Another Reader’s Question: Any Suggestions on How to Learn How to Invest?

Index investing outperforms active management year after year.–Jim Rogers

Reader: How Do I learn how to invest? Suggestions?

My reply follows in three parts: What NOT to do, traditional advice, and what I suggest.

What NOT to do

Here is what you should NOT do when learning how to invest.

Ignore the difference between price and value: http://www.youtube.com/watch?v=pMz_sPs11HU

Sit all day watching CNBC so you can be “up on the economy and markets.” http://video.cnbc.com/gallery/?video=3000034368

Buy whatever Cramer recommends:http://www.youtube.com/watch?v=gUkbdjetlY8 but wait until the price pops higher so you can be sure.  You remember the adage: “Only buy what goes up, and if it don’t go up, don’t buy it.”  If you can find the most popular companies mentioned relentlessly in the news wait until the price has been rising for a several months, then buy. Price is everything. Be part of a group. Ignore any conflicting information in your investments because you won’t be successful being negative. After any purchase, ask friends what they think of the stock. Choose someone randomly and ask them why you own the stocks you have in your portfolio. If they don’t answer, yell at them for their stupidity.

After losses, blame anyone but yourself. Buy as many stock-tip newsletters as you can afford, so you don’t miss anything. If the story sounds good, then buy the stock.  Read Barron’s to supplement what you hear on CNBC and buy what the experts think–just do it quickly. Avoid becoming confused by reading the 10-K, proxy, annual reports, product and customer information and/or credit reports. Do what the charts say. Attend expensive training and trading schools like http://www.tradingacademy.com/stamford/ (Click on Video)

Or http://www.wallst-training.com/

You will make so much money that spending $10,000 for a two-day course will be a great “investment.”

Spend as much time learning about Macaulay Duration, efficient frontiers, and predicting the markets as you can. Live by the saying, “Often wrong, but never in doubt.”

Traditional advice in order of preference:

  1. http://www.aier.org/product/how-invest-wisely-2010 A non-profit research organization on economics and personal investing in Great Barrington, Ma. A good source of independent research for individual investors. Recommended that you view their store on investing materials.
  2. http://news.morningstar.com/classroom2/home.asp?colId=397&CN=COM This site has a series of classes to teach you the simple basics. Not bad for beginners.
  3. American Association of Individual Investors: http://www.aaii.com/
  4. http://www.fool.com/how-to-invest/index.aspx?source=ifltnvpnv0000001
  5. http://finance.yahoo.com/education/begin_investing/article/101181/Advice_for_a_Novice

What I suggest

Any advice I give is from my perspective so what works or worked for me may not fit your personality, goals and situation. With that caveat let me suggest:

First, read the classics: The Intelligent Investor by Ben Graham, Rev. Edition by Zweig. Get a feel for how Graham approaches investing. Next read, Margin of Safety by Seth Klarman (in Value Vault) as a further reinforcement of the value investing approach. You can then read, The Interpretation for Financial Statements by Graham in the Value Vault to give you a basic background for reading 10-Ks.

You will need to read Warren Buffett’s letters to shareholders several times to grasp all the points he is making. A good book, The Essays of Warren Buffett here:http://www.amazon.com/Essays-Warren-Buffett-Lessons-Corporate/dp/0966446119organizes his letters into subjects for easier reading. Or go to http://www.berkshirehathaway.com/letters/letters.html

Second, pick an industry with a simple product that you can understand with a few industry participants and pretend to write a story on the industry. Take the carbonated beverage or beer industry–the product is simple and there are fewer than a dozen major companies in either industry.  Read the 135-year history of Coca-Cola, read a book or two about Pepsi. Then take five years of annual reports and proxies from Cott beverages, Pepsi, and Coke and read them.

Third, figure out what their returns on capital are, sales trends, profit margins and company risks. Would you want to buy one of these businesses? At what price? Why are certain companies doing better or worse than their competitors? Have their market shares changed much over the years? Can they raise prices?

You will need to spend about two or three months reading about 30 minutes each day but you will become fairly knowledgeable about beverages. If you don’t like my idea for beverages then choose an industry/business that YOU are really interested in.

Finally, read through Security Analysis by Ben Graham (6th Edition). Note your interest in the readings. If sitting alone for hours is agony or pawing through Security Analysis is unbearable, then that will tell you volumes. Don’t worry if you haven’t the personality or interest to be a self-directed investor, just know your limitations and respect them.

If you struggle with financial statements, take a free internet course on accounting or take a course at a community college. There are plenty of programmed texts so you can learn on your own.

Learn Austrian economics–see prior post on studying financial history here: http://wp.me/p1PgpH-wN.

If you are very ambitious, get a subscription to Grants at http://www.grantspub.com. Then download all the issues since 1983, read all the books mentioned in the issues and try to understand the investment merits or lack thereof in the companies mentioned. You will learn more than going to business school.

Read the commentary in the Value Investors Club at http://www.valueinvestorsclub.com/value2

Learn how investors view various investments. Try to reverse engineer the company recommendation by looking at the original financial statements.

I hope this helps.  Let me know how your journey progresses.

18 responses to “Another Reader’s Question: Any Suggestions on How to Learn How to Invest?

  1. How funny! You reminded me of a comment made at The Rational Walk recently, which made me laugh, knowing how Benjamin Graham described Mr. Market…

    Jim Cramer = Mr. Market

    • The market will always have people like Jim Cramer. In the 1930s it was Gerald Loeb, E.F. Hutton’s mouthpiece broker. Loeb’s visibility in the press was, as it often is, mistaken for respectability. Both Cramer and Loeb are entertainers who know how to turn a phrase to cajole the inexperienced investor and make a commission off it. Loeb and Cramer are the personification that you can’t believe everything you read or see.

  2. I like how you don’t hold back when you share information. I also really like your approach of figuring out what’s going on in the business through the financial statements – seeing what jumps out at you and figuring out what’s what on first glimpse.

    If anything, your blog will most likely be a foundation stone for future generations of investors who didn’t go the ivy/business school route.

    Second that about reading/learning about the industry and business.

    It would be nice to form a small group/team so we could dissect picks by people like David Einhorn and share notes on daily SEC RSS pickings.

    Like Orpah book club but not books. 10k/Q and other country variants.

    I have a question about the multiples you have used in a couple of your lecture writeups (lesson 2 you used 13 p/e and in the “What’s it Worth” on Enron you used 9-11). What did you base that on? Competitors’?

    Thank you very much.

    http://www.farnamstreetblog.com/2012/01/what-you-were-supposed-to-learn-in-kindergarten/

    What You Were Supposed to Learn in Kindergarten

    In his 1986 book, All I Really Need to Know I Learned in Kindergarten, Robert Fulghum laid out the foundation for life.

    Some of his advice:

    – Share everything.
    – Play fair.
    – Don’t hit people.
    – Put things back where you found them.
    – Clean up your own mess.
    – Say you’re sorry when you hurt somebody.
    – Watch for traffic, hold hands, and stick together.

    • Dear Kevin:

      Try to stay focused on absolute values and don’t deviate.Investing is like healthy living. Obvious given enough experience but hard to consistently do well.

      13 P/E came from Prof. Greenblatt. He chose that as the lowest of the P/E multiples based on quality of business, industry, interest rates. P/E multiples are just discount/cost of capital in drag. Try not to just slap a multiple on things.

      With Enron I used 9-11 as a proxy for an average business. Go to The Triumph of the Optimists and you see the long term return on equity for the past 100 years has been in the 9 to 11% range so I use those rates as multiples. No other reason.

      If you want a group I am happy to send out an email for you. I am more of a lone wolf and I struggle now to read all the documents I need to, so I don’t know if I could participant much in any group but if you can find a bullentin-board and such and if there is interest I will do what I can.

      Good luck.

  3. With regard to the statement of Jim Rogers, I believe one also learns to make a distinction between active and passive after a while.

    I believe one should make a decision based on elements like resources, research abilities, discipline, drawdowns you can handle (try to think in absolute amounts and you would be surprised how risk averse most people are),… Something like drawdowns is irrelevant to a rational value investor but a lot of retail investors fall in that trap and just want something that has reasonable expected returns and limited drawdowns that keep them from bailing out at the lowest point of the market. Therefore, I believe you should first evaluate your own psychological and research capabilities as well as your goals. If you think a value-oriented approach will give you better returns and / or lower risk (as in impairment of capital) and if you are willing to invest in your research, it is probably one of the ways to go in investing. But if not, my two cents is that you shouldn’t be ashamed of buying just beta at a low cost in a ‘diversified / smart’ way. This last solution is at least better than outsourcing your beta and pay alpha fees for it.
    As always, just my two cents…

  4. Hi John, just some thought/questions.

    1. I recall you recommending once for new investors to review value line reports. I can see this strategy fitting in nicely with your 3rd step. How far back do you generally recommend one look to get a good feel for the companies within the industry?

    2. You also recommend in your 2nd step to find books about a the industry and/or some of the major competitors in that space. Do you have any recommendations by industry? One recommendation I have gotten for the oil & gas industry is Nontechnical Guide to Petroleum Geology, Exploration, Drilling and Production. Perhaps we can start a list of useful books for those looking to learn about specific industries. I would be willing to help organize/maintain such a list or library.

  5. Scott, I also sometimes look around for industry books, but I believe there aren’t a lot of them around (so I end up with AR)? If you would have others, would be great if you could share…

  6. Dear Scott:

    AR means Annual Reports. Usually the 10 to 12 years Value-Line (VL) goes back gives you at least one or two business cycles to look at to gain an understanding of average operating results.

    Go to S&P industry reports for a list of sources for each industry or ask people in that industry what sources there are to read.

    Studying an industry is like putting together a puzzle–one source will lead to another and another.

  7. I did not read the AR itself but for example see http://www.oldschoolvalue.com/blog/stock-analysis/rarely-do-you-see-such-an-excellent-airline/. Probably it is worth reading this AR if interested in this industry.

    You can also find a lot of information on the internet. For example: you might have read in the newspaper/found via google that Valueact as well as Yacktman fund are two big shareholders of http://www.google.com/finance?q=bcr. On the google finance page, you see directly that BDX and COV are two big competitors. Go to http://www.dataroma.com and you will see BDX and COV were also in the portfolios of people like Einhorn. Sooo, if you think standing on the shoulders of these investors is a good idea, you could be on to something.

    Next steps could be:
    (1) Try to make an industry overview : how does BCR compare to JNJ, COV, BDX, MDT, BSX, STJ, SYK, What are the other players in this niche industry? Can you make a broader picture of the whole healthcare sector, since maybe you noticed people like Greenwald are positive on companies like WLP (think local economies of scale). Do you have marketshare data (check presentations on company website)? Does regulation / healthcare reform has an impact here? Other drivers like aging population? What is the relationship with hospitals?

    (2) Try to find the specific competitive advantage of BCR. Is there any?

    (3) What’s the history of the company? Read press articles.

    (4) You see that the simple P/E is not that low. Why do people like Yacktman buy it? Do they think EPS will grow into the P/E? Does this company deserves a premium multiple maybe? Did a competitor have problems so that BCR can take advantage of it?

    (5) etc. etc. etc.

    Also read AR of funds, I believe these are often free textbooks that are often overlooked!

  8. And most importantly….wait…have patience…and go for it if you think you understand the situation. Without an investment mandate and without a deadline, you are by definition ahead of 90% of the investment industry.

    I keep on repeating it..these are just my two cents of course…everybody has its own way.

  9. Mohammed Al-Alwan

    The following book volume 1+2 was an excellent start for me to learn about industry analysis. Also, S&P industry survey is another good source but they are quite expensive.
    http://www.amazon.com/Handbook-Canadian-Security-Analysis-Evaluating/dp/0471641812

    the following book was a good start on understanding oil and shipping industry.
    http://www.amazon.com/Oil-101-Morgan-Downey/dp/0982039204

    you can also,check ken fisher investment series,he has an nice series on industry analysis
    http://www.fisher-investments-press.com/fisher-investments-press-books/investment-sector-guides.aspx

  10. Thanks Mohammed for your links. If you are near a major library, you will find the S&P Industry Surveys, but for those who do not have access, your links could be very helpful.

  11. Good list of resources. I suggest following Warren Buffett since he is the world’s greatest investor. Be careful though because his company buys stocks that the media says are Buffett purchases, and he also buys mostly preferred stock which is different than common stock (regular kind you see on charts and stuff). But he has been buying BNI Burlington Northern common stock lately and a lot of it, so I suggest that.

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