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Kindle Notes & Highlights
by
Gautam Baid
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July 29 - October 3, 2024
I learned early in my career that if you read the annual reports, you’ve done more than 90 percent of the people on Wall Street. If you read the notes to the annual report, you’ve done more than 95 percent of the people on Wall Street. —Jim Rogers
In investing, the person that turns over the most rocks wins the game. There is no alternative to hard work. In life, relationships, business, or investing, nothing will work unless you do. And there is no intelligent reason for an investor to settle for an inferior track record in a marketplace filled with companies with outstanding fundamentals.
As Feynman says, “The first principle is that you must not fool yourself—and you are the easiest person to fool.”
Chapter 8 of Graham’s book talks about not letting the mood swings of Mr. Market coax us into speculating, selling in panic, or trying to time the market. Chapter 20 explains that, after careful analysis of a company’s ongoing business and its prospects for future earnings, we should consider buying only if its current price implies a large margin of safety. In chapter 12 of The General Theory of Employment, Interest, and Money (“The State of Long-Term Expectation”), Keynes remarks that most professional investors and speculators were “largely concerned, not with making superior long-term
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As Albert Einstein said, “If you can’t explain it simply, you don’t understand it well enough.”
The P/E ratio in isolation, however, tells us nothing about the business’s capital intensity, cash flow generation, management quality, or balance sheet strength, or about the expected duration of its competitive advantage period. There’s a lot more to making money in the stock market than just looking at P/E ratios.
Short-sellers shouldn’t be reviled or banned; most should be celebrated and encouraged. They are the policemen of the financial markets, identifying frauds and cautioning against bubbles. In effect, they protect the unsophisticated from predatory schemes that regulators and enforcement agencies don’t seem able to prevent.
Building wealth over time has less to do with your income levels or investment returns and more to do with your savings discipline.
invigorate
Spend each day trying to be a little wiser than you were when you woke up. Discharge your duties faithfully and well. Step by step you get ahead, but not necessarily in fast spurts. But you build discipline by preparing for fast spurts. … Slug it out one inch at a time, day by day. At the end of the day—if you live long enough—most people get what they deserve. —Charlie Munger
“It’s good to have money and the things that money can buy, but it’s good, too, to check up once in a while and make sure that you haven’t lost the things that money can’t buy [emphasis added].”
Shane Parrish writes, “The little mental trick is to remember that success, money, fame, and beauty, all the things we pursue, are merely the numerator! If the denominator—shame, regret, unhappiness, loneliness—is too large, our ‘Life Satisfaction Score’ ends up being tiny, worthless. Even if we have all that good stuff! … It’s so simple. This is why you see people that ‘should be happy’ who are not. Big denominators destroy self-worth.”
“There is no pillow so soft as a clear conscience.”
If you’re glued together and honorable and get up every morning and keep learning every day and you’re willing to go in for a lot of deferred gratification all your life, you’re going to succeed. —Charlie Munger
Wealth, in fact, is what you don’t see. It’s the cars not purchased. The diamonds not bought. The renovations postponed, the clothes forgone and the first-class upgrade declined. It’s assets in the bank that haven’t yet been converted into the stuff you see. —Morgan Housel
Maurer talks about six strategies that can help us bring about big changes in our life over a period of time: 1. Asking small questions 2. Thinking small thoughts 3. Taking small actions 4. Solving small problems 5. Giving small rewards 6. Recognizing small moments
vagaries
The biggest advantage for an individual investor is the option to calmly wait until identifying a business that is available at a significant discount to intrinsic value.
Bharat Financial Inclusion’s low-cost leadership in India’s microfinance industry, Eicher Motors’s coveted Royal Enfield franchise, Can Fin Homes’s pristine asset quality, HEG’s strongly guarded proprietary technology in graphite electrodes, Bhansali Engineering Polymers’s leadership position in India’s acrylonitrile butadiene styrene (ABS) market, and CCL Products’s deeply entrenched relationships with coffee makers worldwide. Today, the stock market has given me, among other things, part ownership of Bajaj Finance’s, CreditAccess Grameen’s, SBI Cards’s, and Aavas Financier’s deep expertise
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Sales growth. The higher sales growth is, the better (provided it is profitable). Over the long term, stock returns are highly correlated to sales growth as margins revert to the mean. Organic growth driven by internal accruals is most desirable. Be cautious of high growth driven primarily by big-ticket acquisitions.
Gross profit margin. Focus on the trend over the years. If it is fluctuating a lot in a cyclical manner, then it means that the company does not have pricing power over its customers and is not able to pass on increases in raw material cost. On the contrary, if it is high and stable or improving over the years, then the company in question may have an economic moat. Dig deeper in such cases (as well as when a company’s operating margins are much higher than that of its industry peers).
Interest income (usually shown as “other income”). Check the cash and investments figure on the balance sheet. If the interest income is not at least equal to the bank’s fixed deposit return, then analyze it deeper to see where the company has invested its cash. Interest expense. A low-interest expense or a high-interest coverage ratio in isolation should never be taken at face value. Always check whether the company has been capitalizing the interest cost. Multiply the total debt figure by the prevailing rate of interest for similarly rated corporations and compare that figure with the total
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Cash Flow Analysis Cash flow from operating activity (CFO). The higher the CFO is, the better. Compare the CFO with net profit over the years to see whether the funds are getting stuck in or released from working capital. Capital expenditure (capex). Compare capex with the CFO to see whether the company can fund its capital expenditures from its operating cash flow. Companies that show high sales growth without much capex potentially could be capital-light compounders. Total debt. The lower the debt is, the better. High debt (for nonfinance businesses) signifies living beyond one’s means.
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Return Ratios Analysis Self-sustainable growth rate (SSGR). This represents the debt-free, SSGR potential of a company. Companies growing at a higher rate than SSGR are using more resources than their inherent operations can generate, and they experience increasin...
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Profit before tax/average net fixed assets. The higher this ratio is, the better. A company should earn more on its tangible assets (as well as tangible equity and capital employed) than the bank’s fixed deposit rate. Pretax return on tangible equity. The higher the pretax return is, the better. Tangible equity is calculated by subtracting intangible assets and preferred equity from the company’s book value. Be cautious of companies for which the high return on equity figure is being primarily driven by higher leverage. Return on capi...
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Operating Efficiency Analysis Net fixed asset turnover ratio. The higher this ratio is, the better. A high ratio shows that the company sweats its fixed assets in an efficient manner. Receivables days. The lower the number of days, the better. A higher number means that the company is giving customers a longer credit period to generate sales. In case of fictitious sales, in which cash is not received from customers, the number of receivables days will be constantly increasing. Inventory turnover ratio. The higher this ratio...
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Balance Sheet Analysis Net fixed assets. Look for sharp increases in this figure on the balance sheet. These increases signify that the company has completed a capex program, which could drive higher sales and profits in the future. Capital work in progress. Look for sharp increases in this figure on the balance sheet. These increases signify that the company is currently undertaking a capex program, which may be on the verge of completion. Share capital. Ideally, the share count should be constant over the years, or it should decrease because of buyback. An increase in share capital that is
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6. Management Analysis Study the background and credentials of promoters and search the Internet for any corporate governance issues. Use keywords like “fraud,” “scam,” “litigation,” “investigation,” and the like. Management red flags include exorbitant salaries, perks, and commissions (most worrisome if paid during a period of losses); a high percentage of insider holdings being pledged; promoters merging their weaker privately owned companies into their publicly listed company; engaging in significant relatedparty transactions; appointing relatives who lack adequate qualifications; using
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Neuroscientists have found that the prospect of making money stimulates the same primitive reward circuits in the brain that cocaine does.”
Capital allocation is a CEO’s most important job. How he or she allocates capital is what determines the value created for the business and its shareholders in the long run.
Although many great lessons can be gleaned from the transcript of this talk, the big idea that I took away was the fact that Munger does not think in terms of intrinsic value today, which is an imprecise number and often triggers a hornet’s nest of debates regarding the discount rate to be used for valuing future earnings, or the perpetual growth rate (also known in finance parlance as “terminal growth rate”) to use at the end of the explicit forecasting period.
EBITDA, however, does not take into account real cash expenses like capital expenditure (capex), interest, and taxes.
so do not take the accountants’ definition of capex at face value. Accountants don’t evaluate; they record transactions.
A margin of safety is achieved when securities are purchased at prices sufficiently below underlying value to allow for human error, bad luck, or extreme volatility in a complex, unpredictable and rapidly changing world. —Seth Klarman
According to Hamtil, The lesson from this exercise, I believe, is that investors should always be conscious of starting valuation when placing their bets. 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
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The stock markets, in aggregate, have been a positive-sum game over the long term.
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 attention to the quality of business and management above all else.
(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.)
Crash diets, predatory pricing, dishonesty, and shortcuts can work well for a while, but they are never sustainable.
Rule number 1: Most things will prove to be cyclical. Rule number 2: Some of the greatest opportunities for gain and loss come when other people forget rule number 1.3
Peter Lynch calls the “bladder theory” of corporate finance: “The more cash that builds up in the treasury, the greater the pressure to piss it away.”5
John Templeton has described bull markets: “Bull markets are born on pessimism, grow on skepticism, mature on optimism, and die on euphoria.”
insidious
prudence
“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].”17
perniciously
Diversification is the best way to admit you have no idea what’s going to happen in the future. It’s how you prepare a portfolio for a wide range of future possibilities and admit your own infallibility. —Ben Carlson
Overdiversification tends to result in mediocre performance …
George Soros was referring to when he said, “It’s not whether you’re right or wrong that’s important, but how much money you make when you’re right and how much you lose when you’re wrong.”4
We should not aim for the highest possible returns in the shortest period of time but rather we should seek above-average returns over a long period of time with the lowest possible risk.
