Tuesday, January 21, 2014
Warren Buffett On The Stock Market From Fortune
http://money.cnn.com/magazines/fortune/fortune_archive/2001/12/10/314691/
Wednesday, January 15, 2014
Buffett CNBC Interview Transcript Compilation
http://www.scribd.com/collections/2645024/Warren-Buffett-CNBC-Interview-Transcripts
http://www.grahamanddoddsville.net/wordpress/Files/Gurus/Warren%20Buffett/WEB%20on%20Charlie%20Rose%20-%2011-2009.pdf
http://www.grahamanddoddsville.net/wordpress/Files/Gurus/Warren%20Buffett/WEB%20on%20Charlie%20Rose%20-%2011-2009.pdf
Wednesday, January 8, 2014
De-dopaminize Your Investment Process
During 2013 I’ve had the honor and luck to meet a few great investors and one of the questions I always ask is “how do you suppress your urge to act?”
The reason I ask that question is because my experiences have taught me that fewer but wiser bets will likely to lead better performance. All of us have heard of Buffett’s “20 punch cards” advice to investors but how many of us have acted accordingly? Human nature pushes us to get active, not inactive. When our brain recognizes an opportunity for financial reward, it releases dopamine, which tells the rest of the brain to pay attention to that opportunity and get our greedy little hands on it before we miss it. Worse yet, our rewards system gets much more excited about a possible big win so it will motivate us to do whatever provides the chance to win.
In this article I want to share with the readers the answers I got from 3 great investors and how I have used their strategies to pass on ideas that initially got me excited.
1. Mohnish Pabrai - It is widely known that Mohnish Pabrai uses a checklist to minimize the number of mistakes he will make. While the checklist is a powerful approach, Mohnish said most of his ideas won’t even get to the checklist step before they are killed. Among the strategies he uses to kill an idea, discussing the ideas with his friends such as Guy Spier and seeking contrarian information will often make him less excited about the idea.
Case in point – Chinese banks: during 2013, I paid a lot of attention to a few large Chinese Banks because they were trading below tangible book value. I read the Annual Reports of China Construction Bank and Bank of Communication. My initial analysis made me feel that they were much undervalued. Before acting on the idea, I sent it to a friend who knows a lot about Asian banks and asked for his feedback. He responded to me with his detailed analysis of the Chinese banks, along with the comparison to banks in other parts of Asia. After reading his response, I did a lot more research and eventually I came to the conclusion that while the valuation is low, the risk level is too high to justify a position.
2.Arnold Van Den Berg – Van Den Berg has an amazing track record. Since Century Management’s inception in 1974, it only has 4 down years compared to 11 of S&P. Furthermore, the losses were below 10% except for 2008. The most remarkable characteristic in Century Management’s portfolio since 1974 is the relative rarity of losers, compared to other asset managers. Century Management’s publications – The CM Value Investors are one of the best value investing publications I have ever read, you can find them on the following link http://centman.com/insights/category/cm-value-investor/. If you read the CM Value Investors, you will find that their discipline is phenomenal. If the downside risk is too big, they will most likely pass on the idea even if the upside is appealing. By looking at downside closely and establishing a purchase price as close to bear case as possible, Century Management has been able to outperform the market consistently.
Case in point – Weight Watchers International: During November last year, I wrote an article on Weight Watchers International. Through my research and analysis, it looked like Weight Watchers International has had an inherently favorable business model and although the moat was narrowing, valuation looked attractive. Some big name investors such as Joel Greenblatt and Jeff Auxier took positions in WTW as well during Q2 and Q3 of 2013. What eventually prevented me from looking further is the downside scenario, which was 36% below where WTW was traded in late November.The downside was too high to justify a position in WTW. I told myself to take a look at WTW if it ever drops to mid 20s, which is much closer to the worst case scenario.
3. Stephen Yacktman – In my interview with the Yacktman Funds, Stephen told me one of the best ways to suppress your excitement with an idea is to force yourself to look for WTCGs (what can go wrong). Each WTCG will make you feel less excited about the idea and very often, before you list out all the WTCGs you can think of, the idea is not that appealing any more.
Case in point – Corinthian Colleges: I was looking for ideas in the for-profit education industry and there was an interesting article on Corinthian College (COCO) on gurufocus submitted as a value investing contest. The case for COCO looked compelling. It is an established institution with high margins and lots of cash flows. The stock was cheap at merely above $2.5 per share. The upside looked really good. My brain was telling me “don’t miss this, you gotta act.” I passed on the idea once I started compiling the WTCGs. One of the WTCGs I found is management’s lack of integrity may lead to eventual scrutiny by regulators. There was a public article on Corinthian Colleges' officials' engagement in a no-holds-barred campaign to drive down their schools' rates by pushing former students to obtain temporary forbearance and deferments on their loans. Another WTCG that really threw me off was COCO’s horrible cohort default rates, which are so bad compared to Strayer Education that regulatory non-compliance was a real concern.
Conclusion: Most of us are born to be frequent batters. Although we know that the future is unknowable and there is a downside risk related to every investment, our reward system often pushes us to act on the ideas that promise the highest rewards, no matter how big the downside risks are. Worse yet, we are often temped to buy stocks simply to avoid missing out on the action, especially during a bull market. Designing a personalized strategy to suppress your urge to act will benefit one investor in many ways. But most importantly, doing so will force you to pay more attention to the downside and it has been repeatedly said by many renowned investors, if you take care of the downside, the upside will take care of itself.
The reason I ask that question is because my experiences have taught me that fewer but wiser bets will likely to lead better performance. All of us have heard of Buffett’s “20 punch cards” advice to investors but how many of us have acted accordingly? Human nature pushes us to get active, not inactive. When our brain recognizes an opportunity for financial reward, it releases dopamine, which tells the rest of the brain to pay attention to that opportunity and get our greedy little hands on it before we miss it. Worse yet, our rewards system gets much more excited about a possible big win so it will motivate us to do whatever provides the chance to win.
In this article I want to share with the readers the answers I got from 3 great investors and how I have used their strategies to pass on ideas that initially got me excited.
1. Mohnish Pabrai - It is widely known that Mohnish Pabrai uses a checklist to minimize the number of mistakes he will make. While the checklist is a powerful approach, Mohnish said most of his ideas won’t even get to the checklist step before they are killed. Among the strategies he uses to kill an idea, discussing the ideas with his friends such as Guy Spier and seeking contrarian information will often make him less excited about the idea.
Case in point – Chinese banks: during 2013, I paid a lot of attention to a few large Chinese Banks because they were trading below tangible book value. I read the Annual Reports of China Construction Bank and Bank of Communication. My initial analysis made me feel that they were much undervalued. Before acting on the idea, I sent it to a friend who knows a lot about Asian banks and asked for his feedback. He responded to me with his detailed analysis of the Chinese banks, along with the comparison to banks in other parts of Asia. After reading his response, I did a lot more research and eventually I came to the conclusion that while the valuation is low, the risk level is too high to justify a position.
2.Arnold Van Den Berg – Van Den Berg has an amazing track record. Since Century Management’s inception in 1974, it only has 4 down years compared to 11 of S&P. Furthermore, the losses were below 10% except for 2008. The most remarkable characteristic in Century Management’s portfolio since 1974 is the relative rarity of losers, compared to other asset managers. Century Management’s publications – The CM Value Investors are one of the best value investing publications I have ever read, you can find them on the following link http://centman.com/insights/category/cm-value-investor/. If you read the CM Value Investors, you will find that their discipline is phenomenal. If the downside risk is too big, they will most likely pass on the idea even if the upside is appealing. By looking at downside closely and establishing a purchase price as close to bear case as possible, Century Management has been able to outperform the market consistently.
Case in point – Weight Watchers International: During November last year, I wrote an article on Weight Watchers International. Through my research and analysis, it looked like Weight Watchers International has had an inherently favorable business model and although the moat was narrowing, valuation looked attractive. Some big name investors such as Joel Greenblatt and Jeff Auxier took positions in WTW as well during Q2 and Q3 of 2013. What eventually prevented me from looking further is the downside scenario, which was 36% below where WTW was traded in late November.The downside was too high to justify a position in WTW. I told myself to take a look at WTW if it ever drops to mid 20s, which is much closer to the worst case scenario.
3. Stephen Yacktman – In my interview with the Yacktman Funds, Stephen told me one of the best ways to suppress your excitement with an idea is to force yourself to look for WTCGs (what can go wrong). Each WTCG will make you feel less excited about the idea and very often, before you list out all the WTCGs you can think of, the idea is not that appealing any more.
Case in point – Corinthian Colleges: I was looking for ideas in the for-profit education industry and there was an interesting article on Corinthian College (COCO) on gurufocus submitted as a value investing contest. The case for COCO looked compelling. It is an established institution with high margins and lots of cash flows. The stock was cheap at merely above $2.5 per share. The upside looked really good. My brain was telling me “don’t miss this, you gotta act.” I passed on the idea once I started compiling the WTCGs. One of the WTCGs I found is management’s lack of integrity may lead to eventual scrutiny by regulators. There was a public article on Corinthian Colleges' officials' engagement in a no-holds-barred campaign to drive down their schools' rates by pushing former students to obtain temporary forbearance and deferments on their loans. Another WTCG that really threw me off was COCO’s horrible cohort default rates, which are so bad compared to Strayer Education that regulatory non-compliance was a real concern.
Conclusion: Most of us are born to be frequent batters. Although we know that the future is unknowable and there is a downside risk related to every investment, our reward system often pushes us to act on the ideas that promise the highest rewards, no matter how big the downside risks are. Worse yet, we are often temped to buy stocks simply to avoid missing out on the action, especially during a bull market. Designing a personalized strategy to suppress your urge to act will benefit one investor in many ways. But most importantly, doing so will force you to pay more attention to the downside and it has been repeatedly said by many renowned investors, if you take care of the downside, the upside will take care of itself.
Saturday, December 28, 2013
2013 Year End Reflections
As the year 2013 draws to a close, it is time to sit down and reflect upon the investment mistakes that I’ve committed during the year. In doing so, I am immediately reminded of an excerpt from Warren Buffett’s 1989 letter to shareholders.
“To quote Robert Benchley, ‘Having a dog teaches a boy fidelity, perseverance, and to turn around three times before lying down.’ Such are the shortcomings of experience. Nevertheless, it's a good idea to review past mistakes before committing new ones.”
Alas, how I wish I had a magic dog to teach myself to avoid soggy cigar butts on the street. The biggest mistake I made this year unmistakably falls under this “cigar butt” category. In a year where S&P advanced more than 30%, I’ve brilliantly managed to invest in a company whose share price has sunk over 50% since the beginning of the year. It is certainly not fun to slip up but getting up and learn from the fall has proved to be extremely rewarding. Heck, in fact, I consider this the best investing lesson that I have ever learned because as a result of the mistake, I now have a much better understanding of the shortcomings of the cigar butts approach to investment.
This cigar butt is called JC Penney. The mistake I made is a multifaceted one that involves analytical errors, human psychological biases, and a horrible purchase price.
To be clear, I don’t think buying JC Penney is a mistake per se. I’ve bought JC Penney in 4 tranches, the lowest at $8 and the highest at $17.Whether it is a mistake depends on the price paid. As Howard Marks has said before:
“In investing there is no such thing as a good or bad idea. Only a good idea at a price. Anything can be a good idea at one price and time, and a bad one at another. There is no investment idea so good that it can not be ruined by a too-high entry price. And there are few things that can not be attractive investments if bought at a low-enough price.
It has been demonstrated time and time again that no asset is so good that it can’t become a bad investment if bought at too high a price. And there are few assets so bad that they can’t be a good investment when bought cheap enough. No asset class or investment has the birthright of a high return. It’s only attractive if it’s priced right.”
I have certainly paid too much for JC Penney and that was a huge mistake that has cost me dearly. At the time I bought the first tranche of JC Penney, it was around $17 per share. In an article I wrote called “JC Penney – Maximum Pessimism,” I laid out my thesis based on JCP was trading around the liquidation value estimated to be between $13 to $16 per share. One of the readers made the following great comment: Liquidation value is one of those things with a big range of possibilities IMO. In a bankruptcy preceding, I doubt current shareholders will get even $9 per share or even $5 for that matter. Although I don’t know this member personally, I can tell he is without a doubt a much better investor than I am.
I’ve learned the hard way that liquidation value is as real as a mirage. First of all, the liquidation value is very likely to evaporate like liquid left in the sun if the business is not improving. JC Penney’s book value dropped almost by half within a relative short period of time. Therefore, using the present liquidation value was very foolish. Had I extrapolated the liquidation value for JC Penney based on the speed at which the business was deteriorating, I would have come up with very different scenarios. Secondly, as I have learned through studying Buffett’s partnership letters, liquidation value itself provides very limited downside protection unless you can accumulate a controlling position and even if you can end up controlling the business, the liquidating process is likely to be very painful.
Given the inadequacy of liquidating value, it is not surprising that my worst case scenario was way too optimistic, which leads to another lesson – risk means worst case scenario can happen more often and can be more severely than you think. Frankly, I did not think JC Penney was going to drop to merely $6 per share. Mark Twin said “a man who carries a cat by the tail learns something he can learn in no other way.” My experience with JC Penney has certainly proved his point. Almost everything that could go wrong did go wrong. Sales dropped precipitously; the board room was full of dramas; drastic leadership turnovers; solvency issues; liquidity crunch; massive equity dilution. Even when sales are improving, no one seems to care because everyone is now concerned that margin will stay low forever. I would be lying if I tell you that all the negativity did not bother me one bit. It was unpleasant mentally to go through the turmoil but I am also fully aware that I deserve such agitation. However, without such agitation, I probably won’t be able to fully appreciate the beauty of “it's far better to buy a wonderful company at a fair price than a fair company at a wonderful price.”
I wish I could stop right here and tell everyone that’s all the mistakes I’ve made about JC Penney. Unfortunately, the dimension of this flub extends beyond sheer analytical flounder. I also failed utterly to recognize the human psychological forces that were in play.
At the time I made my purchase decision, JC Penney had a very promotional CEO and a promotional activist, Bill Ackman, who I actually admire a lot. Looking back, my analysis was heavily influenced by the way Ron Johnson and Bill Ackman presented information (framing bias) and the ease at which the information can be recalled (availability bias). What initially got me really interested in JC Penney were a few articles on gurufocus and Bill Ackman’s presentation. Unfortunately, the presentation served as my initial anchor. Below are the slides that got the neurons in the nucleus accumbens part of my brain fired like wild.
Upon deep reflection, I think the root of my mistake lies in the part of my brain that handles anticipation for rewards. In Chapter 3 of the great book “Your Money or Your Brain” by Jason Zweig, the author noted that “Making money feels good, all right; it just doesn’t feel as good as expecting to make money. In a cruel irony that has enormous implications for financial behavior, your investing brain comes equipped with a biological mechanism that is more aroused when you anticipate a profit than when you actually get one. The arousal piece is actually the main component of euphoria, and it’s expectation- not satisfaction – that causes most of that arousal. When rewards are near, the brain hates to wait. Neurons in the caudate nucleus, a region in the center of the primate brain, become active even before the predictive cue is presented.” Now I can imagine that the neurons in the caudate nucleus must have been fired up when I saw Mr.Ackman’s base case offered a 6.5 times upside when JC Penney was trading at $17 per share.
Fixating on the upside made me overlook the magnitude of the downside. Under influence, my calculated risk reward ratio seemed favorable: using 20 year low of $10 as worst case and $39 - only half of Mr. Ackman’s base case, at $17 per share, the downside was $7 and upside was $22 with. For every dollar of risk, I thought I was getting 3 dollars of rewards. The odds were favorable.
The reward seemed so real and the anticipation was so exciting. There was only one little problem – in reality, it doesn’t work that way. The rewards are imaginary while the risks are real.
I had the fortune to talk about JC Penney with a few renowned investors including Arnold Van Den Berg, Stephen Yacktman and Michael Shearn. All of them have considered investing in JC Penney yet all passed. Among the reasons they ultimately did not invest are promotional management, too hard to figure out and too much downside. None of them even mentioned the upside during our conversations. This is the difference between a wise man and a fool when it comes to investing. The wise man knows that if you take care of the downside, the upside will take care of itself. Now I realize that even though the risk reward was favorable, the downside of 40% was too much and because the uncertainty was so high, one should pay a lot less for taking on the risks, not more.
The above may all seem very obvious to most of the readers but I had to learn it the hard way over and over.The confluence of the framing bias, the availability bias and the anchoring has been skewed my reasoning in the past to the more euphoric side of the pendulum. It was not until the second half of this year did I recognize the power of the lollapalooza effect, which Charlie Munger has warned us. But better late than never. The JC Penney experience will definitely serve me as a reminder going forward.
The last mistake I made with the JC Penney investment is related to portfolio sizing. It had been a 15% position in my portfolio. I am still debating whether this is as huge as a mistake as the analytical error and the lollapalooza effect. After all, I resonate with the idea of concentration unless everything gets cheap like the experience of 2008. Nevertheless, a 15% position in a struggling retailer does seem too high with the benefit of hindsight.
Now that I have finally listed out all the mistakes I’ve made with JC Penney, I feel obligated to apologize for having rambled so much on an investment that has been discussed very extensively on gurufocus. Of all the mistakes I have made and believe me, there are a lot, the JC Penney blunder is by far my favorite because I have learned tremendously from a multidisciplinary approach.
Charlie Munger once said “I like people admitting they were complete stupid horses’ asses. I know I’ll perform better if I rub my nose in my mistakes. This is a wonderful trick to learn.”
Therefore, at the end of 2013, I’d like to admit that I was a complete stupid horse’s ass but I’ve learned to rub my nose in my mistakes.
Thanks for reading and happy new year!
“To quote Robert Benchley, ‘Having a dog teaches a boy fidelity, perseverance, and to turn around three times before lying down.’ Such are the shortcomings of experience. Nevertheless, it's a good idea to review past mistakes before committing new ones.”
Alas, how I wish I had a magic dog to teach myself to avoid soggy cigar butts on the street. The biggest mistake I made this year unmistakably falls under this “cigar butt” category. In a year where S&P advanced more than 30%, I’ve brilliantly managed to invest in a company whose share price has sunk over 50% since the beginning of the year. It is certainly not fun to slip up but getting up and learn from the fall has proved to be extremely rewarding. Heck, in fact, I consider this the best investing lesson that I have ever learned because as a result of the mistake, I now have a much better understanding of the shortcomings of the cigar butts approach to investment.
This cigar butt is called JC Penney. The mistake I made is a multifaceted one that involves analytical errors, human psychological biases, and a horrible purchase price.
To be clear, I don’t think buying JC Penney is a mistake per se. I’ve bought JC Penney in 4 tranches, the lowest at $8 and the highest at $17.Whether it is a mistake depends on the price paid. As Howard Marks has said before:
“In investing there is no such thing as a good or bad idea. Only a good idea at a price. Anything can be a good idea at one price and time, and a bad one at another. There is no investment idea so good that it can not be ruined by a too-high entry price. And there are few things that can not be attractive investments if bought at a low-enough price.
It has been demonstrated time and time again that no asset is so good that it can’t become a bad investment if bought at too high a price. And there are few assets so bad that they can’t be a good investment when bought cheap enough. No asset class or investment has the birthright of a high return. It’s only attractive if it’s priced right.”
I have certainly paid too much for JC Penney and that was a huge mistake that has cost me dearly. At the time I bought the first tranche of JC Penney, it was around $17 per share. In an article I wrote called “JC Penney – Maximum Pessimism,” I laid out my thesis based on JCP was trading around the liquidation value estimated to be between $13 to $16 per share. One of the readers made the following great comment: Liquidation value is one of those things with a big range of possibilities IMO. In a bankruptcy preceding, I doubt current shareholders will get even $9 per share or even $5 for that matter. Although I don’t know this member personally, I can tell he is without a doubt a much better investor than I am.
I’ve learned the hard way that liquidation value is as real as a mirage. First of all, the liquidation value is very likely to evaporate like liquid left in the sun if the business is not improving. JC Penney’s book value dropped almost by half within a relative short period of time. Therefore, using the present liquidation value was very foolish. Had I extrapolated the liquidation value for JC Penney based on the speed at which the business was deteriorating, I would have come up with very different scenarios. Secondly, as I have learned through studying Buffett’s partnership letters, liquidation value itself provides very limited downside protection unless you can accumulate a controlling position and even if you can end up controlling the business, the liquidating process is likely to be very painful.
Given the inadequacy of liquidating value, it is not surprising that my worst case scenario was way too optimistic, which leads to another lesson – risk means worst case scenario can happen more often and can be more severely than you think. Frankly, I did not think JC Penney was going to drop to merely $6 per share. Mark Twin said “a man who carries a cat by the tail learns something he can learn in no other way.” My experience with JC Penney has certainly proved his point. Almost everything that could go wrong did go wrong. Sales dropped precipitously; the board room was full of dramas; drastic leadership turnovers; solvency issues; liquidity crunch; massive equity dilution. Even when sales are improving, no one seems to care because everyone is now concerned that margin will stay low forever. I would be lying if I tell you that all the negativity did not bother me one bit. It was unpleasant mentally to go through the turmoil but I am also fully aware that I deserve such agitation. However, without such agitation, I probably won’t be able to fully appreciate the beauty of “it's far better to buy a wonderful company at a fair price than a fair company at a wonderful price.”
I wish I could stop right here and tell everyone that’s all the mistakes I’ve made about JC Penney. Unfortunately, the dimension of this flub extends beyond sheer analytical flounder. I also failed utterly to recognize the human psychological forces that were in play.
At the time I made my purchase decision, JC Penney had a very promotional CEO and a promotional activist, Bill Ackman, who I actually admire a lot. Looking back, my analysis was heavily influenced by the way Ron Johnson and Bill Ackman presented information (framing bias) and the ease at which the information can be recalled (availability bias). What initially got me really interested in JC Penney were a few articles on gurufocus and Bill Ackman’s presentation. Unfortunately, the presentation served as my initial anchor. Below are the slides that got the neurons in the nucleus accumbens part of my brain fired like wild.
Upon deep reflection, I think the root of my mistake lies in the part of my brain that handles anticipation for rewards. In Chapter 3 of the great book “Your Money or Your Brain” by Jason Zweig, the author noted that “Making money feels good, all right; it just doesn’t feel as good as expecting to make money. In a cruel irony that has enormous implications for financial behavior, your investing brain comes equipped with a biological mechanism that is more aroused when you anticipate a profit than when you actually get one. The arousal piece is actually the main component of euphoria, and it’s expectation- not satisfaction – that causes most of that arousal. When rewards are near, the brain hates to wait. Neurons in the caudate nucleus, a region in the center of the primate brain, become active even before the predictive cue is presented.” Now I can imagine that the neurons in the caudate nucleus must have been fired up when I saw Mr.Ackman’s base case offered a 6.5 times upside when JC Penney was trading at $17 per share.
Fixating on the upside made me overlook the magnitude of the downside. Under influence, my calculated risk reward ratio seemed favorable: using 20 year low of $10 as worst case and $39 - only half of Mr. Ackman’s base case, at $17 per share, the downside was $7 and upside was $22 with. For every dollar of risk, I thought I was getting 3 dollars of rewards. The odds were favorable.
The reward seemed so real and the anticipation was so exciting. There was only one little problem – in reality, it doesn’t work that way. The rewards are imaginary while the risks are real.
I had the fortune to talk about JC Penney with a few renowned investors including Arnold Van Den Berg, Stephen Yacktman and Michael Shearn. All of them have considered investing in JC Penney yet all passed. Among the reasons they ultimately did not invest are promotional management, too hard to figure out and too much downside. None of them even mentioned the upside during our conversations. This is the difference between a wise man and a fool when it comes to investing. The wise man knows that if you take care of the downside, the upside will take care of itself. Now I realize that even though the risk reward was favorable, the downside of 40% was too much and because the uncertainty was so high, one should pay a lot less for taking on the risks, not more.
The above may all seem very obvious to most of the readers but I had to learn it the hard way over and over.The confluence of the framing bias, the availability bias and the anchoring has been skewed my reasoning in the past to the more euphoric side of the pendulum. It was not until the second half of this year did I recognize the power of the lollapalooza effect, which Charlie Munger has warned us. But better late than never. The JC Penney experience will definitely serve me as a reminder going forward.
The last mistake I made with the JC Penney investment is related to portfolio sizing. It had been a 15% position in my portfolio. I am still debating whether this is as huge as a mistake as the analytical error and the lollapalooza effect. After all, I resonate with the idea of concentration unless everything gets cheap like the experience of 2008. Nevertheless, a 15% position in a struggling retailer does seem too high with the benefit of hindsight.
Now that I have finally listed out all the mistakes I’ve made with JC Penney, I feel obligated to apologize for having rambled so much on an investment that has been discussed very extensively on gurufocus. Of all the mistakes I have made and believe me, there are a lot, the JC Penney blunder is by far my favorite because I have learned tremendously from a multidisciplinary approach.
Charlie Munger once said “I like people admitting they were complete stupid horses’ asses. I know I’ll perform better if I rub my nose in my mistakes. This is a wonderful trick to learn.”
Therefore, at the end of 2013, I’d like to admit that I was a complete stupid horse’s ass but I’ve learned to rub my nose in my mistakes.
Thanks for reading and happy new year!
Sunday, December 22, 2013
Good Read For The Day
http://www.farnamstreetblog.com/2013/12/margin-of-safety/?utm_source=twitterfeed&utm_medium=twitter&utm_campaign=Feed%3A+68131+%28Farnam+Street%29&utm_content=FaceBook
http://www.farnamstreetblog.com/mental-models/
http://www.valueinvestingworld.com/2013/12/a-checklist-for-investors-by-jason-zweig.html?utm_source=feedburner&utm_medium=feed&utm_campaign=Feed%3A+ValueInvestingWorld+%28Value+Investing+World%29&utm_content=FaceBook
http://www.valuewalk.com/2011/10/exclusive-interview-famous-investor-tom-russo/
http://www.farnamstreetblog.com/mental-models/
http://www.valueinvestingworld.com/2013/12/a-checklist-for-investors-by-jason-zweig.html?utm_source=feedburner&utm_medium=feed&utm_campaign=Feed%3A+ValueInvestingWorld+%28Value+Investing+World%29&utm_content=FaceBook
http://www.valuewalk.com/2011/10/exclusive-interview-famous-investor-tom-russo/
Thursday, December 19, 2013
A Great Lesson From Todd Combs
I was reading the notes I took from this year’s Berkshire meeting today. One of the things that stood out was an article on Todd Combs from the World Herald.
http://www.omaha.com/article/20130428/MONEY/704289987
This article came out on the Monday of the Berkshire Hathaway Shareholder Meeting. I remember reading it right before I went to the shareholder meeting. It was certainly not the fanciest article but absolutely one of my all-time favorites. I want to share with the readers the part I enjoy the most because I found it extremely inspiring and illuminating. Below is an excerpt from the article:
“One of the students asked what he could do now to prepare for an investing career. Buffett thought for a few seconds and then reached for the stack of reports, trade publications and other papers he had brought with him."
“Read 500 pages like this every day,” said Buffett, or words to that effect. “That's how knowledge works. It builds up, like compound interest. All of you can do it, but I guarantee not many of you will do it.”
"Remarkably, Combs began doing just that, keeping track of how many pages and what he read each day. Eventually finding and reading productive material became second nature, a habit. As he began his investing career, he would read even more, hitting 600, 750, even 1,000 pages a day.Combs discovered that Buffett's formula worked, giving him more knowledge that helped him with what became his primary job — seeking the truth about potential investments.”
Let’s do a simple math here. Assuming the average number of words per page is 250, then 500 pages means 125,000 words. The amount of time it takes to read 100,000 words depends on your reading speed. I don’t know how fast Warren Buffett reads but if I have to guess, I would say at least 1,000 words per minute, compared to the average of say 300 words per minutes. At 1,000 words per minute, it takes Buffett a little over 2 hours to read 500 pages whereas at 300 words per minute, it takes an average adult almost 7 hours to read 500 pages. This is based on the assumption that one actually reads 500 pages per day. Like Buffet said, all of us can do it, but not many of us will do it. Out of all the students Buffett talked to in Combs’ class, he is probably the only one who listened to Buffett’s advice and practiced the daily 500 pages drill. This is truly remarkable! No wonder Buffett eventually hired him as one of Berkshire’s investment managers.
I have been keeping track of the number of pages and what I read consistently since I got back from Omaha this year. With a very busy full time work schedule, I can only manage to read between 200-300 pages per day. This mostly includes books, annual reports, magazines, periodicals, articles, and industry surveys. Although 200-300 pages are nothing compared Combs and Buffett’s 1000 pages per day, I am starting to feel the power of compounding knowledge. The first time I read an annual report of a crude oil shipper, I have to spend so much time understanding the terms. I may still spend a good amount of time refreshing my memories on the shipping terms the second time I read it. By the time I read it for the third time, it may take me 70% less time and the knowledge applies to all other crude oil shippers. I know I am not a prodigy like Buffett so the process of repetition is inevitable. I think the key is to be consistent and persistent. My goal is to reach 500 pages per day in the next year or two.
Of course reading 500 pages every day almost sounds brutal. But as Albert Gray shrewdly observed in book The Common Denominator of Success, “The common denominator of success – the secret of success of every man who has ever been successful – lies in the fact that he formed the habit of doing things that failures don’t like to do.”
Combs did just that. As such, he rightly deserved the job offer from Warren Buffett.
http://www.omaha.com/article/20130428/MONEY/704289987
This article came out on the Monday of the Berkshire Hathaway Shareholder Meeting. I remember reading it right before I went to the shareholder meeting. It was certainly not the fanciest article but absolutely one of my all-time favorites. I want to share with the readers the part I enjoy the most because I found it extremely inspiring and illuminating. Below is an excerpt from the article:
“One of the students asked what he could do now to prepare for an investing career. Buffett thought for a few seconds and then reached for the stack of reports, trade publications and other papers he had brought with him."
“Read 500 pages like this every day,” said Buffett, or words to that effect. “That's how knowledge works. It builds up, like compound interest. All of you can do it, but I guarantee not many of you will do it.”
"Remarkably, Combs began doing just that, keeping track of how many pages and what he read each day. Eventually finding and reading productive material became second nature, a habit. As he began his investing career, he would read even more, hitting 600, 750, even 1,000 pages a day.Combs discovered that Buffett's formula worked, giving him more knowledge that helped him with what became his primary job — seeking the truth about potential investments.”
Let’s do a simple math here. Assuming the average number of words per page is 250, then 500 pages means 125,000 words. The amount of time it takes to read 100,000 words depends on your reading speed. I don’t know how fast Warren Buffett reads but if I have to guess, I would say at least 1,000 words per minute, compared to the average of say 300 words per minutes. At 1,000 words per minute, it takes Buffett a little over 2 hours to read 500 pages whereas at 300 words per minute, it takes an average adult almost 7 hours to read 500 pages. This is based on the assumption that one actually reads 500 pages per day. Like Buffet said, all of us can do it, but not many of us will do it. Out of all the students Buffett talked to in Combs’ class, he is probably the only one who listened to Buffett’s advice and practiced the daily 500 pages drill. This is truly remarkable! No wonder Buffett eventually hired him as one of Berkshire’s investment managers.
I have been keeping track of the number of pages and what I read consistently since I got back from Omaha this year. With a very busy full time work schedule, I can only manage to read between 200-300 pages per day. This mostly includes books, annual reports, magazines, periodicals, articles, and industry surveys. Although 200-300 pages are nothing compared Combs and Buffett’s 1000 pages per day, I am starting to feel the power of compounding knowledge. The first time I read an annual report of a crude oil shipper, I have to spend so much time understanding the terms. I may still spend a good amount of time refreshing my memories on the shipping terms the second time I read it. By the time I read it for the third time, it may take me 70% less time and the knowledge applies to all other crude oil shippers. I know I am not a prodigy like Buffett so the process of repetition is inevitable. I think the key is to be consistent and persistent. My goal is to reach 500 pages per day in the next year or two.
Of course reading 500 pages every day almost sounds brutal. But as Albert Gray shrewdly observed in book The Common Denominator of Success, “The common denominator of success – the secret of success of every man who has ever been successful – lies in the fact that he formed the habit of doing things that failures don’t like to do.”
Combs did just that. As such, he rightly deserved the job offer from Warren Buffett.
Tuesday, December 17, 2013
1998 - When Buy And Hold The Greatest Business Did Not Work
Here is a question: If you had bought equity ownership interests in the Coca-Cola Company on July 15th 1998, what would your return be for the next 13 years excluding dividends?
Many readers may have guessed the answer: not much. In fact, the return from price appreciation is almost negligible if you bought KO at the high point in July 1998.
This is a discovery I was lucky enough to stumble on when speaking to Stephen Yacktman and Jason Subotky from Yacktman Asset Management.
http://www.gurufocus.com/news/237005/yacktman-funds-interview--great-answers-from-great-investors
Although I am not surprised by the fact that an investor could lose money in a wonderful business like Coca Cola, I have been pondering the implication of stagnant KO’s share price during that 13 year period. After all, Coca Cola probably has the widest moat among all wonderful businesses. We all know that Warren Buffett has repeatedly said “buying a wonderful business at a fair price is far better than a fair business at a wonderful price.” However, the Oracle did not disclose what his definition of fair price is. Obviously in this case, the market was not offering Coca Cola at a fair price during July 1998. And no one knows for sure what the exact fair price for Coca Cola was in 1997, but that’s probably out of my current circle of competence anyway. Instead, to practice reverse thinking advocated by Charlie Munger, I would like to analyze the reasons why one should not buy Coca Cola during July 1998.
Let’s look at the reported numbers first. Here is the 5 year summary up until 1997. These are numbers from audited financial statements.
The average closing price for Coca Cola during July 1998 is about $85 per share. Assuming an investor purchased KO at the average closing price, he or she was paying a hefty 51 times unadjusted earnings. And if we refresh our memories from the Yachtman Asset Management interview, Jason and Stephen had said that the earnings in 1997 were of lower quality compared to previous years. Shrewd readers may have already observed from the above table, 1996 and 1997 earnings include unusually large other incomes. A careful read of the 1997 annual form 10k shows that these are mostly made up of gain on sales of non-core assets and gain on issuance of stock by equity investees, both non-recurring in nature. The details are disclosed in the footnotes:
Furthermore, the 1996 income tax rate includes a one-off settlement benefit that lowered the tax rate to 24% for 1996 only. Without this benefit, Coke’s 1996 income tax rate should have been 31%. This is also disclosed in the footnote:
After adjusting for the non-recurring items and tax rates, Coca Cola’s earnings in 1996 and 1997 are much worse than they appear to be. The following table summarizes the result of the adjustments.
If we use the adjusted EPS for 1997, Coca Cola was trading at more than 60 times trailing 12 months' earnings at $85 per share. This is almost priced into perfection.
Out of curiosity, I pulled a few sell side analyst reports on Coca Cola from June 1998 to July 1998. Not surprisingly, almost all the analyst reports have buy ratings on KO:
“Our 12-month target price range is of $88-90. We feel that it is important to note that our confidence and conviction in The Coca-Cola business model and its long-term growth opportunities have never been stronger.” -July 1998 Donaldson, Lufkin & Jenrette Analyst Report
“The long-term story for Coke remains a very strong one. Coke appears capable of achieving a high-teens rate of EPS growth longer term, driven by 8-10% annual volume growth overseas, a 5% increase in weighted concentrate price overseas, a 2-3 percentage point increase in volume driven unit profitability, and continued share repurchase (another 1-2 percentage points). Our 12-month target price for Coke is $90. Coke’s P/E multiple is at approximately 47x this year’s earnings, and holding that multiple would result in a $90 price by next year.” –June 1998 Paine Webber Analyst Report
"We continue to believe KO shares could trade to the $85–86 level over that next 12–18 months, or at roughly 46–47 times our 1999 EPS estimate of $1.84." - June Morgan Stanley Analyst Report
None of the analyst report I read adjusted 1997’s earnings for the non-recurring items, let along the 1996 earnings for the tax rate effect. Interestingly enough, almost all the analyst whose reports I read did a good job compiling the fundamental information and business updates of Coca Cola. It is the almost-ridiculous multiples they used and the EPS figure that left unadjusted that reflect poor and shallow thinking, albeit likely caused by institutional imperative.
Now I have a much better understanding of the situation of Coke in 1998. Low quality earnings combined with a high multiple and human euphoria created a classic example of “don’t just buy a wonderful business and hold it.”
The lesson is pretty clear. History rhymes. There are a few times in Coca Cola’s history where an investor can get stuck with a stagnant stock price for an extended period of time. Human nature guarantees that this will be a repeating theme in the future as well. How to avoid the mistake of paying too much for a wonderful business? Fortunately, Warren Buffett has laid out the ground rule for us:
“Be Fearful When Others Are Greedy and Greedy When Others Are Fearful.”
And I have nothing to add.
Many readers may have guessed the answer: not much. In fact, the return from price appreciation is almost negligible if you bought KO at the high point in July 1998.
This is a discovery I was lucky enough to stumble on when speaking to Stephen Yacktman and Jason Subotky from Yacktman Asset Management.
http://www.gurufocus.com/news/237005/yacktman-funds-interview--great-answers-from-great-investors
Although I am not surprised by the fact that an investor could lose money in a wonderful business like Coca Cola, I have been pondering the implication of stagnant KO’s share price during that 13 year period. After all, Coca Cola probably has the widest moat among all wonderful businesses. We all know that Warren Buffett has repeatedly said “buying a wonderful business at a fair price is far better than a fair business at a wonderful price.” However, the Oracle did not disclose what his definition of fair price is. Obviously in this case, the market was not offering Coca Cola at a fair price during July 1998. And no one knows for sure what the exact fair price for Coca Cola was in 1997, but that’s probably out of my current circle of competence anyway. Instead, to practice reverse thinking advocated by Charlie Munger, I would like to analyze the reasons why one should not buy Coca Cola during July 1998.
Let’s look at the reported numbers first. Here is the 5 year summary up until 1997. These are numbers from audited financial statements.
The average closing price for Coca Cola during July 1998 is about $85 per share. Assuming an investor purchased KO at the average closing price, he or she was paying a hefty 51 times unadjusted earnings. And if we refresh our memories from the Yachtman Asset Management interview, Jason and Stephen had said that the earnings in 1997 were of lower quality compared to previous years. Shrewd readers may have already observed from the above table, 1996 and 1997 earnings include unusually large other incomes. A careful read of the 1997 annual form 10k shows that these are mostly made up of gain on sales of non-core assets and gain on issuance of stock by equity investees, both non-recurring in nature. The details are disclosed in the footnotes:
Furthermore, the 1996 income tax rate includes a one-off settlement benefit that lowered the tax rate to 24% for 1996 only. Without this benefit, Coke’s 1996 income tax rate should have been 31%. This is also disclosed in the footnote:
After adjusting for the non-recurring items and tax rates, Coca Cola’s earnings in 1996 and 1997 are much worse than they appear to be. The following table summarizes the result of the adjustments.
| 1996 | 1997 | |
| Reported Pre Tax Income | $ 4,596.00 | $ 6,055.00 |
| Adjustments for Non-Recurring Item - Gain on Sales of Non-Core Assets | (508.00) | |
| Adjustments for Non-Recurring Item - Gain on Issuance of Stock by Equity Investee | (413.00) | (343.00) |
| Adjusted Pre Tax Income | 4,183.00 | 5,204.00 |
| Adjusted Tax Rate | 31% | 31.80% |
| Adjusted Net Income | $ 2,886.27 | $ 3,549.13 |
| Shares Outstanding- Diluted | 2,523 | 2,515 |
| Adjusted Diluted EPS | $ 1.14 | $ 1.41 |
| Reported Diluted EPS | $ 1.40 | $ 1.67 |
| Difference% | -18% | -15% |
If we use the adjusted EPS for 1997, Coca Cola was trading at more than 60 times trailing 12 months' earnings at $85 per share. This is almost priced into perfection.
Out of curiosity, I pulled a few sell side analyst reports on Coca Cola from June 1998 to July 1998. Not surprisingly, almost all the analyst reports have buy ratings on KO:
“Our 12-month target price range is of $88-90. We feel that it is important to note that our confidence and conviction in The Coca-Cola business model and its long-term growth opportunities have never been stronger.” -July 1998 Donaldson, Lufkin & Jenrette Analyst Report
“The long-term story for Coke remains a very strong one. Coke appears capable of achieving a high-teens rate of EPS growth longer term, driven by 8-10% annual volume growth overseas, a 5% increase in weighted concentrate price overseas, a 2-3 percentage point increase in volume driven unit profitability, and continued share repurchase (another 1-2 percentage points). Our 12-month target price for Coke is $90. Coke’s P/E multiple is at approximately 47x this year’s earnings, and holding that multiple would result in a $90 price by next year.” –June 1998 Paine Webber Analyst Report
"We continue to believe KO shares could trade to the $85–86 level over that next 12–18 months, or at roughly 46–47 times our 1999 EPS estimate of $1.84." - June Morgan Stanley Analyst Report
None of the analyst report I read adjusted 1997’s earnings for the non-recurring items, let along the 1996 earnings for the tax rate effect. Interestingly enough, almost all the analyst whose reports I read did a good job compiling the fundamental information and business updates of Coca Cola. It is the almost-ridiculous multiples they used and the EPS figure that left unadjusted that reflect poor and shallow thinking, albeit likely caused by institutional imperative.
Now I have a much better understanding of the situation of Coke in 1998. Low quality earnings combined with a high multiple and human euphoria created a classic example of “don’t just buy a wonderful business and hold it.”
The lesson is pretty clear. History rhymes. There are a few times in Coca Cola’s history where an investor can get stuck with a stagnant stock price for an extended period of time. Human nature guarantees that this will be a repeating theme in the future as well. How to avoid the mistake of paying too much for a wonderful business? Fortunately, Warren Buffett has laid out the ground rule for us:
“Be Fearful When Others Are Greedy and Greedy When Others Are Fearful.”
And I have nothing to add.
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