A great book which I read in Summers '18 and have started applying his principles in investing in businesses by owning stocks of public companies.
Introduction: The advantages of dumb money
- Analysts miss ten baggers but normal people can see the companies selling goods around them.
- The power of common knowledge: We can understand how consumer react to the products of companies because we & our friends have bought them.
- Invest only in companies which you understand. Don't invest in microcontrollers if you can't understand product specifications.
- Understand consumer behaviour but also read financial statements.
Part I: Preparing to Invest
1. The Making of a Stockpicker
- No such things as a hereditary knack for picking stocks.
- Playing golf is great because it gives you access to people who have resources.
- Studying courses like history, psychology, political science, metaphysics, epistemology, logic, religion & philosophy can be extremely helpful if put to good use.
- Markets aren't really efficient and anyone can beat the market with a disciplined approach to investing.
2. The Wall Street Oxymorons
Problems of Wall Street Professionals:
- Street Lag: Wall Street notices companies after they have had a significant boost in prices thus missing out on the majority of return.
- Inspected by 4: If the fund managers buys an unknown stock and it does down, blame comes on the fund manager but if he bought IBM, blame shifts to the market. Also, too many people to convince to buy a single stock.
- Oysters Rockeefeller: Many funds can't buy a stock not in the prescribed list. Also, it is easier to get returns on small funds than larger ones.
- Going it alone: Don't invest like an institution because you can then focus on long term growth than quarterly results.
3. Is this gambling or what?
- Nothing went wrong with bonds
- Fluctuations in long term bonds which depend on interest rates are as fluctuating as stock markets.
- Equities have always outperformed bonds.
- Ten baggers in debts aren't possible unless one invests in distressed debt.
- There is no way to separate investing from gambling into those categories that are meant to reassure us.
4. Passing the Mirror Test
Ask yourself these questions before investing in stocks:
- Do I have a house? A house is a good first investment which of the people do. It is also difficult to loose money in this.
- Do I need the money? Only invest what you could afford to loose without that loss having any effect on your daily life in the forseeable future.
- Do I have the personal qualities it takes to success?
- Self Reliance
- Common Sense
- A tolerance for pain
- Open mindedness
- A wilingness to do independant research
- An ability to ignore general panic
- You need to be able to resist your human nature and your "gut feeling"
- When it comes to predicting the market, the important skill here isn't listening, but instead it's snoring.
5. Is this a good market? Please don't ask
- Talking about good markets, bad market, bull/bear phases is futile.
- Penultimate Preparedness: We always keep preparing ourselves for the last thing that's happened, as opposed to what's going to happen next. The next time isn't like the last time.
- The Cocktail Theory:
- When ten people would rather talk to a dentist about plaque than to the manager of an equity mutual fund about stocks, it's likely that the market is going to turn up.
- In stage two, after Peter confesses what he does for a living, the new acquaintances linger a bit longer - perhaps to tell Peter about how risky stock market is before they talk to the dentist. The market is 15% up.
- In stage three, with the market 30% up from stage 1, a crowd of interested parties ignores the dentist and circles around Peter all evening.
- In stage four, crowd starts telling Peter what to buy. This is a sign that market has reached a top.
- As Warren Buffet says, "The stock market is only a reference to see if anybody is offering to do anything foolish."
Things to remember from this section:
- Don't overestimate the skills and wisdom of professionals.
- Take advantage of what you already know
- Look for opportunities that haven't been discovered and certified by Wall Street companies that are "off the radar scope".
- Invest in a house before you invest in a stock.
- Invest in companies, not in the stock market.
- Ignore short term fluctuations.
- Large profits can be made in common stocks.
- Large losses can be made in common stocks.
- Predicting the economy is futile.
- Predicting the short-term direction of the stock market is futile.
- The long-term returns from stocks are both relatively predictable and also far superior to the long term returns from bonds.
- Keeping up with a company in which you own stock is like playing an endless stud-poker hand.
- Common stocks aren't for everyone, nor even for all phases of a persons' life.
- The average person is exposed to interesting local companies and products years before the professionals.
- Having an edge will help you make money in stocks.
- In the stock market, one in hand is worth ten in the bush.
Part II: Picking Winners
6. Stalking the tenbagger
- Try to find stocks in products of everyday companies
- Try to find the industry where you work or know about in detail.
7. I've Got it, I've Got it - What is it?
- Treat the company you saw at the mall as an anonymous tip and do your own thorough analysis
- Big companies move small while small companies move big.
The Six Categories:
- The Slow Growers:
- Large & aging companies
- High dividend because no place else to invest money
- The Stalwarts:
- Have economic "moats"
- Big companies
- Better returns than cash
- Doesn't fall in value easily even if grossly overprices
- The Fast Growers:
- Small, aggressive high growth companies
- Doesn't necessarily have to belong to fast-growing industry
- Plenty of risk since companies are over-zealous and underfinanced
- Once they turn to slow growers, the stock gets beaten.
- Look out for good balance sheets and making substantial profits.
- Figuring out when they'll stop growing, and how much to pay for growth is tricky and non-trivial.
- The Cyclicals:
- Profits rise and fall in regular but not completely predictable fashion.
- Autos, airlines, tire companies, steel companies, chemical companies and even defense companies.
- Flourish in expanding economies (more than stalwarts) while if it goes in the other direction, it is east to loose a lot.
- The Turnarounds:
- Battered & depressed
- No growers
- But they make up lost ground very quickly
- The Asset Plays:
- Companies sitting on something valuable like cash or real estate.
- It can also be loyal subscribers who pay monthly.
Highfliers to Low Riders: Companies don't stay in the same category forever.
Exit the position in accordance to the stock category it belongs to.
8. The Perfect Stock, What a Deal!
- It sounds dull or even better ridiculous
- It does something dull
- It's a spinoff
- The institutions don't own it, and the analysts don't follow it
- The rumors around: It's involved with toxic waste and/or the mafia
- There is somethign depressing about it
- It's a no-growth industry
- It's got a niche
- People have to keep buying it
- It is a user of technology
- The insiders are buying it
- The company is buying back its shares
9. Stocks - I'd avoid
- If you aren't clever at selling hot stocks (and the fact that you have bought them is a due that you won't be), you would soon see your profits turn to loss.
- High growth & hot industries attract a very smart crowd that wants to get into business. Entrepreneurs and venture capitalists stay awake nights trying to figure out how to get into the act as quickly as possible.
- Beware of the next something
- Avoid companies who prefer to blow money on foolish acquisitions.
- Beware the whisper stock
- Beware the middleman companies whose major sales come from a single entity.
- Beware the stock with the exciting name
10. Earnings, Earning, Earnings
- People who work in secure jobs that pay low salaries and modest raises are slow growers, the human equivalent of the electric utilities.
- People who command good salaries and get predictable raises, such as middle-level managers of corporations are stalwarts.
- Farmers, hotel and resort employees, summer camp operator who make money in short bursts are cyclicals.
- Those who live off family fortunes but contribute nothing from their own labor are asset plays.
- Guttersnipes, drifters, down-and-outers, bankrupts, workers who've been laid off, and others in the unemployment lines are all potential turnarounds, as long as there's any energy left in them.
- Actors, inventors, real estate develoeprs, small businessmen, athletes, musicials are all potential fast growers but also extremely risky.
- P/E low for slow growers and high for fast growers.
- Avoid stocks with excessively high P/E ratios
- When you find that a few stocks are selling at inflated prices, it's likely that most stocks are selling at inflated prices.
- Investors pay more for stocks when interest rates are low.
- Don't try to predict earnings
- Figure out how the company plans to increase it's earnings.
- The five basic ways are: reduce costs, raise prices, expand into new markets, sell more of its product in the old markets, or revitalize, close or otherwise dispose off a losing operation.
11. The Two Minute Drill
- Give a two minute monologue that covers the reason why you are interested in a particular stock.
- The mistake Peter did when he bought Buildner's was that he assumed that he cloning this model would work everywhere which didn't turn out to be true.
12. Getting the facts
- Try to get the most out of your broker especially if you are using a full service brokerage firm.
- Calling the company:
- Investors relations are often helpful and provide a good info only if you know how to ask.
- Ignore the marketing bullshit and focus on the actual business.
- Visit the headquarters
- Visit investors relations in person
13. Some Famous Numbers
- Percent of sales
- The P/E ratio
- The cash position
- The debt factor
- Book value (extremely tricky)
- more hidden assets like inventory, real estate subsidiaries, tax breaks, etc.
- Pension Plans
- Earning growth
14. Rechecking the Story
- Three stages: start-up phase (riskiest), rapid expansion phase (most money is made), mature/saturation phase (where company struggles to increase earnings).
- One has to always be on it's toes and keep rechecking the company.
15. The Final Checklist
Stocks in general:
- P/E ratio, its relative value in the industry
- % of institutional ownership (the lower the better)
- Whether insiders are buying & the company itself buying back its own shares. Both +ve.
- Growth & consistency of earnings (except for asset play)
- Whether a strong balance sheet (debt to equity ratio)
- The cash position
- If bought for dividends, check for consistency and growth.
- % of earnings as dividends
- Big companies which wouldn't go out of business
- But check for P/E ratio
- Possible diworseifications that may reduce earnings
- Check the company's long term growth rate
- Check how the company has fared during previous recessions
- Keep a close watch on inventories and supply demand relationship.
- Anticipate a shrinking P/E multiple over time as business recovers and investors look ahead to the end of the cycle when peak earnings are achieved.
- If you know the cyclical, you have an advantage in figuring out the cycles.
- Verify whether the fast growing business is a major part of the company's business.
- Growth rate in earnings
- Company has duplicated its success in multiple locations.
- Company still has room to grow
- Whether the expansion is speeding up or slowing down.
- Few institutions & only handful of analysts cover the stock.
- Can the company survive a raid by its creditors? How much cash the company has? How much debt? What is the debt structure?
- If bankrupt, what's left for the shareholders?
- How is the company supposed to be turning around? How it rid itself of unprofitable divisions?
- Is business coming back?
- Are costs being cut?
- What's the value of the assets? Are there are any hidden assets?
- How much debt is there to detract from these assets?
- Is the company taking on new debt, making the assets less valuable?
- Is there a raider in the wings to help shareholder reap the benefits of these assets?
Some more pointers from this section?
- Understand the nature of the companies you own and the specific relations for holding the stock.
- By putting your stock into categories, you'll have a better idea of what to expect from them
- Big companies have small moves and small companies have big moves.
- Consider the size, if you expect to profit from a product.
- Look for small companies that are already profitable and have proven that their concept can be replicated.
- Be suspicious of copmanies with growth rates of 50% to 100% a year.
- Avoid hot stocks in hot industries.
- Distrust diworseifications
- Long shots almost never pay off
- It's better to miss the first move in a stock and wait to see if a company's plans are working out.
- People get incredibly valuable information from their jobs that may not reach the professionals.
- Separate all stock tips from the tipper, even if the tipper is very smart, very rich and his or her last tip went up.
- Some stock tips from experts in the field may turn out to be valuable.
- Invest in simple companies that appear dull, mundane, out of favour, and haven't caught the fancy of Wall Street.
- Moderately fast growers (20-30%) in non-growth industries are ideal investments.
- Look for companies with niches.
- When purchasing depressed stocks in troubled companies, seek out the ones with superior financial conditions.
- Companies that have no debt can't go bankrupt.
- Managerial ability may be important, but it's quite difficult to assess.
- A lot of money can be made when a troubled company turns around.
- Carefully consider P/E ratio. If overprices, it's difficult to make money.
- Find a story line to follow as a way of monitoring company's progress.
- Look for companies that consistently buy back shares.
- Study the dividend record for consistency & growth.
- Look for companies with little or no institutional ownership.
- Favour companies in which management has a significant personal investment.
- Insider buying is a positive sign.
- Devote an hour a week to do investment research.
- Be patient. Watched stock never boils.
- Buying stocks purely on book value is dangerous.
16. Designing a Portfolio
If you have high expectations you will more likely get frustrated at stocks for defying you, and you may become impatient. Or worse, you may take unnecessary risks in the pursuit of illusory payoffs.
The only way to maximize long-term gains is to stick to a strategy through good and bad years.
How many stocks is too many? Don't rely on any fixed number of stocks but rather judge on a case by case basis.
If looking for a ten bagger, more stocks you own, better it is.
Spreading your money among several categories of stocks is another way to minimize downside risk.
- Slow growers: Low risk, low gain
- Stalwarts: Low risk, moderate gain
- Asset Plays: low risk, high gain
- Cyclicals may be low risk & high gain or high risk and low gain depending on investor's ability at understanding cycles.
- Fast Growers: high risk, high gain
Check company stories regularly, not prices.
Rotate in & out of stocks depending on what has happened to the price as it relates to the story.
17. The Best Time to Buy & Sell
- When to buy?
- Year end tax loss harvesting
- Market collapses & drops
- When to sell?
- Review the reason why you bought it?
- When to sell a slow grower?
- There has been a 30%-50% appreciation
- Fundamentals have deteriorated
- Company has lost market share
- No new products being developed
- Recently failed acquisitions
- Even at lower price, dividend yield might not be high enough
- When to sell a stalwart?
- Different P/E ratio than expected
- New products have mixed results
- Higher P/E as compared to the industry
- A major division is vulnerable to economic slump
- Company's growth rate has been slowing down
- When to sell a cyclical?
- It is difficult to predict cycles
- Inventories are building up
- Failling commodity prices
- Competition business
- Lower demands
- Can't cut costs further
- When to sell fast growers?
- Watch carefully the second phase of growth
- All the characteristiccs of the stock you'll avoid are characteristics of the stocks you want to sell
- Same store sales are down
- New store results are disappointing
- Top executives join a rival firm
- Stock is selling at a higher P/E
- When to sell a turnaround?
- Sell after it is turned around. All the troubles are over & everybody knows it.
- Debt rose.
- Inventories twice the sales growth
- Inflated P/E
- One major leading customer
- When to sell an asset play?
- Wait for the corporate raider
- Wait for market to realize the full potential
18. The Twelve Silliest (and most dangerous) things people say about stock prices
- It has gone down this much already, it can't go much lower
- If it's gone this high already, how can it possibly go higher?
- It's only $3 a share, what can I loose?
- Eventually they always come back
- It's always the darkest before the dawn
- When it rebounds to $10, I'll sell.
- What me worry? Conservative stocks don't fluctuate much.
- It's taking too long for anything to happen.
- Look at all the money I've lost: I didn't buy it
- I missed that one, I'll catch the next one.
- The stock's gone up, so I must be right or the stock's gone down so I must be wrong.