Books:
You should be very careful what you read and who wrote it. You want to keep the noise to a minimum.
Read and re-read intelligent investor. May be boring but you need to understand what he says in that book.
Then go read The little book on value investing. By Christopher Browne. There is a lot of good additional material on his funds site, tweedybrowne.com
Before getting into Security Anaysis (1940 best to begin with) I would become familiar with what some accounting:
Tutorial on Financial Statements:
http://www.baruch.cuny.edu/tutorials/statements/
As you are learning try to think about the following: what is the company really earning and what can they expect to earn in the future? Also what do you reasonably not know?
Diversification?
Diversification is over used. The typical issue with investing in only a few businesses is that aggregate returns could be adversely affected by any one security. Investment selection should be based upon a thorough
understanding of each business and its underlying economics, acquired only at sensible prices. While seemingly obvious, the fact is that most people who buy fractional ownership do not know nearly what they should to make informed long-term investment decisions (the so called "professionals" included).
Ultimately, the premise is that it makes more sense to invest large amounts in those businesses with which you understand a great deal, instead of putting very small amounts in many business that you understand very little. Concentration may very well decrease risk if it raises, as it should, both the intensity with which an investor thinks about a business and the comfort-level he must feel with its economic characteristics before buying an ownership interest.
Some stuff to think about:
The fundamental purpose to save or invest versus spend is to have more money in the future. In a simple world, one without inflation or investments as alternatives to saving, the money grows through saving more out of income relative to what is consumed, or spent. Today’s dollars are valued in the same terms as are tomorrow’s dollars. Any interest earned on savings translates into increased purchasing power-the ability to buy something.
Introduce Inflation and money not spent must earn an amount equal to the inflation rate just to maintain purchasing power. This is because $1 today with 3% inflation means that you need $1.03 in a year from now in order to have the same "purchasing power". That is what costs $1 today costs $1.03 next year, so if you save (or invest) you must earn at least 3%, otherwise you have less money than you started with. If you are unable to earn 3% you should just spend the money.
In this world the fundamental problem is where to put money in order to grow future purchasing power. This implies a reasonable rate of return over inflation (ignoring income taxes for now).
On the Economy:
A few things on the economy and the "markets". Don't worry about what people say, friends, media, whoever. In the last 100 years we have had two world wars, a great depression where unemployment reached unbelievable levels, two almost three serious financial fiascos, 9-11, the cold war, an assassinated president, etc. yet our living standards increased seven-fold. So called "bad-times" lead to good investment opportunities because of depressed prices, but only those who didn't loose money are able to take advantage of this. I'll spare you, with more details. The moral being do not pay attention to discussions about interest rates, the economy, the stock market, etc. do what makes sense at all times, nothing less.
I hate thinking of business valuations like this but you may come across such terms and should be familiar with them:
Generally speaking, there are two very broad and contrasting ideas: a “macro” perspective as opposed to a "micro" perspective. A macro approach is often also called a “top down approach” whereas micro is bottom up. Basically the macro approach looks at things like sectors or industries, potential changes in interest rates, foreign exchange rates, and the like. For more information on the differences between top down and bottom up see the following link:
http://www.tiaa-cref.org/about/press/publications/market_monitor/2006_11_20.
pdf
It takes time and effort!
If investing were easy to do there would be many, many more people like Warren Buffet. And while there are many people that have made great fortunes in the investment management and related businesses nearly all of them made their money on fees not associated with actual investment results. So this is one reason not to pay attention to about 99% of these guys especially those on TV. Of the investors who actually invest in securities with successful long term “track records” nearly all of them might be referred to as Value Investors, with the exception of maybe one. George Soros is a successful investor who practices what seems to be a very much top down approach, but the problem is that he cannot explain his success although others will claim that they can. Some have written books about his approach, but if they truly understood it they would apply it by investing and not so much by writing books. (Same goes for all those books on Buffett.)
It is not my intent to undermine investors like Soros, but his approach or selection process is almost equivalent to throwing darts (at least as far as outsiders are concerned). For one, it is truly difficult to determine what
the ultimate factors were in their decision making process.
Assume one makes a decision to buy a given stock, the stock price goes up, and then the person decided to sell at a profit. Can it be said that a good investment decision has been made?
This has a very dangerous implication too often overlooked. Just because you made money on an investment doesn’t necessarily make it a good decision. If you invested in a housing company and a year later you sell making a 20% return on your investment you might conclude that indeed your choice was a good one in which case you are likely to make future investments based upon a similar thought process. But if the reason you decided to invest in that company was made based upon a belief that demand for new housing was to increase in the near term, but the company decided that demand for new houses was actually declining and in response they issued a regular dividend that appealed to the big mutual funds resulting in the biding up of the stock price.
Such would not qualify as a good investment decision in my mind, because the next investment
is not likely to result in such a positive outcome. That is, the next company you invest in may not have funds to distribute as a dividend and the price may very well then drop off significantly-the direct result of failing to account for price paid relative to reasonable business value.
"You are correct only because your decision was based on the facts and sound logic."
The Term Value Investing:
By the way The term Value investor is redundant. Value investing is considered purchasing businesses for less than they would sell to a knowledgeable buyer in a negotiated transaction. But this is the only form
of an "investment", otherwise you are speculating. Furthermore, the purchase of commons stocks must always be thought of as buying fractional ownership of the entire business. So think of "Value Investing" simply as "investing" and everything else as speculating. Speculating is the purchase of a "stock" on the basis that you believe the stock price will go up. Speculators in other words, DO NOT ask themselves (i) what exactly am I buying and (ii) is the price being offered an attractive one?
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3 comments:
You mentioned that the economy has rebounded from seemingly disastrous events in the past. Yes, our living standards have increased, but at a multi-trillion dollar cost. Furthermore, modern economics in our great country can be traced not much further than a century - a mere wrinkle in time compared to the history of human civilization. Unprecedented events that will test the magnitude of human perseverance will likely occur during our lifetime or the next (nuclear war, diminished resources, over-population, etc), so who's to say an economy will survive that? At some point, the focus will be simply on survival, not the power of your dollar, or whatever currency you hold.
What say you, good Cogitator?
In response to vabeechguy:
I am uncertain what you mean by, "Yes, our living standards have increased, but at a multi-trillion dollar cost."
Regarding, "Furthermore, modern economics in our great country can be traced not much further than a century - a mere wrinkle in time compared to the history of human civilization."
Our country is only about 224 years old to begin with. The use of the term modern may need clarification. Japan was hit with a nuclear bomb, and lost WWII but economically speaking are doing pretty well. Germany lost a few World Wars, experienced hyper inflation, and are currently pay reparations for WWII, but again their economy to date is very strong indeed. It the unfortunate case where something as severe as hyperinflation were to occur to the United States, Money in every respect would become worthless, cash and stocks, rather the entire global means of trade paper currency would likely end. There are many reasons that this will not happen and is better left for future conversation.
On A more rational scale, the dollar is likely to decline although very slowly, relative to the other major currencies of the world. However given that we live here, we are restricted to the use of U.S. Dollars as a means of turning work into food, or whatever you require.
Ownership of assets have been in the history of mankind for thousands of years and likewise some form of currency. The basic means for trade and distribution remain very much the same, only more elaborate, functional.
During the dark ages there was a spell of something like 200 years where the standard of living did not increase. Since then our standard of living thanks in large part to Ameritocracy, has increased as mentioned earlier.
The Primary reason for this is that the United States has created a system that tends to allow the best, brightest, most talented, etc to achieve great success, beyond that of any other country. It is the Example that Buffett Often refers to: We have a 500 horse power engine which we are able to use efficiently effectively generating 500 horsepower. Other countries like maybe China have 1000% horse power but sue to their system, are only able to effectively use 10%. And although they have caught on in a big way, still have a ways to go. I doubt that there will be a major shift in the way the world runs, although it is possible that a shift may occur in who has the most influence on it-but this is a slow moving process which will require hundreds of years time.
I will make a separate comment regarding the major item that would stunt our sustained economic strength.
Malthus
We see in almost every part of the world vast powers of production which are not put into action, and I explain this phenomenon by saying that from the want of a proper distribution of the actual produce adequate motives are not furnished to continued production. ... I distinctly maintain that an attempt to accumulate very rapidly, which necessarily implies a considerable diminution of unproductive consumption, by greatly impairing the usual motives to production must prematurely check the progress of [National] wealth. ... But if it be true that an attempt to accumulate very rapidly will occasion such a division between labour and profits as almost to destroy both the motive and the power of future accumulation and consequently the power of maintaining and employing an increasing population, must it not be acknowledged that such an attempt to accumulate, or that saving too much, may be really prejudicial to a country?…
…the principles of saving, pushed to excess, would destroy the motive to production. If every person were satisfied with the simplest food, the poorest clothing and the meanest houses, it is certain that no other sort of food, clothing, and lodging would be in existence. ... The two extremes are obvious; and it follows that there must be some intermediate point, though the resources of political economy may not be able to ascertain it, where, taking into consideration both the power to produce and the will to consume, the encouragement to the increase of wealth is the greatest.
The Physiology of Industry, by J. A. Hobson and A. F. Mummery 1889
Saving enriches and spending impoverishes the community along with the individual, and it may be generally defined as an assertion that the effective love of money is the root of all economic good. Not merely does it enrich the thrifty individual himself, but it raises wages, gives work to the unemployed, and scatters blessings on every side. From the daily papers to the latest economic treatise, from the pulpit to the House of Commons, this conclusion is reiterated and re-stated till it appears positively impious to question it… Undue exercise of the habit of saving is possible, and that such undue exercise impoverishes the Community, throws labourers out of work, drives down wages, and spreads that gloom and prostration through the commercial world which is known as Depression in Trade. ... The object of production is to provide “utilities and conveniences” for consumers, and the process is a continuous one from the first handling of the raw material to the moment when it is finally consumed as a utility or a convenience. The only use of Capital being to aid the production of these utilities and conveniences, the total used will necessarily vary with the total of utilities and conveniences daily or weekly consumed.
The above has implications of dynastic wealth-that is wealth passed down from generation to generation. Meaning huge accumulations of money may be distributed among very few and in such cases their heirs will have “claim checks” on the future production of goods and services. Allowing this accumulation without at least some intervention is almost certain to lead to increasing wealth of those who have done nothing, in essence, to earn it other than having been born, no act of their own (i.e. dynastic wealth). Furthermore since this is dynastic wealth, this money is saved, very probably by non-productive uses, which therefore must limit a disproportional amount of money that would otherwise be in circulation and available to those enterprising individuals capable of pushing out country forward. Also, business owners tend to do financially better than their workers.
A Few Points:
1.
If it is assumed that the owners of business have the vast majority of the net amount of money in available to society and they transfer their money (or claims) by the purchase of some good (like a car, tv, beer, whatever-then they are in a sense providing additional profits to those who are already doing quite well i.e the owners of business) and therefore is an increase in the wealth of the already (hugely) wealthy at an increasing rate in relation to the average worker.
2.
Eventually if this were to continue, there would be a lack of incentive for those otherwise enterprising individuals to venture their skills into productive activity, which is required for the for the continued success of our country as a whole. Most of the great innovations and social benefits have come as a result of those with only modest means to turn an idea into something useful or needed. (Although there are of plenty of exceptions, Andrew Carnegie – immigrant child, son of a weaver, John D. Rockefeller – Son of a “traveling” salesman.)
As a collateral point think about those people within the last 100-200 years that generated huge wealth because of some special ability for which society was willing to pay a great deal. (Think Athletes, Musicians, Actors, good businessmen.) The question then is to what extent should the claim checks (or wealth) sitting in their bank accounts upon their death be available to others with similar talents and abilities of equal value to the following generation, and to what extent should the claim checks (or wealth) be transferred their heirs who are almost certain to have no special talent and nothing to contribute to the overall enhancement of society or more specifically our country as a whole?
This is begging the question, should the son or daughter of a former United States Olympian be entitled to represent our country in the upcoming Olympics simply because their mother or father had some special talent, or should this generation’s most talented person take such a position? Or similarly, should Brittney Spears’ children, and her children’s, children, have a free ride at the expense of all others, and similarly with the Hilton Family (with reference to their current heir, Paris)? To further the point, of the many who have accumulated such enormous wealth can you identify any of their heirs that accomplished anything or contributed to society in any meaningful way that might be considered within hailing distance of those that preceded them? I know of few Americans who support democracy, but who would also proclaim the Monarchies of Kings and Queens as beneficial to society (and their subsequent Royal Dynasties which follow).
As for example, without progressive taxation on both income and inheritance (or death tax), wealth accumulation is increasingly disproportionate to those who already have it and offer nothing with regards to the requirement of America’s sustained advancement and those with special talents not sufficiently compensated –doctors, teachers, public servants, even enterprising and curious persons who find cures for things like cancer, AIDS, etc. will begin to disappear from America but not the world. The problem is that as we become less productive and less important to the remaining world our claim checks increasingly become of lesser value and our purchasing power of American Society as a whole therefore will and is slowly losing our ability to acquire the future goods and services that will be needed let alone desired.
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