[The Weekend Bulletin] #177: A Lot of Lessons
On learning from life, mistakes, gambling, Charlie Munger, and also avoiding learning the wrong lessons.
A digest of some interesting reading material from around the world-wide-web. Your weekly dose of multi-disciplinary reading.
🖋️ Not sure if I got overtly reflective this past week, or if this is simply a coincidence, but a majority of the links this week point to learning lessons - from life, mistakes, gambling, and Charlie Munger. So we'll skip the usual sections this week and dive straight in:
First up is a wealth adviser counting twenty of his most important lessons from the first 80 years of his life: Byron Wien’s 20 Life Lessons
Next up is this part-spiritual, part-philosophical take on mistakes, including why we should not be afraid of making them, why being shameful of making this is good, and how we can learn from them: What Have You Learned?
In this next piece, the author discusses the difficulty of learning the right lessons from investing mistakes. He warns against drawing the wrong conclusions and setting arbitrary rules for oneself based on past performance, and encourages investors to be wary of dismissing entire areas of the market just because they haven't worked in the past. The author discusses the difficulty of learning the right lessons from investing mistakes: On Learning The Right Lessons
This article, interestingly, draws parallels between investing and gambling. As unusual as it may sound, the author makes a strong case for what investors can learn from some of the successful betters: Gambler
Lastly, no discussion on learning and investing is complete without the mention of Charlie Munger. The following two links present some lessons from the learning machine himself:
Mohnish Pabrai talks about the seven habits that he has learned from Charlie Munger: 7 Habits from Charlie That Made Me Rich
What better closing act than listening to the man himself. In what is his first-ever podcast appearance during his 99 years of existence, Charlie Munger lays down his wisdom on a variety of subjects. I particularly liked the small discussion around pricing power of brands and investing in quality businesses: Charlie Munger
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 #100:
In this article, hedge fund manager Mark Sellers lists seven traits that he believes all great investors share (making them great). A revealing and hard-hitting read. We observed a similar list in Issue 67.
Since the pandemic began, this well known bias has been identified by financial advisers as the second most prevalent investor bias and one that has increased by 25% within two years. This is one of those biases that can seriously hurt portfolio returns.
Discussing the fate of a batsman who couldn't find his favorite bat during the Indian Premier League, this article reveals a bias which makes us believe in our abilities more than we should.
In Issue 55 we came across Charles Ellis' theory of 'The Loser's Game' and how it applies to investing. (To recap: There are two levels of game play - amateur and expert. At an amateur level, winning is a function of losing less, while at en expert level, winning is a function of gaining more). Taking the idea forward, this article discusses how we can apply this model to investing, and to life in general by seeking to be less stupid than brilliant.
A modern day Indian actor who is worth learning from (IMHO) is Akshay Kumar. Its not as much about his acting skills as much as his journey (and his healthy habits) that impress me. He has not only survived a long career but also is amongst the richest; all this without a Godfather, family name, super-stardom or block-busters (until a few years back), or lots of awards. In most walks of life, we'll find such people who are not the best in what they do, and yet are quite successful (and rich!). How do these people manage to do this? As per this article, success is not about being the best or the most well known, but about a combination of three things. These principles apply to investing too.
Readworthy Passage
Let's read together a random, but read-worthy, passage from a randomly picked book.
Company valuation
1. The most often-repeated mistake in finance is “It doesn't matter - it's only a non-cash item”.
While it is true that the value of a company is the discounted value of its future free cash flows, it does not follow that non-cash items do not matter. There is a clear difference between provisions for deferred taxation that are unlikely ever to be paid, and provisions for decommissioning a nuclear power station - a large future cost that will certainly be incurred.
2. It is easy to get to a high value for a company - just underestimate the capital investments that it will need to make.
There are three components to a cash flow forecast: profit, which is often analysed quite carefully; depreciation and other non-cash items, which are usually analysed adequately; and capital expenditure, which is often a banged-in number that is quite inconsistent with the other two, and generally much too low.
3. Valuations must be based on realistic long term assumptions - at best GDP growth rates and barely adequate returns.
It is tempting, when valuing fast growing companies with strong technical advantages over their rivals, to assume that these conditions will continue forever. They will not. As the saying goes, 'In the end, everything is a toaster'. If this means that the forecast needs to be a very long one, so be it - it will be less inaccurate than running a valuation off an accurate five year forecast, and then extrapolating this to infinity.
4. Don't spend too much time worrying about financial efficiency.
Playing mathematical games with the weighted average cost of capital is tempting and fun, but generally has a disappointingly small effect on valuation. Substituting debt for equity shifts value from the government to the providers of capital because the company pays less tax. That is it. And even then there is an offsetting factor - it is more likely to incur everyone the inconvenience of going bankrupt.
5. Remember the ‘Polly Peck phenomenon’, especially in countries with high inflation.
If a company operates in a weak currency with high inflation, its revenues, costs and profits will probably grow quickly. If it funds itself by borrowing in a strong currency, with low interest rates, it will pay little interest, but will tend to make large unrealised currency losses on its debt. It may still be looking very profitable on the day that it is declared insolvent.
6. Unfunded pension schemes should be treated as debt.
Many companies fund their employees’ pensions by paying into schemes operated by independent fund managers. These schemes are off their balance sheets. Some companies operate a ‘pay-as-you-go’ system. They will show a provision for pension liabilities on their balance sheets, generally offset by a pile of cash among their assets. These companies are effectively borrowing from their employees - the provision should be treated as debt.
7. Remember to ask: ‘Who's cash flow is it anyway?’
Companies consolidate 100% of the accounts of their subsidiaries, even if they only own 51% of the shares in the subsidiary. In the profit and loss account the profit that is not attributable to their shareholders is deducted and shown as being attributable to third parties. Unless it is paid out in dividend, however, the cash remains inside the company. This means that the popular ‘cash flow per share’ measure implies that the shares should be valued by including something that does not belong to them - they should not.
8. Accounting depreciation is a poor measure of impairment of value.
If an asset is bought for £100 and has a five year life then it will be depreciated at a rate of £20 a year. This is not the same as saying that its value falls at a rate of £20 a year. The result is that the profitability of the asset is generally understated early in its life and overstated later in its life. This means that companies’ profitability tends to be understated when they grow, and overstated when they stop growing.
9. You can’t judge an acquisition by whether it adds to earnings.
Acquisitions are just very big, very long term, investments. So they are extreme examples of the rule mentioned above that new investments tend to look unprofitable in the early years. This does not mean that they are bad investments. Company managers have preferred not to explain this awkward fact, but to evade it by using accounting tricks to avoid creating and amortising goodwill. New accounting rules are increasingly making this more difficult. It should not matter, but managers still believe that it does.
10. Operating leases are debt - they just don’t look like it.
Companies often lease assets - aeroplanes, ships or hotels, for example. If the lease effectively transfers the asset, it is a finance lease, and looks like debt in the accounts. If it doesn’t then the lease just appears as rental payments in the operating costs. But it is still debt, and the shares will still reflect that fact, being much more volatile than it looks as if they ‘ought’ to be.
- From The Harriman House Book of Investing Rules by Philip Jenks and Stephen Eckett
Quotable Quotes
"It's a great thing to be rich in unanswered questions. And this is one of those situations where the rich get richer, because the best way to acquire new questions is to try answering existing ones.Questions don't just lead to answers, but also to more questions. The best questions grow in the answering."
- Paul Graham
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That's it for this weekend folks.
Have a wonderful week ahead!!
- Tejas Gutka
[Nov 04, 2023]