A review of Guy Spier’s new book “The Education of a Value Investor”

“The unexamined life is not worth living” – Socrates

“We have met the enemy and he is us” – Pogo

Guy Spier has written a very thoughtful book about investing and about life. Fans of value investing may initially be disappointed that the book does not dispel more valuation techniques or models. But alas anyone who has seriously taken up the task of becoming a skilled value investor eventually realizes that the value investing framework per se is relatively straightforward. Ben Graham and Warren Buffett have already provided these and there are no secrets. The real challenge is the emotional and psychological discipline required to actually implement this proven investing framework.

Some investors such as Warren Buffett and Mohnish Pabrai display a kind of natural virtuosity in this regard that can make it look easy (this may indeed be their greatest genius). Yet, anyone who has seriously undertaken the task of becoming a skilled investor who can add real value – whether measured in relative terms (beating the S&P 500) or in absolute terms (doubling your money every X years) – is sooner or later disavowed of the notion that it is easy.

Fortunately, to quote one of Guy’s mentors, Tony Robbins, “Biography is not destiny. The past does not equal the future.” This is where Guy’s book shines. It is a book-length memoir of one man’s journey to overcome his mistakes and limitations and become a successful investor. Along the way, he discovers much more about life and relationships and important values that we all need to learn or be reminded of.

Charlie Munger has taught us to learn from other peoples mistakes. Here Guy has been remarkably candid and generous in his self-revelations, and there is much to learn from them. It can be a catalyst to look at our own foibles and blind spots and work to overcome them.

In case all this sounds too fluffy and devoid of real meat, I want to assure you that the book contains plenty of useful and actionable investing information, from how to set up an environment that supports rational behavior, to rules of thumb for countering your psychological biases, to how to research a stock, to the importance of checklists and how to construct one that adds value, to a first-rate reading list.

I commend this book to you and look forward to using its many lessons myself to become a better investor and, hopefully, along the way, a better person.

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Buffett & Munger’s Four Investing Filters

A few takeaways:

  1. (Filter #1) The most important thing is to understand the business.
  2. (Filter #2) Look for a business with an enduring competitive advantage.
  3. (Filter #3) Invest with able and trustworthy managers.
  4. Filter out most prospective investments through inversion, i.e. businesses you don’t understand, businesses with lousy economics, etc.
  5. (Filter #4) Pay a price that makes sense and affords a margin of safety.
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Mohnish Pabrai at Google

A few takeaways:

  1. There is a big difference between risk and uncertainty.
  2. When you own a stock you own part of business. Learn to think like an owner.
  3. Compounding is a powerful force.
  4. Don’t seek false precision.
  5. Try to isolate the handful of key variables that drive the business.
  6. You should be able to state your investment thesis in a few sentences.
  7. Patience is essential.
  8. Stay within your circle of competence.
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Links of Interest – August 1, 2014

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Links of Interest – May 23, 2014

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A few thoughts from Omaha on Berkshire Hathaway’s future ($BRK.A, $BRK.B)

I came away from the Berkshire Hathaway meeting generally reassured about its future as a sound investment.

The results will not be spectacular going forward. Berkshire is simply too big for that. However, the result are likely to be quite satisfactory. I think it is rational to assume (as Buffett himself believes) that Berkshire can still beat the S&P 500 over a complete business cycle, something few managers can do. Moreover, in Berkshire’s case you have a high probability of selecting the manager BEFORE you invest, a rarity.

Buffett has put together a collection of businesses that are not only highly profitable, but also remarkably immunized from creative destruction, which provides a margin of safety. It is not a stretch to assume that one hundred years from now BNSF will still be riding the rails, BH power will be providing energy in one form or another and BH insurance companies will be underwriting. This also is rare.

The key question that will drive Berkshire’s results going forward is whether Buffett or his successors will be able to intelligently put to work the enormous capital the company generates.

For now, Berkshire has shown that it still has this capacity to do this given the following options.

  1. Tuck-in acquisitions and organic growth, i.e. NFM Texas store
  2. Large cap-ex investments in rails and energy. Tens of billions can be put to work here over time at satisfactory returns, i.e. 11%-12%.
  3. Stakes in publicly traded companies
  4. An occasional whale (this may be aided by 3G Capital)
  5. “Special Deals” (such as those done with Goldman, GE, BOA, etc.) – Buffett thinks these will still be available after he is gone, based on Berkshire’s reputation and its ability to write a huge check.
  6. Something we are not thinking about. This may seem a bit of a stretch (and certainly not something to count on) but Buffett is an investing genius who has surprised many times in the past by coming up with new ways to deploy capital.

Another positive is that Berkshire is one the few companies that will have both the firepower – cash, operating profits, borrowing capacity, liquid securities – and investing philosophy to exploit Mr. Market when he goes into a future depressed state. Moreover, confidence is growing that Todd Combs and Ted Weschler are skilled investors who could have a long and successful run ahead of them at Berkshire.

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Links of Interest – April 25, 2014

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Brief notes on the 1979 Berkshire Hathaway Shareholder Letter

  • Buffett continues to espouse return on equity as the preferred metric for economic performance, provided it is adjusted, where necessary, to capture economic reality.
  • The scorecard for investment results must take both inflation and taxes into account.
  • Buffett underscores outstanding management as a key driver of a successful business, particularly in insurance which tends to “magnify, to an unusual degree, human managerial talent – or the lack of it”.
  • Buffett suggest that it probably makes sense to pay-up for great businesses – those that produce high returns on tangible capital employed – rather than purchase statistical bargains in mediocre or subpar businesses.
  • Early on, Buffett showed the discipline to walk away from insurance business if it could not be underwritten with an expectation of a profit.
  • Successful investing in insurance requires the ability to tolerate lumpy returns.
  • Buffett is disinterested in market trends or fads.
  • Even sophisticated managers can ignore reality if it is too painful to deal with or if it requires a difficult change in direction. (See the example of how the insurance industry reacted to losses on long-term bonds.)
  • Lending money at a fixed price for an extended duration (long-term bonds) is inherently risky in an inflationary world. This is why Buffett favors convertible bonds which function as if they have shortened maturities.
  • It generally doesn’t pay to be clever when the tide is running against you.
  • You usually have to pay up to purchase a high-quality business.
  • “It is difficult to say anything new or meaningful each quarter about events of long-term significance.”
  • Buffett takes pride in running a very lean operation at the top.
  • Buffett wants a shareholder base that understands Berkshire Hathaway and has rational expectations.
  • Buffett likes the trade-offs inherent in running a decentralized operation: whatever he misses by not having more controls he gains in cost savings and responsiveness.
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Brief notes on the 1978 Berkshire Hathaway Shareholder Letter

  • GAAP financial statements are merely a starting point to understand the economics of a business.
  • Berkshire is best understood by looking at its various segments.
  • Buffett tries to provide segmented information to investors (“partners”) in the same form that he likes to see it.
  • One-time capital gains should not be used in evaluating the performance of any given single year. Nevertheless, they are a meaningful component of Berkshire’s longterm performance.
  • Buffett does not believe it is possible to forecast short-term stock market prices.
  • Return on equity may be overstated if balance sheet assets, such as property and equipment, are carried materially below replacement cost.
  • Textiles is a lousy business characterized by slow capital turnover, low profit margins, poor returns on capital.
  • Attempts to improve profitability may yield little benefit if a business’s competitors are able to make the same improvements, i.e. differentiating products, lowering costs, increasing productivity, changing product mix, etc. [Author's note: Buffett will later write that this is akin to standing on your tippy toes at a parade.]
  • When it come to controlling costs, management’s past track record is a meaningful indicator of future performance.
  • As long as a business is generating at least modest returns, Buffett will consider non-economic factors when deciding to remain in the business.
  • The hallmarks of Berkshire’s highly successful insurance operations were already on display in 1978: discipline, growth, realism, conservative expectations, and recognition of the tremendous power of low-cost float coupled with investment skill.
  • Buffett reiterates his investment criteria: “(1) businesses we can understand, (2) with favorable long-term prospects, (3) operated by honest and competent people, and (4) priced very attractively.”
  • Buffett chides pension fund managers for investing heavily when the market was richly valued and investing relatively little at bargain prices.
  • Buffett sought blocks of stock for Berkshire’s insurance portfolios at valuations lower than what they would “command in negotiated sales”.
  • As a net buyer of securities, Buffett prefers share prices to stay undervalued rather than quickly re-pricing to unattractive levels.
  • Buffett’s policy is to concentrate holdings.
  • Forgoing control is completely rational when 1) a meaningful portion of a business can be purchased in the market for less than it would cost to create it, 2) the business has relatively certain prospects, and 3) possesses proven management. See the SAFECO example.
  • Buffett praises investee companies’ reinvestment of retained earnings, provided it is done at attractive returns. This anticipates his concept of look-through earnings.
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Links of Interest – March 14, 2014

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