The Best way to find fair value of your business & Learnings from 3 Fund Managers Letters
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How to value business - 2 Best Practical methods (Video Clip)
Sustainability of Growth vs ROIC
Investing Biases and Anomalies
Why you shouldn’t chase high performance in investing (With Data)
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The Behavior Gap: Simple Ways to Stop Doing Dumb Things with Money (Part-2)
PLANS ARE WORTHLESS
When we come upon things that we don’t understand, it can generate anxiety and fear. In our pursuit of control, we often obsess over the consequences of future events, even if they are almost always beyond our control.
So here are three things to remember when you feel like you have no control or understanding of how the world is about to change:
First, these things are not problems now. When I start to worry about future events, I’ve found that it’s helpful to focus on what’s going on right now in my life.
Second, focus on your personal economy and stop worrying about the global one.
Jim Rogers Says: “Any economy which saves and invests and works hard always wins out in the future over countries which consume, borrow, and spend.”
We’re swimming in a sea of money-related questions, worries, and hopes. But we’re not fully conscious of the fundamental role that money plays in our lives.
The change in our relationship with money starts as soon as we realize how important money is in our lives. When that happens, we start to understand how important it is to make financial decisions that will free us from anxiety and confusion. (It’s harder to make money when you’re foolish, sick, and confused.)
My rule is simple: limit your attention to things that meet two criteria— they matter to you and you can influence them
People worry a lot about things they simply cannot control. The solution: focus on the things that matter to you and can be influenced by your behavior. Forget the rest.
FEELINGS
Emotions play a huge role in making the decision to sell—or not to sell. We don’t want to pay taxes because it makes us feel bad to give up part of our profit to Uncle Sam. Or maybe we don’t want to give up the fantasy that this particular stock is going to be the one that makes us, at long last, rich. Or maybe we just like being able to say that we own the latest cool (hot) stock. But when we let our feelings get in the way of our direct perception of the facts (for example, the fact that a stock is much riskier now that its price has climbed), we get hurt. Sometimes we even suffer life-changing losses.
The Overnight Test
A friend of mine recommends what he calls the Overnight Test. Ask yourself what you would do if someone came in and sold all of your investments overnight. The next morning you wake up and you’re left with 100 percent cash in your account. Here’s the test: you can repurchase the same investments at no cost. Would you build the same portfolio? If not, what changes would you make? Why aren’t you making them now?
Picking the next Apple is not a financial goal. Saving for retirement or having enough money to send your kids to college are financial goals.
One of the more common behavioral mistakes we make when it comes to investment decisions is the tendency to get stuck on a certain value or price. When we get stuck on a price, it can lead to costly blunders.
The market doesn’t care what you paid it all matter is what is it worth today
In an intellectual exercise, knowledge wins (buy low, sell high!). But in the real world, we’re hardwired to pursue the things that give us pleasure or provide security and run as fast as possible from the things that cause us pain. If that weren’t the case, we would have been eaten by saber-toothed tigers a long time ago. This means that we’re often driven by how we feel instead of what we know.
Investment decisions should be made based on what we know, not how we feel.
So if you’re thinking about making a sudden change to your portfolio, ask yourself if your decision is based on how you feel or what you know. Is it based on your feelings about what is going on in the market or is it based on an investment plan you put in place when you were thinking clearly?
A lack of action implies we’re missing an opportunity or making a mistake. Cultivating a garden takes lots of hard work, but at some point, you have to let the plants grow. If you have a plan, let it work. If you’re still convinced that you need to act, take a mandatory time-out. Write yourself a letter that explains what you intend to do and why.
Please. Ignore your gut feelings about the direction of the stock market. I can’t tell you how many times I have heard people use their “gut” as an excuse to buy or sell stocks at what turns out to be just the wrong time.
Uncertainty Is Okay Investing, like life itself, forces us to make decisions in the midst of uncertainty. We will never be right all the time.
We can control the process of making the decision, but we can’t control the outcome.
Most of the time, you shouldn’t react to new information at all. But sometimes you should. How can you tell whether to act or not? Try asking these two questions: One: if I act on this new information and it turns out to be right, what impact will it have on my life? Two: if I act on this new information and it turns out to be wrong, what impact will that have on my life?
YOU’RE RESPONSIBLE FOR YOUR BEHAVIOR (BUT YOU CAN’T CONTROL THE RESULTS)
BERNIE Madoff spent most of the past two decades running the largest Ponzi scheme in history, defrauding thousands of investors of billions of dollars. Many of those investors were intelligent, sophisticated people. Some were top managers at major Wall Street firms. What happened? Same old, same old. He promised the moon, and we wanted to believe he could deliver it. There were warning signs. Many people on Wall Street had their suspicions of Madoff.
Part of the problem lies with our almost universal tendency to believe what we want to believe. It’s really, really hard to resist a deal that looks too good to be true— especially when other people are buying into it.
The more vulnerable we are, the more tempted we are to grab a great deal,
Most financial advisors are trying to make a living by helping their clients. Sometimes, however, those two goals are in conflict. That’s okay— but only if we understand that the conflict exists.
inherent in almost any situation when you’re paying for advice. Lawyers, accountants, financial advisors, auto mechanics… we all have to cope with situations when our interests may not fully align with the interests of our clients, at least in the short run. Your job is to identify those conflicts, and then keep them in mind as you make your decisions. Think of it this way: when you walk into a Toyota dealership, you don’t expect the guys there to tell you that Hondas are the greatest car around. You hope they’re honest, but you know they’re going to try to sell you a Toyota
There is a great deal of debate about which model is best. And while the commissions-based model offers the most potential for conflicts of interest, no model can eliminate them. A fee-based planner may lose money when a client withdraws savings to pay down his mortgage, but it might be the right thing for the client. That’s a potential conflict of interest right there.
There are exceptions, but it’s unwise to pretend that the people on the other side of the desk have a duty to put your interests in front of those of the firm that employs them.
investing is fun while you’re making money. And it’s fun to indulge in occasional daydreams about getting rich the easy way. But this is not Monopoly. This is real life. We’re dealing with real money and real goals. When we forget that— when we confuse investing and entertainment—we almost always end up behaving badly.
So next time you are tempted to “play the stock market” maybe you should go to the movies instead.
While you’re thinking, make sure you consider the bigger picture— the context of your behavior. A single action may have broader financial consequences that aren’t immediately obvious.
WHEN WE TALK ABOUT MONEY
We all bring our personal biases to the table when it comes to money.
At the same time, we may need to be aware of our own biases, and find language to express what we need and what we feel about money.
Kids often know more than we think they do.
We may say we want simplicity, but we tend to choose complexity.
We often resist simple solutions because they require us to change our behavior.
Saving money, avoiding speculative investments, and repeating that process over and over may not be sexy, but it gets the job done.
The simple options that have the largest impact on your financial success require discipline, patience, and hard work.
More recently, I read an article in Newt week about how Americans were spending again, whether they could afford it or not. Just two years earlier, the media was claiming that an entire generation of people had changed their consumption habits and ideals based on the economic tumult they had experienced. But evidence suggests that many of us have already forgotten what it felt like to be pushed to the brink.
We all know the old saying that old habits die hard, and nowhere does this seem to be more true than with our spending habits. They are awfully difficult to change.
In the sixties, researchers at Stanford University launched a decades-long study that looked at our ability to delay gratification. They found that people who’ve figured out how to postpone the fulfillment of their desires, instead of giving in immediately, experienced greater success than those who haven’t.
A few years ago, I had an interesting conversation with a gentleman who had managed to turn a relatively small inheritance into very large net worth.
His reply: “Carl, I just bought boring things and paid them off over thirty years.”
The reality is that there is no secret. Just boring stuff like spending less than you earn, setting some money aside for a rainy day, paying down debt, and steering clear of large losses.
what we read in the financial press is written to sell magazines or drive traffic to websites. Slow and steady does not sell magazines or drive traffic to websites.
I’ve seen firsthand the damage investors inflict on themselves by chasing hot investments.
I had a conversation recently with a prospective client who told me that he had done pretty well with an aggressive trading strategy. I have heard that enough times over the years to know that we all have selective and short-term memories. Sometimes it takes only a few winning trades for someone to forget the losers. That was the case here. True, things had indeed gone well for my prospective client during recent months. But he had lost around 50 percent of his savings when the market slumped in 2008— so his growth was on a much smaller capital base. All things considered, he had a terrible investment record. Moral: if you decide to be slow and steady, remember to take with a huge grain of salt all those stories of people getting rich quickly.
The goal isn’t to make the “perfect” decision about money every time, but to do the best you can and move forward.
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Excerpts and Learning from Articles/Blogs
1) 1 Main Capital Management Shareholder Letter (Link)
Stocks typically get cheap exactly when there are things to worry about, and right now there is no shortage of them. In fact, the list seems to be getting longer by the day. In periods such as these, our minds try to convince us to avoid additional near-term pain by selling things until the skies are clear. However, we must remind ourselves that today’s lower prices are better, not worse, for long-term investors when compared to those from the start of the year. As such, those with a time horizon measured in the years rather than months are likely best served to stay the course and selectively adding exposure if prices continue heading lower.
It is a fool’s errand to jump in and out of the market, or from sector to sector, consistently without detracting from the long-term compounding of effect of business’ earnings.
If one has a sound investment strategy, it is dangerous to change the strategy after a period of poor performance. In the words of Nassim Taleb, “if you must panic, panic early.” Panicking late turns temporary losses into permanent ones.
In the words of Howard Marks, “If you stand at a bus stop long enough, you’ll get a bus. But if you keep running from bus stop to bus stop, you may never get a bus.” Of course, this doesn’t mean to stay the course and do nothing with one’s portfolio. Market drawdowns tend to be associated with periods where things are rapidly changing, making it more important than ever to underwrite and re-underwrite positions to ensure our portfolio is optimized for risk-adjusted returns.
Sticking to the broader strategy that works over long periods is less risky than
trying to jump in and out of the market.Nothing is ever as good or as bad as it seems. Business conditions and consumer behavior aren’t static. Neither are the decisions of policymakers, employees, or management teams
2) Ensemble Capital Q2 Letter (Link)
This rapid reduction in investors’ time horizons is characteristic of market panics. When humans become highly stressed, their mental focus shifts away from long-term considerations to prioritize short term considerations. For instance, even bearish economic forecasters today generally agree that the economy will recover in the years ahead. Recessions are not typically long events. Yet today, investors are ignoring the level of earnings that companies are likely to generate over the next 3-5 years and instead focusing on whether the coming quarter or year will generate results that are weaker than expected. This is a mistake that investors make time and again. It is such a repetitive behavior that psychologists have given it a name; “hyperbolic discounting”
investing is a matter of seeking to understand what a company’s long-term future
cash generation will be and ensuring you pay a fair price for those cash flows. If the corporate outlook faces headwinds, it makes sense that the valuation would contract. But headwinds do not need to send stocks down to record low valuations. When this happens, investors are best served by checking (and double checking!) their analysis of the future outlook and then simply waiting for the market to stop panicking and return to more rational valuations.
Forecasting growth over long time periods is difficult (Ensemble’s Way)
There are two things that can negatively impact investment performance for these types of stocks.
1) We may overestimate the magnitude or duration of a company’s growth rate, or 2) during periods of fear about the future, other investors may suddenly start to ignore the long-term opportunity and focus instead on the very near term. This is the issue of hyperbolic discounting that we discussed above.
Periods of underperformance, including sharp or extended periods, are part of
every long-term successful investment manager’s track record. It simply isn’t possible to build a portfolio that is different from the broader market, a requirement for out-performance, while avoiding periods of under-performance
3) The Sustainability of Growth vs Return on Invested Capital (Link)
High returns on invested capital are far more sustainable than high growth rates and thus this metric is more important than growth in determining valuation.
It isn’t just next year’s results that matter or the year after that. Businesses are long-lived organizations and their value is determined by the long-term sustainability of their cash flow. So while ROIC and growth both drive valuation, it is the sustainability of these metrics that matter, not their outcomes in the next couple of years.
For a company growing at 17% initially (a rate of growth that would clearly label the company a “growth stock”), has seen their growth rate slow to 6%-7% on average within 5-years and then gone on to slow to 5%. While analysts will often project a company like this to grow at a double-digit rate for five years or more, in practice this sort of company will see its growth rate drop into the single digits within just two to three years. Even hyper growth companies growing at over 30% per year generally see their growth rate drop into the single digits within four years.
This rapid rate at which growth “decays” to average is a primary reason why investors should be hesitant to pay high valuations for quickly growing companies. While certainly some quickly growing companies maintain high growth for a decade or more, the average high growth company does not. Offsetting those potential long-term growth opportunities is the math behind average results that means that an equal number of current growth companies will see their growth rate collapse even faster than the averages shown above.
The average company with an initial ROIC of 17% was still producing an above average ROIC of 13% after five years and 12.5% over a decade later. Top performing firms returning 25% or more returns on capital have seen their ROIC persist in the mid-teens or better even over the very long run.
4) I Beg to Differ (Link)
→ The Essential Difference
If you seek superior investment results, you have to invest in things that others haven’t flocked to and caused to be fully valued. In other words, you have to do something different.
If your behavior and that of your managers is conventional, you’re likely to get conventional results – either good or bad. Only if the behavior is unconventional is your performance likely to be unconventional ...and only if the judgments are superior is your performance likely to be above average.
You can’t take the same actions as everyone else and expect to outperform.”
If you want to be above average, you have to depart from consensus behavior. You have to overweight some securities, asset classes, or markets and underweight others. In other words, you have to do something different.
The challenge lies in the fact that (a) market prices are the result of everyone’s collective thinking and (b) it’s hard for any individual to consistently figure out when the consensus is wrong and an asset is priced too high or too low.
Every active bet placed in the pursuit of above average returns carries with it the risk of below average returns. There’s no way to make an active bet such that you’ll win if it works but not lose if it doesn’t. Financial innovations are often described as offering some version of this impossible bargain, but they invariably fail to live up to the hype.
You can’t hope to earn above average returns if you don’t place active bets, but if your active bets are wrong, your return will be below average.
If you hope to distinguish yourself in terms of performance, you have to depart from the pack. But, having departed, the difference will only be positive if your choice of strategies and tactics is correct and/or you’re able to execute better.
→ Second Level Thinking
Millions of people are competing for each dollar of investment gain. Who’ll get it? The person who’s a step ahead. In some pursuits, getting up to the front of the pack means more schooling, more time in the gym or the library, better nutrition, more perspiration, greater stamina or better equipment. But in investing, where these things count for less, it calls for more perceptive thinking ...at what I call the second level.
The basic idea behind second-level thinking is easily summarized: In order to outperform, your thinking has to be different and better.
In short, being right may be a necessary condition for investment success, but it won’t be sufficient. You have to be more right than others ...which by definition means your thinking has to be different.
First-level thinkers look for simple formulas and easy answers. Second-level thinkers know that success in investing is the antithesis of simple.
Anyone who thinks there’s a formula for investing that guarantees success (and that they can possess it) clearly doesn’t understand the complex, dynamic, and competitive nature of the investing process. The prize for superior investing can amount to a lot of money. In the highly competitive investment arena, it simply can’t be easy to be the one who pockets the extra dollars.
→ Contrarianism
if the extreme highs and lows are excessive and the result of the concerted, mistaken actions of most investors, then it’s essential to leave the crowd and be a contrarian.
Unfortunately, overcoming the tendency to follow the crowd, while necessary, proves insufficient to guarantee investment success . . . While courage to take a different path enhances chances for success, investors face likely failure unless a thoughtful set of investment principles undergirds the courage.
Joel Greenblatt, an exceptional equity investor, provided a very apt observation regarding knee-jerk contrarianism: “...just because no one else will jump in front of a Mack truck barreling down the highway doesn’t mean that you should.” In other words, the mass of investors aren’t wrong all the time, or wrong so dependably that it’s always right to do the opposite of what they do. Rather, to be an effective contrarian, you have to figure out:
what the herd is doing;
why it’s doing it;
what’s wrong, if anything, with what it’s doing; and
what you should do about it.
intelligent contrarianism is deep and complex. It amounts to much more than simply doing the opposite of the crowd. Nevertheless, good investment decisions made at the best opportunities – at the most overdone market extremes – invariably include an element of contrarian thinking.
→ The Decision to Risk Being Wrong
If your portfolio looks like everyone else’s, you may do well, or you may do poorly, but you can’t do different. And being different is absolutely essential if you want a chance at being superior....
Most great investments begin in discomfort. The things most people feel good about – investments where the underlying premise is widely accepted, the recent performance has been positive, and the outlook is rosy – are unlikely to be available at bargain prices. Rather, bargains are usually found among things that are controversial, that people are pessimistic about, and that have been performing badly of late.
You gain when you make the right choice and lose when you’re wrong.
In a presentation I occasionally make to institutional clients, I employ PowerPoint animation to graphically portray the essence of this situation:
A bubble drops down, containing the words “Try to be right.” That’s what active investing is all about. But then a few more words show up in the bubble: “Run the risk of being wrong.” The bottom line is that you simply can’t do the former without also doing the latter. They’re inextricably intertwined.
Then another bubble drops down, with the label “Can’t lose.” There are can’t-lose strategies in investing. If you buy T-bills, you can’t have a negative return. If you invest in an index fund, you can’t underperform the index. But then two more words appear in the second bubble: “Can’t win.” People who use can’t-lose strategies by necessity surrender the possibility of winning. T-bill investors can’t earn more than the lowest of yields. Index fund investors can’t outperform.
And that brings me to the assignment I imagine receiving from unenlightened clients: “Just apply the first set of words from each bubble: Try to outperform while employing can’t-lose strategies.” But that combination happens to be unavailable.
It should be clear that you can’t hope to earn superior returns if you’re unwilling to bear the risk of sub-par results.
Unconventional behavior is the only road to superior investment results, but it isn’t for everyone. In addition to superior skill, successful investing requires the ability to look wrong for a while and survive some mistakes. Thus each person has to assess whether he’s temperamentally equipped to do these things and whether his circumstances – in terms of employers, clients and the impact of other people’s opinions – will allow it...when the chips are down and the early going makes him look wrong, as it invariably will.
You can’t have it both ways. And as in so many aspects of investing, there’s no right or wrong, only right or wrong for you.
→ A Case in Point
Marks on David Swensen
Swensen dared to be different. He did things others didn’t do. He did these things long before most others picked up the thread. He did them to a degree that others didn’t approach. And he did them with exceptional skill. What a great formula for outperformance.
Uninstitutional behavior from institutions – We all know what Swensen meant by the word “institutions”: bureaucratic, hidebound, conservative, conventional, risk-averse, and ruled by consensus; in short, unlikely mavericks. In such settings, the cost of being different and wrong can be viewed as highly unacceptable relative to the potential benefit from being different and right. For the people involved, passing up profitable investments (errors of omission) poses far less risk than making investments that produce losses (errors of commission). Thus, investing entities that behave “institutionally” are, by their nature, highly unlikely to engage in idiosyncratic behavior.
→ One Way to Diverge from the Pack
We really shouldn’t care about the short term – after all, we’re investors, not traders.
most investors would be better off ignoring short-term considerations if they want to enjoy the benefits of long-term compounding.
Even if we think we know what’s in store in terms of things like inflation, recessions, and interest rates, there’s absolutely no way to know how market prices comport with those expectations. This is more significant than most people realize. If you’ve developed opinions regarding the issues of the day, or have access to those of pundits you respect, take a look at any asset and ask yourself whether it’s priced rich, cheap, or fair in light of those views. That’s what matters when you’re pursuing investments that are reasonably priced.
The possibility – or even the fact – that a negative event lies ahead isn’t in itself a reason to reduce risk; investors should only do so if the event lies ahead and it isn’t appropriately reflected in asset prices.
In fact, highly disciplined managers who hold most rigorously to a given approach will tend to report the worst performance when that approach goes out of favor. Regardless of the appropriateness of a strategy and the quality of investment decisions, every portfolio and every manager will experience good and bad quarters and years that have no lasting impact and say nothing about the manager’s ability. Often this poor performance will be due to unforeseen and unforeseeable developments.
Thus, what does it mean that someone or something has performed poorly for a while? No one should fire managers or change strategies based on short-term results. Rather than taking capital away from underperformers, clients should consider increasing their allocations in the spirit of contrarianism (but few do).
One quarter’s or one year’s performance is meaningless at best and a harmful distraction at worst. But most investment committees still spend the first hour of every meeting discussing returns in the most recent quarter and the year to date. If everyone else is focusing on something that doesn’t matter and ignoring the thing that does, investors can profitably diverge from the pack by blocking out short-term concerns and maintaining a laser focus on long-term capital deployment.
(Sorry for so long takeaways post of Howard Marks’s Latest Memo :) )
5) The 'bahubali' investor
Small Video Clips
Concentration vs Diversification (Ashwath Damodaran) (19:40 to 21:38)
What to do in a tough market (Safal Niveshak) (9:42 To 14:56)
How Long term investing should be done! (18:32 to 20:50)
How to find the fair value of any business (2 Best practical Methods) (27:12 To 42:34) A Must watch section 👌
Big Investing Learning from Vinod Sethi (A man who invested in Hero, Infosys, and HDFC when no one knows about these companies) (45:06 to 48:03)
Investing Biases and Anomalies and How to get rid of that (Behavioural Economics)
Why you should never buy a Mutual fund just based on the Top performing list and why you should never chase the highest return/numbers game (9:44 to 21:21)
(Again would recommend watching the full session if you love long investing videos, Many myths debunked)
The stock market is forward-looking, should we ignore the past? (46:26 to 48:49)
Thanks for reading.
See you again next week.
- Dhaval (Investment Books)
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