More on this book
Community
Kindle Notes & Highlights
by
Gautam Baid
Read between
August 16, 2023 - January 13, 2024
A premortem is an investigation of a bad outcome, but before it happens. We tend to bask in an optimistic view of the future and overestimate the probability of favorable outcomes. A premortem tempers this innate bias.
Journaling by hand reduces the possibility of hindsight bias. It is hard to look at your own writing and deny your previous thoughts.
Never ask anyone for their opinion, forecast, or recommendation. Just ask them what they have—or don’t have—in their portfolio.
“Perhaps the most important rule in management is to get the incentives right.”
Many times, conventional valuation measures based on reported earnings or accounting book values result in an optically high price-to-earnings or price-to-book ratio for a moated business, and investors end up making costly mistakes of omission because they find these businesses to be overvalued. But, as Buffett has said:
P/E multiples should be the result of the valuation exercise and not the cause. Evaluating accounting numbers from the right perspective is vital to succeeding as an investor. For example, goodwill can reflect either having paid too much for an acquisition or enduring long-term intangibles whose value increases over time. Investors will have to figure this out, because the accountants won’t. With that in mind, let us evaluate some of the important components of economic earnings, namely, maintenance capex and working capital.
All capex that is not growth capex must necessarily be maintenance capex. So if we can estimate growth capex, we can estimate maintenance capex.
When we correctly treat the money spent on such frequent capex programs not as capex but as maintenance capex, we will figure out that, essentially, there are no owner earnings. And when there are no owner earnings, there is no value.
In businesses like oil, or any business that involves extracting stuff from below the earth’s surface, that range can be huge.
Each business’s economics is different. All earnings are not created equal. Ten dollars of earnings from a capital-light business like Moody’s, with its low reinvestment requirements, is obviously worth a lot more than the same earnings figure from a capital-intensive business like General Dynamics, so investors should capitalize each of them differently.
It took me many years to learn this big market lesson: expensive is expensive for a reason and cheap is cheap for a reason.
With few exceptions, eventually valuations that are simply too high will drift back down to more reasonable levels, often at the expense of poor intermediate-term performance. This appears to be true no matter how revolutionary the new business appears to be, and no matter how much potential you believe it has [emphasis added]. Of course, if your conviction is such that you plan on holding your shares for multiple decades, valuation may indeed matter less to long-term returns, but that is assuming you follow through on your commitment. Over several years of sub-par performance, that is much
...more
At times, the valuation of a stock we have held for a long time becomes so absurdly high that we should be able to sell it instantly, without any hesitation or doubt. But this type of sale is not mentally easy to execute, because the valuation expansion would have been accompanied by huge gains for the investor, leading to excessive greed and the subsequent tendency to debunk “traditional” measures of valuation.
compound annual growth rate (CAGR)
An investor with 14 percent average annual return (20 percent, 40 percent, 20 percent, −50 percent, and 40 percent) over a five-year period underperforms someone with 9 percent average annual return if the latter is consistent every year.
It takes a fairly short time to learn how to make money, but it takes a lifetime to learn how to not lose it. A margin of safety in investing is necessary to avoid “compounding in reverse.”
Buffett’s adaptation of margin of safety for the masses follows: Rule number 1: Never lose money. Rule number 2: Never forget rule number 1.
If investors focused on reducing unforced errors instead of trying to hit the next home run, then their returns would improve dramatically.
No one can avoid making new mistakes, but the great investors repeat old mistakes less often.
On balance, paying a high price for even a great business may not always work out well if you have to sell that business in one or two years. But if you plan to hold your stocks for longer periods of time—say, five years, ten years, or longer—then quality becomes “much more important” than cheap initial valuations when assessing margin of safety. This leads to an important conclusion: when investing in short-term opportunities like commodities, cyclicals, and special situations, pay greater attention to price and mean reversion, but when investing in long-term compounders, pay maximum
...more
(Between two lenders with similar levels of return on equity and growth, I would prefer the lender with a higher price-to-book valuation for two reasons: (1) growth capital in the future would be available at a lower equity dilution, and (2) a higher price-to-book valuation tends to signify important nondisclosed aspects like superior underwriting skills, robust internal processes, and better quality of the loan book.)
that is, bad things will happen to good businesses and good things will happen to bad businesses. Buffett–Munger–Fisher investors invest in businesses with fundamental momentum, that is, a high probability of sustaining excess returns over long periods of time.
High quality always beats a bargain over time. Although there are certainly exceptions, in the long run, bargains never outperform solid investments. This simple yet profound principle can be applied to virtually every area of life. Crash diets, predatory pricing, dishonesty, and shortcuts can work well for a while, but they are never sustainable.
When investing in commodities and cyclicals, look for industries that are in a major down cycle and are starved for capital. This step should be followed by a detailed analysis of the fundamentals of individual companies and behavioral insights within the sector to uncover stocks that are selling at a significant discount to their intrinsic value. Next, conduct a stress test to check whether the short-listed companies have manageable debt and are capable of surviving another couple of years in a downturn. Then wait for a few companies in the industry to go bust or shut down some plants and
...more
Never confuse your time frame with someone else’s. A meaningful price level for a shorter-time-frame participant is often an irrelevant figure to someone planning to hold longer term.
The fifty-two-week high list is often a shortcut to the minds of smart investors.
Even if you do not end up investing in any of the breakout stocks, the positive takeaway from this exercise would be the fact that your mental database will have expanded by studying the annual reports, presentations, and conference call audio recordings and transcripts of the various companies in the industry. (Conference calls are a vital component of any serious investor’s research activity list.)
Well-managed low-cost commodity producers usually do not generate higher returns. High-cost producers do, because they show a higher percentage gain in profitability. This is highly counterintuitive for most investors.
For loss-making companies with sizeable revenues and a low market cap-to-sales ratio, even a small improvement in profit margin adds a significant number to the profit value. In addition, loss-making companies usually have sizeable tax loss carryforwards from the previous down-cycle, resulting in lower taxes and high net profits during the up-cycle.
Commodity stocks are valued on an EV/EBITDA multiple, not on price-to-earnings. Investors in commodity stocks need to shift focus away from the profit-and-loss statement to a balance sheet–driven approach.
when it comes to the infrastructure and construction sectors, the market rewards the stocks of only those companies that have strong execution capabilities and a healthy balance sheet that can support fundraising for the execution of future order wins. This very insight eventually helped me identify PSP Projects in 2018.
As a result, it was able to maintain inventory for fewer than five days, against an industry average of fifty to ninety days. This was exceptional working capital management. (As investors, we make our money off the income statement, but we survive off the balance sheet. A cooked-up income statement eventually sinks in the quicksand of the balance sheet. A bull market merely delays the inevitable for such companies.)
Insider participation is one of the key areas to look for when picking and choosing between spinoffs—for me, the most important area. Are the managers of the new spinoff incentivized along the same lines as shareholders? Will they receive a large part of their potential compensation in stock, restricted stock, or options? Is there a plan for them to acquire more? When all the required public documents about the spinoff have been filed, I usually look at this area first.
you want to participate in the high growth rate of an industry that is characterized by poor profitability, do so indirectly through an ancillary industry that has better economics and lower competition (the best-case scenario would be if it’s a monopoly business and the sole supplier to all the players in the primary industry). For example, the organized luggage industry in India (characterized by moderate competition) could be used as a proxy to profit from the high traffic growth of airlines (characterized by hypercompetition).
It is far more important to invest in the right business than it is to worry about whether to pay 10× or 20× or even 30× for current-year earnings.
The bitterness of poor quality remains long after the sweetness of low price is forgotten. —Benjamin Franklin
What ultimately determines investment returns is the future trajectory of the return ratios, margins, balance sheet, and working capital situation of a company, and not the current numbers or ratios in absolute terms.
Companies that produce high returns on capital generally do so in one of two ways: by earning above-average profit margins or by turning over their capital quickly. This is essentially the crux of the DuPont analysis: Return on invested capital = Owner earnings ÷ Sales × Sales ÷ Invested capital.
To create strong value propositions, firms should ask customers what they want to achieve and how they measure success and failure. (Instead, too many firms still ask customers what they want. Customers are not experts on the solution.)
Dit is een zwak punt voor Learning momenteel
When assessing the moat of any business, simply ask yourself how quickly a smart competitor with unlimited financial resources could replicate it. If your competitors know your success secret and still can’t copy it, you have a strong moat.
Often, management teams that engage in empire building destroy value through extravagant merger and acquisition (M&A) deals. Always check to see whether company size, measured in terms of total revenues, with no mention of profitability, is a factor in management compensation.
The simple M&A rule of thumb is this: the bigger the deal size and the less similarity between buyer and target, the more likely the deal will destroy value.
Benjamin Graham had said, “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.”
Always remember: stock prices randomly fluctuate every day, sometimes wildly on either side, but business value changes very slowly. Therein lies the big opportunity.
Buffett reminds us to always evaluate data in the appropriate context: “Stocks are high, they look high, but they’re not as high as they look.”6 For example, the high price-to-earnings (P/E) ratio of the U.S. markets in 1921 should not have been concerning, because corporate profits were highly depressed and at a cyclical low.
“Markets can remain irrational longer than you can remain solvent.”
(The market is characterized by meta-randomness. Stocks are conditionally random on news. News is conditionally random on people. People are conditionally random on moods. Moods are conditionally random on mind-set.)
A big bear market needs to be preceded by complete euphoria, a major unexpected negative dislocation, and a complete drying up of liquidity.
“During such scary periods, you should never forget two things: First, widespread fear is your friend as an investor, because it serves up bargain purchases. Second, personal fear is your enemy [emphasis added].”
Stock prices sometimes fall to such extremely low levels that the earnings of the next three to four years alone add up to the current market cap. Conversely, sometimes stock prices go to such extremely high levels that even a high earnings growth rate for a decade would not produce earnings sufficient to justify a future value large enough to make a commitment today.
