Archives for May 2015

Book Review: A Short History of Financial Euphoria

This book review has been submitted by Ankit Kanodia.

If anyone would ask me to summarize A Short History of Financial Euphoria in quick words, I would borrow the following three quotes to make my point…

All I want to know is where I’m going to die so I’ll never go there. ~ Charlie Munger

History does not repeat itself, it rhymes. ~ Mark Twain

There are two kinds of forecasters: those who don’t know, and those who don’t know they don’t know. ~ John Kenneth Galbraith

For starters, the book does not give you any tip on how to compound wealth or how to invest to earn great returns on capital. On the contrary, it brings to your notice how you can lose it all and thus how difficult but important it is to avoid that danger.

A small, thin book of only 110 pages, it consists of almost everything one needs to know about the speculative bubbles in economic history.

Life 2.0: Journaling

Today I am going to share an insight that shook my life pretty hard, for the good of course.

How many times it has happened with you that after reading a book you thought that you understood the idea until you were asked to explain it. The idea seemed pretty clear in your head but the moment you had to verbalise it you discovered that either you didn’t have a proper grasp on the idea at the first place or you were unable to explain it in a logical coherent way to a third person.

This is the kind of silent reaction I got from people “You’re telling me that you just finished reading a compelling book but can’t explain the central idea in few sentences?”

This problem haunted me for a long time. Then one fine day I discovered the Feynman Technique, which says that the mere action of writing something down allows for a more effective integration of the learning. This further led me to the idea of Journaling. It was a Eureka moment!

Let me first share my definition of journaling. Journaling is simply an activity of writing in plain language about what’s going on around you and what your thoughts are about them. It can include things like your future goals, plans, dreams, reminders to yourself, comments on ideas/people or any unrelated thing that crosses your mind. It’s a conversation that you have with yourself.

So what’s so special about journaling? Stick with me through the rest of the post and you might find some surprising insights.

Journaling allows you to take fuzzy thinking and distil it into precise line of thought. If you want to think better you have to start writing your thoughts. It’s not a common knowledge that writing, apart from being a communication tool, is a thinking tool too. Famous author, Dan Pink, further validated my belief in this commencement speech.
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Latticework of Mental Models: Variable Reinforcement

It’s not often that you would find me exercising my thumb muscles with a TV remote but it so happened that on a Saturday afternoon while killing time in front of the idiot box, an unsettling thought caught me off guard. I realized that I had been surfing through the TV channels for the past hour without really spending more than a minute on any single channel.

This habit is not uncommon but the unusual thing was once I had looped through all the channels a couple of times and once it was obvious that there was nothing interesting on TV, I still kept going without getting bored. So what was keeping me hooked?

As a flash of insight the answer that my mind constructed was an uncomfortable one.

Latticework of Mental Models: Gresham’s Law

This article is the fifth of this weekly series called Latticework of Mental Models, which will be authored by my friend and partner in writing the Value Investing Almanack, Anshul Khare. Anshul will write on various mental models – big ideas from various disciplines – which can help you think more rationally while analyzing businesses and making your stock investment decisions.

Few weeks back, we discussed the mental model of Storytelling. I am going to use the same model to start this post. Let me start with a true story, and take you back to medieval India.

Between the years 1324 to 1351, Delhi was ruled by an emperor named Mohammad-bin-Tughluq from the Tughluq dynasty. He had a scholastic background and spoke multiple languages. In spite of good intentions, some of the policies that he enforced during his rule backfired which made him infamous as an eccentric ruler. One such failed idea was about an experiment that he did with the local currency.

Tughluq noticed that India had very few silver coins and a comparatively larger number of bronze and copper coins. He decided to promote bronze or copper coins by passing a royal order that bronze and copper coins are to be accorded the same value (i.e., same purchasing power) as silver coins. In other words, he wanted the markets to mentally consider bronze and copper as silver itself so that 1 gram coin of bronze can buy the same goods as 1 gram of silver. It looked like a neat idea however the emperor failed to consider the law of unintended consequences.

Corporate Governance: Charlie Munger on Governance

Charlie Munger is widely quoted in value investing community for his multidisciplinary ideas. However, he has some unconventional advice on the subject of corporate governance also which deserves a discussion. Let’s look at some of the insights from Munger on the issue of governance.

Munger believes more in the spirit of corporate governance rather than enforcement of compliance rules and regulations. If the intention is not right, people can always bend the rules and find workarounds for carrying out unethical practices without breaking the law. But when you know that the intentions are right then even an occasional instance of non-compliance doesn’t bother you because you trust the person and know that things will eventually get sorted out.

Munger is of the opinion that different companies have different cultures and you cannot come up with a one-size-fits-all solution in form generic compliance rules. An organization is made up of diverse set of people with different interests and values. Such collection of people behaves as a complex adaptive system. The moment complex rules are infused to command more control it invariably results in unintended consequence. So the solution is not to device more rules but to make the system simpler.

In the annual meeting for Wesco Financials in 2007, Munger pointed out –

A lot of people think if you just had more process and more compliance—checks and double checks and so forth—you could create a better result in the world. Well, Berkshire has had practically no process. We had hardly any internal auditing until they forced it on us. We just try to operate in a seamless web of deserved trust and be careful whom we trust.

This brings us to the Munger’s first idea for simplifying the corporate governance puzzle.

Seamless Web of Deserved Trust

A system in which the individuals making decisions do not bear the consequences of those decisions seems incompatible with a seamless web of deserved trust. Munger explains –

Good character is very efficient. If you can trust people, your system can be way simpler. There’s enormous efficiency in good character and dis-efficiency in bad character.

Moreover, unethical behavior is contagious. Gresham’s law says that bad values (or currency or people) drive out the good values from a system. If you find that it’s easy to cheat and steal in an organization, it’s just a matter of time before majority of the people in that system start exhibiting dishonest and unethical behaviour. Even if everybody was absolutely honest to begin with. Such is the human behaviour.
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When to Sell a Stock (E-Book & Checklist)

Most investing discussions revolve around when to buy a stock. “Which stock should I buy?” is the first question that comes to your mind when you think about investments. But equally important is the question – “When should I sell a stock?”

Now, there aren’t any “10 Immutable Laws of Selling.” In fact, the answer to this question is often as difficult and subjective as deciding when to buy a stock.

But, without doubt, a disciplined sell process injects a healthy dose of Darwinism – survival of the fittest – into the portfolio. This process weeds out the weakest stocks – the ones that have deteriorated / deteriorating fundamentals or diminished margins of safety – in favour of stronger ones.

In a special e-book, and through a diagrammatic checklist (see below), I try to answer some of the questions around when to sell a stock. Not every selling rule under the sun may be included herein, but I’m sure what you read and see below will still be of some help to you.

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Latticework of Mental Models: Mean Reversion

This article is the fourth of this new weekly series called Latticework of Mental Models, which will be authored by my friend and partner in writing the Value Investing Almanack, Anshul Khare. Anshul will write on various mental models – big ideas from various disciplines – which can help you think more rationally while analyzing businesses and making your stock investment decisions.

There are certain days in everybody’s life which in spite of being ordinary remain etched in the memory for a long time. It was 15th of December. I distinctly remember it because I bought my car that day.

The ownership of new car brought with it an excitement to take care of it which included an urge to diligently track the car mileage. You know, boys with toys. At an average of 13 km/litre it was a satisfactory performance. However, after few weeks I started noticing that the mileage numbers would go down occasionally and then come back again to the normal.

There wasn’t any change in my driving style or driving routes. Except the source of fuel there was no other variable that could cause the variation in performance. So my hypothesis was that the quality of fuel was affecting my vehicle’s performance. To empirically validate my theory I decided to keep track of different fuel stations where I got the petrol from.

How to Find Great Businesses, the Peter Lynch Way

One of the first books I ask new investors to read is Peter Lynch’s One Up on Wall Street.

The easy-going and simplistic stock-picking style discussed in this book brought Lynch great success in his profession as a fund manager at the US mutual fund company, Fidelity, where he generated an average annual return of 29% during 1977 to 1990.

Lynch wasn’t just a great investor, he had a wonderful way of getting across the secrets of his success in everyday language, exemplified by this warning of the perils of putting money into businesses that you don’t understand.

Another of his catchphrases was to “invest in what you know” and he believed everyone could use this advice to spot successful companies.

In fact, he got many of his best ideas at home or when wandering around shopping malls, rather than by poring over company accounts.

Latticework of Mental Models: Storytelling

This article is the third of this new weekly series called Latticework of Mental Models, which will be authored by my friend and partner in writing the Value Investing Almanack, Anshul Khare. Anshul will write on various mental models – big ideas from various disciplines – which can help you think more rationally while analyzing businesses and making your stock investment decisions.

What if I told you that the DCF (discounted cash flow) analysis and the principle of time value of money was first discovered in 600 B.C.? And the person who discovered it was neither an economist nor a mathematician. He was a storyteller called Aesop.

“You must be kidding,” you might say. Well, let’s find out.

In my personal experience, one of the most effective ways to make a conversation (written or verbal) interesting is to tell a story capturing your idea. In fact, I can safely claim that whenever I hear or read something that starts with “let me tell you a story,” it gets me hooked for at least few minutes. I am sure your experience won’t differ too much from mine.

Even most of the holy texts in different religions contain lot of stories. Questions is, why is it so?

A Guide to Reading for Investors (Plus, What Prof. Sanjay Bakshi Reads)

Note: This article formed part of the April 2015 Special Report that I recently sent to subscribers of my premium newsletter Value Investing Almanack. If you wish to read similar premium posts in the future, I invite you subscribe to the Almanack. Click here to subscribe.

“I do not take a single newspaper, nor read one a month, and I feel myself infinitely happier for it. The man who reads nothing at all is better informed than the man who reads nothing but newspapers.” ~ Thomas Jefferson

Long time readers of Safal Niveshak blog and attendees to my investing workshops know my dislike for reading newspapers. The dislike is so deep that I’ve not had a newspaper subscription at my home for the past six years now, and neither do I consume news via electronic media. This also holds true of business television which I watch very occasionally and only when I want to get a hearty laugh and there’s nothing else that’s as funny on television at that time.

Now, one big reason I do not read newspapers is because I have a big problem with the fact that they decide for us what we should pay attention to and what we should ignore. It isn’t just the text of a news story that can mislead us; it’s also the choice of which stories get covered at all, and where they’re placed in the paper.