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The More Things Change, The More They Stay The Same


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About two years back, I read an interview entitled "An Hour With Benjamin Graham".

 

What struck me was how the author of Security Analysis felt that after a successful career in investment management, he had come to the conclusion that elaborate techniques of security analysis was a waste of time.

 

This was contrary to all my instincts. I was leaning far more towards Warren Buffett (focused understanding of the business) than Benjamin Graham (statistical approach).

 

Two years later, I have come full circle back to Benjamin Graham.

 

The book Quantitative Value and countless studies have shown that simple models out-performs experts (even value investors). And unless your investing institutionally (i.e. > 100 million AUM), it seems that there are plenty of spots in which you virtually have no competent competition (micro-caps, foreign markets where no one even speaks English etc).

 

In a strange reversal, I had the exact opposite revelation of plenty of people on the board. I started buying good businesses at cheap prices (started in 2010), went to good businesses at reasonable prices, and ended up buying sub-par businesses at dirt cheap prices.

 

Looking at the type of analysis that we tend to do these days, with the amount of information available (spreadsheets, DCFs, poring over small percentage changes in margins etc), and what Graham or Buffett did with simple financial statements, buying stocks by going door to door etc...

 

The question which always come to my mind (inspired from a speech I found here a long time ago) is... are we simply trying too hard?

 

It seems to me that much of what we do simply exists just because its so easy to access information, to perform complex calculations with Excel. But are our actions actually valuable? Or are we spending too much time focusing on the 20% of work that actually yields low level results.

 

Just some thoughts that's been on my mind of late.

 

 

 

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From His Interview:

 

In selecting the common stock portfolio, do you advise careful study of and selectivity among different issues?

In general, no. I am no longer an advocate of elaborate techniques of security analysis in order to find superior value opportunities. This was a rewarding activity, say, 40 years ago, when our textbook "Graham and Dodd" was first published; but the situation has changed a great deal since then.

 

In the old days any well-trained security analyst could do a good professional job of selecting undervalued issues through detailed studies; but in the light of the enormous amount of research now being carried on, I doubt whether in most cases such extensive efforts will generate sufficiently superior selections to justify their cost.

 

To that very limited extent I'm on the side of the "efficient market" school of thought now generally accepted by the professors.

 

PS: As someone pointed out to me, what he was trying to stress was not that there was no money to be made from investing. Just that he favored a simple group approach (low P/E, low P/B, combined with a quality factor like < 0.50 debt), and that his research over 50 years should that they yielded a "satisfactory" result.

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If you find yourself working on complex DCF calculations or poring through Excel spreadsheets all day, then yes, you are in fact trying way way too hard.

 

My personal belief is that the benefit that comes from quantitative value investing is the systematization and not the quantitative nature of the investing. The systematization prevents psychology from entering the equation -- I remember reading that Glenn Greenberg's son started a quant firm, and they sometimes overrode their algorithm only to figure out that they were wrong to do so. It turns out those really crappy looking investments eventually recover, but, they do not necessarily recover fast enough to calm an investor's nerves.

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I think the notion of statistical screens acting as a ceiling rather than a floor makes perfect sense. I personally can't invest that way, it just doesn't fit my personality. But if there was a low cost ETF that just bought the lowest decile on EV/EBIT, I would have no problem holding that as a significant portion of my holdings.

 

I do wonder whether all the quants and value investors won't arbitrage away the advantage of simple statistical screens though. It seems like someone like Klarman who can find hidden value would have an even larger advantage in the current environment.

 

Of course both Buffett and Graham probably made more money on Geico than any of their cigar butts.

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The question which always come to my mind (inspired from a speech I found here a long time ago) is... are we simply trying too hard?

 

It seems to me that much of what we do simply exists just because its so easy to access information, to perform complex calculations with Excel. But are our actions actually valuable? Or are we spending too much time focusing on the 20% of work that actually yields low level results.

 

1. Maybe, maybe not.  Klarman in Margin of Safety cites the Pareto Principle in saying 80% of the research benefit is achieved in the first 20% of the time spent (or something like that).  I think there are plenty of guys on this board who are successful at a few concentrated positions in great companies at a fair price.  Others are similarly skillful but just not as lucky:  http://www.pmjar.com/?p=1401

 

2. And, it may also be a matter of temperament and psychology.  Graham may simply have been at a stage in life when he preferred to spend more time translating Greek and Latin classics (as well as spending quality time with his son's mistress) than in security analysis.  All the research and experience shows that all varieties of value investing work.  Check out the varied list of investing and trading styles in the chart from the book Excess Returns (featured in a recent Books thread on this board):  http://www.amazon.com/Excess-Returns-Comparative-Greatest-Investors/dp/0857193511/ref=sr_1_1?ie=UTF8&qid=1410890655&sr=8-1&keywords=excess+returns+a+comparative+study+of+the+methods+of+the+world%27s+greatest+investors  (The chart is available in the "Look Inside" feature of Amazon.)

 

So it's largely a matter of Know Thyself, and Know Which Style/Process You Enjoy.

 

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I'm perfectly happy blindly and strictly applying the Magic Formula. But it took a lot of reading to have the conviction to do so. Think of all the time a first-time investor could save by simply reading The Little Book That Still Beats the Market, picking 2-3 stocks chosen with a list-randomizer from Greenblatt's site every time they get their paycheck, and never deviating from that course. I think the chances of beating the market by a good amount given a long time period with this approach are far better than that person trying to become a value investor in the traditional sense of the word.

 

That saved time could be used for many things that would be more productive than trying to learn security analysis, which most people can't do.

 

But I haven't seen many (well, any) people do this. From a selfish perspective, that makes me quite happy. But the implications are quite troubling. No one will ever get a job by beating the market by blinding doing the Magic Formula. But there are many who pick stocks (and may not even beat the market) and then get paid handsomely to do so with other people's money. And it's much more brag-worthy to pick stocks. So the incentives apart from how much money you make actually investing really lean towards not applying a strict quantitative strategy that actually works, like the Magic Formula or Price and Quality.

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I've been coming to the same conclusion. In fact, once I'm able to roll my 401k into an IRA, I plan to simply buy the lowest P/B stocks I can find that are available to me. This will be about 30-35% of my investable assets. The only question is the holding period before rebalancing.

 

I'm doing this as a hedge. I know the statistics. I know that this is generally the ceiling. But I hate that additional knowledge doesn't help. It's so counterintuitive. I've been spending most of my time studying behavioral and decision making biases recently with an intent to build myself guard rails and systematize some of my thinking. The remainder of my 65% will be invested this way with the hope that I can find an intelligent way to improve on simple blind baskets of stocks.

 

If I continue to fail over time, the portfolios will rebalance for me over time with. Heavier weighting towards systematic and less to active. I might even switch over some of the 65% but I think I will always want to attempt to improve on the results. It just doesn't make sense that we can't use an understanding of business and securities and valuation to better separate the wheat and chaff.

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Different strokes for different folks ... I would phrase things a bit differently - how do I find a process which shields me from my biases yet allows me to develop and strengthen my competence & conviction?

 

I personally feel most people tend to focus on the first part, but in my direct experience most people, even when given a simple plan/method cannot bring themselves to act ... this is IMHO mostly because they do not have conviction & competence in their system. The virtue of any mechanized system (even WEB's "buy the S&P") is in direct proportion to the chances it will be implemented! Ironically, these "simple" systems require that you trust them or apply them without thought - there is no effective middle and I would argue this is exactly why WEB, following Graham, sees only two types of investors - active and passive.

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Guest longinvestor

Different strokes for different folks ... I would phrase things a bit differently - how do I find a process which shields me from my biases yet allows me to develop and strengthen my competence & conviction?

 

I personally feel most people tend to focus on the first part, but in my direct experience most people, even when given a simple plan/method cannot bring themselves to act ... this is IMHO mostly because they do not have conviction & competence in their system. The virtue of any mechanized system (even WEB's "buy the S&P") is in direct proportion to the chances it will be implemented! Ironically, these "simple" systems require that you trust them or apply them without thought - there is no effective middle and I would argue this is exactly why WEB, following Graham, sees only two types of investors - active and passive.

 

Also to not act. This is really, really difficult. The most successful active investment, ironically is minimally active. The twenty ticket thing.

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Different strokes for different folks ... I would phrase things a bit differently - how do I find a process which shields me from my biases yet allows me to develop and strengthen my competence & conviction?

 

I personally feel most people tend to focus on the first part, but in my direct experience most people, even when given a simple plan/method cannot bring themselves to act ... this is IMHO mostly because they do not have conviction & competence in their system. The virtue of any mechanized system (even WEB's "buy the S&P") is in direct proportion to the chances it will be implemented! Ironically, these "simple" systems require that you trust them or apply them without thought - there is no effective middle and I would argue this is exactly why WEB, following Graham, sees only two types of investors - active and passive.

 

Also to not act. This is really, really difficult. The most successful active investment, ironically is minimally active. The twenty ticket thing.

 

That's a really good turn of phrase.

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A few observations ...

 

Moving from DCF to the simple (ie: magic formula) is emotional maturity. The investor has stopped trying to substitute the vagaries of DCF, for actual experience & thinking like a business. A handful of variables, & some critical thinking, will suffice for most situations.

 

Eventually, most folks realize that all valuations are just estimates - not guarantees. The most precise estimate in the world, does not magically assure that the projection is actually going to happen - exactly as forecast.

 

Very few realize that value investment is actually about using optionality, & that the G&D formulas were just simple applications. We don't need to understand asymmetry to use the formulas; but when you do - you get the remainder of the ice-berg.

 

Most of the world routinely applies value investing principles every day, they just do it in different applications. Every market vendor, small businessman, etc. either makes a profit every week or very quickly goes out of business. What they call business sense is just optionality by a different name.

 

Nothing particularly complicated, but its not a formula. Get over it.

 

SD

 

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A few observations ...

 

Moving from DCF to the simple (ie: magic formula) is emotional maturity. The investor has stopped trying to substitute the vagaries of DCF, for actual experience & thinking like a business. A handful of variables, & some critical thinking, will suffice for most situations.

 

Eventually, most folks realize that all valuations are just estimates - not guarantees. The most precise estimate in the world, does not magically assure that the projection is actually going to happen - exactly as forecast.

 

Very few realize that value investment is actually about using optionality, & that the G&D formulas were just simple applications. We don't need to understand asymmetry to use the formulas; but when you do - you get the remainder of the ice-berg.

 

Most of the world routinely applies value investing principles every day, they just do it in different applications. Every market vendor, small businessman, etc. either makes a profit every week or very quickly goes out of business. What they call business sense is just optionality by a different name.

 

Nothing particularly complicated, but its not a formula. Get over it.

 

SD

 

 

Well said.  I have never used a DCF calculation.  I tried but it made no sense to me.  Kind of like when physicists apply the Universal fudge factor to make their equations work.  The Drake equation is my favourite example of adding BS with BS and getting well more BS.  If a company seems cheap on a P/B, p/E, p/cf or p/dividend then it warrants further investigation. 

 

At that point we start dating and get to know each other.  As we get to know each other more we either break up or continue seeing one another, perhaps more. 

 

 

Also to not act. This is really, really difficult. The most successful active investment, ironically is minimally active. The twenty ticket thing.

 

I agree that not acting can be important to learn.  I disagree with the notion that most successful active investors are minimally active.  I think the twenty ticket thing is an outcome of experience.  The only way to gain experience is to make mistakes, alot of them, along the way.  Its the best way to develop a style and philosophy that works for YOU!  The problem with Buffett is we only hear about his successes... there is a reason he changed styles to more qualitative version. 

 

There is no substitute for the experience of buying Washington Mutual in August 2008 - yes I did that.  Sold the position right quick when I realized I had walked into a firestorm.  I would guess that I have held somewhere over 300 companies over 18 years.  Each one provided part of my philosophical and procedural framework, that I use today. 

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Guest longinvestor

A few observations ...

 

Moving from DCF to the simple (ie: magic formula) is emotional maturity. The investor has stopped trying to substitute the vagaries of DCF, for actual experience & thinking like a business. A handful of variables, & some critical thinking, will suffice for most situations.

 

Eventually, most folks realize that all valuations are just estimates - not guarantees. The most precise estimate in the world, does not magically assure that the projection is actually going to happen - exactly as forecast.

 

Very few realize that value investment is actually about using optionality, & that the G&D formulas were just simple applications. We don't need to understand asymmetry to use the formulas; but when you do - you get the remainder of the ice-berg.

 

Most of the world routinely applies value investing principles every day, they just do it in different applications. Every market vendor, small businessman, etc. either makes a profit every week or very quickly goes out of business. What they call business sense is just optionality by a different name.

 

Nothing particularly complicated, but its not a formula. Get over it.

 

SD

 

 

Well said.  I have never used a DCF calculation.  I tried but it made no sense to me.  Kind of like when physicists apply the Universal fudge factor to make their equations work.  The Drake equation is my favourite example of adding BS with BS and getting well more BS.  If a company seems cheap on a P/B, p/E, p/cf or p/dividend then it warrants further investigation. 

 

At that point we start dating and get to know each other.  As we get to know each other more we either break up or continue seeing one another, perhaps more. 

 

 

Also to not act. This is really, really difficult. The most successful active investment, ironically is minimally active. The twenty ticket thing.

 

I agree that not acting can be important to learn.  I disagree with the notion that most successful active investors are minimally active.  I think the twenty ticket thing is an outcome of experience.  The only way to gain experience is to make mistakes, alot of them, along the way.  Its the best way to develop a style and philosophy that works for YOU!  The problem with Buffett is we only hear about his successes... there is a reason he changed styles to more qualitative version. 

 

There is no substitute for the experience of buying Washington Mutual in August 2008 - yes I did that.  Sold the position right quick when I realized I had walked into a firestorm.  I would guess that I have held somewhere over 300 companies over 18 years.  Each one provided part of my philosophical and procedural framework, that I use today.

We can learn from experience and also from other people's mistakes. In fact, I just shared my top ten investment mistakes with a small group near here. "Mistakes I made that you don't have to"

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im bothered by the overuse of Ebitda. And the abuse. Take note of this gem from the Fiat VIC write up:

An after tax multiple of 15 puts Ferraris value at €3.8b. Using an EBIT multiple of 12 yields €4.4b and an EBITDA multiple of 9 leads to €5.9b.

 

Note how the earnings get more imaginary , the more bullish he gets! Ofcourse if you say it is worth a 23x earnings multiple in the bull case then readers might deem that too expensive. So let's just put a 9x ebitda multiple on that. Nobody will know what that really translates to in real earnings at first glance.

 

Why do people use Ebitda if there are no comparisons? Or if competitors cost structure looks different? Why use it at all with valuation? Everytime I see someone say 'well this thing deserves a 7x ebitda multiple' I end up having to look up what that translates to in actual real earnings. Might as well use revenue multiples then.

 

Another thing that blows my mind is reading quarterly call transcripts and having analysts ask question about details that just do not matter. Maybe some tiny part of their operation generates like 5% of total earnings and will always stay small. And then some analyst proceeds to ask like 3 super detailed questions because he wants to exactly understand wether that 5% could maybe change into 7 or 4% sometime soon. If that 5% matters that much your looking at the wrong stock.

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Another thing that blows my mind is reading quarterly call transcripts and having analysts ask question about details that just do not matter. Maybe some tiny part of their operation generates like 5% of total earnings and will always stay small. And then some analyst proceeds to ask like 3 super detailed questions because he wants to exactly understand wether that 5% could maybe change into 7 or 4% sometime soon. If that 5% matters that much your looking at the wrong stock.

 

It's really annoying. They're basically just trying to fill whatever boxes are empty in their spreadsheet models, trying to come up with their EPS target for the next quarter...

 

Every time someone asks about long-term strategy, competitive advantages, etc, I almost fall out of my chair..

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longinvestor said:

 

"We can learn from experience and also from other people's mistakes. In fact, I just shared my top ten investment mistakes with a small group near here. "Mistakes I made that you don't have to"

 

I would like to think that is true, but I suspect I learn more throughly by making some of my own mistakes.

 

I think we don't hear about Buffett's failures because he just doesn't have that many.

 

I'm not convinced.  His partnership and pre-partnership days are a black box from 60 years away. 

 

His investing shifted around the time he bought Disney, and Amex.  By that time he had been investing at least 10 years. 

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Thanks for the many great responses.

 

I've had my own learning experiences and revelations. Reminds me of what Bruce Lee said, "You first have to learn the rules before you can break them".

 

I remember a couple of years back, S-Chips (China listed companies listed in Singapore) were trading at insanely cheap valuations. There were plenty of articles discussing future growth prospects, why they were deeply undervalued an so on.

 

Turns on the vast majority of people didn't ask the first question: Is the business legitimate? (as opposed to asking Do I understand the business).

 

I think that's something borne out of experience. Graham couldn't teach you that simply because its a different socio-political setting.

 

My own take away is that active investors are compared to most of the world, virtually sloth like in behavior. But what seems to pay off very well is being very active in knowledge acquisition, reading a lot, learning a lot, travelling a lot.

 

That seems to be Buffett "activeness" for me.

 

Its from all this active and frenetic learning that a few timeless principles are distilled, and that's where I get the ah-ha moment. A deeper understanding of a simple principle which I learned early on when I read the Intelligent Investor, but never really "understood".

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Guest longinvestor

Thanks for the many great responses.

 

I've had my own learning experiences and revelations. Reminds me of what Bruce Lee said, "You first have to learn the rules before you can break them".

 

I remember a couple of years back, S-Chips (China listed companies listed in Singapore) were trading at insanely cheap valuations. There were plenty of articles discussing future growth prospects, why they were deeply undervalued an so on.

 

Turns on the vast majority of people didn't ask the first question: Is the business legitimate? (as opposed to asking Do I understand the business).

 

I think that's something borne out of experience. Graham couldn't teach you that simply because its a different socio-political setting.

 

My own take away is that active investors are compared to most of the world, virtually sloth like in behavior. But what seems to pay off very well is being very active in knowledge acquisition, reading a lot, learning a lot, travelling a lot.

 

That seems to be Buffett "activeness" for me.

 

Its from all this active and frenetic learning that a few timeless principles are distilled, and that's where I get the ah-ha moment. A deeper understanding of a simple principle which I learned early on when I read the Intelligent Investor, but never really "understood".

Like your expression, active in knowledge acquisition. It's" read, read, read and do nothing", most of the time. But when it is time to do something, have no self-doubt, plunge in. Take the whole thing. The activeness in knowledge acquisition should help in removing self doubt at these occasional moments of "activeness". Of the twenty tickets, if you get five wrong, I think you'll still do OK. Likely, quite satisfactory, borrowing Ben Graham's line.

 

Easier said than done though.

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