on them.

ANNIE OAKLEY— THE BUTTERFLY EFFECT AND YOU

The conclusion here is this: The market, like life in general, is full of surprises. No one can predict its movements consistently. The market is too dynamic and too complex. Beinhocker advises investors to keep an adaptive and highly pragmatic mindset that“ values tangible facts about today more than guesses about tomorrow.”

As investors, you can make that uncertainty work for you. Focus on what you are getting for your money today. Look to back that purchase price with loads of tangible assets and/ or a super-strong financial condition. Then your portfolio will be better equipped to handle those instances when a sure shot misses its mark.

MARK TIER— TIMELESS WEALTH-BUILDING SECRETS

There are really no “secrets” about how to invest successfully. There are lots of good ideas out there in plain sight— in books, newsletters, magazines, and more— and you can acquire them cheaply. The problem is that there are lots of really bad ideas about investing out there, too. Most people can’t tell the difference between the two. This makes it hard to create a winning investment strategy.

The second difficulty is that even when you find the genuine article— a timeless bit of investing wisdom— it is not something you can use to great effect in isolation. In other words, the“ secret” to creating a successful investing strategy is about combining some great ideas with other great ideas. Knowing one idea is like having a 16-step recipe and knowing only step number 6. You need to know all that comes before and after step 6 to make the recipe work well.

Finally, there are a lot of great recipes. This means, that there are many great investors who have made fortunes in a number of different ways. Some of these recipes are relatively simple, and some are rather intricate. The variety just makes it harder for the aspiring master investor to figure out what the heck to do.

The greatest investors have long track records, measured in decades. (And don’t limit yourself to the living— I’ve learned many things from studying the dead investors of long ago.) The subtitle of his book is “Harness the Investment Genius of the World’s Richest Investors.” This gives you some idea of his method.

The book is mainly about Buffett and Soros, two great investors who probably need no introduction. Tier’s book walks you through 23 winning investment habits (as well as 7 deadly investment sins) that he maintains are shared by all the great investors she’s studied. Let’s go through some of those habits. Perhaps you can add these to your repertoire and start seeing immediate results.

Bet big. In the hands of some novice investors, this advice is financial suicide. But the fact remains that many of the great investors got that way by making big bets on their favorite ideas instead of spreading out their money over many smaller positions.

No one ever got rich following a great diversification strategy.

Of course, betting big without having a well-thought-out investment strategy is probably a recipe for disaster. You need more than just this single idea— which gets back to what I was saying about great ideas working in combination.

Start with the As. One of my favorite Buffett anecdotes in the book goes like this: A reporter asks Buffett where he gets his investment ideas. He replies that he reads annual reports and learns about every company in the United States with publicly traded securities. “But there are twenty-seven thousand public companies,” the reporter responds. “Well,” replies Buffett, “start with the As.”

What’s great about this story is how well it illustrates the diligence of great investors. They are constantly searching for new investment ideas. And the scope of their search is extensive. You have to read a lot and read widely.

When there’s nothing to do— do nothing. “You don’t get paid for activity,” Buffett once told shareholders at his annual meeting. “You only get paid for being right.” If there’s one thing I would tell an aspiring investor, it would be this. Learn when to do nothing.

Don’t invest just because you have the cash. Let the opportunities drive your buy decisions.

Most investors feel like they have to be doing something. As Tier writes, “Waiting is alien to his mentality because, without criteria, he has no idea what to wait for.”

Know when to sell. Most investors seem to have little idea about when to sell.

They sell when their stocks go up in price. They sell when they go down. There is little to guide the sell decision other than emotion and stock price changes.

Buffett sells under three conditions. First, he sells if the business is broken in some way and no longer meets his criteria. Second, he sells if he needs the money to fund an even better opportunity (something he hasn’t had to do in many years, since he has been in the position of having more cash than good ideas in recent years). Third, he sells if he realizes he’s made a mistake.

Tier goes through other examples of possible sell strategies, but for the long-term investor— who studies and invests by the fundamentals of a business— Buffett’s rules are the best.

Master the craft .“ I have enjoyed the process [of making money] far more than the proceeds,” Buffett once wrote,“ though I have learned to live with those also.” Ever wonder what could motivate a billionaire investor to keep going long after he’s already made his fortune? Tier finds that the great investors are emotionally involved and get satisfaction from the process of investing.

“For many successful investors,” Tier writes, “the most rewarding and exciting part of the process is the search, not the investment he eventually finds.” He quotes one investor as saying,“ Investing is like a giant treasure hunt. I love the hunt.”

So the final and great irony in all of this is that to get rich you have to love the game. When the money doesn’t matter so much is when the money comes. Life works in funny ways. And investing is no different.

Excerpts and Learning from Articles/Blogs

1) The Art of (Not) Selling (Best Read)

Of our most costly mistakes over the years, almost all have been sell decisions.

The mistake, in virtually every instance, has been selling too soon. Reflecting on these mistakes gave rise to this letter, and its title, “The Art of (Not) Selling.”

Neither valuation nor price targets play a role in our sell decisions
This determination to hold on is a critically important, and not always well understood, aspect of our investment philosophy. At its core, it relates to the power of compounding. We believe these two ideas — (not) selling and compounding — are inextricably linked. Getting the first wrong makes the second impossible.

Patience and a long-term perspective are required to give the power of compounding an opportunity to do its magic.

You are given the choice between two sums of money: one million dollars or a penny that will double every day for 30 days. Which should you choose?

Here are a couple hints. The penny that doubles daily would be worth $1.28 after the first week. After the second week, it would be worth $163.84.

You will probably reason that the penny would be worth more than the one million dollars. (Why, otherwise, all the theatrics?) By just how much, though, might surprise you.

It turns out that after doubling 30 times, the penny would be worth $10,737,418.24!

This is a terrific exercise because it highlights the not-so-obvious power of compound returns (in this case, the penny compounds at 100% for 30 periods).

From this riddle, we learn the importance of holding on so that we allow our investments to compound uninterrupted for long enough that the compounding effects we saw in days 27 to 30 have an opportunity to play out in our portfolios.

it has been our experience that we are at our worst as investors when we allow concerns about these issues, including elections, trade wars, and Fed policy, to influence our investment decisions.

Politics, the economy, and valuation

We are unfazed when our businesses are quoted in the market at prices above what we would pay for them. It might be worth reading that last sentence again for emphasis.

Why? For three reasons…

First, when selling because of valuation, it is often with the idea that there will be an opportunity down the road to buy back in at lower prices. In our experience, it seldom works out this way.

Second, of the thousands of publicly traded companies, there are probably fewer than one hundred that meet our criteria, and opportunities to buy them at attractive prices are few and far between. Unlike average businesses that can be traded like-for-like on the basis of valuation alone, growing and competitively advantaged businesses are just too hard to replace.

Third, the very best businesses tend to exceed expectations. What may seem like a high price today may be proven to be perfectly reasonable in hindsight.

More compounding math

Having doubled your money once already, the next time the stock price doubles your investment will be 4x your cost. The next time after that, 8x. Then 16x. The key idea is that compound returns are exponential.

when we believe it is appropriate and necessary to sell.

when a business (1) is no longer growing at an above-average rate, (2) has had its competitive advantage impaired, or (3) has had an adverse change in management.

It is also always possible that we just change our minds. The process of getting to know a business takes time, and we sometimes uncover new facts or form new opinions that overturn our original reasons for buying. This usually happens with newer additions to the portfolio.

“Never forget that people whose self-interest is diametrically opposed to your own are trying to persuade you to act every day.”

Wall Street trading desks do not earn commissions when you buy and compound, and the cable news channels do not attract an audience by saying “there is nothing new to report today.”

2) Good Enough

Everyone knows the economy is hard to predict, and the history of economic predictions is abysmal.

But leaving it at that is too simplistic.

I think we’re actually very good at predicting the future – except for the surprises, which tend to be all that matter.

The question then is, how much effort do we put into forecasting the economy only to have that forecast upended by an event no one could have predicted?

So much.

Too much.

When you see how much effort and energy are devoted to forecasting the next year or two, then compare it to the constant level of threat and surprise we face, it’s astonishing.

Investing in your long-term future is of course great, because the odds that you’ll be around and everyone else will become more productive are pretty good.

But trying to predict the exact path we’ll take to get there can be such a waste of resources.

I’m confident in other people’s overconfidence, so I know there will be mistakes and accidents and booms and busts along the way.

When you keep forecasting that simple, you free up time and bandwidth to invest elsewhere.

It’s less about admitting that we can’t forecast, and more about acknowledging that if your forecast is merely good enough, you can invest your time and resources more efficiently elsewhere.

3) The opposite of things that will change the world, will change the world.

What changes the game does so in ways that are invisible because we focus only on today’s leaders. It wasn’t evident that Jio would make India a super-consumer of data services. It wasn’t evident that UPI would hit 10 lakh crores in month transactions, leaving behind a 1 lakh crore in credit cards all over the country. It wasn’t evident that Amazon would be the world’s leader in remote computing.

If you asked someone in 2012: Who’ll change telecom? The answer would have been Bharti Airtel. In 2005: “Who’ll be the go-to place for building applications?” – Akamai, Microsoft or such. Who’ll be the biggest player in bank-to-bank retail transfers? – HDFC Bank.

How does Google and Walmart win in interbank transfers? How does an Amazon win cloud applications? How did an oil refiner like Reliance win telecom in India?

None of these was right. Because each of these original answers is a great company, with a solid track record. And yet, someone else seems to have won as of today. When we look at data of the past, and expect that those companies will win, we might want to say that any valuation is worth it, no matter how high. The bigger point, however, is to be able to change course when you’re wrong, to have strong opinions but to be willing to switch, and to live by the adage that a person I deeply respect, Joy Bhattacharjya, told me once:

Angels can fly because they take themselves lightly.