Graham And Doddsville

A few weeks ago, I noticed a sudden increase in the number of people who follow me on Twitter.  The reason, I soon discovered, was an article titled “Read ‘Em and Reap” by Jason Zweig that was posted on the Wall Street Journal’s Total Return Blog.  For those of you who have never heard of Jason Zweig (I doubt that includes most readers of this blog), he is a columnist for the Wall Street Journal and writes the weekly “Intelligent Investor” column.  In fact, Jason Zweig edited one of the most widely read editions of “The Intelligent Investor” by Benjamin Graham.   Jason’s post was a follow-up to another article he wrote, “Can Peers Burn Holes In Your Portfolio?”

My “Intelligent Investor” column this weekend discusses new research on what psychologists call “shared attention”—the state of paying heed to an object or event at the same time your peers are also focusing on it. Believing that other people like you are paying attention to the same thing you are can make you more likely to remember it, to take action on it and to experience more intense emotions about it, the research finds.

In my column, I encouraged investors to socialize “only with investors who are calm and methodical.” Here’s a small selection of websites, blogs and Twitter feeds that I think pass that test.  It is far from complete; there are other sites I like for other reasons, but the sources I’ve listed here all encourage investors to ignore the markets’ momentary twitches and spasms and, instead, to focus on the long term.

GrahamAndDoddsville.net was one of the websites on Jason’s list.  To say it is an honor to appear on Jason’s list, alongside some of my favorite websites, would be a major understatement.

When the proverbial apple fell on my head and I discovered value investing (a term I now believe to be a proxy for all intelligent investing), I wanted to read and learn as much as I could.  There were several websites and blogs that helped me navigate the vast number of available resources.  While many of the websites that were helpful to me no longer exist, these resources were invaluable to my own investing journey.  Over time, however, I realized that many aspiring analysts / investors, including myself, fell into the pitfall of spending too much time reading about investors and not enough time investing.  Once you have covered the basics (and it is my opinion that studying The Intelligent Investor, Warren Buffett’s Letters to Berkshire Shareholders, and Joel Greenblatt’s You Can Be a Stock Market Genius will get you 99.9% of the way there), there is no better way to learn how to invest than by taking your hard earned money and investing it.  I have often heard people reply, “I don’t have enough money to invest in stocks on my own.”  Hogwash!  I may have accepted that reply prior to the turn of the century, but in 2014, anyone can open an online brokerage account with almost no minimum account balance.  In most cases, this ease of access proves to be very bad for investors.  But if you are truly learning how to be an intelligent investor, it is wonderful!

This brings me to the dilemma.  At a certain point, my recommendation to aspiring analysts and investors is to spend their non-investing time delving into case studies and hunting for undervalued securities.  Some of my favorite places to do both are on your left – right there in the margin – or on the Valuable Investing Resources page.

I am amazed how many visitors the GrahamAndDoddsville blog receives, especially in light of how infrequently it is updated.  I am humbled by number of analysts and investors who have told me that they used this site as a lunching point for their own journey to become an intelligent investor.  My original motive for starting the site was to have a place where I could store all of the resources I have found.

With all of this in mind, I plan for the site to become a bit more active.  A reboot, if you will.  The number of posts may not dramatically increase, but in the coming days, weeks and months, you will start to see fixed links, updates to the hunting grounds, research essentials and top blogs, and additions to the SuperInvestor Resources.  Hopefully this will serve as a compromise.  By not dramatically increasing the number of posts, my hope is that I will not draw aspiring analysts / intelligent investors away from the sites where they should be spending most of their non-investing time – websites and blogs filled with case studies and discussions of current investment ideas.  At the same time, GrahamAndDoddsville.net will hopefully become an even better tool for those who continue to use the site as either a starting point or as an ongoing resource in the never-ending journey to become a more intelligent investor.

I receive many e-mails want to sincerely apologize to those who have received a reply.  I do enjoy hearing from likeminded investors and can be reached at admin@grahamanddoddsville.net.  I will do my best to respond.

See: “Read ‘Em and Reap: Smart People for Investors to Follow” (WSJ Total Return Blog, 9/6/2014)

On November 1, 2011, Charlie Rose interviewed Superinvestor Seth Klarman for the Facing History and Ourselves New York Benefit Dinner.  If you have not seen this interview, it is fantastic.

One of my favorite nuggets is the following (see 25:30):

Warren evolved through 3 stages:  He went from buying cigar butts and getting the last few puffs for free, to buying great businesses at really cheap prices, to buying and holding great businesses at so-so prices.  And maybe even this new area of buying weird securities from crappy businesses at better than market prices – like B of A preferred or whatever… I’m still in phase one.  We’re still buying cigar butts, there’s a good business there in buying them and it’s a lot of fun.

I think Warren captured the idea himself in his 1964 (sic) article The Superinvestors of Graham and Doddsville and in it he talks about – value investing is like an innoculation – you either get it right away, or you never get it.  And I think it’s just true.  I actually think there’s just a gene for this stuff.  Whether it’s a value investing gene or a contrarian gene.

When asked why we trade, many of us would answer with traditional, rational responses. We see an undervalued company. We like a business, a brand or a strategy. Or, it’s the flip side: We’re selling because we may think the fundamentals point to trouble. We see an investment that looks overvalued.

As we know, most people follow the herd.  But what about contrarian investors – the ones featured on this blog – who consistently move against the herd?

It’s what the academics describe as a relatively new intersection of financial economics, psychology, and evolutionary biology including new interpretations of mutation. And the upshot, to me at least, is that we may not be as deliberative as we might think when it comes to trading decisions. In other words, we’re wired to trade a certain way.

According to Andrew Lo of MIT and Thomas J. Brennan of Northwestern claim that science evolution may explain both the herd mentality and also a contrarian one.

In other words, many of us are bound to the pack. A minority of us break away from it.

Both behaviors are necessary from an evolutionary standpoint because they’re necessary for the species to survive.  Every species needs its normal populations and its mutants.

I think I was just called a “mutant.”  I guess if that puts anywhere near the same group as Warren Buffett and Seth Klarman, then I am proud to be a mutant.

Click here to read the entire article The missing link of investing: Science may explain why we trade at MarketWatch.com.

Click here to see An Interview with Seth Klarman and Charlie Rose.

Click here to learn more about Seth Klarman.

On October 29, 2012 The New York Times published an article titled “That Guy Won? Why We Knew It All Along.”

Amid the many uncertainties of next Tuesday’s presidential election lies one sure thing: Many people will feel in their gut that they knew the result all along. Not only felt it coming, but swear they predicted it beforehand — remember? — and probably more than once…

Most will also have a ready-made argument for why it was inevitable that Mitt Romney, or Barack Obama, won — displaying the sort of false, after-the-fact “foresight” that psychologists call hindsight bias.

Political pundits aren’t the only ones to suffer from hindsight bias.

“The important thing to know about hindsight bias is that it not only changes how you see the world, but also how you see yourself in it,” said Neal Roese, a professor of marketing at the Kellogg School of Management at Northwestern University, who just published a review paper on the bias with Kathleen D. Vohs of the University of Minnesota. “You begin to think: ‘Hey, I’m good. I’m really good at figuring out what’s going to happen.’ You begin to see outcomes as inevitable that were not.”

Investors must be extra careful to remain aware of how hindsight bias might affect their decisions.

Once they know an outcome, people tend to inflate their initial predictions by an average of 15 to 20 percent, Dr. Roese said — ample wiggle room to retrospectively alter almost any prediction from “it’s going to happen” to “it probably won’t,” be it a tennis match, a legal decision or a presidential race.

It’s only natural.

One reason it’s hard to avoid this bias is that it mirrors how the brain operates biologically. The brain cannot possibly make sense of incoming sensory information instantaneously; it continually reconstructs, inserting meaning and making judgments very quickly, but post hoc.

Can we change human behavior?

The solution is contained in the psychological processes that underlie the bias itself, studies suggest. Take the presidential race. It’s a dead heat in the polls, and the fact that so many will argue after the vote that the winner was inevitable implies that they have front-loaded arguments to support both outcomes. One way to counteract the bias is to play out those possibilities before the final outcome.

[“That Guy Won? Why We Knew It All Along”, The New York Times 10/29/2012]

The October issue of Harvard Business review included an article by Legg Mason Strategist and Columbia Business School Professor Michael Mauboussin titled “The True Measures of Success”.

About a dozen years ago, when I was working for a large financial services firm, one of the senior executives asked me to take on a project to better understand the company’s profitability. I was in the equity division, which generated fees and commissions by catering to investment managers and sought to maximize revenues by providing high-quality research, responsive trading, and coveted initial public offerings. While we had hundreds of clients, one mutual fund company was our largest. We shuttled our researchers to visit with its analysts and portfolio managers, dedicated capital to ensure that its trades were executed smoothly, and recognized its importance in the allocation of IPOs. We were committed to keeping the 800-pound gorilla happy.

Part of my charge was to understand the division’s profitability by customer. So we estimated the cost we incurred servicing each major client. The results were striking and counterintuitive: Our largest customer was among our least profitable. Indeed, customers in the middle of the pack, which didn’t demand substantial resources, were more profitable than the giant we fawned over.

What happened? We made a mistake that’s exceedingly common in business: We measured the wrong thing. The statistic we relied on to assess our performance—revenues—was disconnected from our overall objective of profitability. As a result, our strategic and resource allocation decisions didn’t support that goal. This article will reveal how this mistake permeates businesses—probably even yours—driving poor decisions and undermining performance. And it will show you how to choose the best statistics for your business goals.

The article is based on Professor Mauboussin’s new book The Success Equation:Untangling Skill and Luck in Business, Sports, and Investing which was released last week.

Both the article and book mention Michael Lewis’ Moneyball.  I think this clip from Moneyball provides a perfect analogy for Professor Mauboussin’s premise.

Meanwhile, in concert with my last post, I will begin adding material to the VI Resources, SI Resources, and Security Analysis pages.  Not all additions will make it to the front page of the blog, so check back to see what is new.

Prior to 2008, it was normal for a value investor to have no particular “view on the economy.”   As Ben Graham said “Analysis should be penetrating not prophetic.”  In The Little Book of Behavioral Investing James Montier explains that “All Investors should devote themselves to understanding the nature of the business and its intrinsic worth, rather than wasting their time trying to guess the unknowable future.”

After 2008, several highly regarded value investors began to argue that while they still might not attempt a detailed economic forecast, they now found it more important to be aware of the economic environment and macro outlook.

As usual, my view is not as black and white.  Whether or not a value investor should have a “view on the economy” is still up for debate.  However, there is no doubt that investors must understand the the impact different economic outcomes can have on the intrinsic value of each stock they own.  Montier goes on to quote Howard Marks of Oaktree Capital who in 2001 wrote:

There are a few things I dismiss and a few I believe in thoroughly. The former include economic forecasts, which I think don’t add value, and the list of the latter starts with cycles and the need to prepare for them.

“Hey, ” you might say, “that’s contradictory. The best way to prepare for cycles is to predict them, and you just said it can’t be done.” That ’s absolutely true, but in my opinion by no means debilitating. All of investing consists of dealing  with the future .

. . and the future is something we can’t know much about. But the limits on our foreknowledge needn’t doom us to failure as long as we acknowledge them and act accordingly.

In my opinion, the key to dealing with the future lies in knowing where you are, even if you can’t know precisely where you ’re going. Knowing where you are in a cycle and what that implies for the future is different from predicting the  timing, extent and shape of the cyclical move.

As usual, I completely agree with Marks.  So how do we know where we are and how do we analyze the effect of a range of economic conditions on the intrinsic value of an investment?  I believe that the best way is to study the only thing we know for certain – the past.  I know, things change, the world is different, we have globalization, a major worldwide debt crisis, a housing market the likes of which we have not seen since the 1930s, and the list goes on…  That being said, we must start somewhere.

One of the important steps in my investment process is what I call “Exploratory Research.” In this phase, I try to arrange all of the data I gathered to analyze how it relates to both each other and also many different variables.  The goal of this exercise is to get as creative as possible, with the hope of developing an analytical edge.  At the very least, this analysis will help me to understand how a business might react considering a range of economic scenarios.

I used to find economic data on Bloomberg, Capital IQ, or dozens of different websites.   However, I recently discovered an incredible Add-In for Microsoft Excel.   It is called the “FRED Add-in” and is provided by the Federal Reserve Bank of St. Louis.  As described on their website:

The Federal Reserve Bank of St. Louis Economic Data (FRED) Add-In is free software that will significantly reduce the amount of time spent collecting and organizing macroeconomic data. The FRED add-in provides free access to over 30,000 data series from various sources (e.g., BEA, BLS, Census, and OECD) directly through Microsoft Excel.

Key Features:

• One-click instant download of economic time series.
• Browse the most popular data and search the FRED database.
• Quick and easy data frequency conversion and growth rate calculations.
• Instantly refresh and update spreadsheets with newly released data.
• Create graphs with NBER recession shading and an auto update feature.

The best part is that the Add-In is free!  It is an amazing and powerful tool that you can download here.

A second resource I recently stumbled upon is Insidertrading.org which can be found here:  http://insidertrading.org/ .  It is another fantastic FREE resource to track insider buys and sells.  While I have found several websites in the past that provide insider buying/selling summaries, insidertrading.org seems to be the most comprehensive free site.  As value investors know, insider transactions can be a great place to find new investment ideas or raise questions about existing holdings.

James Montier of GMO, LLC recently penned a piece titled “The Seven Immutable Laws of Investing.”  These “laws” are certainly not new to adherents of value investing.  However, I believe we need to constantly reinforce these laws, especially since they are often inconsistent with our natural tendencies.

So, now, for the moment of truth, I present a set of principles that together form what I call The Seven Immutable Laws of Investing.

1.  Always insist on a margin of safety

2.  This time is never different

3.  Be patient and wait for the fat pitch

4.  Be contrarian

5.  Risk is the permanent loss of capital, never a number

6.  Be leery of leverage

7.  Never invest in something you don’t understand

You can find the entire report here.  (Free registration is required)