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Book Review: Investing Between The Lines

Note: This book review was originally published in the May 2016 edition of our premium newsletter Value Investing Almanack. To know more and subscribe, please click here.

When an investor starts investigating a business, the first thing he wants to know is if the business is strong and profitable? And he can usually find the answer from the company’s annual report by reading the numbers like net earnings, debt, cash flow, profitability ratios etc.

The next question is, how accurate or authentic those numbers are? Of course, they are verified by auditors. But even Enron and Satyam numbers were also certified by auditors. And both of them ended up as biggest accounting scandals.

As an investor, how do you know that the management is telling you the truth? And how does an honest CEO communicate with the shareholders in a manner which establishes trust?

Laura Rittenhouse, in her book Investing Between The Lines, attempts to answer the above questions. She offers clues to separate the facts from the fluff in annual reports and quarterly earnings calls. Rittenhouse had raised a red flag on Enron, much before it collapsed, noticing a discrepancy between the net income cited in its CEO letter and its audited financial statement, among other things.

Safal Niveshak Stream – November 26, 2016

Note to Readers: In Stream, we suggest worthwhile reading material on a variety of topics, not all of which are directly related to investing. Some of the articles require you to be paid subscriber of those sites. However, it is often possible to read such articles by going to Google News and searching for the article’s title.

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

Investing/Stock Market

(3 minutes watch) Recently, government of India took a drastic step to invalidate the Rs. 1000 and Rs. 500 currency notes. We don’t have any opinion on how effective or ineffective this demonetization step would be in addressing the problem of black money and fake currency. However, it would be very interesting to see the unintended (positive and negative) consequences of this policy. One immediate effect was that people started hoarding Rs. 100 notes. Valid currency notes (1000s and 500s) suddenly turned into bad money and it drove out the good money (lower denomination notes i.e. 50s and 100s), perhaps temporarily, from the circulation. This is known as Gresham’s law. It is a monetary principle stating that “bad money drives out good.” Watch the latest episode of Latticework of Mental Models video series on Gresham’s Law.

Click Here if you can’t see the video above. [Read more…] about Safal Niveshak Stream – November 26, 2016

Latticework of Mental Models: Lucifer Effect

Let me ask you a disturbing question.

“Would you electrocute a stranger?”

Most of you would respond with an emphatic no. But perhaps you are underestimating yourself.

I am neither doubting your character nor your sense of morality but empirical evidence suggests that human beings underestimate their own vulnerabilities that can turn them into evil. To support my claim let me take you through a fascinating experiment.

In 1971, Philip Zimbardo, a young psychologist from Stanford University, wanted to study the psychology of imprisonment i.e., study the roles people play in prison situations. So he invited students to participate in an experiment and randomly assigned them the roles of ‘prisoners’ and ‘guards’. Tests showed that all students were normal people and physically and mentally healthy. A simulated prison environment was created to mimic real-life prison conditions, where they lived for several days. As part of the role playing the ‘guards’ behaved aggressively and ‘prisoners’ behaved helplessly. [Read more…] about Latticework of Mental Models: Lucifer Effect

Investing and the Art of Metaphorical Thinking

My momma always said, “Life is like a box of chocolates. You never know what you’re gonna get.” Mama always had a way of explaining things so I could understand them. ~ Forrest Gump

About a century ago, when the first automobile was introduced on the roads, most people referred to it as “horseless carriages”. Not only that, when the first set of cars came out, people called them “iron horses.”

Amusing, right? How limited people’s imagination was!

But today when the first lot of autonomous vehicles are getting ready for the roads, most people like to call them driverless cars. I am sure our future generation will be amused at our choice of words.

“Driverless? What driverless?” They would probably chuckle at the unimaginative terminology of their previous generation.

But that’s how a human mind works. The seeds of most revolutionary ideas are sown in those moments of unimaginative thoughts, like horseless carriages and driverless cars.

Driverless cars are as complicated and unbelievable to us as horseless carriages were to our great grandparents. And for a human mind, the best way to learn a complex idea is to find it living inside something else it already understands.

Safal Niveshak Stream – November 19, 2016

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

Life/Learning

(970 words / 4 minutes read) Nilanjana Roy discusses the concept of being a “time-millionaire”, a measure of how much person has control over his or her time. It’s not so straightforward to draw an analogy between time and money in the bank. However, the importance of having control of one’s time cannot be emphasized enough when it comes to understanding human happiness…

The American writer and blogger Mason Currey tracked the daily routines of 161 highly creative people, from Twyla Tharp and Agatha Christie to Matisse and Benjamin Franklin, in Daily Rituals: How Artists Work. Despite wide variations in working styles and habits, some patterns emerge. The brightest humans find work satisfying in itself, continuing to be productive long after they’ve achieved financial stability; they tend to work for a few hours every day, with the odd marathon session.

The most happily successful people you might imagine — Warren Buffett, for example — have the knack of enjoying what they do for work, and take time off to play bridge, learn the ukulele, or whatever. Although Currey didn’t explicitly say this, it also becomes clear that highly creative people exercise iron control over their time — and enjoy spending time, perhaps as much as we’re conditioned to think of enjoying spending wealth.

[Read more…] about Safal Niveshak Stream – November 19, 2016

Latticework of Mental Models: Porter’s Five Forces Analysis

Peter Lynch, who successfully ran Fidelity’s Magellan mutual fund for more than a decade, has often mentioned that investors are well advised to buy a business that’s so good that an idiot can run it because sooner or later an idiot will run it. That’s Lynch’s trademark style of saying that some businesses have structural advantages.

The easiest example that comes to mind is when Vijay Mallya ran two different kinds of businesses i.e the liquor business and the airline business. The alcohol business has great economics and aviation industry is known for its horrible economics. It didn’t matter how skillful Mallya was (or wasn’t). The outcome of the events in these two cases proves Lynch’s point.

So how do you find businesses which have a structural advantage? The search should begin by evaluating the industry. If one can answer following questions then he or she can get deeper insights about the industry.

Is this a good industry to look for quality businesses?
Is this is a mediocre industry, but are there companies which are exceptionally good performers?
What are the growth drivers for the industry?
What are the challenges?
What factors might influence how the industry might do in the future?
Who are the dominant players? Why are they dominant?

Of course, one needs to read a lot about the industry and the companies operating in it to answer above questions. But there’s is smarter approach to get quick insights on the competitive nature of any industry. And that brings us to a very important mental model – Porter’s Five Forces Analysis. [Read more…] about Latticework of Mental Models: Porter’s Five Forces Analysis

Safal Niveshak Stream – November 12, 2016

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

Life/Learning

(1250 words / 6 minutes read) The ability to expand your mind and strive for lifelong learning is more critical to your success than you think. Don’t give up on lifelong learning. Ever. Research shows that it pays beyond the skills you acquire. More than ever before, a challenged, stimulated brain may well be the key to a vibrant later life. There are a few skills that are hard to learn but pay off for the rest of your life. Like the skill of adaptability…

We live in ever-changing world which is unlikely to ever slow down. So, what mattered yesterday (e.g. skill, knowledge, social circle, etc.) very much so might not be worth a dime tomorrow. Change used to be slow and incremental: now it is rapid, radical and unpredictable.

Adaptability enables us to dwell on new circumstances and stay on top of the situation. Of course, this skill is best when combined with insight, giving us fresh perspective before the change itself. Growth depends on how adaptable you are. To stay relevant, most companies will need people who can change with time.

[Read more…] about Safal Niveshak Stream – November 12, 2016

Safal Niveshak Stream – November 9, 2016

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

Investing/Stock Market

(1700 words/7 minutes read): It’s said that there’s very little we can learn from successes for studying successful people is fraught with survivorship bias. However, one shouldn’t outrightly reject the idea of looking at methods of successful because it does have some value. John Huber in his latest post on the competitive advantage of an owner-operator writes –

…the risk of succumbing to survivorship bias is a risk worth taking. I’d rather risk that bias in exchange for the reward of potentially learning something useful from these success stories…They key is trying to reverse engineer their success while simultaneously being aware of the inherent bias can occur when analyzing these situations…. So it’s good to be aware of bias (hindsight, survivorship, etc…), but it’s not worth letting those biases restrict you from trying to learn why something or someone became so successful.
(3 minutes watch): Here’s the next episode of Latticework Video Series. In this video we explain a very important mental model from the field of Statistics, called Mean Reversion, and what investing lessons one can draw from this big idea. Click here to watch the video. [Read more…] about Safal Niveshak Stream – November 9, 2016

Don’t Dump Your Stocks On Trump

Anshul wrote about the mental model of Antifragility some time back. It is a term coined by Nassim Taleb, and he defines it as being the opposite of fragility. So, things that benefit from shocks are antifragile. They thrive and grow when exposed to volatility, randomness, obstacles, disorder, unexpected events, change, and stressors.

An example of something that’s antifragile is Hydra, a serpent-like creature from Greek mythology that grew two new heads every time you cut one off. In Indian mythology, there is a similar character called Raktavija, a demon who had the magic boon that every drop of blood shed from his body gave rise to another Raktavija (literally the blood borne).

In this context, one thing or character that looks highly antifragile in today’s world is…hold your breath…Donald Trump. 🙂

This US presidential candidate has received massive criticism – and for obvious reasons – ever since he entered the field. But note this, the more he has been criticized for his past deeds and present words, the more robust his base has become. In fact, despite whatever the world thinks of the character of Donald Trump, this guy is on the verge of becoming the world’s most powerful man.

Latticework of Mental Models: Ludic Fallacy

On October 23, 2010, Francis Crippen, an American national, drowned while swimming in the sea near the shores of United Arab Emirates. He was only 26 years old.

Francis’ story shouldn’t strike you as very unusual. Thousands die every year because of drowning. In fact, your best guess would be that it’s such a non-event that it wouldn’t have found even a single mention in any of the prominent newspapers. However, what I haven’t told you about Francis is that he was no ordinary swimmer.

All three of Crippen’s sisters were competitive swimmers. Being inspired by his sister Maddy, Crippen started swimming at the age of six. Maddy was a 2000 Olympian in the 400 individual medley. Crippen’s other sister Claire was an Olympic Trials qualifier. Teresa Crippen, Fran’s third sister was a member of U.S. national swimming team. Francis himself was a six-time US National Champion and won several international medals.

This is the account of the events that followed on that fateful day.