A Reader Seeks Advice

I must create a system, or be enslaved by another man’s–William Blake

This reader confronts a quandary that many of you might have faced. Thoughts or suggestions? Advice?  I will post my thoughts later.

A Reader Writes about transitioning to value investing

I have traded equities, futures, and options successfully from a carve-out from a fund. I have spent my entire 11 year career in two buyside proprietary shops. Fortunately or unfortunately, I never had any finance exposure in school or career wise (in the traditional sell-side sense). I graduated magna cum laude from XXX with major in psychology. I have always wanted to become a value investor and run my own fund one day. I currently run my own book now but it is 180 degrees from what value investing is as I’m sure you know being a former trader.

The struggle for me is that I don’t have the fundamental basics down yet for value. I am currently teaching myself basic accounting (I actually had to go back and do a refresher in algebra as well). I’m not an analyst although I use and trade off analysts for work and find the transition difficult in analyzing financial statements, companies, etc. because of my lack of experience. I came into trading without a mentor and had to self teach myself, and find myself in the same position again for value investing.

I have read a lot of the value investing grails like Graham and Dodd, Buffett, Greenblatt, Greenwald, Montier, Klarman, etc., However, putting things together without the basics has been overwhelming and tough for me. I understand the very simple concept of buying with a margin of safety but actually putting that into practice is not an easy task without some guidance.

I am having a tough time learning valuation. When I took Greenwald’s executive course on Value Investing last summer, I understood the big concepts but when we got down to the numbers, such as figuring out WACC, going through items line by line, a lot of things were over my head. I know these are things I gain from experience and learning the basics but it’s been tough trying to figure out what to learn on my own. Another problem is I don’t have a network of people to tap into that are value people. Everyone in my world is fast money whether they are fundamental or not.

I had the fortunate opportunity to sit down and speak to one of the value managers at A Value Investing Firm recently who is also a professor in the Columbia Value Investing Program. I had seriously considered going back to school, but she and I agreed that since I just turned 36 and that there is no guarantee that I will be selected into the Value investing program, that self-instruction may still be the best course for me. I have had a successful run as a trader but I would love to make the transition to Value just as you have. I would love any suggestions you have for me or perhaps we could even get together for a drink. I would be very curious and interested how you made the transition.

28 responses to “A Reader Seeks Advice

  1. I, too, am trying to teach myself how to properly value a business. I feel lost as well. I have more finance/investing books than I know what to do with and my time studying may be spread too thin and that I would be better off focusing on the few materials that are really worth it.

    So far, the few books that I have found helpful (and always come back to) in determining how to value a company and what drives value are:

    “Valuation” (Mckinsey), “Accounting for Value” (Penman), and “Financial Statement Analysis and Security Valuation” (Penman). I’ve heard a good intro into accounting and financial statement analysis is “Financial Statement Analysis” (Thomas Ittelson), although I have not read this book.

    One thing that I have noticed (learned?) as I read more and more (particularly from this blog), is that valuation may be the easy part. It’s not too hard to find a company that has a high ROIC and good earnings. I think the more important question, is whether the high ROIC and earnings are sustainable and what they will look like 10-20 years down the road. Don’t miss the forest for the trees (I think that is how the quote goes). That said, I think books that help frame this question and focus the analysis are: “Competition Demystified” (Greenwald), “The Little Book that Builds Wealth” (Dorsey), and “Hidden Champions” (Simon), help show what makes a business superior to others (the moat) and how wide/long a competitive advantage may be.

    I would love feedback from others, as I am also looking for the few books to know “cold” and so that can get more “value” out of my time reading and studying.

    Hope this helps.

    • Good post Tom. I want to think about your question and perhaps reply in a post. Note what Buffett has invested in. I doubt all companies can be valued but some can. You don’t have to value everything since some companies may be too variable or options (bio-tech) for example. Walk away.

      Buffett said he would only teach two things: How to think about prices and how to value. I believed he said he would teach about valuing a farm first. How many acres, yields, cost of fertilizer, variability of crops, range of prices, cost to borrow and what cash is left over then discount back to the present. He mentioned to Bernstein the Reporter from the Washington Post, that valuation is like reporting on a story–What’s it worth?

      Rent the movie, Other People’s Money with Danny Devito (an early post here) and see how he values NE Wire and Cable.

  2. If anyone disagrees with the above materials, please say so. I would love to hear why and what may be better alternatives.

    • Tom take the figures from the annual reports of the companies–found on company web-sites.

      I am not a big fan of Mary Buffett–just wanted to post as a GENERAL example.

      Thanks for your thoughts.

  3. Your reader sounds like a smart guy, but doesn’t have a firm foundation on basics of finance. He could always elect to take NYU’s Damodaran’s free course on Corporate Finance and learn about WACC etc.

    I have spoken to other great investors too, and they will tell you that going to Columbia or Harvard will not make you a great analyst/investor – if that was the case that CBS tuition would not be affordable, because all the graduates would eventual be billionaires. Insert Ben Graham quote here: “courage becomes the supreme virtue after adequate knowledge and a tested judgment are at hand”. They don’t teach judgement or courage at business school.

    CBS lets in roughly 40 people into their AVI program out of about 150 who apply. So the odds are against you and I heard their is no rhyme or reason to how individuals get selected. As an anecdote, their is always only one person of African descendant in the program! BUT, if you are student at CBS and not in the program, professor will allow you access to their classes as an auditor.

    Building a network and finding a mentor are very difficult. Finding a mentor is hard even if you go to CBS, most people who find a mentor are lucky in my opinion. I work in the same building as a famous investor who is an alumnus CBS and asked to met with him. He wrote back and said, I find meeting with people a waste of my time!

    I do find business school, great in terms of building a network, but you can go to any of the top MBA programs, join the investment clubs and build from their. Another piece of advice, CBS is not very strong in terms of the intimacy of their network, you are better off at HBS or Stanford IMO.

    4 years ago, I was accepted into CBS’s MBA program, I could not attend because that was the year the financial crisis destroyed the international student loan program. CBS was the only Ivy League school they did not backstop its International Students that were admitted in those years. With no American cosigner, I was unable to get financing despite trying for 3 years and a Value Investing Need Based Scholarship.

    Fortunately and unfortunately, I am on the buy-side, but not at the fund I would aspire to work for. What I am finding out now is that and MBA from a top school is a good option, if you want to want to move into a better firm.

    Ironically, I am still saving up for CBS’s MBA program and plan to attend one day, so I can move to a place with a mentor and build a network. I am not looking elsewhere, because I recently moved my family to NYC and my daughter loves it here.

    Investing is a continual learning process, business school can only accelerate that so much.

    Those are my puts and takes.

  4. I’d be very interested in any useful advice that readers have here, as i am in a similar boat (although i’m only 26). I’m also struggling with learning effective techniques to do valuations and develop a strong understanding of financial statements and accounting. I tossed Damodaran’s book after he started talking about Beta, and unfortunately i didn’t really get much from Greenwald’s book on the topic either (is it just me or does this guy talk the talk but then not really walk the walk? Everytime i see a pro like Einhorn or Michael Price talk about a valuation i’m thoroughly impressed and they never talk about reproduction values etc. that greenwald always emphasizes).

    On that note, The only advice i can give you as someone who is completely self-taught and basically only started reading about value investing 3 years ago is the following:

    READ EVERYTHING: When i first started, i read a lot of the books that talked about the psychology and theory of value investing. I started with “The Little Book of Value Investing” by Chris Browne. That is an excellent primer, and then i built from there, reading Margin of Safety by Klarman, and interviews with a lot of top hedge fund guys. Even if i didn’t understand everything they were talking about in terms of specific financial jargon, having the main theory hammered into me for a few years really prepares you for the turbulence in the market. Now, when one of my stocks goes down, i always have enough confidence to double down on it if i truly understand the stock. (Side note here, i still haven’t actually read Security Analysis or Intelligent Investor all the way through, everyone hypes those books but they are not for a novice and i always found myself in over my head when trying to read them, start with other more recent books, the same concepts are covered but are often explained more clearly and concisely)

    In addition, look for articles where respectable hedge fund managers discuss their thesis on an investment (einhorn, ackman, michael price, etc.) Read the Graham and Doddsville Newsletter from Columbia business school (free on their website) where these managers get interviewed and read their “Letters to the Investors” when you get the chance. You’ll notice that they don’t necessarily spend a lot of time talking about specific accounting numbers, they have a lot of understanding of the businesses themselves and the business models. You’ll rarely see them get into an esoteric conversation on how accurate the GAAP Earnings figure is, but you will see them discuss why they think earnings are depressed or why they will rebound and why the market is overreacting. That is far more fundamental to value investing than knowing a lot about accounting in my experience. When you read Buffetts letters (i highly recommend reading his partnership letters), you’ll see that even then, he doesn’t talk about the specifics of the balance sheet, but rather, the few simple reasons about why the stock is cheap. It is MUCH easier for me to grasp those principles than to learn the minutae of financial statements, and you can even successfully pick stocks by applying simple techniques.

    Speaking of simple techinques, there are 2 books that really stand out (besides Greenblatt’s magic formula, which is a good book but i can sense you want more than that). The first book is Why Do Stocks Go Up (and Down)? It was recommended by Michael Burry and i recommend it whole heartedly to you, it’s very very simple and illuminates most of what you need to know in terms of financial statements.
    The second book is the 5 Keys to Value Investing (found out about it from this site actually!), The reason this book turned me on was because Michael Price is my biggest influence (my goal is to work for him at MFP Investors) and the author of this book worked for him when he was at Mutual Series. He sets out very clear and basic criteria for investing in stocks and shows you exactly how he does it, there is no guesswork involved, and the explanations are very clear and detailed. I highly recommend that book. Again, it doesn’t require that much in terms of financial statement knowledge to grasp the concepts, and you’ll learn all you need to know from the Why Do Stocks Go Up book anyways.

    By the way, i highly recommend reading up about successful value investors and picking a few whose style you admire, for me that’s michael price, for you it may be someone else. Read their 13-F’s, read their explanations, and then go to EDGAR online and try to put together the same stories that they tell using your own intuition, it will be slow and painful the first few times but you will learn exponentially.

    I think the most important advice that i can give though is to remember that it is a marathon, not a sprint, i struggle with this a lot myself because i always think i should be learning faster and that i’m so far behind other people. The fact of the matter is if you keep reading and keep doing your own research you will soon find that your brain starts making a lot of connections and things slowly become clear to you. Like i said, i’ve only been studiyng investing for 3 years, and i still haven’t learned even a fraction of what i could know, but i get up every day and read SOMETHING investing related, every single day.

    So again, i hope that advice helps, and i’d be interested to hear what people recommend to learn about accounting and financial statement analysis.

    Regards,
    Krishna

  5. Perhaps it would be instructive to work on a more comprehensive valuation case study as a group. I would be willing to participate. Anyone else?

    We’ve briefly covered valuation a few posts back when we were going through a few Value Line case studies. That could serve as a good starting point.

    I have a question. How much do each of you rely on gathering data/information in spreadsheets on companies? Does it depend on the complexity of the investment? For example, David Einhorn, Ackman, etc. usually have 50+ slide deck presentations for the investments they present to the public. Do you think that much work is necessary? I know some private investors that deeply analyze complex investment situations (i.e. Sears Holdings), These guys go through and essentially look at everything. For a person working on their own, this task seems very cumbersome. Other investors think more about the businesses they are analyzing, so their spreadsheets and models are less complex.

    Would appreciate feedback.

    Thanks.

    • Dear Logan:

      Good idea, but I want to mention that there are 5 or 6 extensive indepth case studies on valuation with videos of the case studies on this blog. You would need to view the videos from the value vault folders.

      If you havent’ seen them, I can group all the links in a future post. There is Hudson General, Liz Clairborne, Munsingwear, etc. You can do a word search on this blog by plugging in the work in the search box to view the case studies.

      I will discuss valuation extensively but I want to finish Competition Demystified. Asset value is linked to earnings power value (always normalized so don’t take 0 interest rates as a forever) while franchise value has the value of future growth in a franchise (pray for impentrable barriers to entry)

  6. I think the reader who emailed you will be *far more* successful than most value investors, simply because he is cognizant of the existence of things he doesn’t know about. I tell people that the less they know about finance, the better, because calculating numbers is just a very small portion of it, in my opinion.

    I don’t know that I can recommend how to get started, but I would consider the length of what you’re doing. For example, let’s say that you’re writing auto loans. If you write a 1 year loan, then you’ll know how you did after just 1 year. If you write a 5 year loan, then it will take a little longer, and it’ll be 5 years before you know how you really performed.

    Stocks? Buffett has called these “100 year bonds” in a 1977 Fortune article that he wrote. It takes a much longer time.

    I still have a ton of work to do, but I will say that I started out with the shorter-term views by focusing on things like liquidation value. As I’ve progressed, I’m now looking around trying to find companies that I would be comfortable owning in their entirety and never selling them. The finance aspect can be handled, but the tougher part is just finding businesses that I really like and am willing to own for 20-30 years. Today, I start with understanding business and business strategy before valuations. Using historical data has many benefits, however requires a lot of discretion and judgement when projecting anything out into the future, and so I let that almost be a secondary aspect of what I’m doing.

    I could be wrong too though – we won’t know for a long time.

  7. I would also like to make a humble contrarian comment, within the frame of the transformation from a trader to a value investor.

    I do know most people who are reading this blog are interested in ‘value investing’ so it is natural to only consider this path of investing on this blog. In my opinion however, I think investing is about allocating money to get a certain (ex-ante) return versus risk award. How you define return and risk is of course subject to the personal interpretation of you as a capital allocator.

    In a broad sense this capital allocation can take any form. You can work with ETFs, you can trade commodities, you can invest in bonds, you can have your own start up in whatever business, you can invest à la Buffet, etc. As long as your investment approach satifies your needs and you stick to it, you should be fine.

    By this I mean…I don’t think you should consider value investing as the only possible investment approach. For me it makes sense since I always want to understand situations and a big part of value investing for me is to understand the business you are investing in. I think this should be the starting point why you pursue a ‘value investing’ approach. So first I believe you should write your goals and beliefs on a piece of paper, and then you could see this type of investing fits you.

    Just some random comments of course:)

    • I would agree with you – sometimes value investing takes form in many places, like the startup world, commodities, bankruptcies, etc. That said, I think you can take the same thing, even Coca Cola stock, and it can be speculative to one person while a value investment to another. I’m not sure what we invest in matters nearly as much as how well we know the item we’re investing in… and, of course, price 😀

      (Sometimes… I think the price we pay is actually going to modify the actual business outcome. If we invest in a startup at a very low price and management ends up with a miniscule ownership in the business, they may be demotivated, so price alone isn’t the only thing I personally look at, just as an example)

  8. Something else that helps me (I’m still at the beginning of my investment path so) is to look at history in terms of inflation, bond yields, equity returns, bankruptcies, etc. And by history I don’t mean the history of bond yields as available in Bloomberg as of 1962…go for example to Shiller’s website and look at data from 1900.

  9. Btw, if you would go in the fund industry…also read the latest GMO and Research Puzzle article.

  10. The best advice we can give others is usually the best advice we can give ourselves, so, in that vein, I offer this:

    Spend more time looking at actual companies and their actual financial statements and historical data, and less time reading theory. The theory all backs up and becomes gobbeldy-gook if you’re not continually applying it in a practical manner to REAL companies.

    There are THOUSANDS of companies with financial data out there, waiting to be examined. You will not find a bargain every time you look at one. You WILL learn something each time, however, and that’s invaluable.

    Part of Buffett’s humongous advantage is the great VOLUME of companies, deals, trades, etc., he’s considered and actually looked at. When you do so, patterns and one-offs start to jump out at you. You scratch your head less and go “a-ha!” more.

    How is business school going to do that work for you? It won’t. If you’re going to be a great value investor, you’ll find a way to do it on your own, as you must. Business school, generally, is for people who want to go work for others, not for themselves.

    Summed up, “Put down your value investing books, pick up your Value Line tearsheets. Start digging.”

    Man, if I just could learn to take my own advice, Buffett himself might have to look out! 😀

    • I am im the same boat as op, in that i am trying to teach myself and i find it all very confusing.

      I also find it that having only a high school edu. Makes learning that much slower. Thats why i respected walter schloss so much.he found and applied a system nd it worked very well.

      The best advice i can give anyone in a situation like mine is to rewrite the concepts and simpliy them so that they make sense to you.

  11. +1 for valueprax. If you have already read The Intelligent Investor, Margin of Safety etc. Spend your time on reading financial statements and not more books. When you go over a statement and you are not clear about something simply search it on the net.

    • Thanks John, Valuprax, and Roy. My hesitation has been that I don’t trust my knowledge of finance and investing enough to “take the plunge” and actually start analyzing companies. I guess the only way to really learn is by doing. Just start with the “A’s”, right?

  12. Pingback: Advice to a Reader on Transitioning to Value Investing | csinvesting

  13. There are many ways to go about getting what you want. I suppose the most important thing is to know what you really want in the first place. Do you want to get a job, start a fund? Those are worthy goals. Working with well known money managers or at a fund could open you to new ideas or opportunities. But it’s also important to focus on the basics. I just want to learn more about businesses and how to identify good companies and situations. Then I want to buy them. I think I’m getting that education not only here from John and the cases, but from the commenters and other ways – by doing. Someone I know who works as an analyst for a fund tells me how she works: she spends most of her time studying industries, annual reports, and understanding the business and how it changes. Also by talking to companies etc. She has her criteria for investment and a few valuation tools and that’s it. The rest comes with experience. I think the simple approach is good and obviously there’s a lot more to thinking and researching. I think JG said in his first lecture, no one can teach you this. But you can learn it. The person who wrote to John has skills that are very hard to achieve. Learning to invest is essential for financial stability but will going only to Columbia at 36 teach you this? Maybe. Maybe not. But definitely learn from others.

    Anderson Business School (UCLA) is trying to become the Columbia (the Value Investing Program) of the West Coast. Maybe you could take a certificate if you desire a structured approach and need a certificate. IThe UCLA external offers an online option that I’m considering because I have to fulfill a requirement and investigated it.

    As for contact, you have this blog. The people here seem really nice. You could always post questions and someone will answer with a well thought out reply (John: thanks for the information on the quick way to calculate excess cash; I now also have the full CFA instructions to find excess cash too; I was struggling to figure out how Logan James came up with 5mill in his calculations).

    Don’t give up. Someone very wise once told me nothing worthwhile is ever easy. There’s a lot to learn. How badly do you want it.

  14. About CBS … Go to a biz school if you want to change careers. It helps.

    About learning yourself …

    I’m only speculating here but seems to me that most successful investors have a very good understand of theory. Just because Buffett rejects beta or black-scholes doesn’t mean that he doesn’t understand these concepts. Quite the contrary. So if one is emulating these guys then its illogical and lazy to say “avoid theory because so and so says its b/s”.

    At the very least having a good grasp of accounting should be a prerequisite for someone who’s trying to value companies by looking at financial statements. WEB will be the first one to tell you that 🙂

    OP seems very willing to learn, which is half the battle won already. (Lovely attitude btw with the drink offer and the sit down with CBS person etc.) However, like everyone else he (she?) wants to ACCELERATE the learning process. Understandable … given their age, opportunity cost etc. My suggestion would be to shift the focus a bit from reading to CRITICAL reading. If I were to start my education again I would start with Buffett’s letters. Be really critical when you read them, i.e., read a few paragraphs then think about what he’s saying. Keep intermediate accounting and valuation textbooks (any except Penman) close to you and keep checking everything you don’t understand. Also, like Roy suggested … use internet to find concepts. Rinse & repeat as needed.

    Meanwhile also start reading posts on VIC to see how others value companies. Be critical and cross check what you don’t understand. When you like a thorough write-up then dig everything you can on the company. Again, be critical when you read the 10k, 10q, 8Ks etc. Look up what you don’t understand and don’t take anything for granted until you completely understand … stock option treatment, pensions, leases , taxes, whatever. Just keep referring back to your textbooks and internet. This will be a much more fun and fruitful way to learn than sitting in a class. You are in some sense designing your own curriculum. Might not be the most efficient way to learn but I doubt anyone knows the most efficient way. At least this way is sustainable and can be used for life.

    And obviously, keep reading John’s blog 🙂 Go through his folders. Try to solve his case studies etc. It’s a life long process for everyone so if after reading a lot you understand that you don’t understand much then you’re going in the right direction.

    Good luck.

  15. Comatozz,

    Why do you suggest avoding Penman’s books? What would you recomend instead. Just curious.Thanks.

    • Hi Tom,

      I tried reading his Fin Statements and Security Analysis a couple of times and just can’t understand what he’s trying to say. Accounting and FSA are not easy but he makes these more difficult than they should be. But that very easily could be my lack of IQ (in fact significant likelihood that’s the case!)

      I find Damodaran or Mckinsey fine for valuation. Stickney Weil is good for beginners accounting and James Morris is decent for intermediate issues. CFA accounting material is ok too.

  16. I slightly disagree with Comatozz:
    No question his Text, FSA and Sec. Val is not an easy read. Plus you have to have a worksheet of all the jargon: ROCE, FLEV, NFI, etc. But, you have to do the problems chapter by chapter religiously to learn the material. See the website for the book (Student Guide). Don’t get the text unless you can get the student manual (on website).

    But he teaches you how all the info links together and how it relates to valuation. He discusses valuing growth (Important!) such as segmenting growth for leverage. You will also learn how to build your own finanical models on companies (good for the job hunt for professional investors).

    To get a feel for his work see his 23 minute video here:
    http://www.youtube.com/watch?v=fL17offewa4

    A easier book is his Accounting for Value by Stephan Penman. Like Comatozz I first skimmed this book and threw it aside due to all the jargon, but returned to it after I struggled with valuing growth. I recommend it but for intermediate readers and don’t tackle it unless you are willing to substantially invest in reading and studying it.

    I will post on his methods when we get into valuation AFTER Comp. Demystified cases.

    But my word is not the only voice–see comments on Amazon.com on Penman.

    Good luck, its a slog, but you will learn.

    • Yea I think the acronyms put me off. I found it tough to keep them all straight in my head and found myself going back and forth just to parse all those. The book reads more like a collection of research papers but I didn’t do the problems in the end so its probably my laziness that’s to blame!

      Looking forward to your posts on his methods. Thanks as always.

  17. Hi All,
    I am the actually the writer of the original question to John about transitioning to Value. I wanted to thank everyone for all the great comments and suggestions. It’s reassuring to know there are is a community out there for beginners. I am a veteran of trading but investing is a different world for me. I have learned that there are ton of ways to skin a cat on wall street, (and double that number on ways to be skinned), but I have found there is a common thread in all the investors I respect: knowing how to value a business and buying with a margin of safety. Hopefully I will be able to make the transition.

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