warren buffett

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.

On The Most Important Thing

I recently finished reading The Most Important Thing – Uncommon Sense for the Thoughtful Investor – by Howard Marks.

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

Few people have what it takes to be a great investors. Some can be taught, but not everyone… and those who can be taught can’t be taught everything. Valid approaches work some of the time but not all. And investing can’t be reduced to an algorithm and turned over to a computer. Even the best investors don’t get it right every time.

Because investing is at least as much art as it is science, it’s never my goal—in this book or elsewhere—to suggest it can be routinized. In fact. one of the things I most want to emphasize is how essential it is that one’s investment approach be intuitive and adaptive rather than be fixed and mechanistic.

Second-level thinking is deep, complex and convoluted. The second level thinker takes a great many things into account: What is the range of likely future outcomes? Which outcome do I think will occur? What’s the probability I’m right? What does the consensus think? How does my expectation differ from the consensus? How does the current price for the asset comport with the consensus view of the future, and with mine? Is the consensus psychology that’s incorporated in the price too bullish or bearish? What will happen to the asset’s price if the consensus turns out to be right, and what if I’m right?

Return alone—and especially return over short periods of time—says very little about the quality of investment decisions. Return has to be evaluated relative to the amount of risk taken to achieve it. And yet, risk cannot be measured. Certainly it cannot be gauged on the basis of what “everybody” says at a moment in time. Risk can be judged only by sophisticated, experienced second-level thinkers.

The road to long-term investment success runs through risk control more than through aggressiveness. Over a full career, most investors’ results will be determined more by how many losers they have, and how bad they are, than by the greatness of their winners. Skillful risk control is the mark of the superior investor.

The pendulum swing regarding attitudes toward risk is one of the most powerful of all. In fact, I’ve recently boiled down the main risks in investing to two: the risk of losing money and the risk of missing opportunity. It’s possible to largely eliminate either one, but not both. In an ideal world, investors would balance these two concerns. But from time to time, at the extremes of the pendulum’s swing, one or the other predominates.

What weapons might you marshal on your side to increase your odds? Here are the ones that work for Oaktree: a strongly held sense of intrinsic value. insistence on acting as you should when price diverges from value. • enough conversance with past cycles—gained at first from reading and talking to veteran investors, and later through experience—to know that market excesses are ultimately punished, not rewarded. a thorough understanding of the insidious effect of psychology on the investing process at market extremes. a promise to remember that when things seem “too good to be true,” they usually are. willingness to look wrong while the market goes from misvalued to more misvalued (as it invariably will), and • like-minded friends and colleagues from whom to gain support (and for you to support).

To boil it all down to just one sentence, I’d say the necessary condition for the existence of bargains is that perception has to be considerably worse than reality. That means the best opportunities are usually found among things most others won’t do. After all, if everyone feels good about something and is glad to join in, it won’t be bargain-priced.

What We Learn from a Crisis—or Ought To: Too much capital availability makes money flow to the wrong places…When capital goes where it shouldn’t, bad things happen…hen capital is in oversupply, investors compete for deals by accepting low returns and a slender margin for error…Widespread disregard for risk creates great risk…Inadequate due diligence leads to investment losses…In heady times, capital is devoted to innovative investments, many of which fail the test of time…Hidden fault lines running through portfolios can make the prices of seemingly unrelated assets move in tandem…Psychological and technical factors can swamp fundamentals…Markets change, invalidating models…Leverage magnifies outcomes but doesn’t add value…Excesses correct.

On a closing note:

Thus, it’s our goal to do as well as the market when it does well and better than the market when it does poorly. At first blush that may sound like a modest goal, but it’s really quite ambitious.

A must read in the area of investing.

On Quiet

I recently finished reading Quiet – The Power of Introverts in a World That Can’t Stop Talking by Susan Cain. This book was referenced by one of my colleagues during a recent Toastmaster’s speech, which sparked my interest in reading it.

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

1- “It makes sense that so many introverts hide even from themselves. We live with a value system that I call the Extrovert Ideal—the omnipresent belief that the ideal self is gregarious, alpha, and comfortable in the spotlight. The archetypal extrovert prefers action to contemplation, risk-taking to heed-taking, certainty to doubt. He favors quick decisions, even at the risk of being wrong. She works well in teams and socializes in groups. We like to think that we value individuality, but all too often we admire one type of individual—the kind who’s comfortable “putting himself out there.” Sure, we allow technologically gifted loners who launch companies in garages to have any personality they please, but they are the exceptions, not the rule, and our tolerance extends mainly to those who get fabulously wealthy or hold the promise of doing so. Introversion—along with its cousins sensitivity, seriousness, and shyness—is now a second-class personality trait, somewhere between a disappointment and a pathology. Introverts living under the Extrovert Ideal are like women in a man’s world, discounted because of a trait that goes to the core of who they are. Extroversion is an enormously appealing personality style, but we’ve turned it into an oppressive standard to which most of us feel we must conform.”

2- “What exactly do I mean when I say that Laura is an introvert? When I started writing this book, the first thing I wanted to find out was precisely how researchers define introversion and extroversion. I knew that in 1921 the influential psychologist Carl Jung had published a bombshell off a book, Psychological Types, popularizing the terms introvert and extrovert as the central building blocks of personality. Introverts are drawn to the inner world of thought and feeling, said Jung, extroverts to the external life of people and activities. Introverts focus on the meaning they make of the events swirling around them; extroverts plunge into the even themselves. Introverts recharge their batteries by being alone; extroverts need to recharge when they don’t socialize enough.”

3- “Nor are introverts necessarily shy. Shyness is the fear of social disapproval or humiliation, while introversion is a preference for environments that are not overstimulating. Shyness is inherently painful; introversion is not. One reason that people confuse the two concepts is that they sometimes overlap (though psychologists debate to what it degree). Some psychologists map the two tendencies on vertical and horizontal axes, with the introvert-extrovert spectrum on the horizontal ax and the anxious-stable spectrum on the vertical. With this model, you end up with four quadrants of personality types: calm extroverts, anxious (or impulsive) extroverts, calm introverts, and anxious introverts.”

4- “If there is only one insight you take away from this book, though. I hope it’s a new found sense of entitlement to be yourself I can vouch personally for the life-transforming effects of this outlook.”

5- “At the onset of the Culture of Personality, we were urged to develop an extroverted personality for frankly selfish reasons—as a way off outshining the crowd in a newly anonymous and competitive society. But nowadays we tend to think that becoming more extroverted not only makes us more successful, but also makes us better people. We see salesmanship as a way of sharing one’s gifts with the world.”

6- “If we assume that quiet and loud people have roughly the same number of good (and bad) ideas, then we should worry if the louder and more forceful people always carry the day. This would mean that an awful lot of bad ideas prevail while good ones get squashed. Yet studies in group dynamics suggest that this is exactly what happens. We perceive talkers as smarter than quiet types—even though grade-point averages and SAT and intelligence test scores reveal this perception to be inaccurate.”

7- “”Among the most effective leaders I have encountered and worked with in half a century,” the management guru Peter Drucker has written, “some locked themselves into their office and others were ultra-gregarious. Some were quick and impulsive, while others studied the situation and took forever to come to a decision…. The one and only personality trait the effective ones I have encountered did have in common was something they did not have: they had little or no ‘charisma’ and little use either for the term or what it signifies.””

8- “It’s impossible to say. No one has ever run these studies, as far as I know—which is a shame. It’s understandable that the HBS model of leadership places such a high premium on confidence and quick decision-making. If assertive people tend to get their way, then it’s a useful skill for leaders whose work depends on influencing others. Decisiveness inspires confidence, while wavering (or even appearing to waver) can threaten morale. But one can take these truths too far; in some circumstances quiet, modest styles of leadership may be equally or more effective.”

9- “…I wonder whether students like the young safety officer would be better off if we appreciated that not everyone aspires to be a leader in the conventional sense of the word—that some people wish to fit harmoniously into the group, others to be independent of it. Often the most highly creative people are in the latter category.”

10- “A mountain of recent data on open-plan offices from many different industries corroborates the results of the games. Open-plan offices have been found to reduce productivity and impair memory. They’re associated with high staff turnover. They make people sick, hostile, unmotivated, and insecure. Open-plan workers are more likely to suffer from high blood pressure and elevated stress levels and to get the flu; they argue more with their colleagues; they worry about coworkers eavesdropping on their phone calls and spying on their computer screens. They have fewer personal and confidential conversations with colleagues. They’re often subject to loud and uncontrollable noise, which raises heart rates; releases Cortisol, the body’s fight-or-flight “stress” hormone; and makes people socially distant, quick to anger, aggressive, and slow to help others.”

11- “Psychologists usually offer three explanations for the failure of group brainstorming. The first is social loafing: in a group, some individuals tend to sit back and let others do the work. The second is production blocking: only one person can talk or produce an idea at once, while the other group members are forced to sit passively. And the third is evaluation apprehension, meaning the fear of looking stupid in front of one’s peers.”

12- “The way forward, I’m suggesting, is not to stop collaborating face-to-face, but to refine the way we do it. For one thing, we should actively seek out symbiotic introvert-extrovert relationships, in which leadership and other tasks are divided according to people’s natural strengths and temperaments. The most effective teams are composed of a healthy mix of introverts and extroverts, studies show, and so are many leadership structures.”

13- “Psychologists often discuss the difference between “temperament” and “personality.” Temperament refers to inborn, biologically based behavioral and emotional patterns that are observable in infancy and early childhood; personality is the complex brew that emerges after cultural influence and personal experience are thrown into the mix. Some say that temperament is the foundation, and personality is the building. Kagan’s work helped link certain infant temperaments with adolescent personality styles like those of Tom and Ralph.”

14- “When combined with Kagan’s findings on high reactivity, this line of studies offers a very empowering lens through which to view your personality. Once you understand introversion and extroversion as preferences for certain levels of stimulation, you can begin consciously trying to situate yourself in environments favorable to your own personality—neither overstimulating nor under-stimulating, neither boring nor anxiety-making. You can organize your life in terms of what personality psychologists rail “optimal levels of arousal” and what I call “sweet spots,” and by doing so feel more energetic and alive than before.”

15- “Dom has observed that her extroverted clients are more likely to be highly reward-sensitive, while the introverts are more likely to pay attention to warning signals. They’re more successful at regulating their feelings of desire or excitement. They protect themselves better from the downside.”

16- “When I first met Mike Wei, the Stanford student who wished he was as uninhibited as his classmates, he said that there was no such thing quiet leader. “How can you let people know you have conviction if you’re quiet about it?” he asked. I reassured him that this wasn’t so, but Mike had so much quiet conviction about the inability of quiet people to convey conviction that deep down I’d wondered whether he had a point. But that was before I heard Professor Ni talk about Asian-style soft power, before I read Gandhi on satyagraha, before I contemplated Tiffany’s bright future as a journalist. Conviction is conviction, the kids from Cupertino taught me, at whatever decibel level it’s expressed.”

17- “But the most interesting part of Thorne’s experiment was how much the two types appreciated each other. Introverts talking to extroverts chose cheerier topics, reported making conversation more easily, and described conversing with extroverts as a “breath of fresh air.” In contrast, the extroverts felt that they could relax more with introvert partners and were freer to confide their problems. They didn’t feel pressure to be falsely upbeat. These are useful pieces of social information. Introverts and extroverts sometimes feel mutually put off, but Thorne’s research suggests how much each has to offer the other. Extroverts need to know that introverts—who often seem to disdain the superficial—may be only too happy to be tugged along to a more lighthearted place; and introverts. who sometimes feel as if their propensity for problem talk makes them a drag, should know that they make it safe for others to get serious.”

Regards,

Omar Halabieh

Quiet

The Intelligent Investor

I recently finished reading The Intelligent Investor – The Definitive Book on Value Investing by Benjamin Graham. This is  a book that has been on my reading list for a while – as The reference in the investment field (from a fundamental analysis perspective). As Benjamin puts it in the introduction: “the purpose of this book is to supply, in a form suitable for the laymen, guidance in the adoption and execution of an investment policy.”

The author makes it very clear from the beginning of the book (and throughout it) that his advice is addressed to investors and not speculators (see excerpts below). Within the investor class – he further makes a distinction between the “defensive” and “aggressive” investor as it relates to the time and energy intended to be spent on research/analysis and in conjunction the expected associated returns. Regardless of which class the investor belongs to, the main premise of the book revolves around value investing – buying securities when they are undervalued based on their fundamentals. Benjamin goes on to discuss a breadth of topics in the area of investing including inflation, market fluctuation, portfolio management, stock selection, convertible issues, bonds etc.

Last but not least, the commentary by Jason Zweig, adds a more modern context and further explains the concepts presented by Graham. By reading both texts, the ideas and concepts are in definite reach of any reader.

A must read for any investor, whether a beginner or pro. As an investor myself, I have found (as I am sure others have as well) that the perspective Benjamin brings is both timeless and very applicable.

Below are excerpts summarizing some of the key investing principles outlined in the book:

1) “1 – Obvious prospects for physical growth in a business do not translate into obvious profits for investors. 2 – The experts do not have dependable ways of selecting and concentrating on the most promising companies in the most promising industries.”

2) “Note that investing, according to Graham, consists equally of three elements: a) you must thoroughly analyze a company, and the soundness of the underlying business, before you buy its stock; b) you must deliberately protect yourself against serious losses; c) you must aspire to “adequate”, not extraordinary, performance.

3) “The more enthusiastic investors become about the  stock market in the log run, the more certain they are to be proved wrong in the short run.”

4) “The only thing you can be confident of while forecasting future stock returns is that you will probably turn out to be wrong. The only indisputable truth that you will probably turn out to be wrong…And the corollary to that law of financial history is that the markets will most brutally surprise the very people who are most certain that their views about the future are right. Staying humble about your forecasting powers, as Graham did, will keep you from risking too much on a view of the future that may well turn out to be wrong.”

5) “To obtain better than average investment results over a long pull requires a policy of selection or operation possessing a twofold merit: (1) It must meet objective or rational tests of underlying soundness and (2) it must be different from the policy followed by most investors or speculators.”

6) “Investment policy, as it has been developed here, depends in the first place on a choice by the investor of either the defensive (passive) or aggressive (enterprising) role. the aggressive investor must have a considerable knowledge of security values – enough, in fact, to warrant viewing his security operations as equivalent to a business enterprise. There is no room in this philosophy for a middle ground, or a series of gradations, between the passive and aggressive status. Many, perhaps most, investors seek to place themselves in such an intermediate category; in our opinion that is a compromise that is more likely to produce disappointment than achievement.”

7) “A great company is not a great investment if you pay too much for the stock.”

8) “Those formulas (forecasting and trading) that gain adherents and importance do so because they have worked well over a period, or sometimes merely because they have been plausibly adapted to the statistical record of the past. But as their acceptance increases, their reliability tends to diminish.  This happens for two reasons: First, the passage of time brings new conditions which the old formula no longer fits. Second, in stock-market affairs the popularity of a trading theory has itself an influence on the market’s behavior which detracts in the long run from its profit-making possibilities.”

9) “Basically, price fluctuations have only one significant meaning for the true investor. They provide him with an opportunity to buy wisely when prices fall sharply and to sell wisely when they advance a great deal. At other times he will do better if he forgets about the stock market and pays attention to his dividend returns and to the operating results of his companies.”

10) “The most realistic distinction between the investor and the speculator is found in their attitude toward stock-market movements. The speculator’s primary interest lies in anticipating and profiting from market fluctuations. The investor’s primary interest lies in acquiring and holding suitable securities at suitable prices.

11) “Which factors determine how much you should be willing to pay for a stock?…Graham feels that five elements are decisive. He summarizes them as: a) the company’s “general long-term prospects” b) the quality of its management c) its financial strength and capital structure d) its dividend record e) and its current dividend rate. ”

12) “Nevertheless, the future itself can be approached in two different ways, which may be called the way of prediction (or projection) and the way of protection. Those who emphasize prediction will endeavor to anticipate fairly accurately just what the company will accomplish in future years…By contrast, those who emphasize protection are always especially concerned with the price of the issue at the time of study. Their main effort is to assure themselves of a substantial margin of indicated present value above the market price 0 which margin could absorb unfavorable developments in the future.”

13) “No matter which techniques they use in picking stocks, successful investing professionals have two things in common: First, they are disciplined and consistent, refusing to change their approach even when its unfashionable. Second, they think a great deal about that they do and how to do it, but they pay very little attention to what the market is doing.”

14) “Our preference for the analyst’s work would be rather that he should seek the exceptional or minority cases in which he can form a reasonably confident judgement that the price is well below value. He should be able to do this work with sufficient expertness to produce satisfactory average results over the years.”

15) “In the short run the market is a voting machine, but in the long run it is a weighing machine.”

16) “To achieve satisfactory investment results is easier than most people realize; to achieve superior results is harder than it looks.”

17) “…the intelligent investor must focus not just on getting the analysis right. You must also ensure against loss if your analysis turns out to be wrong – as even the best analyses will be at least some of the time.”

Regards,

Omar Halabieh

The Intelligent Investor

The Intelligent Investor

On Buffett – The Making of an American Capitalist

I have just finished reading the book Buffett – The Making of an American Capitalist by Roger Lowenstein. As the title indicates this book is a biography of the self-made billionaire investor Warren Buffett. It takes us through his family upbringing, his early years, his eduction and the building of his capitalist empire in Berkshire Hathaway. The author focuses on the people that were influential in his life, particularly his mentor in value investing: Benjamin Graham. This theme is central to Warren’s investment strategy (with adaptation on intangibles – such as brand, reputation etc.) . Through the years, despite all the macro-economics event, changes to the business landscape and technological advances this strategy has driven unparalleled sustained business returns over a period of over 40 years which the book covers.  The book is full of non-investment business advice, relationship building, career management etc.

Below are some excerpts from the book I found particularly insightful:

-“One sees in Buffett a strongly similar suspiscion of public opinion. Buffett viewed a crowd as a potential source of a sort of intellectual contagion. It was the author of acts and feelings which, rather than being a summing-up of the parts, no one individual among the crowd would have subscribed alone.”

-“Regardless of price, we have no interest at all in selling any good business that Berkshire owns, and are very reluctant to sell sub-par businesses as long as we expect them to generate at least some cash and as long as we feel good about their managers and labor relations. We hope not to repeat the capital allocation mistakes that led us into such sub-par businesses….Nevertheless, gin rummy managerial behavior (discard your least promising business at each turn) is not our style.”

-“A compact organization lets all of us spend our time managing the business rather than managing each other.”

-“Buffett’s guides to finding such a stock could be summarized quickly:

a) Pay no attention to macroeconmic trends or forecasts, or to people’s predictions about the future of stock prices. Focus on long-term business value – on the size of the coupons down the road.

b) Stick to stocks within one’s “circle’s of competence.” For Buffett, that was often a company with a consumer franchise. But the general rule was true for all: if you don’t understand the business – be it a newspaper or a software firm – you couldn’t value the stock.

c) Look for managers who treated the shareholders’ capital with ownerlike care and thoughfulness.

d) Study prospects – and their competitors – in great detail. Look at raw data, not analysts’ summaries. Trust your own eyes, Buffet said. But one needn’t value a business too precisely. A basketball coach doesn’t check to see if a prospect is six foot one or six foot two; he looks for seven-footers.

e) The vast majority of stocks would not be compelling either way – so ignore them. Merrill Lynch had an opinion on every stock; Buffett did not. But when an investor had conviction about a stock, he or she should also show courage – and buy ton of it.

-“I want employees to ask themselves whether they are willing to have any contemplated act appear on the front page of their local paper the next day, to be read by their spouses, children and friends…If they follow this test, they need not fear my other message to them: Lose money for the firm and I will be understanding; lose a shred of reputation for the firm, and I will be ruthless.”

-“Among history’s great capitalists, Buffett stands out for his sheer skill at evaluating businesses. What John D. Rockefeller, the oil cartelist, Andrew Carnegie, the philanthropic steel baron, Sam Walton, the humble retailer, and Bill Gate, the software nerd, have in common is that each owes his fortune to a single product or innovation. Buffett made his money as a pure investor: picking diverse businesses and stocks.”

-“More than most, he reclaimed the rewards that spring not from trading commitments one for the next, but from preserving them.”

For anyone interested in the field of investment, it goes without saying that this is a must read book. Given that I had read another book by Roger L. (When Genius Failed – The Rise and Fall of Long Term Capital Management), I had very high expectations from him and he did not dissapoint. Don’t let the size of the book discourage you, once you get started you will have a hard time stopping.

Regards,

Omar Halabieh

Buffett

Buffett