I am on the road and will post this Sunday.
The goal of this blog is to help self-directed, motivated investors to learn to think strategically and independently–to be the best you can be.
To that end, if you have any digital books, case studies, lectures, and/or links that you believe will further our educational goals, please don’t hesitate to email me at aldridge56@aol.com with your ideas.
Have a good weekend.
Reality is merely an illusion, albeit a very persistent one. ~Albert Einstein
Sign up for a free course on the U.S. Constitution from Hillsdale College: http://constitution.hillsdale.edu/ If you are a U.S. citizen, you should read the Declaration of Independence, the Bill of Rights and the Constitution at least once.
See Howard Marks’ Memos: http://www.oaktreecapital.com/
Assessing performance: http://www.scribd.com/doc/81843377/Assessing-Performance-Records-A-Case-Study-02-15-12 You will see why so many institutional investors are index huggers. Also, luck plays a huge role in short-term performance–obviously.
The cycles of value investing: http://www.pzena.com/investment-analysis-4q11
How rss can save you time in your research: http://www.eurosharelab.com/newsletter-archive/252-what-the-hell-is-rss-and-how-can-it-save-you-hours-per-day
“I put instant coffee in a microwave oven and almost went back in time.” –Steven Wright
A reader who blogs at http://valueprax.wordpress.com/2012/02/15/wall-street-mesmerized-perplexed-by-400-man-but-why-valueinvesting/ sent me this interesting article. The lessons here are simple, you have huge advantages over traditional money managers if you invest independently. You have to be patient and selective. Pedigree does not matter but clear, rational and independent thinking does matter.
Focus on understanding the businesses behind your stocks and understand the businesses from the CUSTOMERS’ perspective.
By BRETT ARENDS (abbreviated)
On a fall day in 2010, half a dozen wealthy investors and portfolio managers converged on an office in midtown Manhattan. These were serious Wall Street moneymen; in aggregate, they handled more than a billion dollars. They had access to the most exclusive hedge funds and investment partnerships and often rubbed shoulders with the elite of New York, Greenwich and Palm Beach.
But on this day, they had turned out to meet an unknown college dropout from Utah — and to find out how he was knocking them all into a cocked hat.
The unknown, Allan Mecham, had been posting mind-bogglingly high returns for a decade at a tiny private-investment fund called Arlington Value Management, and the Wall Streeters were considering jumping on board. For nearly two hours, they peppered him with questions. Where did he get his business background? I read a lot, he replied. Did he have an MBA? No. I dropped out of college. Did he have a clever computer model or algorithm? No, he replied. I don’t use spreadsheets much. Could the group look at some of his investment analyses? I don’t have any of those either, he said. It’s all in my head. The investors were baffled. Well, could he at least tell them where he thought the stock market was headed? “I don’t know,” Mecham replied.
Money pros who know him say none of Allan Mecham’s investing tactics are astonishingly difficult — but for various reasons, most investors don’t use them.
His investment approach will be familiar to anyone who has been even a casual follower of Buffett. Mecham looks for businesses with great long-term prospects, great management, strong cash flow and big defensive “moats,” or barriers to entry for potential competitors. And he stresses the importance of sitting still and doing nothing. “Activity is the enemy of returns,” says Mecham. “If I find two new ideas a year, that’s phenomenal.” Two ideas a year adds up to a pretty small portfolio — Mecham typically owns between six and 12 stocks. (That’s one thing that sets him apart from mutual fund managers; because of industry regulations on diversification, traditional funds typically have to have at least 15 holdings.)
I will post my answers at the end of this week to the Philips Electronics case study mentioned here: http://wp.me/p1PgpH-r2. Readers feel free to post your analysis.
Normally I am not a huge fan of investment books since many are poor substitutes for the classics.
The Investment Checklist The_Investment_Checklist by Michael Shearn (2012) gives new and intermediate investors a more programmed approach to analyzing investments including competitive advantages. I have no affiliation with the author, but I recommend. Is the book perfect? No. Figuring out if management is motivated is harder than the checklist approach would make it seem. However, you will benefit by being relentlessly thorough BEFORE you invest.
Two reviews below.
Anyone wishing to utilize a disciplined method for investing should read this book by Shearn.
Good investing mean avoiding mistakes and taking calculated risks. Identification of risk involves deep thinking about “what can go wrong?”. This is where this book shines, since it forces you to adopt a structured approach of working through a checklist of the possible unknowns. Too many unanswered items? – Take a pass until you can complete the checklist.
What I really liked about the book are the tons of real life examples of exactly what he means. You look at investor conference calls in a different way, as it has an exhaustive section on evaluating management and their responses. Are they honest? Are the overly promotional? What are they trying to hide? You see real life examples of both sides – the good and the bad ones.
The book made me think of many situations in the past that were strong clues about excessive risk.
Another useful aspect of the book is that it provides many outside sources (websites, etc) to check your facts. Investing in teen retailers? Shearn provides a number of free sources to verify and understand trends.
I’ve no doubt that this book will make me better at researching a company.
For anyone not employing a checklist – the Shearn checklist provides a great template to success.
R. Michael Knipp
Private Investor
Overall, I thought the book was very interesting and well written. It did a nice job of helping people learn how to think about businesses from a strategic and competitive point of view. The one thing that would have made the book better would have been some discussion to tie the strategic analysis of the company to some valuation frameworks. There was some mention of what the author and his firm were paying for certain companies when they purchased the stock, but it was not a complete discussion of valuation and the related value investing concept of a margin of safety. With that said, I do think that the anecdotes included in the book were helpful and added good context.
If it’s a penny for your thoughts and you put in your two cents worth, then someone, somewhere is making a penny.” –Steven Wright
The questions are on Chapter 7 (pages 137 to 159) from Competition Demystified. Also, read: An Open Letter to Warren Buffett Re: Cisco Systems http://www.capatcolumbia.com/Articles/Reports/Buffett.pdf and Philips Case Study: http://www.scribd.com/doc/81400135/pcd
Question 1: Discuss first mover conditions that Philips might have considered in entering the compact disc and compact disc player markets. Consider: market growth, establishment of standards specs, patents, customer captivity, economies of scale.
Question 2: Why was Cisco able to dominate the router market in the 1980s and 1990s in a way that Philips was not in the compact disc market?
Question 3: Explain the statment, “No matter how complex and unique products seem at the start, in the long run they are all toasters.”
We will follow up by the end of the week.
“I just got out of the hospital. I was in a speed reading accident. I hit a book mark and flew across the room.” –Steven Wright
Q: What competitive advantages does Microsoft enjoy in the operating system industry?
The only segments within the PC world with features suggesting that there are barriers to entry protecting incumbent firms from new entrants are operating systems and CPUs. In both there are a small number of competitors and stable market share. Microsoft enjoys both customer captitivy and economies of scale in the operating systems business. Customers prefer to stick with what they know, especially regarding software. Swithching costs can be prohibitive when many users have to be taught to use unfamiliar programs. Search costs also inhibit change because the buyer has to have confidence in the reliability of the new system and the survivability of its creators.
The most important advantage is economies of scale. Writing complicated software keeps expensive engineers at their terminals and benches for hundreds of thousands of work hours. On the other hand, the marginal costs of the next unit of the operating system can be low as zero, and seldom more than a few dollars, even when burned on a CD and boxed with a manual.
Network effects enhance both customer captivity and economies of scale.
Q2: Why have “box makers” not been able to establishy a competitive advqtage over other competitors? Why was the enormous growth in the market for PCs such a problem for Compaq specifically? Did it have any alternatives that might have worked out better than its chosen strategy? Did Apple?
The Compaq story is so interwined with the hsitory of the PC that it is easy to miss the more general significance. It lost its competitive advantage and the resulting high levels of profitability as the markets grew and allowed competitors to develop equivalent economies of scale. Rosen, the venture capitalist, was astute to recognize that the quality and economies of scale advantages of Compaq benefited from in the 1980s were now history, and that unless Compaq changed its business plan, it was going to be fighting against lower-cost but qualitatively equal competitors. He and his team pursued the operational efficiency in the absence of competitive advantage.
Apple confronted a grim situation. In the two market segments–microprocessors and operating systems–there were powerful competitive advantages, enjoyed by Intel and Microsoft, based on economies of scale, supplemented by captive customers and some proprietary production technologies. The other segments were highly competitive.
Apple operated, either by itself or in partnership with Motorola, in five market segments within the PC universe. Apple did not possess a competitive advantage. Tying those segments together in the name of “synergy” did not help. Also, the evolution of the industry toward separate maor players in each segment argued strongly against the existence of significant advant5ages from vertical integration. Apple held only 10% of the PC market so it had no bargaining power in alliances.
Apple should have specialized and focused on operational efficiency at least to where it could have earned its cost of capital.
END
This blog is slowly being reorganized. This weekend I will post the answers to the questions posed for Chapter 6 in Competition Demystified. Readers have already posted excellent analysis. The readers here far surpass the “professor.”
I will write-up study questions for the funeral case studies. If you don’t have those cases simply email: aldridge56@aol.com with FUNERAL HOMES in the subject line.
And finally, I will have new cases for Chapter 7 and 8 in Competition Demystified next week. We must move forward.
Valuation formula: Earnings next year/(Cost of Capital – Perpetual Growth Rate) = Intrinsic Value. Or $1 in earnings/(10% – 5%) = $20.00
It takes two minutes to learn how to use the formula but a lifetime to know what to plug into the formula.
”I do not ask that you place hands upon the tyrant to topple him over, but simply that you support him no longer; then you will behold him, like a great Colossus whose pedestal has been pulled away, fall of his own weight and break in pieces.” -Étienne de La Boétie
Do you see any flaws in the author’s argument. If not, then read the next article on the Economics of a P.O.W camp.
What do animal pelts, tobacco, fake wampum, gold, and cotton-paper bank notes have in common? At one point or another, they’ve all stood for the same thing: U.S. currency.
IN DOLLARS WE TRUST
The dollar, meanwhile, remained the anchor currency of the world: the one ring that kinda rules them all. Other governments hold on to dollars and use them for paying debts, and in the aisles of the global supermarket of goods, most items are priced in U.S. dollars.
This is what’s so weird about commentators in the U.S. proudly declaring that the dollar is the most stable currency in the world, as if this were because of American economic policy today, when it’s really just the result of negotiations a few generations ago that made it the backbone of the whole system. The greenback is stable because the U.S. economy is huge and the United States is a terrific republic–OK. But it’s also stable because everyone else’s well-being depends on it, and on belief in its stability. That may be changing, though.
As for paper money itself, the end of the gold standard meant that cash had become a total abstraction. Its value now comes from fiat, government mandate. It’s a Latin word meaning let there be. In God we better trust.
From The End of Money: Counterfeiters, Preachers, Techies, Dreamers–and the Coming Cashless Society by David Wolman. Reprinted courtesy of Da Capo Press.
http://mindhacks.com/2008/07/06/the-economics-of-a-prisoner-of-war-camp/ and PDF article here (excellent!) http://www-rohan.sdsu.edu/~hfoad/e111su08/Radford.pdf
Commodity money is money whose value comes from a commodity out of which it is made. It is objects that have value in themselves as well as for use as money.[1]
Examples of commodities that have been used as mediums of exchange include gold, silver, copper, peppercorns, large stones (such as Rai stones), decorated belts, shells, alcohol, cigarettes, cannabis, candy, barley etc. These items were sometimes used in a metric of perceived value in conjunction to one another, in various commodity valuation or price system economies.
Commodity money is to be distinguished from representative money which is a certificate or token which can be exchanged for the underlying commodity, but only as the trade is good for that source and the product. A key feature of commodity money is that the value is directly perceived by the users of this money, who recognize the utility or beauty of the tokens as they would recognize the goods themselves. That is, the effect of holding a token for a barrel of oil must be the same economically as actually having the barrel at hand. This thinking guides the modern commodity markets, although they use a sophisticated range of financial instruments that are more than one-to-one representations of units of a given type of commodity.
Since payment by commodity generally provides a useful good, commodity money is similar to barter, but is distinguishable from it in having a single recognized unit of exchange. (Radford 1945) described the establishment of commodity money in P.O.W camps
To learn more about avoiding fallacious thinking* take a course in logic from an outstanding professor, David Gordon. I have taken this course–recommended for those who have never taken logic. http://academy.mises.org/courses/logic/
The author in the first article makes an assertion without logic or evidence to back up the statement. Money doesn’t have value just because the government says it does. Obvious proof of that is the German Hyper-Inflation in the 1920s when the currency went to worthlessness. A monetary crack-up.
One reason so few of us achieve what we truly want is that we never direct our focus; we never concentrate our power. Most people dabble their way through life, never deciding to master anything in particular. –Tony Robbins
The article below reinforces our studies in strategic logic. Corporate diversification destroys value. “Diworsification” says the famous money manager, Peter Lynch. Teledyne posted here: http://wp.me/p1PgpH-2c) proves the rule.
https://www.mckinseyquarterly.com/Corporate_Finance/M_A/
Testing_the_limits_of_diversification_2924. The exhibit shows how the total return to shareholders of conglomerates has capped upside but unlimited downside.
The argument that diversification benefits shareholders by reducing volatility (beta!) was never compelling. The rise of low-cost mutual funds underlined this point, since that made it easy even for small investors to diversify on their own. At an aggregate level, conglomerates have underperformed more focused companies both in the real economy (growth and returns on capital) and in the stock market. From 2002 to 2010, for example, the revenues of conglomerates grew by 6.3 percent a year; those of focused companies grew by 9.2 percent. Even adjusted for size differences, focused companies grew faster. They also expanded their returns on capital by three percentage points, while the ROCs of conglomerates fell by one percentage point. Finally, median total returns to shareholders (TRS) were 7.5 percent for conglomerates and 11.8 percent for focused companies.
As usual, the median doesn’t tell the entire story: some conglomerates did outperform many focused companies. And while the median return from conglomerates is lower, the distribution’s shape tells an instructive story: the upside is chopped off, but not the downside (exhibit). Upside gains are limited because it’s unlikely that all of a diverse conglomerate’s businesses will outperform at the same time. The returns of units that do are dwarfed by underperformers and therefore probably won’t affect the entire conglomerate’s returns in a meaningful way.
Moreover, conglomerates are usually made up of relatively mature businesses, well beyond the point where they would be likely to generate unexpected returns. But the downside isn’t limited, because the performance of the more mature businesses found in most conglomerates can fall a lot further than it can rise.
Consider a simple mathematical example: if a business unit accounting for a third of a conglomerate’s value earns a 20 percent TRS while other units earn 10 percent, the weighted average will be about 14 percent. But if that unit’s TRS is negative 50 percent, the weighted average TRS will be dragged down to about 2 percent, even before other units are affected. In addition, the poor aggregate performance can affect the motivation of the entire company and how the company is perceived by customers, suppliers, and potential employees.