7 ms·

To Become a Better Investor, Think Like Darwin

116 points by t23 9y ago

deleted 9y ago
[deleted]
acconrad 9y ago
None of this is new news, this is exactly what The Intelligent Investor and Margin of Safety are based on: that the market is irrational. To go further, this is what Warren Buffett made his first few millions off of what is considered "cigar butt" investing. These are stocks trading below their Net Current Asset Value (NCAV). That means take all of their cash, real estate, equipment... those are your net current assets. Now take a subset of those stocks, and you find some at such steep discounts that they are trading below the cash they are holding. How is that possibly rational? To put that in perspective with a contrived example would be Apple, currently trading at $153 with a market cap of nearly $800B, $250B of that is in cash. Now imagine Apple is trading at $45 a share. That would value Apple at $235B...but if they liquidated the company, they would have more than that in the cash alone! And that is exactly the kinds of companies that folks like Ben Graham and Warren Buffett invested in, because they were so cheap, and probably not even great businesses, but had "one less puff" (hence cigar butt) in them before they closed up shop, were acquired, etc. Now, one retort might be that these guys were investing in two of the worst markets in the history of the US economy - Ben Graham came out of the Great Depression and Warren Buffett from the bear market of 61-62. But there are still examples of this today. Seth Klarman's fund (which still exists today) has only had 3 down years and is considered to be one of the greatest investors since Buffett. These investments still exist, and it's all based on buying cheap when the market has irrationally priced them at a sale.
- Retric 9y ago
  Don't forget your looking at the winners not the median returns for that category of investor. A company with 100 Million in liquid assets can easily be facing a 200 Million dollar lawsuit tomorrow.
  - tome 9y ago
    Yeah I've never understood how value investors account for hidden liabilities. Perhaps you have to be very good at reading financial statements.
    - valuearb 9y ago
      Public companies are required to report on all of their liabilities. You read the quarterly and annual reports and intelligently assess which risks are significant or not, and how to discount for them. Beyond that you spend time thinking about their business and what could go wrong. If there is something obvious to you they didn't disclose, that would tend to mean management is untrustworthy or incompetent, two other huge risks. Buffett spends lots of hours reading reports away from CNN and computers and distractions. I'm sure he talks to Charlie and others regularly about things that concern him and gets different perspectives.
      - Retric 9y ago
        Again, a lot can happen in a week let alone 3 months between annual reports. The secret of Buffet's success is not limited to value investing he had quite a bit of early leverage and of course is also quite old now which give plenty of time to compound gains.
        prewett 9y ago
        It's difficult to compound gain at 19% for 50 years--the S&P only did 10%. The secret of Buffett's success, which he explains in every letter, is that he bought an insurance company. As long as you are diligent in writing non-money-losing policies, you get the premiums up front and pay later. So you have all this float that you can do something with. But he also picks good companies, picks good managers, and is careful to make sure that the financial incentive for the manager is the same as the financial incentive for Berkshire, which is not the case with most executive packages.
        9y ago
- FLUX-YOU 9y ago
  >but if they liquidated the company, they would have more than that in the cash alone! Someone has to buy that though, right? I'm sure a ton of people would buy a lot of pieces of a liquidated Apple, but what other effects on the economy does a suddenly-liquidated Apple have since it's such a major company? Does Apple take any other companies with it? The only way to insulate yourself completely and still benefit is to only own Apple shares, otherwise, Apple going down is going to affect the rest of your position. What if they continue to trade below the cash that they are holding for 10+ years? Plus, since they use tax havens, what happens to that cash if someone did liquidate Apple? Wouldn't it have to come back to America and would be taxed heavily?
  - valuearb 9y ago
    Real cigar butts are usually tiny companies that no cross effects on the economy at large. Their risk is that they hold the cash for 10 years, or worse, burn it all trying a whole new business model (self driving cars!). The returns can be very good, but you do need to diversify out to 10 to 20 holdings to limit risk from one going south or taking forever. Buffett stopped investing in cigar butts because his portfolio got too big and the risk/return ratio wasn't always great. His big change was leaving Graham's philosophies for Mungers, and focusing on getting great businesses at a fair price rather than fair businesses at a great price.
- static_noise 9y ago
  Could it be the moral cost that is factored in when valuing companies under their cash value? Some companies come with liabilities that are not in the books; such as having promised to guarantee their workers wages or retirement for decades. If you buy the company and close up shop, you might either be liable to cover these "soft costs" or you might cause political harm to your own operation.
- hackunomatter 9y ago
  Yahoo, for long, had a market cap much below the value of all of its assets (including $BABA). One reason why it was undervalued was because the market didn't believe that they could dispose of their $BABA assets without incurring a huge tax penalty.
  - oskarth 9y ago
    Interesting example. Do you have a link to more info? In general, where do you read such analysis? Seems like the kind of thing that would be discussed on a HN for finance people.
    - hackunomatter 9y ago
      Just search around in HN for, say, "Yahoo core business", in the last couple of years. Here's one story: https://www.usatoday.com/story/money/markets/2015/12/03/yahoo-worthless-math-divest/76721586/ https://www.usatoday.com/story/money/markets/2015/12/03/yaho...
    - imrehg 9y ago
      Some of Matt Levine's Bloomberg finance newsletter touches on that, and there's a bigger writeup as well: https://origin-www.bloombergview.com/articles/2015-12-02/yahoo-is-looking-for-a-new-way-around-alibaba-taxes https://origin-www.bloombergview.com/articles/2015-12-02/yah...
- ice109 9y ago
  I've been reading intelligent investor and there's something I don't understand - maybe you can explain. I get that the point here is if the company were liquidated you would get a positive return but how often does that happen? Yes in principle you're getting something at a discount but you can't exit - not like it can go to Apple HQ and demand a withdrawal commensurate with your equity? So why does it matter?
  - acconrad 9y ago
    They are not as common today because we are in a huge bull market, but they can still be found: https://www.oldschoolvalue.com/stock-screener/net-asset-current-value-ncav-stock-screen.php https://www.oldschoolvalue.com/stock-screener/net-asset-curr...
SirLJ 9y ago
I don't have the back data to test this, so I would not invest in this manner...
dharma1 9y ago
The last chapter, to me, was the most interesting, and I would have liked it if author had expanded on this: "If we need 100,000 people to cure cancer, to deal with Alzheimer’s, to figure out fusion energy and climate change…I don’t know of any other way to do that other than financial markets: equity, debt, proper financing and proper payout of returns. I think that in many cases [finance] probably is the gating factor" How do you attribute finance as an organising/motivating factor to solve some of these problems? Energy, and patented medicine, yes I can see that - but pollution and climate change?
- vkou 9y ago
  When you have a hammer, everything looks like a nail. Never mind that most of the biggest contributions to science had nothing to do with the market economy...
  - AstralStorm 9y ago
    They have, but it's a second order connection. Academic institutions didn't spring up out of charity but due to general idea of the rulers of the day that it will make their and their subjects lives better. This including both financial and non-financial gains, both affecting economy in general though not linked to it in detail. This is why most big academic centers are government funded and not privately funded - and it's always a high risk game and few businesses like high risk. (Even startups, most go for low hanging fruit and quick returns. Academia in total is supposed to go for long game with high payout instead.) Patents came out of the left field, to protect and enhance private research, provide more incentive to do so, cover the huge costs which few private companies could otherwise bear without exclusivity. (Because private company has to make profit while government funding does not necessarily directly because it has huge buffers of cash and social capital.)
    - pbhjpbhj 9y ago
      >Academic institutions didn't spring up out of charity // Are you sure? Didn't the library of Alexandria invite academics and give them bed-and-board to stay and study? (It may have been one of the other early libraries??) With the aim to expand human knowledge. Yes wealth will always have a relationship with knowledge/wisdom but that doesn't mean supporting academia has to have other than altruistic basises. Weren't a lot of early academic institutions monastic, seeing accrual of knowledge as a service to the world by leading to greater understanding of the creator? (Which you kinda intimate.) Isn't that "charity"?
valuearb 9y ago
I think this is silly gobbledygook. The author seems to argue that you pull out of stocks when expected volatility rises. Well expected volatility can be a trailing indicator. The market has low volatility because investors expect great times, yet it suddenly crashes and loses 20%, and volatility skyrockets because investors basically believe that patterns continue forever and expect the market to continue to fall. So now you sell, at 20% below peak prices. Maybe prices continue to fall, maybe not, but it's unlikely expected volatility will fall until the market starts climbing again significantly, say 20%. So then you buy back in, well above the lows. Essentially this seems like a sell low, buy high mechanism, sell on dips, and buy on spikes. Value investing means you invest in only what you can reasonably estimate a value for. You buy when the price is substantially less than it's value. You sell when value and price are similar. Selling a stock you though was worth $10 and bought at $7, because it goes to $6 doesn't make sense if you believe in your original valuation. Buying it back because it goes to $9 doesn't make sense either. If you cannot confidently assess value, you shouldn't be doing anything but buying and holding index funds.
tigrensolutions 9y ago
it's very useful, thank for sharing!
jbmorgado 9y ago
"The Egyptians built some beautiful pyramids, but they did that with hundreds of thousands of slaves over decades." This is now actually disproved. Made me doubt quite a bit about if the rest of the article (and his book) is actually based on any evidence or just the author's personal views.

116 points by t23 9y ago

deleted 9y ago

[deleted]

None of this is new news, this is exactly what The Intelligent Investor and Margin of Safety are based on: that the market is irrational. To go further, this is what Warren Buffett made his first few millions off of what is considered "cigar butt" investing. These are stocks trading below their Net Current Asset Value (NCAV). That means take all of their cash, real estate, equipment... those are your net current assets. Now take a subset of those stocks, and you find some at such steep discounts that they are trading below the cash they are holding. How is that possibly rational? To put that in perspective with a contrived example would be Apple, currently trading at $153 with a market cap of nearly $800B, $250B of that is in cash. Now imagine Apple is trading at $45 a share. That would value Apple at $235B...but if they liquidated the company, they would have more than that in the cash alone! And that is exactly the kinds of companies that folks like Ben Graham and Warren Buffett invested in, because they were so cheap, and probably not even great businesses, but had "one less puff" (hence cigar butt) in them before they closed up shop, were acquired, etc. Now, one retort might be that these guys were investing in two of the worst markets in the history of the US economy - Ben Graham came out of the Great Depression and Warren Buffett from the bear market of 61-62. But there are still examples of this today. Seth Klarman's fund (which still exists today) has only had 3 down years and is considered to be one of the greatest investors since Buffett. These investments still exist, and it's all based on buying cheap when the market has irrationally priced them at a sale.

Retric 9y ago
Don't forget your looking at the winners not the median returns for that category of investor. A company with 100 Million in liquid assets can easily be facing a 200 Million dollar lawsuit tomorrow.
- tome 9y ago
  Yeah I've never understood how value investors account for hidden liabilities. Perhaps you have to be very good at reading financial statements.
  - valuearb 9y ago
    Public companies are required to report on all of their liabilities. You read the quarterly and annual reports and intelligently assess which risks are significant or not, and how to discount for them. Beyond that you spend time thinking about their business and what could go wrong. If there is something obvious to you they didn't disclose, that would tend to mean management is untrustworthy or incompetent, two other huge risks. Buffett spends lots of hours reading reports away from CNN and computers and distractions. I'm sure he talks to Charlie and others regularly about things that concern him and gets different perspectives.
    - Retric 9y ago
      Again, a lot can happen in a week let alone 3 months between annual reports. The secret of Buffet's success is not limited to value investing he had quite a bit of early leverage and of course is also quite old now which give plenty of time to compound gains.
      - prewett 9y ago
        It's difficult to compound gain at 19% for 50 years--the S&P only did 10%. The secret of Buffett's success, which he explains in every letter, is that he bought an insurance company. As long as you are diligent in writing non-money-losing policies, you get the premiums up front and pay later. So you have all this float that you can do something with. But he also picks good companies, picks good managers, and is careful to make sure that the financial incentive for the manager is the same as the financial incentive for Berkshire, which is not the case with most executive packages.
        9y ago
FLUX-YOU 9y ago
>but if they liquidated the company, they would have more than that in the cash alone! Someone has to buy that though, right? I'm sure a ton of people would buy a lot of pieces of a liquidated Apple, but what other effects on the economy does a suddenly-liquidated Apple have since it's such a major company? Does Apple take any other companies with it? The only way to insulate yourself completely and still benefit is to only own Apple shares, otherwise, Apple going down is going to affect the rest of your position. What if they continue to trade below the cash that they are holding for 10+ years? Plus, since they use tax havens, what happens to that cash if someone did liquidate Apple? Wouldn't it have to come back to America and would be taxed heavily?
- valuearb 9y ago
  Real cigar butts are usually tiny companies that no cross effects on the economy at large. Their risk is that they hold the cash for 10 years, or worse, burn it all trying a whole new business model (self driving cars!). The returns can be very good, but you do need to diversify out to 10 to 20 holdings to limit risk from one going south or taking forever. Buffett stopped investing in cigar butts because his portfolio got too big and the risk/return ratio wasn't always great. His big change was leaving Graham's philosophies for Mungers, and focusing on getting great businesses at a fair price rather than fair businesses at a great price.
static_noise 9y ago
Could it be the moral cost that is factored in when valuing companies under their cash value? Some companies come with liabilities that are not in the books; such as having promised to guarantee their workers wages or retirement for decades. If you buy the company and close up shop, you might either be liable to cover these "soft costs" or you might cause political harm to your own operation.
hackunomatter 9y ago
Yahoo, for long, had a market cap much below the value of all of its assets (including $BABA). One reason why it was undervalued was because the market didn't believe that they could dispose of their $BABA assets without incurring a huge tax penalty.
- oskarth 9y ago
  Interesting example. Do you have a link to more info? In general, where do you read such analysis? Seems like the kind of thing that would be discussed on a HN for finance people.
  - hackunomatter 9y ago
    Just search around in HN for, say, "Yahoo core business", in the last couple of years. Here's one story: https://www.usatoday.com/story/money/markets/2015/12/03/yahoo-worthless-math-divest/76721586/ https://www.usatoday.com/story/money/markets/2015/12/03/yaho...
  - imrehg 9y ago
    Some of Matt Levine's Bloomberg finance newsletter touches on that, and there's a bigger writeup as well: https://origin-www.bloombergview.com/articles/2015-12-02/yahoo-is-looking-for-a-new-way-around-alibaba-taxes https://origin-www.bloombergview.com/articles/2015-12-02/yah...
ice109 9y ago
I've been reading intelligent investor and there's something I don't understand - maybe you can explain. I get that the point here is if the company were liquidated you would get a positive return but how often does that happen? Yes in principle you're getting something at a discount but you can't exit - not like it can go to Apple HQ and demand a withdrawal commensurate with your equity? So why does it matter?
- acconrad 9y ago
  They are not as common today because we are in a huge bull market, but they can still be found: https://www.oldschoolvalue.com/stock-screener/net-asset-current-value-ncav-stock-screen.php https://www.oldschoolvalue.com/stock-screener/net-asset-curr...

SirLJ 9y ago

I don't have the back data to test this, so I would not invest in this manner...

dharma1 9y ago

The last chapter, to me, was the most interesting, and I would have liked it if author had expanded on this: "If we need 100,000 people to cure cancer, to deal with Alzheimer’s, to figure out fusion energy and climate change…I don’t know of any other way to do that other than financial markets: equity, debt, proper financing and proper payout of returns. I think that in many cases [finance] probably is the gating factor" How do you attribute finance as an organising/motivating factor to solve some of these problems? Energy, and patented medicine, yes I can see that - but pollution and climate change?

vkou 9y ago
When you have a hammer, everything looks like a nail. Never mind that most of the biggest contributions to science had nothing to do with the market economy...
- AstralStorm 9y ago
  They have, but it's a second order connection. Academic institutions didn't spring up out of charity but due to general idea of the rulers of the day that it will make their and their subjects lives better. This including both financial and non-financial gains, both affecting economy in general though not linked to it in detail. This is why most big academic centers are government funded and not privately funded - and it's always a high risk game and few businesses like high risk. (Even startups, most go for low hanging fruit and quick returns. Academia in total is supposed to go for long game with high payout instead.) Patents came out of the left field, to protect and enhance private research, provide more incentive to do so, cover the huge costs which few private companies could otherwise bear without exclusivity. (Because private company has to make profit while government funding does not necessarily directly because it has huge buffers of cash and social capital.)
  - pbhjpbhj 9y ago
    >Academic institutions didn't spring up out of charity // Are you sure? Didn't the library of Alexandria invite academics and give them bed-and-board to stay and study? (It may have been one of the other early libraries??) With the aim to expand human knowledge. Yes wealth will always have a relationship with knowledge/wisdom but that doesn't mean supporting academia has to have other than altruistic basises. Weren't a lot of early academic institutions monastic, seeing accrual of knowledge as a service to the world by leading to greater understanding of the creator? (Which you kinda intimate.) Isn't that "charity"?

valuearb 9y ago

I think this is silly gobbledygook. The author seems to argue that you pull out of stocks when expected volatility rises. Well expected volatility can be a trailing indicator. The market has low volatility because investors expect great times, yet it suddenly crashes and loses 20%, and volatility skyrockets because investors basically believe that patterns continue forever and expect the market to continue to fall. So now you sell, at 20% below peak prices. Maybe prices continue to fall, maybe not, but it's unlikely expected volatility will fall until the market starts climbing again significantly, say 20%. So then you buy back in, well above the lows. Essentially this seems like a sell low, buy high mechanism, sell on dips, and buy on spikes. Value investing means you invest in only what you can reasonably estimate a value for. You buy when the price is substantially less than it's value. You sell when value and price are similar. Selling a stock you though was worth $10 and bought at $7, because it goes to $6 doesn't make sense if you believe in your original valuation. Buying it back because it goes to $9 doesn't make sense either. If you cannot confidently assess value, you shouldn't be doing anything but buying and holding index funds.

tigrensolutions 9y ago

it's very useful, thank for sharing!

jbmorgado 9y ago

"The Egyptians built some beautiful pyramids, but they did that with hundreds of thousands of slaves over decades." This is now actually disproved. Made me doubt quite a bit about if the rest of the article (and his book) is actually based on any evidence or just the author's personal views.