[The Weekend Bulletin] #116: Joel Greenblatt, Quality Conundrum, Seeking Status,...
...Momentum, Non-financial Investments, Side Hustles, and more.
A digest of some interesting reading material from around the world-wide-web. Your weekly dose of multi-disciplinary reading.
Section 1: Investing Wisdom
William Green (author of Richer, Wiser, Happier) interviews Joel Greenblatt about concentration, margin of safety, magic formula, and more in this very insightful conversation. Below are two of my favorite moments from the conversation:
“And it's kind of like finding one of the best things you've ever seen, but putting one or two % of your portfolio into it. That's not getting it right. That's getting it wrong.”
“Yes, o, i think what you're alluding to is to be a really good investor and have a strong enough stomach, you have to have a screw loose some place to be able to handle it. And i think the answer is, yes, you have to have a little bit of a screw loose to be able to take those risks.”
"Price momentum is one of the strongest anomalies in stock markets. We know momentum strategies create excess returns over the market and these excess returns are similar in size or even larger than the value or the small cap premium. Momentum effects have also been documented across asset classes and it can be shown that momentum in one asset class creates momentum in another." But what really creates this momentum, and like most anomalies, why hasn't it been arbitraged away? This article explains.
The benefits of investing in good quality businesses are widely known. However, quality investing has two shortcomings and an important tradeoff that investors today need to think of. This article explains.
Section 2: Mental Models & Behavioral Biases
Social hierarchies (Status) are inbuilt into most species, and are inescapable. Research shows that those at the top of social hierarchy have a higher quality of life. However, maintaining top status also comes with a lot of stress, and can burn you out. Thus, getting to the top is both rewarding and painful (and inescapable). This article has some useful advice on how to make seeking status less painful.
Section 3: Personal Development
All of personal development is with either of two objectives: to get better at what you do or to learn new skills. While a lot of attention is usually paid to improving existing skills, there is merit in developing newer skills, at least at the adjacencies. Here are two interesting articles that talk about such adjacancies and link them to financial benefits:
This article bridges personal development with finance. Since future wealth is a function of initial investment and compounding, it proposes that improving skills can help you increase the initial investment (PV in the equation FV=PV*(1+r)^n).
This article goes a step further and lists four types of side hustles that you can participate in to develop multiple streams of incomes.
Section 4: Blast From The Past
Revisiting articles from a past issue for the benefits of refreshing memory and spaced repetition, as well as for a fresh perspective. Below are articles from #42:
He is often referred to as the Guru of the Gurus. He also developed the Earnings Power Value metric to determine the value of the firm without using the DCF model in his book released around the 2002. In this talk, Bruce Greenwald updates his concepts around earnings power and franchise value, especially in light of the last ten years (increasing importance of intangible assets) that will also form part of the second edition of his book to be released next month. He provides a good framework for valuing business and identifying if growth is value accretive or not.
When it comes to making money - as a tool to amass wealth - it’s easy to get lured by the upside. But we often forget, that making money is easy, preserving capital is tough. This is how we get lured into high flying returns of lesser known small and micro caps only to realise later that we lost our capital in the process (remember the 2018 crash in small cap stocks in India?). Most people learn the wrong lesson of avoiding small and micro cap stocks altogether, failing to comprehend a far simpler lesson: Avoiding stupidity is easier than seeking brilliance.
Here is how Morgan Housel puts it:
Section 5: Readworthy Passage
Let's read together a random, but read-worthy, passage from a randomly picked book.
SHORT PERIODS ARE VALUELESS
Consider the “Soaring Sixties.” The go-go growth managers of the era switched stocks so fast they were called gunslingers. Performance was the name of the game, and buying stocks with outstanding earnings growth was the way to get it.
In hindsight, look at how misleading a five-year period can be. Between December 31, 1963 and December 31, 1968, $10,000 invested in a portfolio that annually bought the 50 stocks in the Compustat database with the best one-year earnings-per-share percentage gains soared to almost $35,000 in value, a compound return of more than 28 percent per year. That more than doubled the S&P 500’s 10.16 percent annual return, which saw $10,000 grow to just over $16,000. Unfortunately, the strategy didn’t fare so well over the next five years. It went on to lose over half its value between 1968 and 1973, compared to a gain of 2 percent for the S&P 500.
More recently, the mania of the late 1990s provided yet another exam- ple of people extrapolating shorter term results well into the future. Here, it wasn’t “gunslingers” pouring money into just the stocks with the highest gain in earnings, but rather new-era disciples pouring money into Internet compa- nies that in many instances had little more than a PowerPoint presentation and a naïve belief that they were going to revolutionize the economy. In both cases, things ended very badly.
IT’S DIFFERENT THIS TIME
People want to believe the present is different than the past. Markets are now computerized, block traders dominate, the individual investor is gone, and in his place sit huge mutual funds to which he has given his money. Some peo- ple think these masters of money make decisions differently, and believe that looking at how a strategy performed in the 1950s or 1960s offers little insight into how it will perform in the future.
But not much has really changed since Isaac Newton—a brilliant man indeed—lost a fortune in the South Sea Trading Company bubble of 1720. Newton lamented that he could “calculate the motions of heavenly bodies but not the madness of men.” Herein lay the key to why basing investment decisions on long-term results is vital: The price of a stock is still determined by people. And as long as people let fear, greed, hope, and ignorance cloud their judgment, they will continue to misprice stocks and provide opportuni- ties to those who rigorously use simple, time-tested strategies to pick stocks. Newton lost his money because he let himself get caught up in the hoopla of the moment; he invested in a colorful story rather than the dull facts. Names change. Industries change. Styles come in and out of fashion, but the under- lying characteristics that identify a good or bad investment remain the same.
Each era has its own group of stocks that people flock to, usually those stocks with the most intoxicating story. Investors of the Twenties sent the Dow Jones Industrial Average up 497 percent between 1921 and 1929, buyng into the “new era” industries such as radio and movie companies. In 1928 alone, gullible investors sent Radio Corporation from $85 to $420, all based on the hope that this new marvel would revolutionize the world. In that same year, speculators sent Warner Brothers Corporation up 962 percent—from $13 to $138—based on their excitement about “talking pictures” and a new Al Jolson contract. The 1950s saw a similar fascination in new technologies, with Texas Instruments soaring from $16 to $194 between 1957 and 1959, and other companies like Haloid-Xerox, Fairchild Camera, Polaroid, and IBM taking part in the speculative fever as well.
The point is simple. Far from being an anomaly, the euphoria of the late 1990s was a predictable end to a long bull market, where the silliest invest- ment strategies do extraordinarily well, only to go on to crash and burn. A long view of returns is essential, because only the fullness of time uncovers basic relationships that short-term gyrations conceal. It also lets us analyze how the market responds to a large number of events, such as inflation, stock market crashes, stagflation, recessions, wars, and new discoveries. From the past, the future flows. History never repeats exactly, but the same types of events continue to occur. Investors who had taken to heart this essential mes- sage in the last speculative bubble were those least hurt in the aftermath.
- From WHAT WORKS ON WALL STREET by JAMES P. O’SHAUGHNESSY
Quotable Quotes
“The reason we do not ask basic questions is because, once our brain provides a logical answer, we stop looking for better ones; with a little alchemy, better answers can be found.”
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That's it for this weekend folks.
Have a wonderful week ahead!!
- Tejas Gutka
[April 02, 2022]