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Kindle Notes & Highlights
by
Sven Carlin
If you buy companies that offer good value at a discounted price, your risk is low because in the long term, the value will ultimately be reflected in the price.
Fundamental risk indicators are the book value, stable cash flow, cash per share and others that limit the downside while the high potential earnings
On the other hand, even with 15 minutes a day it is possible to achieve extreme returns by following only a handful of large stocks. The point then is to buy when the earnings return is satisfying and do nothing when those stocks are overpriced. In the long term, such a strategy will lead to outsized returns with low risk creating a lifelong positive asymmetric risk reward portfolio.
This strengthens the notion that each value investment has to be approached in stages to lower risk and
It is very helpful with investing and especially with value investing to understand the notion that our reasoning around a stock will probably be wrong. Therefore, a value investor has to seek as many margin of safety factors that allow for fallible analysis so that even if your estimated value proves wrong, you still don’t lose money.
The best way to explain reflexivity through an example is to use real estate. Real estate enters a bubble when credit becomes cheap and easily available, as it is now. Banks look at higher real estate prices and are willing to give more credit. Their fallacy is that they don’t see the connection between credit availability and rising collateral values. The banks think collateral values are independent from increased credit. Cheap credit leads to higher prices and better credit scores which relax borrowing standards.
I wanted to discuss behavioral finance and reflexivity here because I often see value investors get completely infatuated with fundamentals that look extremely valuable and consequently the stock is undervalued but the stock market never catches up. Actually, the opposite is true; the fundamentals often catch up with the stock, be it upwards or downwards.
“Bottoms in the investment world don’t end with four-year lows; they end with 10 or 15-year lows” Jim Rogers
had. Corporate managers are mostly compensated in relation to the performance of the stock and thus they will continue to indulge in expensive buybacks that lead to them receiving higher bonuses and more options despite the fact that it destroys value.
The main focus of Wall Street are firstly their fees, bonuses and compensation packages and only then your long-term value.
you should always know where the interest of the middleman you are using lies.
6.5%. If you participate in an IPO, the fee you pay to the brokerage is extremely high, usually between 2% and 8%.
multiples. With interest rates at historical lows, I find it difficult to believe that the companies filing for IPOs have lots of prospects but are short of capital.
The fact is that Wall Street is never satisfied with success, it will always look toward the next commission
Value investing is about being conservative and really limiting the
There is no real value in goodwill as it depends on how much the management paid when acquiring another company. As goodwill values are extremely high in bull markets and economic expansions but extremely low in recessions, a value investor doesn’t really look at goodwill as a margin of safety and prefers tangible assets.
The definition of intrinsic value is simple: It is the discounted value of the cash that can be taken out of a business during its remaining life.
However, the only way to measure it properly is by looking at the change in the book value of the business adjusting for dividends or other capital transactions. As the change in book value shows only what happened in the past the best way to approach the analysis of intrinsic value is by combining the following three factors: book value, earnings and expected future return on retained earnings.
The liability side of a balance sheet has to always be taken at face value while one has to be extremely conservative when analyzing the asset side.
The best way to assess earnings is to use their past averages and adjust them for growth and cyclicality.
The third component of intrinsic value is the expected future return on retained earnings which is the most subjective component of the three.
which according to Charlie Munger results in a similar long-term return on investment.
Charlie Munger states that over the very long term, the return on capital is what determines the return that the stock will offer no matter the current discount.
However, a stable and high ROIC provides the necessary security that a permanent loss of capital is unlikely.
show you the value created in the past that you are buying now. Current earnings or the change in book value will show you the value that is created at the moment you are analyzing the stocks. The third component; return on capital will tell you what to expect in the long term as that is the actual future value creation. The higher the return on invested capital and the cheaper the stock from a valuation perspective, the better.
Sometimes a stock is undervalued because it is in a process of building a new hotel, pipeline, mine, or whatever kind of investment where the value will be returned only in a few years. The market usually discounts such projects at a much larger rate than normal, creating excellent investing opportunities for the patient and intelligent value investor. More about that in the part about hyperbolic discounting.
And remember, a back of a napkin calculation is usually more valid than tens of mathematical formulas and complicated discount models.
The first advantage the CAPE ratio has over its shorter-term counterpart, the PE ratio, is that it is much less volatile as it uses long term average earnings. The second is that as it uses long term earnings that represent real business performance. In other words, the CAPE shows when a market is cheap or expensive from a value perspective. When earnings decline in a recession, the standard PE ratio spikes while the CAPE ratio declines alongside lower stock prices as it takes much more time than a recession for average earnings to decline.
Rebalance across sectors and countries
Given that China and India have been growing at staggering rates in the past 10 years, corporate earnings have also been booming, which skews the CAPE metric because of past low earnings. Therefore, be sure to adjust the usage of the CAPE by also analyzing the
To be conservative, assume two recessions in the next 10 years when calculating future earnings by using the CAPE ratio.
For example, in October 2008, more than 1,000 stocks out of the almost 8,000 traded on U.S. markets were trading at a price that was below their cash per share, not even real estate values, pure cash! At the same time there were many stocks, especially in emerging and frontier markets that were trading at 10% or even less of the value of their assets, in some cases extremely valuable real estate.
Willingness to underperform for indefinite periods of time as a stock can remain undervalued for longer due to negative market sentiment. As long as the market is irrationally euphoric about something, it won’t recognize nor look for value.
Growth and biotechnology companies often have large cash balances due to capitalization rounds which makes them seem cheap, but given their cash burn rate, they aren’t.
downturn. If the margins are tight and even a small change in the form of competitor pressure would make the dividend questionable, then there is really no margin of safety there.
the vast majority turn out to be value traps. There are a few things to look at which lower the probability of getting stuck with a value trap.
Avoiding a value trap is easier said than done but it’s important to discuss as owning a value trap might lock up precious capital for long periods of time and have
safety. The problem is that the market might never recognize the mispricing, and the stock could fall even more. Therefore, apart from finding value in stocks, an investor has to also look for catalysts that are going to unlock that value. If there aren’t any catalysts on the horizon, the stock could easily become a value trap.
The catch is that small cap value stocks tend to have a mind of their own and don’t move in sync with the S&P 500.
Hyperbolic discounting describes the tendency people have to prefer a smaller reward that will come sooner rather than a larger reward that can come later.
The academic way to do this is to add two percentage points to the country’s risk-free rate of where the company is operating.
Contingent liabilities are liabilities where a company guarantees another company’s liability.
The best hedges against quantitative easing are assets that are fixed in supply like precious metals, fixed supply real estate like land, and commodities that have a fixed supply but stable demand.
Also, investors tend to think their insight is special and that their insight gives them an advantage over their peers. This could be the case only if the analyst has more research on the matter than anybody else in the field. If not, beware of such overconfidence.
Growing Economy & Inflation Below Expectations
In the U.S., economic growth has been a bit better but still just above 2.1% with inflation below the targeted 2%.
The best asset class for such an environment is, of course, stocks.
A Growing Economy & Growing Inflation
the best thing to do is to own emerging market bonds or dividend stocks alongside commodities. I prefer commodity stocks because they offer you a yield and their earnings increase disproportionately when commodity prices increase.
Scenario #4: A Slowing Economy & High Inflation
