Blog on Value Investing | Safal Niveshak

Safal Niveshak Stream – October 22, 2016

Some nice stuff we are reading, watching, and observing at the start of this weekend…

Investing/Stock Market

Jason Zweig, The Wall Street Journal’s investing columnist, in an interview with Philip Tetlock, the co-author of “Superforecasting: The Art and Science of Prediction,” explore why amateurs can actually be better than experts at predicting the future, and what the experts can learn from it…

One reason is that experts sometimes know too much. I was talking once to John McLaughlin, former director of the CIA, about the end of the Cold War period, and he was remarking that the analysts who were slowest to recognize that East Germany was disintegrating were the people who had been on the case for 20 years.

It was the newbies coming in who got it pretty quickly. And there’s a lot of psychological evidence that attests to the power of preconceptions to grip us and make it hard for us to be timely belief updaters. So sometimes knowledge is actually an impediment. Another big factor is that there is a large amount of uncertainty in the world. So no matter how smart you are, it isn’t going to give you a lot of traction.

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Video Series: Investing Lessons From Occam’s Razor

It’s a human tendency to address a complex problem with a complex solution. And when it doesn’t work, man starts looking for an even more complex solution.

In an uncertain world, seeking complexity is a big error. Complex problems do not always require complex solutions. Overly complicated systems like financial markets are not only difficult to comprehend but easy to exploit and possibly dangerous.

In investing, less is more.

Warren Buffett, in his 2004 letter to shareholders, wrote…

Last year MidAmerican wrote off a major investment in a zinc recovery project that was initiated in 1998 and became operational in 2002. Large quantities of zinc are present in the brine produced by our California geothermal operations, and we believed we could profitably extract the metal. For many months, it appeared that commercially-viable recoveries were imminent. But in mining, just as in oil exploration, prospects have a way of “teasing” their developers, and every time one problem was solved, another popped up. In September, we threw in the towel.

Our failure here illustrates the importance of a guideline – stay with simple propositions – that we usually apply in investments as well as operations. If only one variable is key to a decision, and the variable has a 90% chance of going your way, the chance for a successful outcome is obviously 90%. But if ten independent variables need to break favorably for a successful result, and each has a 90% probability of success, the likelihood of having a winner is only 35%. In our zinc venture, we solved most of the problems. But one proved intractable, and that was one too many. Since a chain is no stronger than its weakest link, it makes sense to look for—if you’ll excuse an oxymoron—mono-linked chains.

Safal Niveshak Stream – October 19, 2016

Some nice stuff we are reading, watching, and observing during the middle of this week…

Investing/Stock Market

The long run is just a collection of short runs, writes Morgan Housel…

…value is ultimately created in the long run. That’s where scale takes off and compounding works its magic – over years and decades, not months and weeks.

The key is recognizing that the long run is just a collection of short runs, and capturing long-term growth means managing the short run effectively enough to ensure you can stick around for a long time.
In 2011, Seth Klarman explained the psychology necessary to be a good value investor, in an interview that he did with Charlie Rose. In this interview, Klarman says, “Investing is the intersection of Economics and Psychology.” He added…

The economics, the valuation of a business is not that hard. The psychology, how much do you buy, do you buy at this price, do you wait for a lower price, what do you do when it looks like the world might end. Those things are harder.

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What Buses Taught Me About Stocks

When I was studying in College in Mumbai, I heard a saying from my friends about BEST buses.

“You should never run behind a bus because if you miss one, there’s always the next one coming in few minutes.”

And it was quite true because I don’t remember waiting at any bus stop for more than 15-20 minutes ever in Mumbai for whatever period I stayed there.

It’s funny that later I found the same analogy being used in the context of stock market. Occasionally, I visit few online stock discussion forums, not for fishing new ideas but just to see what’s keeping people busy these days.

In one such forum an investor argued, “If my stock seems overpriced, I sell it even if it’s a good business to own. I’ll buy it again when it comes down.”

“What if it doesn’t come down?” someone countered.

“Well, then I’ll buy something else,” the first guy reasoned. “There’s always the next stock to buy in the share market. Isn’t it?”

Now, that reminded me of Mumbai’s BEST buses. I thought of naming it the “Mumbai BEST Effect”. Don’t worry, it’s not really an official psychological bias. But just for the fun of it, I coined the term.
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Safal Niveshak Stream – October 15, 2016

Some amazing stuff we are reading, watching, and observing at this start of this weekend…

Investing/Stock Market

If I could reveal just one secret of sensible, successful investing (which isn’t a secret, by the way), it would be…
Buying stocks when the market collapses is far harder to do than to imagine. But the great economist — and equally great investor — John Maynard Keynes waded into the wake of the Great Crash of 1929, when US stocks fell by more than 80% from peak to trough. His experience should teach all investors the importance of preparation, courage and patience…

Keynes understood, as did his contemporary, the American value investor Benjamin Graham, that bear markets are so unpredictable that reliably sidestepping them is nearly impossible — and that the pain of losing money is nearly unbearable.

Still, Keynes knew, barging into bear markets to buy, rather than trying to sidestep them, is the way to prevail. Since, over the long run, stocks tend to go up more than they go down, one of the greatest advantages an investor can have is the gumption to buy stocks aggressively in falling markets.

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Latticework of Mental Models: Denominator Blindness

Imagine you are engrossed in a very interesting book and your concentration is broken by a call from a friend (let’s call him Hobbes). It’s rather unusual to receive Hobbes’ call at this time during the day so, expecting to hear something urgent, you pick up the phone and ask him –

“What’s up, buddy? Is everything alright?”

“Dude, the stock that I bought last month has reported a decline in their quarterly profits by 50 crores! Is that a bad news? Should I sell it?” The panic in his voice is clearly evident.

What would you tell him?

As they say, the most useful way of answering a question is to ask another question in response. And in this case, you must ask Hobbes, “50 crores compared to what?”

“What do you mean ‘compared to what’? Isn’t 50 crores a huge number in itself?” You friend is little confused by your response.

The right answer is that the figure 50 crores needs to be considered in full context. The company’s profit declined by 50 crores but what’s the net worth of the company? Is the net worth comparable to 50 crores or is it something in the order of 10,000 crores? Asked in another way, was the profit decline almost 90 percent? Or was it less than 5 percent of the total profits, i.e. part of the daily noise?
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Safal Niveshak Stream – October 12, 2016

Some amazing stuff we are reading, watching, and observing during the middle of this week…

Investing/Stock Market

Warren Buffett’s Berkshire Hathaway’s unique managerial model is lauded for its great value. However, here is a discussion paper that highlights its costs…

Most costs stem from the same features that yield such great value, which boil down, ironically, to Berkshire trying to be something it isn’t: it is a massive industrial conglomerate run as an old-fashioned investment partnership.

The most visible—and measurable—costs of the Berkshire model appear in capital allocation, principally acquisitions and investments. Buffett relies on himself in making these decisions, without board or executive input or oversight. While most such decisions have succeeded, many spectacularly so, some bloopers have appeared, the best-known being Dexter Shoe and Gen Re. The costs of error from such self-reliance could readily be mitigated by broader distribution of decision-making power. Buffett does so by periodically consulting vice chairman Charles Munger. Yet since the net costs of this approach have been modest, thanks to Buffett’s acumen and stature, there is no reason for reform while Buffett is at the helm. But some additional power sharing and oversight would be appropriate for his successors, as Berkshire’s succession plan contemplates.

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How I Missed a 10-Bagger, and Why I’m Proud of That

It was sometime in the middle of 2006 when I met the management of a banking company for the first time. It was HDFC Bank, and I met one of their top executives along with my banking analyst colleague.

The bull market in banking and financial stocks was just beginning to pick up pace and, in hindsight, there we were at the right place and at the right time. We ended up recommending a ‘Buy’ on the stock, which turned out to be a big wealth creator for our clients. Trusting the analysis skills of my colleague, I wanted to buy the stock a month after she recommended it to clients, but stopped at the last moment.

Why? I did not understand the head or tail of HDFC Bank’s balance sheet (I still don’t). Of course, I understood how it made money – by earning interest on its loans, advances and investments – but my competence ended there.

I had no clue on how the bank priced its loans, how it tested credit abilities of borrowers (do they really test that?), and how it accounted for its investments and liabilities on the balance sheet. I knew that if India were to do well, banks would be a direct beneficiary. But it was a tough nut to crack for me, and I gave up there and then.

So, unlike our clients, some of whom would have made a 10-bagger in the stock, I missed this bus. Only that, unlike Warren Buffett who talks about sucking his thumb while missing such obvious opportunities, I had all my fingers tied behind my back, and it was my own choice.

Safal Niveshak Stream – October 8, 2016

Some amazing stuff we are reading, watching, and observing at the start of this weekend…

Investing/Stock Market

One of the most dangerous places to be as an investor is…

…when you’re the smartest person in the room. Smarts, when not combined with a heavy dose of humility, can get you into trouble because it can lead to overconfidence. Overconfidence can lead to overthinking which can be a deadly combination when managing money.
Do you know about the most overlooked trait of investing success, especially when you are managing other people’s money? Hint – It’s a trait not directly related to investing. Go, figure. 🙂
Many investors and investment managers have taken to copying Buffett’s approach, but is it really possible to become a value investor by reading a few books and desiring to make money? In a letter to investors several years ago, Seth Klarman of The Baupost Group warned of value pretenders, investors who brand themselves as value investors but actually miss the essence of value investing. So are you one i.e., a value pretender? Here’s a nice post from John Mihaljevic on ways to determine if you are a value investor or pretender. One of the ways John writes about is…

If you base your purchase decisions on the likelihood that the market will assign a higher P/E or other multiple to a stock in the future, you may not be a value investor. You may instead be engaging in John Maynard Keynes’s “beauty contest”, an exercise centered on guessing the behavior of others. Value investors independently appraise the value of businesses in order to make an informed investment decision.

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Investing and the Art of Suffering

Pain is a complex experience involving sensory and emotional components: it is not just about how it feels, but also how it makes you feel. And it is these unpleasant feelings that cause the suffering we humans associate with pain.

Photo credit: Christopher Macsurak (Creative Commons)
When it comes to investing, there is a third angle to this thought – What you do when you feel the pain? How do you react to it?

Like what you do when the share market is going through a bad phase, and when your portfolio is giving you sleepless nights for reasons outside your control. I believe most people reading this associate the 2008 crisis with one such painful period that’s fresh in their memories.

I attended a lecture yesterday from a famous Indian investor, who has grown his wealth from Rs 0 to Rs 1,000 crore over a span of around 30 years. And what I understood from what he said about his journey was that he has been through several painful periods in his long experience in the markets. And apart from the fact that luck has played a very important role in this wealth creation process – being at the right place at the right time with the right people – it was also his capacity to suffer during the painful times that has helped him reach where he is now.