This weekend Buffet released his annual letter to shareholders. You can read it here. For any aspiring value investors pages 16-20 are a must read. I have advocated many of the points he makes here on this blog. Buffet is a very knowledgeable and intelligent man but like he says in his letter, you don't need to be expert or have superior intelligence to achieve great investment success. There's many lessons Buffet teaches; some key ones are these:
- Be very patient and wait for that fat pitch before taking action. Look for those no brainer situations whereby the price you are paying is so cheap relative to what a conservative estimate of long term earnings will be, that it's not even necessary to know much about the actual operations of the business.
- Buy stocks the same way you would buy a private business which means you don't care what the "market" values the business on any given day aside from the day you are buying it; all you care about are the cash flows the company is generating and the return on your investment from these cash flows - not from your ability to sell to a greater fool. This means that you shouldn't be looking at the value of your stocks every day.
- Stick with predictable businesses whereby you are reasonably sure that their products are going to be around many years from now and not be a victim of technological obsolesce. This allows for good earnings visibility in the long term and thus allows you to have conviction with your risk/reward analysis. This is the reason why Buffet loves insurance, bank, food/beverage, and utility companies and pounces on them when they sell at a discount due to a panic or general economic downturn.
Not sure if you've seen it already or not, but I came across this interesting Motley Fool video on investing with Michael Mauboussin (http://www.youtube.com/watch?v=6poI6_ds0Po&index=4&list=FLBUra6NjTanmnm1kOnT-HFQ) and immediately thought about what you just said about investing like a business owner and having a thoughtful process in place in deciding which company to invest.
ReplyDeleteI bought my very first stock back in 2008. The company was called Washington Mutual. I entered it at around a dollar because I thought it got so oversold and it must rebound. And what do you know the next day I looked the stock quote I think it was around 5 cents because it was forcefully got acquired by JPMorgan under US government instruction. I lost about $5000 in one day. A very expensive lesson for sure but I've learned the differences between investing and gambling.
Just want to say lots of great stuff in the the Little book on Behavioral Investing. Thanks for the recommendation. I am also reading through Animal Spirits by Akerlof and Shiller, I came across this interesting snippet on stock investing that I through I would leave here for you and others to enjoy.
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The Beauty Contest and Delicious Apple Metaphors
In his 1936 book Keynes compared the equilibrium in the stock market to that of a popular newspaper competition of his time. Competitors were ask to pick the six prettiest face from a hundred photographs. The prize was awarded to the competitor whose choices came closest to the average preferences of all of the competitors as a group. Of course, to win such a competition one should not pick the face one thinks are prettiest. Instead one should pick the faces that one thinks others are likely to think the prettiest. But even that strategy is not the best, for certainly others are employing it too. It would be better yet to pick the faces that one thinks others are most likely to think that others think are the prettiest. Or maybe one should even go a step or two further in this thinking. Investing in stocks are often like that: just as in the beauty contest, in the short run one does not win by picking the company most likely to succeed in the long run, but by picking the company most likely to have high market value in the short run.
The Delicious Apple offers another metaphor for much the same theory. Hardly anyone today really likes the taste of the varietal now called Delicious. And yet these apples are ubiquitous. They are often the only choice in cafeterias, on lunch counters, and in gift baskets. Delicious Apples used to taste better, back in the nineteenth century when an entirely different apple was marketed under this name. The Delicious varietal had become overwhelmingly the best-selling apple in the United States by 1980s. When apple connoisseurs began shifting to other varietals, apple growers tried to salvage their profits. The moved the Delicious Apple into another market niche. It became the inexpensive apple that people think other people like, or that people think other people think other people like. Most grower gave up on good yield and better shelf life. They cheapened it by clear-picking an entire orchard at once, no longer choosing the apples as they ripened individually. Since Delicious Apples not selling based on taste, why pay extra for taste? The general public cannot imagine the an apple could be so cheapened. Nor does it imagine the real reason these apples are so ubiquitous despite their generally poor taste.
The same kind of phenomenon occurs with speculative investments. Many people do not appreciate how much a company with a given name can change through time, or how many ways there are to debase its value. Stocks that nobody really believes in but that retain value are the Delicious Apples of the investment world.
Thanks for the comments Dennis. On vacation right now.
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