Multi-Disciplinary Reading - Book Reviews

Southern_Cross · January 26, 2022, 12:08pm

The book starts with Forewords from Howard Marks, Bill Miller & Peter Lynch and Introduction from Kenneth L. Fisher(Phil Fisher’s son) which are all worth reading

Chapter 1 – A Five-Sigma Event. The World’s Greatest Investor

Buffett always claims he won an ovarian lottery as he figures out that the odds of him being born in US in 1930 were 30:1
Based on his own self-assessment, he is wired in a particular way that allows him to thrive in a big capitalistic economy with a lot of action
Buffett’s family briefly were affected due to the great depression in 1930’s and it made a strong impact on his mind even though the tough period was short. His age was less than five when this happened
After a chance reading of “The Intelligent Investor” book by Ben Graham he felt like seeing the light and he joined Graham’s class in Columbia University Graduate School of Business
Buffett becomes a major share-holder in Berkshire Hathaway which is a textile company. This book is about how he evaluates, manages, and buys businesses under Berkshire as well its stock portfolio
The efficient market theory suggests that analysing stocks is a waste of time because all available information is already reflected in current stock price but some minority like Warren Buffett disagree
The efficient market theoreticians say that the theory is not flawed but individuals like Buffett are a five-sigma event and so rare that practically never occurs.

Chapter 2 – The Education of Warren Buffett

Warren Buffet is influenced by three gurus - Ben Graham, Philip Fisher & Charlie Munger
Ben Graham’s definition of investment – “ An investment operation is one which, upon thorough analysis, promises safety of principal and a satisfactory return. Operations not meeting these requirements are speculative”
The memory of being financially ruined twice in a lifetime led him to embrace an investment approach that stressed downside protection versus upside potential.
Graham’s 2 rules of investing –
1. Don’t lose
2. Don’t forget the first rule
Philip Fisher believes that superior profits could be made by
1. Investing in companies with above average potential and
2. Aligning oneself with the most capable management
The characteristic of a company that most impressed Fisher was its ability to grow sales and profits over the years, at rates greater than the industry average
The essential step in prudent investing, he explained, is to uncover as much about the company as possible, from the people who are familiar with the company
He believes in focus portfolio of less than 10 companies and usually 75% in 3 or 4 stocks
Charlie Munger believes it was far better to pay a fair price for a great company than a great price for a fair company
To achieve “worldly wisdom” said Charlie, you must build a lattice work of mental models that unites all the big ideas in the world

To summarise, Graham gave Buffett the intellectual basis for investing – the margin of safety and helped him learn to master his emotions in order to take advantage of market fluctuations.
Fisher gave Buffett an updated, workable methodology that enabled him to identify good long-term investments and manage a focused portfolio over time. Charlie helped Buffett appreciate the
Economic returns that come from buying and owning great businesses.

Chapter 3 – Buying a business. The twelve immutable tenets

Here are the “Tenets of the Warren Buffett Way”.

Business Tenets

Is the business simple and understandable
In Buffett’s view, investors’ financial success is correlated to how well they understand their investment. This is a distinguishing trait that separates investors with a business orientation
From most hit and run types – people who are constantly buying and selling
Does the business have a consistent operating history
Experience has taught him that turnarounds seldom turn. It can be more profitable to look for good businesses at reasonable prices than difficult businesses at cheaper prices
Does the business have favourable long-term prospects
“The most important thing for me is figuring out how big a moat there is around the business. What I love of course is a big castle and a big moat with piranhas and crocodiles.”
Management Tenets
“We do not wish to join with managers who lack admirable qualities”, he says, ”no matter how attractive the prospects of their business. We’ve never succeeded in making good deals with a bad person”
Is management rational?
The most important management act is the allocation of the company’s capital
Is management candid with its shareholders?
“What needs to be reported”, argues Buffett that helps the financially literate readers answer three key questions:
a. Approximately, how much is the company worth?
b. What is the likelihood that it can meet its future obligations?
c. How good a job are its managers doing, given the hand they have been dealt?
Does management resist the institutional imperative?
Buffett isolates three factors as being most influential in management’s behaviour.
a. Most managers cannot control their lust for activity. Such hyperactivity often finds its outlet in business takeovers
b. Most managers are constantly comparing their business’s sales, earnings, and executive compensation to other companies within and beyond their industry.
These comparisons invariably invite corporate hyperactivity
c. Most managers have an exaggerated sense of their own capabilities
Financial Tenets
Focus on return on equity, not earnings per share
“Good business or investment decisions”, he says, “will produce quite satisfactory results with no aid from leverage”
Calculate “Owner earnings”
Cash flow is an appropriate way to measure businesses that have large investments in the beginning and smaller outlays layer on, such as real estate development, gas fields, and cable companies.
Manufacturing companies, on the other hand, which require ongoing capital expenditures, are not accurately valued using only cashflow
Instead of cash flows, Buffett prefers to use what he calls “owner earnings”, a company’s net income plus depreciation, depletion, and amortization, less the amount of capex and any additional working capital
Quoting Keynes, “I would rather be vaguely right than precisely wrong”
Look for companies with high profit margins
Buffett says that the best managers attack costs as vigorously when profits are at record levels as when they are under pressure
For every dollar retained, make sure the company has created at least one dollar of market value
If a company employs retained earnings non-productively over an extended period, eventually market will price the shares of the company lower
Market Tenets
What is the value of the business?
“I put a heavy weight on certainty”, he says, “If you do that, the whole idea of a risk factor doesn’t make sense to me. Risk comes from not knowing what you’re doing”
Growth can add to the value when the return on invested capital is above average, thereby assuming that when a dollar is being invested in the company, at least one dollar of market value is being created
Can the business be purchased at a significant discount to its value?
Focusing on good businesses – those that are understandable, with enduring economics, run by shareholder-oriented managers – by itself is not enough to guarantee success.
If we make mistakes, he points out, it is either because of
a. The price we paid
b. The management we joined or
c. The future economics of the business. Miscalculations in the third instance are, he notes, the most common

“The market, like the Lord, helps those who help themselves,” Buffett says, “But unlike the Lord, the market does not forgive those who know not what they do”

Chapter 4 – Common Stock Purchases
This chapter contains the 9 case studies of the businesses Buffett bought discussing the above 12 tenets

Chapter 5 – Portfolio Management – The mathematics of investing

He refers to himself as a “focus investor” – “We just focus on a few outstanding companies”. This approach , called focus investing, greatly simplifies the task of portfolio management
Decision theory is the process of deciding what to do when you are uncertain what will happen. “Making that decision,” wrote Bernstein,” is the essential first step in any effort to manage risk”.
“Take the probability of loss times the amount of possible loss from the probability of gain times the amount of possible gain. That is what we’re trying to do,” says Buffett. “It’s imperfect but that’s what it is all about.”
The Kelly optimization model, often called the optimal growth strategy, is based on the concept that if you know the probability of success, you bet the fraction of your bankroll that maximises the growth rate”
It is expressed as a formula: 2p-1 = x where 2 times the probability of winning (p) minus 1 equals the percentage of your total bankroll that you should bet(x).
As Charlie Munger puts it, “The wise [investors] bet heavily when the world offers them opportunity. They bet big when they have the odds. And the rest of the time, they don’t. It’s just that simple.”
If the price of a particular stock is going up, we assume good things are happening; if the price starts to go down, we assume something bad is happening, and we act accordingly.
It is a poor mental habit, and it is exacerbated by another: evaluating price performance over short periods of time. Not only are we depending solely on the wrong thing(price), Buffett would say
but we’re looking at it too often and we’re too quick to jump when we don’t like what we see.
“In the short run the market is a voting machine but in the long run it is weighing machine”
The Jeffrey-Arnott study concluded that to achieve high after-tax returns, investors need to keep their average annual portfolio ratio somewhere between 0 and 20 percent.

Chapter 6 – The psychology of investing

To fully understand the markets and investing, we now know we have to understand our own irrationalities.
The study of the psychology of misjudgement is every bit as valuable to an investor as the analysis of a balance sheet and an income statement.
The pain of a loss is far greater than the enjoyment of a gain. Many experiments have demonstrated that people need twice as much positive to overcome a negative.
The impact of loss aversion on investment decisions is obvious, and it is profound. We all want to believe we made good decisions.
To preserve our good opinion of ourselves, we hold on to bad choices far too long, in the vague hope that things will turn around. By not selling our losers, we never have to confront our failures.
“All of us are vulnerable to individual errors of judgement, which can affect our personal success. When a thousand or a million people make errors of judgement, the collective impact is to push the market in a destructive direction.
Then, so strong is the temptation to follow the crowd, accumulated bad judgement only compounds itself. In a turbulent sea of irrational behaviour, the few who act rationally may well be the only survivors.
In a word, Warren Buffett is rational, not emotional.

Chapter 7 – The value of patience

“Humans are cognitive misers,” writes Stanovich, “because our basic tendency is to default to the processing mechanisms that require less computational effort, even if they are less accurate.
In a word, humans are lazy thinkers. They take the easy way out when solving problems; as a result, their solutions are often illogical.

Chapter 8 – The World’s Greatest Investor

It is wrong to assume that if you are not buying and selling, you are not making progress.
In Buffett’s mind, it is too difficult to make hundreds of smart decisions in a lifetime. He would rather position his portfolio so only has to make a few smart decisions.
As part of finding your own way, I believe we can also make the case that knowledge is what defines the difference between investment and speculation.
In the end, the more you know about your companies, the less likely it is that pure speculation will dominate your thinking and your actions.
“Our [investment] attitude,” Buffett says, “fits our personalities and the way we want to live our lives”

In the Preface section, the below texts more or else sums up what you are going to learn from this book.

At the 1995 Berkshire Hathaway annual meeting, Charlie Munger said, “It’s extraordinary how resistant some people are to learning anything”.
Buffet added, “What’s really astounding is how resistant they are even when it’s in their self-interest to learn”.
Then in a more reflective tone, Buffett continued, “There is an incredible resistance to thinking or changing. I quoted Bertrand Russell one time, saying,
‘Most men would rather die than think. Many have’. And in a financial sense, that’s very true”
Here is a succinct and powerful lesson from the 1996 annual report: “Your goal as an investor should be simply to purchase, at rational price, a part interest in an easily
understood business whose earnings are virtually certain to be materially higher, five, ten and twenty years from now. Over time, you will find only a few companies that
meet those standards – so when you see one that qualifies, you should buy a meaningful amount of stock.”

On June 26, 2006, Buffett donated 83%(30 Billion $) of his wealth to Bill and Melinda Gates Foundation and the rest 17%(6 Billion $) to his three children and his wife’s charitable trust.

I have to say, the author used very simple language to engage the reader as much as he can and overall did a commendable job capturing the succinct details of how Buffett evaluates a business.The chapter on psychology of investing is a must read for any investor/trader out there.

Every time, there is a mention of Charlie Munger’s name in the book, you can almost be sure that there is something interesting coming next.

Warren Buffett focused on his learning throughout his life. Majority of his wealth is donated to Bill and Melinda Gates Foundation as he felt, it is the best capital allocation per his rational mind rather than scaling up another foundation. In my view, Buffett demonstrated about how you can reach self-actualisation practising capitalism in professional life and practising socialism in personal life as he was also aware that he is lucky(little) due to fate’s capricious distribution of “long straws”, he donated majority of his wealth to charity.

“It is not enough to have good intelligence”, wrote Descartes; the principal thing is to apply it well”

10/10