On Common Sense on Mutual Funds

I recently finished reading Common Sense on Mutual Funds – New Imperatives for the Intelligent Investor – by John C. Bogle.

Below are key excerpts from this book that I found to be insightful:

Investing is an act of faith. We entrust our capital to corporate stewards in the faith—at least with the hope—that their efforts will generate high rates of return on our investments. When we purchase corporate America’s stocks and bonds, we are professing our faith that the long-term success of the U.S. economy and the nation’s financial markets will continue in the future.

To state the obvious, the long-term investor who pays least has the greatest opportunity to earn most of the real return provided by the stock market.

In my view, market timing and rapid turnover—both by and for mutual fund investors—betray both a lack of understanding of the economics of investing and an infatuation with the process of investing.

My guidelines also respect what I call the four dimensions of investing: (1) return, (2) risk, (3) cost, and (4) time. When you select your portfolio’s long-term allocation to stocks and bonds, you must make a decision about the real returns you can expect to earn and the risks to which your portfolio will be exposed. You must also consider the costs of investing that you will incur. Costs will tend to reduce your return and/or increase the risks you must take. Think of return, risk, and cost as the three spatial dimensions—the length, breadth, and width—of a cube. Then think of time as the temporal fourth dimension that interplays with each of the other three. For instance, if your time horizon is long, you can afford to take more risk than if your horizon is short, and vice versa.

Rule 1: Select Low-Cost Funds…Rule 2: Consider Carefully the Added Costs of Advice…Rule 3: Do Not Overrate Past Fund Performance…Rule 4: Use Past Performance to Determine Consistency and Risk…Rule 5: Beware of Stars…Rule 6: Beware of Asset Size…Rule 7: Don’t Own Too Many Funds…Rule 8: Buy Your Fund Portfolio—And Hold It.

No matter what fund style you seek, you should emphasize low-cost funds and eschew high-cost funds. And, for the best bet of all, you should consider indexing in whichever style category you want to include.

There are three major reasons why large size inhibits the achievement of superior returns: the universe of stocks available for a fund’s portfolio declines; transaction costs increase; and portfolio management becomes increasingly structured, group-oriented, and less reliant on savvy individuals.

Four principal problems are created by this overemphasis on marketing. First, it costs mutual fund shareholders a great deal of money— billions of dollars of extra fund expenses—which reduces the returns received by shareholders. Second, these large expenditures not only offer no countervailing benefit in terms of shareholder returns, but, to the extent they succeed in bringing additional assets into the funds, have a powerful tendency to further reduce fund returns. Third, mutual funds are too often hyped and hawked, and trusting investors may be imperiled by the risks assumed by, and deluded about the potential returns of, the funds. Lastly, and perhaps most significant of all, the distribution drive alters the relationship between investors and funds. Rather than being perceived as an owner oi the fund, the shareholder is perceived as a mere customer of the adviser.

On a closing note, on leadership:

To wrap up this litany, I put before you—both tentatively and humbly—a final attribute of leadership: courage. Sometimes, an enterprise has to dig down deep and have the courage of its convictions—to “press on,” regardless of adversity or scorn. Vanguard has been a truly contrarian firm in its mutual structure, in its drive for low costs and a fair shake for investors, in its conservative investment philosophy, in market index funds, and in shunning hot products, marketing gimmicks, and the carpet-bombing approach to advertising so abundantly evident elsewhere in this industry today. Sometimes, it takes a lot of courage to stay the course when fickle taste is in the saddle, but we have stood by our conviction: In the long run, when there is a gap between perception and reality, it is only a matter of time until reality carries the day.

A recommended read in the areas of investing and leadership.

American Icon

American Icon: Alan Mulally and the Fight to Save Ford Motor Company by Bryce G. Hoffman has been on my reading list for quite some time, particularly for the high rating this book had received and my interest in cars. I finally had a chance to read it and despite the high expectations I had of this book, it exceeded them both in terms of content and delivery.

Below are the highlights from this book.

The backdrop of the american car industry in late 20th century:

Ford may have been the company that put the world on wheels, invented the moving assembly line, and created the industrial middle class, but its glory days were long past. Together with General Motors Corporation and Chrysler Corporation, it had been a powerful engine of prosperity in postwar America…That era of easy profit created a culture of entitlement in Detroit that afflicted management and labor alike – inflating salaries, wages, and benefits until they became the envy of the world. Success was viewed as a birthright, not something that had to be fought for and won. As the Big Three’s share of the market had shrunk, they had not. At least not fast enough. They all had too many factories, too many workers, and too many dealers. Generous union contracts negotiated in better times had created enormous legacy costs that their foreign rivals did not have to bear. And none of the American companies had the stomach for the radical reforms that were now necessary just to stay in business. Wall Street had begun a deathwatch, waiting to see which of the Big Three would fail first. Most of the money was on Ford, which had become infamous for lackluster designs, poor quality, and managerial infighting.

Ford itself had some additional challenges of its own:

While many of Ford Motor Company’s problems were shared by the rest of Detroit, the Dearborn automaker also faced some challenges all its own. Ford’s woes had not begun with of the Japanese in the 1960s or the oil crises of the 1970s. The company had been struggling with itself since Henry Ford started it on June 16,1903. It invested massively in game-changing products, and then did nothing to keep them competitive. It allowed cults of personality to form around larger-than-life leaders, but drove away the talent needed to support them. And it allowed a caustic corporate culture to eat away at the company from the inside. These were birth defects that could be traced back to the automaker’s earliest days. Henry Ford liked to boast that he had created the modern world. In many ways, he had. But he also created a company that was its own worst enemy.

Bill Ford who was CEO knew it was time for a big change in leadership of the company was to be saved:

Hockaday commended Ford for having the self-awareness and the lack of ego to admit that, but he gently suggested that Ford needed something more than a new COO. Bill agreed: The time had come to find a CEO who could save Ford from itself…Though he knew it was coming, Hockaday thought Bill Ford’s speech to the directors was one of the most moving he had ever heard in a boardroom. No one ascends to the top of a major corporation without a healthy ego, but those in the automobile industry we’re oversized even by Fortune 500 standards. It took a big man to admit that he could not save his company, particularly when his name was on the side of the building. In other rooms in Detroit, other CEOs were adamantly refusing? to admit defeat. They would stubbornly cling to power and take their companies down with them. Bill Ford cared too much about Ford to let that happen in Dearborn.

Alan Mulally was the man that was chosen for the task:

The Seattle Times called him “Mr. Nice Guy.” Mulally’s lack of pre-tension was evident in his dealings with other people. At formal events, he showed little interest in the rich and powerful, preferring to mingle with those less interested in comparing resumes or other measurables. He asked more questions than he answered and seemed genuinely interested in what people had to say, be they world leader or waitresses. Mulally made a point of remembering something about everyone he met and would often astonish underlings by recalling some scrap of information about their lives they had shared with him months or years before. He was also big on hugs, and had even been known to plant pecks on the cheeks of both men and women when he was in a particularly exuberant mood. All of this made Mulally adored by subordinates. It also kept his rivals off balance. They could never quite figure out how much of it was an act. And Mulally liked to keep it that way.

Despite being and unconventional choice:

The conventional wisdom in Detroit held that outsiders were incapable of understanding the complexities of the automobile business. Bill Ford’s decision to hire an aeronautical engineer to save his car company spawned plenty of jokes during those early weeks. There was a lot of snickering about flying cars and the return of tail fins. “He has no idea how we do things in Detroit” was the common refrain at Ford’s crosstown rivals, as well as within Ford itself And Mulally knew it. They’re right. I don’t know how they do things in Detroit, he thought. But I do know it doesn’t work.

Mulally had a unique management style that he shared and communicated with his team from the beginning:

Mulally called their attention to a list of rules posted on the wall. There were ten of them: • People first • Everyone is included • Compelling vision • Clear performance goals • One plan • Facts and data • Propose a plan, “find-a-way” attitude • Respect, listen, help, and appreciate each other • Emotional resilience … trust the process • Have fun … enjoy the journey and each other

Listening was a key part of his philosophy, even from his competitors:

As he was leaving, Mulally told Wagoner he would like to be able to call him in the future if he had more questions. He was just trying to be polite, but Wagoner took it as another sign of weakness. He would later claim publicly that Mulally had sought his help as he e struggled to understand the industry in those early days. The truth was, Wagoner had been played so well he did not even notice.

He had a clear vision, even for what Ford would look like after he leaves – his legacy:

The Plan…Mulally also looked to Ford’s past for inspiration…Alan Legacy: • Clear, compelling vision going forward •Survive the perfect Storm—commodities, oil, credit, CO2, safety, UAW • Develop a profitable growth plan, global products and product Strategy • A skilled and motivated team • Reliable ongoing BPR process • A leader and leadership team with “One Ford” vision implementation tenacity

An example of, luck favors the prepared mind:

Did Ford see the credit crisis coming? Certainly not the full magnitude of it. But it is clear that Ford knew the game was changing and had the foresight to get as much cash as it could before it was too late. Other automakers would not prove so prescient. In the end, they would have to borrow their money not from the big Wall Street banks, but from the American people. Ford’s financing deal would allow it to survive without a government bailout. If Bill Ford had not convinced his family to stake everything, the Fords likely would have lost control of the company entirely. A few months later, such a deal would have been impossible for any American automaker. A year later, even the most profitable companies in the world would have been unable to borrow half that amount.

Alan never lost touch with what the business was really about – engaging with customers and making a difference in their lives through vehicles:

It would not be the last time Mulally played at being a car sales man. This was a way for him to see firsthand how Ford’s customers approached its cars and trucks. But it also generated a huge amount of goodwill for the company. Everybody who met Mulally walked away an ambassador for Ford. He had that effect on people.

He knew that a successful relationship with the Union of Automotive Workers was paramount to success and worked hard on nurturing it:

Even in the face of this increasing animosity between the UAW and Detroit’s Big Three, Ford managed to maintain a better relationship with the union. Ford family members often dealt directly with UAW officials, even during the period when there was no Ford in the chairman’s seat. None of the company’s factories had been struck since 1976. But even Ford could not get the concessions it needed to be competitive with the growing number of foreign transplants setting up factories of their own in the southern United States…Mulally took a step toward Gettelfinger and looked him in the eye. “We want to prove that we can do this in America,” he said solemnly. “Ron, will you hold hands with me.? We’ll do this together, and we’ll go out there and say we did this together. We’re going to be able to make products in America and make them profitably and successfully. Or, we’ll just go out there and tell everybody it was too hard. We just couldn’t do it. It’s up to you.” Gettelfinger did not hesitate.

Alan kept refining his vision and rallying the company around it:

Beneath the first, Mulally spelled out his vision for the company: People working together as a lean, global enterprise for automotive leadership, as measured by: Customer, Employee, Dealer, Investor, Supplier, Union/Council, and Community Satisfaction

During the crisis, it was not just about being defensive, it was about the offense – accelerating the transformation with the new product lines:

Accelerating Kuzak’s product time line would require a heroic effort on the part of Ford’s designers and engineers. It would also require other departments to cut deeper. It was a testament to how much Mulally had changed the culture inside the Glass House that they were willing to do so. Fields expressed this new spirit in a speech to his troops that summer “I know this is really a kick in the teeth, but this is not Ford Motor Company not delivering—this is the external environment. This is an egalitarian knock to the industry, and what’s going to separate the winners from the losers is how those companies approach this setback,” he said. “It’s easy to be a victim. It’s harder to say we’re going to take this and we’re going to make lemonade out of lemons.”

While Ford was in a better position than some of its competitors during the financial crisis their were some inter-dependencies within the industry that it had to actively manage with them and with the government:

Both Toyota and Honda were just as concerned as Ford about the impact that the failure of CM or Chrysler could have on their suppliers, as well as about the growing number of parts producers who were already in trouble. When they heard about Ford’s effort to support its suppliers, they wanted in. So Brown forged a tripartite alliance with Ford’s archrivals to prevent a cascading collapse of the entire automobile industry.

Ford was now engaged in a delicate balancing act, trying to convince consumers and investors that it was in better shape than its crosstown competitors while at the same time trying to persuade Washington that it was just as deserving of help. When Mulally was asked why Ford needed taxpayer assistance if it was not in dire financial straits, he said Ford would need help if either GM or Chrysler failed. “It’s just prudent to be prepared together. There’s a lot of issues that we’re all dealing with,” he said. “We are very interdependent, and we’re all dependent on the U.S. economy. If any one of us gets in trouble in a big way, then that’s going to have major ramifications for the entire value stream for the suppliers, for the (automakers), for the dealers.”

The strategy of forgoing the bailout paid off for Ford:

Sales remained depressed, but Ford continued to outperform the market and gain share…The board was pleased. The directors had hoped that Ford would get credit for forgoing a bailout, but none of them expected the decision to generate as much goodwill for the company as it did…The decision to pass on a bailout was a big part of that, but it would have mattered little if the company’s showrooms were still filled with the same old boring products. Fortunately for Ford, transports stacked with new vehicles like the redesigned Fusion and Fusion Hybrid were pulling into dealer lots just as customers decided that the company was worth another look. Once again. Ford’s timing was perfect.

Alan throughout this entire period ensured the team maintained focus on improving Ford’s financials:

Mulally’s focus was now on improving Ford’s balance sheet and beginning the long, slow march out of junk bond territory. The terms of Ford’s massive 2006 financing deal stipulated that all the assets it had pledged to secure those loans would be released once its revolving line of credit was paid off and two of the three major agencies restored the company’s credit rating to investment grade.

For those who down-play Ford’s come back:

There are some who will point to the loans Ford received from the U.S. Department of Energy and the money it borrowed from the U.S. Federal Reserve and say the company did take taxpayer dollars. This is true, but in this sense, so did the rest of the major automakers —and not just the American companies. Japanese and German manufacturers benefited from these programs as well, in addition to receiving support from their own governments. But these were loan programs set up to address systemic problems beyond these companies’ control.

And Alan’s key role in that:

While many of the pieces of Ford’s turnaround were already in place, the company’s own culture was preventing them from being implemented with the speed and scope necessary to effect real change…But Ford would have run out of time and money before it got to where it needed to be if Mulally had not been there to put the pedal to the metal…Mulally ripped off the bandage, cauterized the wound, and cured the disease. Only an outsider could do that. But not just any outsider: It had to be someone who understood the complexities of global manufacturing, labor relations, and heavily engineered products…His disciplined approach cut through the company’s caustic culture and forced everyone to march in the same direction…He taught the other executives how to make decisions based on data instead of boardroom politics. And once he had, most of the decisions that saved Ford were made by the team as a whole.

The keys to Alan’s success in his words:

“What I have learned is the power of a compelling vision, a comprehensive strategy, a relentless implementation process, and talented people working together based on those commitments,” he told me during our last interview for this book, in May 2011. “We laid out a plan, and for four and a half years, we have been relentlessly implementing that plan.”…”You’ve got to trust the process. You need to trust and nurture your emotional resilience,”

Another key, was Bill’s – the chairman – unwavering support:

It was not just Bill Ford’s willingness to step aside and make way for Mulally that helped save the company. It was also his unceasing effort to give him the time, the space, and the resources he needed for his revolution to succeed. Without that, Mulally may well have become just another victim of a company and a culture that seemed impervious to change.

A reminder though that a true test of great leadership is the ability of an organization to sustain itself after the leader leaves:

The ultimate test of Mulally’s revolution will be its ability to endure his absence. Boeing has suffered major setbacks since Mulally left Seattle in 2006. Insiders say that is because his successors have failed to maintain the processes Mulally put in place to guarantee success. When asked if the same thing could happen at Ford, Mulally says simply that he has given Ford the tools it needs to prosper. What the company does with them after he retires is beyond his control. Ford’s history is a long list of stunning successes followed by epic failures, of against-all-odds comebacks that turn into retreats back into mediocrity and mismanagement. But there are important differences this time that augur well for Ford’s future.

On a concluding note:

Henry Ford once said, “A business that makes nothing but money is a poor kind of business.” Ford Motor Company has certainly made a great deal of money since Alan Mulally started there in 2006. But it has also made people believe that the highest principles of American enterprise —ingenuity, innovation, and integrity—have not deserted us entirely. In an economic era marked by avarice and greed, Mulally’s Ford has demonstrated that a company can still succeed by building a good product and selling it at a fair price. As the big Wall Street banks tried to hide their mounting failures, Mulally was exposing Ford’s shortcomings and challenging his company to overcome them. Wall Street’s obfuscation and trickery would ultimately drag the entire world into the Great Recession. With Mulally’s relentless determination to succeed. Ford would defy that downturn and once again become an engine of prosperity. From the day he arrived in Dearborn, Mulally said he was fighting for the soul of American manufacturing. If Ford had failed, a little bit of America would have died, too. But Ford did not fail. Under Mulally’s leadership, it showed the entire world that at least one American automaker could pick itself up, shake off the rust, compete with the best in the business, and win.

A highly compelling, highly valuable and recommended read on leadership, management and corporate transformation as well as on the automotive industry.

Philip A. Fisher: Art of Investing

Is investing a science or an art? This is a question that Kenneth L. Fisher addresses in his introduction to the book Common Stocks And Uncommon Profits written by his father, famed investor Philip A. Fisher:

The craft I described in my first book, Super Stocks (Dow Jones-Irwin 1984), including how to do it and several real-world examples. But again, this is all craft. Whenever you ask, you get answers. The art is to get more questions—and the right questions—flowing from the answers you receive. I’ve seen people who rigidly run down a standard question list, regardless of the responses they get. That isn’t art. You ask. He or she answers. What question best flows from the answer? And so on. When you can do that well on a real-time basis, you are a composer; an artist; a creative, investigative investor. I went with my father about a jillion times to visit companies between 1972 and 1982. I worked for him only for a year, but we did lots of things together after that. In looking at companies, he always prepared questions in advance, typed on yellow pages with space in between so he could scribble notes. He always wanted to be prepared, and he wanted the company to know he was prepared so they would appreciate him. And he used the questions as a sort of outline of topics to be covered. It was also a great backup in case the conversation went bad, and cold, which occasionally it did. Then he could get things back on course instantly with one of his prepared questions. But his very best questions always popped out of his mind, unprepared, never having been written down in advance because they were the angle he picked up on the fly, as he heard an answer to a lesser question. Those creative questions were the art. It is what, in my mind, made his querying great.

Before presenting his investment philosophy Philip, looks to the past and compares it to the present in search for investment clues, concluding that the present offers us just as many if not more opportunities to invest in growth companies:

Before going further, it might be well to summarize briefly the various investment clues that can be gleaned from a study of the past and from a comparison of the major differences, from an investment standpoint between the past and the present. Such a study indicates that the greatest investment reward comes to those who by good luck or good sense find the occasional company that over the years can grow in sales and profits far more than industry as a whole. It further shows that when we believe we have found such a company we had better stick with it for a long period of time. It gives us a strong hint that such companies need not necessarily be young and small. Instead, regardless of size, what really counts is a management having both a determination to attain further important growth and an ability to bring its plans to completion. The past gives us a further clue that this growth is often associated with knowing how to organize research in the various fields of the natural sciences so as to bring to market economically worthwhile and usually interrelated product lines. It makes clear to us that a general characteristic of such companies is a management that does not let its preoccupation with long-range planning prevent it from exerting constant vigilance in performing the day-to-day tasks of ordinary business outstandingly well. Finally, it furnishes considerable assurance that in spite of the very many spectacular investment opportunities that existed twenty-five or fifty years ago, there are probably even more such opportunities available today. 

From a practical guidance standpoint, Philip outlines his methodology for the sources from which one can gather intelligence on the companies to be considered for investment opportunities through his infamous “scuttlebutt method”:

The business “grapevine” is a remarkable thing. It is amazing what an accurate picture of the relative points of strength and weakness of each company in an industry can be obtained from a representative cross-section of the opinions of those who in one way or another are concerned with any particular company…Go to five companies in an industry, ask each of them intelligent questions about the points of strength and weakness of the Other four, and nine times out of ten a surprisingly detailed and accurate picture of all five will emerge. However, competitors are only one and not necessarily the best source of informed opinion. It is equally astonishing how much can be learned from both vendors and customers about the real nature of the people with whom they deal. Research scientists in universities, in government, and in competitive companies are another fertile source of worthwhile data. So are executives of trade associations…There is still one further group which can be of immense help to the prospective investor in search of a bonanza company. This group, however, can be harmful rather than helpful if the investor does not use good judgment and does not do plenty of cross-checking: with others to verify his own judgment as to the reliability of what is told him. This group consists of former employees. Such people frequently have a real inside view in regard to their former employer’s strength and weakness…If enough different sources of information are sought about a company, there is no reason to believe that each bit of data obtained should agree with each other bit of data. Actually, there is not the slightest need for this to happen. In the case of really outstanding companies, the preponderant information is so crystal-clear that even a moderately experienced investor who knows what he is seeking will be able to tell which companies are likely to be of enough interest to him to warrant taking the next step in his investigation. This next step is to contact the officers of the company to try and fill out some of the gaps still existing in the investor’s picture of the situation being studied.

Having identified the sources, the Fifteen Points To Look For In A Common Stock are introduced, each to uncover a particular dimension of the organization being investigated as a potential investment opportunity:

POINT 1. Does the company have products or services with sufficient market potential to make possible a sizable increase in sales for at least several years?

POINT 2. Does the management have a determination to continue to develop products or processes that will still further increase total sales potentials when the growth potentials of currently attractive product lines have largely been exploited?

POINT 3. How effective are the company’s research and development efforts in relation to its size?

POINT 4. Does the company have an above-average sales organization?

POINT 5. Does the company have a worthwhile profit margin?

POINT 6. What is the company doing to maintain or improve profit margins?

POINT 7. Does the company have outstanding labor and personnel relations?

POINT 8. Does the company have outstanding executive relations?

POINT 9. Does the company have depth to its management?

POINT 10. How good are the company’s cost analysis and accounting controls?

POINT 11. Are there other aspects of the business, somewhat peculiar to the industry involved, which will give the investor important clues as to how outstanding the company may be in relation to its competition?

POINT 12. Does the company have a short-range or long-range outlook in regard to profits?

POINT 13. In the foreseeable future will the growth of the company require sufficient equity financing so that the larger number of shares then outstanding will largely cancel the existing stockholders’ benefit from this s anticipated growth?

POINT 14. Does the management talk freely to investors about its affairs when things are going well but “clam up” when troubles and disappointments occur?

POINT 15. Does the company have a management of unquestionable integrity?

Fisher stresses the importance of the last point, integrity, as being foundational:

Any investment may still be considered interesting if it falls down in regard to almost any other one of the fifteen points which have now been covered, but rates an unusually high score in regard to all the rest. Regardless of how high the rating may be in all other matters, however, if there is a serious question of the lack of a strong management sense of trusteeship for stockholders, the investor should never seriously consider participating in such an enterprise. 

On when to buy, the following guidance is provided:

I believe investors in this group should start buying the appropriate type of common stocks just as soon as they feel sure they have located one or more of them. However, having made a start in this type of purchasing, they should stagger the timing of further buying. They should plan to allow several years before the final part of their available funds will have become invested. By so doing, if the market has a severe decline somewhere in this period, they will still have purchasing power available to take advantage of such a decline. If no decline occurs and they have properly selected their earlier purchases, they should have at least a few substantial gains on such holdings. This would provide a cushion so that if a severe decline happened to occur at the worst possible time for them—which would be just after the final part of their funds had become fully invested—the gains on the earlier purchases should largely, if not entirely, offset the declines on the more recent ones. No severe loss of original capital would therefore be involved.

Fisher cautions us on trying to time the market, and miss out on buying opportunities:

So complex and diverse are these influences that the safest course to follow will be the one that at first glance appears to be the most risky. This is to take investment action when matters you know about a specific company appear to warrant such action. Be undeterred by fears or hopes based on conjectures, or conclusions based on surmises.

On when to sell, Fisher provides three drivers (besides personal emergency needs):

I believe there are three reasons, and three reasons only, for the sale of any common stock which has been originally selected according to the investment principles already discussed. The first of these reasons should be obvious to anyone. This is when a mistake has been made in the original purchase and it becomes increasingly clear that the factual background of the particular company is, by a significant margin, less favorable than originally believed. The proper handling of this type of situation is largely a matter of emotional self-control. To some degree it also depends upon the investor’s ability to be honest with himself…We come now to the second reason why sale should be made of a common stock purchased under the investment principles already outlined in Chapters Two and Three. Sales should always be made of the Stock of a company which, because of changes resulting from the passage of time, no longer qualifies in regard to the fifteen points outlined in Chapter Three to about the same degree it qualified at the time of purchase. This is why investors should be constantly on their guard. It explains why it is of such importance to keep at all times in close contact with the affairs of companies whose shares are held. , When companies deteriorate in this way they usually do so for one of two reasons. Either there has been a deterioration of management, or the company no longer has the prospect of increasing the markets for its product in the way it formerly did…For those who follow the right principles in making their original purchases, the third reason why a stock might be sold seldom arises, and should be acted upon only if an investor is very sure of his ground. It arises from the fact that opportunities for attractive investment are extremely hard to find. From a timing standpoint, they are seldom found just when investment funds happen to be available. If an investor has had funds for investment for quite a period of time and found few attractive situations into which to place these funds, he may well place some or all of them in a well-run company which he believes has definite growth prospects. However, these growth prospects may be at a slower average annual rate than may appear to be the case for some other seemingly more attractive situation that is found later. The already-owned company may in some other important aspects appear to be less attractive as well.

He also reminds us, in concluding the chapter on when to sell, and when not to sell, that some of our holdings are worth keeping indefinitely:

Perhaps the thoughts behind this chapter might be put into a single sentence: If the job has been correctly done when a common stock is purchased, the time to sell it is—almost never.

Fisher is not a major proponent of dividends:

Actually dividend considerations should be given the least, not the most, weight by those desiring to select outstanding stocks. Perhaps the most peculiar aspect of this much-discussed subject of dividends is that those giving them the least consideration usually end up getting the best dividend return. Worthy of repetition here is that over a span of five to ten years, the best dividend results will come not from the high-yield stocks but from those with the relatively low yield. So profitable are the results of the ventures opened up by exceptional managements that while they still continue the policy of paying out a low proportion of current earnings, the actual number of dollars paid out progressively exceed what could have been obtained from high-yield shares. Why shouldn’t this logical and natural trend continue in the future?

Finally, he shares with us two lists of five don’ts for investing:

1- Don’t buy into promotional companies.

2- Don’t ignore a good stock just because it is traded “over the counter.”

3- Don’t buy a stock just because you like the “tone” of its annual report.

4- Don’t assume that the high price at which a stock may be selling in relation to earnings is necessarily an indication that further growth in those earnings has largely been already discounted in the price.

5- Don’t quibble over eighths and quarters.

6- Don’t over-stress diversification.

7- Don’t be afraid of buying on a war scare.

8- Don’t forget your Gilbert and Sullivan (There are certain superficial financial statistics which are frequently given an undeserved degree of attention by many investors).

9- Don’t fail to consider time as well as price in buying a true growth stock.

10- Don’t follow the crowd.

Besides being a very practical and applicable book on investing, particularly for those who subscribe to the value investing school of thought. Also, and although this is a book primarily targeted for investors it is just as applicable as a management book, outlining the foundations of a well run organization. Common Stocks and Uncommon Profits is a must read.

On Irrational Exuberance

I recently finished reading Irrational Exuberance by Robert J. Schiller.

This book serves as an awakening call from “the present…whiff of extravagant expectation, if not irrational exuberance, in the air. People are optimistic about the stock market. There is a lack of sobriety about its downside and the consequences that would ensue as a result.” The author advances that “we need to know if the price level of the stock market today, tomorrow, or any other day is a sensible reflection of economic reality, just as we need to know as individuals what we have in our bank accounts.” That being said, the purpose of the book is to advance “a better understanding of the forces that shape the long-run outlook for the market.”

This book covers a myriad of factors ranging from technology, to cultural to psychological that aid the formation and reinforcement of speculative bubbles. It ends with a section on implication of these findings on the various members of society whether individuals, institutions or government.

Below are key excerpts that I found particularly insightful:

1- “Many of the foregoing factors (that are candidates for causing a market boom) have  a self-fulfilling aspect to them, and they are thus difficult, if not impossible, to capture in predictive scientific explanations.”

2- “There are many ultimate causes for this exuberance…and the effect of these causes can be amplified by a feedback loop, a speculative bubble, as we have seen in his chapter. As prices continue to rise, the level of exuberance is enhanced by the price rise itself…The changes in thought patterns infect the entire culture and they operate not only directly from past price increases but also from auxiliary cultural changes that the past price increases helped generate.”

3- “The role of the news media in the stock market is not, as commonly believed, simply as a convenient tool for investors who are reacting directly to the economically significant news itself…The news media are fundamental propagators of speculative price movements through their efforts to make news interesting to their audience. ”

4- “Ends of new eras seem to be periods when the national focus of debate can no longer be upbeat. At such time, a public speaker may still think that it would be good business to extol a vision of a brilliant future for our nation’s economy, but it is simply not credible to do so. One could, at such times, present a case that the economy must recover, as it always has, and that the stock market is underpriced and should go up, but public speakers who make such a case cannot achieve the command of public attention they do after a major stock run-up and economic boom. There are times when an audience is receptive to optimistic statements and times when it is not.”

5- “We have explored the justification people have given, at various points in history, for changing market valuations, and we have seen evidence of the transitory nature of these cultural factors. Ultimately, however, the conclusions we draw from such evidence depend on our view of human nature and the extent of human abilities to produce consistent and independent judgements.”

6- “Two kinds of psychological anchors will be considered here: quantitative anchors, which themselves give indications for the appropriate levels of the market that some people use as indications of whether the market is over-or underpriced and whether it is a good time to buy, and moral anchors, which operate by determining the strengths of the reason that compels people to buy stocks, a reason that they must weigh against their other uses for the wealth which they already have (or could have) invested in the market.”

7- “The effects of new stories on the stock market sometimes have more to do with discovery of how we feel about the news than with any logical reaction to the news. We can make decisions then that would have been impossible before the news was known. It is partly for this reason that the breaking off of a psychological anchor can be so unpredictable: people discover things about themselves, about their own emotions and inclinations, only after price change occur. Psychological anchors for the market hook themselves on the strangest things along the muddy bottom of our consciousness.”

8- “Rationale response to public information is not the only reason that people think similarly, nor is the use of that public information always appropriate or well reasoned.”

9- “Policies that interfere with markets by shutting them down or limiting them, although under some very specific circumstances apparently useful, probably should not be high on our list of solutions to the problems caused by speculative bubbles. Speculative markets perform critical resource-allocation functions, and any interference with markets to tame bubbles interferes with these functions…Most of the thrust of our national policies to deal with speculative bubbles should take the form of facilitating more free trade, as well as greater opportunities for people to take positions in more freer markets. A good outcome can be achieved by designing better forms of social insurance and creating better financial institutions to allow the real risks to be managed more effectively. The most important thing to keep in mind as we are experiencing a speculative bubble in the stock market today is that we should not let it distract us from such important tasks.”


Omar Halabieh

Irrational Exuberance

On The Four Pillar of Investing

I recently finished reading The Four Pillars of Investing – Lessons for Building a Winning Portfolio –  by William Bernstein.

As the title suggests, the author presents within this book four essential pillars of successful investing. Each section of the book is then dedicated to investigating and detailing each of these pillars and they are: 1) Theory 2) History 3) Psychology and 4) Business. The first section on theory, is one which the author calls “the most important part of the book”. In his words it “surveys the awesome body of theory and data relevant to everyday investing”. This section centers itself around the “fundamental characteristic of any investment is that its return and risk go hand in hand.” The second section on History postulates that “an understanding of financial history provides an additional dimension of expertise.” The third section, Psychology,  is one in which the author surveys the area of “behavioral finance”. Where one “learns how to avoid the most common behavioral  mistakes and to confront your own dysfunctional investment behavior.” Last but not least the last section – Business – exposes how “the modern financial services industry is designed solely to serve itself.”

What sets this book apart from other investing books is the breadth of areas covered, and also the writing style which is both “understandable and entertaining”. A highly recommended read for any investor regardless of level.

Below are key excerpts from the book, that I found particularly insightful:

1) “The highest returns are obtained by shouldering prudent risk when things look the bleakest.”

2) “Most small investors naturally assume that good companies are good stocks, when the opposite is usually true.”

3) “Sine you cannot successfully time the market or select individual stocks, asset allocation should be the major focus of your investment strategy. because it is the only factor affecting your investment risk and return that you can control.”

4) “Bubbles occur whenever investors begin buying stocks simply because they have been going up.”

5) “Buying assets that everyone else has been running from takes more fortitude than most investors can manage. But if you are equal to the task, you will be rewarded.”

6) “There are really two behavioral errors operating in the overconfidence playground. The first is the “compartmentalization” of success and failure. We tend to remember those activities, or areas of our portfolios, in which we succeeded an forget about those areas where we didn’t…The second is that its far more agreeable to ascribe success to skill than to luck.”

7) “By indexing, you are tapping into the most powerful intelligence in the world of finance – the collective wisdom of the market itself.”

8) “Rebalancing forces you to be a contrarian – someone who does the opposite of what everyone else is doing. Financial contrarians tend to be wealthier than folks who like to simply follow the crowd.”

9) “Risk and return are inextricably enmeshed. Do not expect high returns without frightening risks, and if you desire safety, you must accept low returns.”

10) “This book should be seen as a framework to which you’ll be continuously adding knowledge.”

11) “The overarching message of this book is at once powerful and simple: With relatively little effort, you can design and assemble an investment portfolio that, because of its wide diversification and minimal expense, will prove superior to most professionally managed accounts.”


Omar Halabieh

The Four Pillars of Investing

Wall Street Demystified

I recently read the book Wall Street – How it works and for whom – by Doug Henwood. This book can be downloaded (for free) from its website.

As the title indicates, this book is an introduction to Wall Street – how it works and for whom. The book is composed of seven chapters as follows:

1- Instruments: This chapter covers the range of instruments traded on Wall Street, such as stocks, bonds, derivatives, currencies etc.

2- Players: This chapter covers the main stakeholders including households, nonfinancial business, financial institutions, the government etc.

3- Ensemble: This chapter discusses how the markets are intertwined, with a focus on credit, finance and the economy, allocation etc. It also includes a sample trading week to put these concepts into action.

4- Market Models: This chapter presents the numerous financial models that have been devised to simulate the market. It also discusses features of these markets, namely efficiency, disinformation, noise, fads, and bubbles.

5- Renegades: This chapter discusses in detail the Keynesian view of the markets, as well as those of Marx.

6- Governance: This chapter is about Corporate Governance, with a section on the relation of Wall Street and the government.

7- What is (not) to be done?: This last chapter includes the author’s thoughts on a number of economic issues such as social security, the Fed, investing socially, taxation, corporate transformation.

The breadth of topics discussed within this book is commendable, backed by a plethora of references for further reading in areas of interest. Chapters 1 and 2, serve as a great introduction and primer on the financial markets. The insight, stories and practical example presented make this book accessible. A final, and important comment to keep in mind, is that the author presents the content of the book (particularly the later chapters) from a leftist perspective.


Omar Halabieh

Wall Street

Wall Street