Investors should expect to make many mistakes – expect this, accept this, and still function:
Charlie Munger on the subject: “It’s natural to have decisions in each individual life that don’t work very well. We live in a world of sin, sorrow, and misdecision. That’s what human beings get to cope with in their days of life. I don’t expect the world to be free of folly and mistakes and so forth — I just hope that I’m invested with people who have more good judgment than bad judgment. I don’t know anybody who’s right all the time.” (February 2023, Daily Journal AGM) So how do you make fewer mistakes?
“If you have good judgment, your life will work a lot better than if you have bad judgment. You get good judgment gradually over time, partly by making bad judgments and having them work out poorly. My counsel has always been to start trying to be better and keep trying to improve all of your life — and you’ve got about half a chance. If you don’t do that, you’ve got no chance.” (February 2023, Daily Journal AGM) You’ve got to do the hard miles to get to the starting line of good judgement Charlie Munger: “I used to say I could only teach what the other person almost knows. Then I can just [push] him over the brink when he’s hanging on the edge. But if a guy is not within miles of even starting, I never succeed. In removing idiocy, I have a 100% failing talent. I have never succeeded.” (February 2023, Daily Journal AGM) An example of Munger’s learning process (at the age of 99): He was asked this question at the Daily Journal’s 2023 meeting: “You’ve said that you should destroy at least one good idea that you have each year. What good idea did you destroy in 2022 and anything in 2023 so far?” CM: “The idea that I destroyed — it wasn’t a good idea, it was a bad idea. When the internet came in, I got over-charmed by the people who were leading the online retailing and I didn’t realize it’s still retailing. It may be online retailing, but it’s also still retailing. I just got a little out of focus and that made me overestimate the future returns from Alibaba. I have never [had to eliminate a mistake] twice. I keep rubbing my own nose in my own mistakes, like I’m doing now, because I think it’s good for myself.” [Munger invested heavily in Alibaba] (February 2023, Daily Journal AGM) Warren Buffett, too, rubs his nose in his mistakes in order to keep learning He said recently: “Over the years, I have made many mistakes. Consequently, our extensive collection of businesses currently consists of a few enterprises that have truly extraordinary economics, many that enjoy very good economic characteristics, and a large group that are marginal. Along the way, other businesses in which I have invested have died, their products unwanted by the public. Capitalism has two sides: The system creates an ever-growing pile of losers while concurrently delivering a gusher of improved goods and services. Schumpeter called this phenomenon “creative destruction.” (Warren Buffett, 2023) It's important for investors to know the history of business mistakes too. One example is IBM’s failure to capitalise on its position as the leading mainframe computer company as the world of computing evolved. Charlie Munger put it well recently: “Everybody makes mistakes. I’d say one of the most interesting things that happened in my lifetime was the rise of IBM and the fall of IBM. IBM was the most admired company in America for most of my young life. They just marched from triumph to triumph to triumph and, in the last ten or fifteen years, they’ve slipped and they’re falling back in relation to other people in their field. As the Apples and the Googles and so forth came ahead, IBM just kind of missed the boat. I think that’s almost inevitable. Kodak missed the boat of the change to digital photography, too. “I’ve heard Bill Gates say that it’s almost the rule that [when] a really disruptive technology comes along, the incumbents screw up their reaction to it. It’s hard to change your ways when they’ve been successful for a long time and go into a totally different way of behaving and thinking.” (February 2023, Daily Journal AGM) Prof Glen Arnold now offers a Managed Portfolio Service at Henry Spain Investment Services under which clients’ portfolios contain the same shares as his (write to Jackie.Tran@henryspain.co.uk)
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Cryptocurrency “isn’t even slightly stupid, it’s massively stupid” says billionaire investor1/4/2023 Charlie Munger had some ripe words to say about cryptocurrency when he addressed a meeting as director of Daily Journal recently (Charlie is Warren Buffett’s business partner and made his billions by choosing his investment carefully over a six decade stretch – and he is still making money and giving good advice aged 99).
Here is what he said: “Naturally, people like to run gambling casinos where other people lose. The people who invented this crypto crappo, which is my name for it, sometimes I call it crypto crappo and sometimes I call it crypto shit. “It’s just ridiculous that anybody would buy this stuff. You can think of hardly nothing on Earth that has done more good to the human race than currency, national currencies. They were absolutely required to turn man from a goddamn successful ape into a modern successful humans and human civilization, because it enabled all these convenient exchanges. “So if somebody says I’m going to create something that sort of replaces the national currency, it’s like saying I’m going to replace the national air. It’s asinine. It isn’t even slightly stupid, it’s massively stupid. “It’s very dangerous and the governments were totally wrong to permit it. I’m not proud of my country for allowing this crap — what I call the crypto shit. It’s worthless, it’s no good, it’s crazy, it will do nothing but harm, and it’s anti-social to allow it. “The guy who made the correct decision on this is the Chinese leader. The Chinese leader took one look at crypto shit and said not in my China. And, boom, there isn’t any crypto shit in China. He’s right and we’re wrong. There is no good argument on the other side. I can’t supply it. “It’s totally, absolutely crazy stupid gambling with enormous house odds for the people on the other side — and they cheat in addition. It’s just crazy. “That is something that there’s only one correct answer for intelligent people — just totally avoid it. And avoid all the people that are promoting it.” Personally speaking, when I look at crypto I see nothing there – not a stitch of clothing on the emperor at all. When you are buying nothing in the hope of selling that nothing to another person…well, that is not investing. Prof Glen Arnold now offers a Managed Portfolio Service at Henry Spain Investment Services under which clients’ portfolios contain the same shares as his (write to Jackie.Tran@henryspain.co.uk) There are a few behavioural traits exhibited by great investors which are good to adopt.
Keep learning and adapting “You have to keep learning if you want to become a great investor. When the world changes, you must change.” (Charlie Munger) How do you expect to be able to adapt appropriately if you do not know what is going on in the world generally; what is going on in the industries that you need to understand, and; what is going on in the companies you have bought into? And where can you obtain this information so you can pull into gather to give insight and knowledge? A good place to start is to spend 2 – 3 hours per day reading intelligent newspapers, particularly, but not exclusively, those that focus on finance, business and economics. Then you need to undertake more specific research on industries and firms – the internet has been a real boon for investors in this quest. A third thought: nothing beats going to speak to key people, especially directors (I’m often quite lonely as a shareholder at AGMs because other “investors” do not take advantage of the opportunity to converse with the people running their companies). Patience and concentration “Patience can be learned. Having a long attention span and the ability to concentrate on one thing for a long time is a huge advantage”. (Charlie Munger) Investors require patience at many points in the process, from the hard graft of finding a real bargain (there are many days of not finding anything) to the long time it often takes for Mr Market to become conscious that your chosen company is selling cheap and should be re-rated (this can often be two or three years). Get started now on practising that patience. You have to keep at, keep paying attention and resilient in sticking to sound investment principles day after day. You do this even if the rest of the world says that you should join the crowd and bet on the latest tech-thing or the mining stocks where the “action is” this month. Concentrate so that you develop a deep knowledge of the businesses you own a part of. Keep following their stories. Learn from the eminent dead “You can learn a lot from dead people. Read of the deceased you admire and detest.” (Charlie Munger) People that were writing a eighty or hundred years ago on investment matters are as relevant today as they have always been – I recommend reading "The Intelligent Investor” by Benjamin Graham to start you off. They are so insightful because they point out fundamental and timeless truths about the investment community and about companies. Human psychology and business rules and behaviour really don’t change in any meaningful way even as we progress on technology. Then there is reading on a much wider range of topics from history and economics to science and politics. All this helps to make sense of the world we live in today. Finally, be a decent person “Early on, write your desired obituary – and then behave accordingly.” (Charlie Munger) Prof Glen Arnold now offers a Managed Portfolio Service at Henry Spain Investment Services under which clients’ portfolios contain the same shares as his (write to Jackie.Tran@henryspain.co.uk) The billionaire investor Charlie Munger has been selecting shares for over 70 years. Generously, he is willing to share what he has learned in that time. I’ll focus today on some of his rules for running a portfolio. They come from a recent interview.
“You don’t need to own a lot of things in order to get rich.” Many portfolio managers seem to think it is necessary to split a portfolio between 40 or 50 stocks – sometimes they go to over 100. The truth is that the benefits of additional diversification beyond 15 stocks are very small in terms of lowering portfolio volatility risk. But there are enormous downsides to holding dozens of shares: (1) insufficient familiarity with any of them – how can you thoroughly analyse so many? (2) moving too far down the marginal attractiveness curve – if you list companies in order of attractiveness why put money into company number 40 on the list when you could have more of company one or two? (3) the more you move towards matching the index the more you will perform like the index – why aim at being mediocre? “A great company keeps working after you are not; a mediocre company won’t do that” There are some companies that are so well positioned in their market place, with durable barriers to entry and pricing power, that they are likely to be making excellent returns on capital decades from now. We can all think of companies in that position, particularly those with a high share of mind, e.g. Coca-Cola, American Express or Diagio So why invest in companies that do not have strong stable strategic positions with first class managers and financial stability, just because it’s the “latest thing”? (Of course, you should not buy strong franchise companies when the shares are over-priced). “Don’t bail away in a sinking boat if you can swim to one that is seaworthy.” From time to time you’ll find yourself invested in a company that loses its way. This could be because the industry economics change and it loses its pricing power. Or it might be that the managers turn out to less than first class in terms of competence or integrity with regard to shareholders. Then you are faced with two options (1) as an interested shareholder you could work with the managers to correct matters, or (2) (the one recommended by Charlie Munger) sell your shares, even at a loss, and buy shares in a better company. Charlie and Warren Buffett have worked together on many bail out operations and on the whole found them exhausting and less profitable than moving money out. “There is no such thing as a 100% sure thing when investing. Thus, the use of leverage is dangerous. A string of wonderful numbers times zero will always equal zero. Don’t count on getting rich twice.” Don’t get greedy and impatient but rather be prepared to stick to sound investing principles and get rich slowly. Why risk losing all your current wealth just to try to rapidly obtain double - risking what you need in the hope of obtaining what you don’t need? “Warren [Buffett] and I hated railroad stocks for decades, but the world changed and finally the country had four huge railroads of vital importance to the American economy. We were slow to recognize the change, but better late than never.” The economics of an industry can change. Where once there was over-capacity, declining volume and low margins, as in US railways, shifts in market structure and the position of substitutes (road freight costs) and complementary services (e.g. shipping containers, ports) can improve the pricing power especially if the industry shifts to a oligopoly. So, keep an open mind. Keep challenging your well-loved ideas. One way Charlie, Warren and I do that is by spending a good proportion of each day reading intelligent newspapers. Prof Glen Arnold now offers a Managed Portfolio Service at Henry Spain Investment Services under which clients’ portfolios contain the same shares as his (write to Jackie.Tran@henryspain.co.uk) Charlie Munger, at 99, and still a director of Berkshire Hathaway, spoke at the AGM of another company he dominates, Daily Journal, about how people fool themselves into believing what they wish to be true. This is especially the case for those offering financial services such as fund management:
“If I had to name one factor that dominates human bad decisions, it would be what I call denial. If the truth is unpleasant enough, their mind plays tricks on them and they think it isn’t really happening. Of course, that causes enormous destruction of business where people go on throwing money into the way they used to do things, even though it isn’t going to work at all well in the way the world is now, having changed. “If you want an example of how denial is affecting things, take the world of investment management. How many managers are going to beat the indexes, all costs considered? “I would say maybe 5% can consistently beat the averages. Everybody else is living in a state of extreme denial. “They’re used to charging big fees for stuff that isn’t doing their clients any good. It’s a deep moral depravity if some widow comes to you with $500,000 and you charge her one point a year when you could put her in the indexes — but you need the one point. So people just charge some widow a considerable fee for worthless advice. The whole profession is full of that kind of denial. It’s everywhere. “I always quote Demosthenes… more than 2,000 years ago he said, “What people wish is what they believe.” “Think of how much of that goes on. Of course, it’s hugely important. You can just see it. “I would say the agency costs of money management, there are just so many billions, it’s unaccountable. And nobody can face it. You want to keep your kids in school, you need the fees. You need the brokerage commissions. You need this or that, so you do what’s good for you and bad for them. “I don’t think Berkshire does that and I don’t think Guerin and I did it at the Daily Journal. Guerin and I never took a dime in salary or directors fees or anything. If I have business and talk on my phone or use my car, I don’t charge it to the Daily Journal. That’s unheard of. It shouldn’t be unheard of and it goes on in Berkshire and it goes on in the Daily Journal. “We have an incentive plan now in this Journal Technologies and it has a million dollars worth of Daily Journal stock. That did not come from the company issuing those shares, I gave those shares to the company to use in compensating the employees. I learned that trick, so to speak, from the guy at BYD which is one of the securities we hold in our securities portfolio. “BYD, at one time in its history, the founder/chairman didn’t use the company’s stock to reward the executives, he used his own stock. It was a big reward, too. “Well, last year, what happened? BYD, last year, made more than $2 billion after taxes in the auto business in China. Who in the hell makes $2 billion as a brand new entrant in the auto business, for all practical purposes? It’s incredible what’s happened. “So there is some of this old-fashioned capitalist virtue left in the Daily Journal and there’s some left in Berkshire Hathaway and there’s some left in BYD. But, most places, everybody is trying to take what they need and just rationalizing whether it’s deserved or not.” Prof Glen Arnold now offers a Managed Portfolio Service at Henry Spain Investment Services under which clients’ portfolios contain the same shares as his (write to Jackie.Tran@henryspain.co.uk) As you’ve observed, twice in the last three years I have been scared by the prospects for the companies in my portfolio. First, in the period leading up to Covid lockdowns in early spring 2020 when I sold off a number of companies vulnerable to what I thought might be a deep recession, moving 40% of my portfolio to cash.
Second, when central bankers were talking about the “transitory” nature of the then slowly rising inflation in early 2022. Again, I went to 40% cash. Sure enough, the money pumped into the economy by the central banks and the cash stuffed into people’s pockets by governments, as well as all the supply side problems, created rising inflation. The war in Ukraine exacerbated this. To a lot of people it seems that we are now in yet another crisis, this time sparked by poor banking practises. I could be wrong (all economic/social phenomena are far from perfectly predictable), but I’m not worried. I think this bank storm will pass. Also that it will be confined to banks plus a few others who made poor decisions in allocating cash piles to assets that fell in market value (see Charles Schwab, a stock broker with piles of cash invested badly, for an example outside of banking). So I’m still 96% invested in equities and only 4% cash (for full disclosure, I still have a few properties which help my diversification). Why am I not worried, much? First, most UK and European banks and their American cousins (of the larger type – “systemic” banks) are well capitalised; they have plenty of money put in the business by shareholders (or left there from retained earnings) to be able to pay out to depositors should they become nervous and want money returned. Since 2008 banking cultural change and regulation have led to banks holding vast amount in both capital reserves and in liquidity reserves (with the exception of smaller US banks). Second, most banks were much more sensible than Credit Suisse and Silicon Valley Bank in where they put the money deposited in them. Credit Suisse was daft in lending to a series of crooks; SVB was daft in buying US government bonds and mortgage-backed bonds when they yielded one or two percent. They are supposed to have managers who can imagine interest rates rising to say 4% and the impact that will have on their assets (those bonds declined by billions when interest rates rose). Third, even if millions of depositors suddenly wanted all their money out of Lloyds or JP Morgan Chase we have the back up of the major central banks around the world. I could be wrong, but I’m betting that scared investors are, like the proverbial Generals, fighting the last war – they fear the things that killed the economy and companies in 2008. But the ingredients are not the same in 2023. In other words, this is a “molehill” moment, not a major setback, as in the words of Benjamin Graham written 100 years ago: “The market is fond of making mountains out of molehills and exaggerating ordinary vicissitudes into major setbacks” It is normal to have interest rates at 4 – 6% (we lived through a very abnormal time when interest rates were around 0 – 1%, but that is an aberration). It is normal to have the odd (sometimes really odd) bank go bust from time to time. It would be strange if we didn’t see this; after all there are some bad managers out there. Ben Graham also said, “Day to day, the stock market is a voting machine; in the long term it’s a weighing machine.” Charlie Munger recently added “If you keep making something more valuable, then some wise person is going to notice it and start buying.” The wisdom in those words is very reassuring to real investors: concentrate on analysing good companies, buying their shares when they are a bargain price and then following them through the evolving business landscape. Eventually, Mr Market will catch up and see the value in those companies; it will weigh properly. Something else from Charlie Munger (in a recent interview) to restore your zest for shares: “Now that share prices have fallen many investments which were already good value have become real bargains. Now is the time to buy into sound companies and wait for the market jitters to pass. Warren and I don’t focus on the froth of the market. We seek out good long-term investments and stubbornly hold them for a long time.” My message: Welcome falling market prices of good companies selling at a low price! More significant than the news coming from the banking sector today is the news coming from the gas market. Gas now sells in Europe for €40 per MWh compared with €340/MWh in August. If maintained, this will have a profound impact on the business environment in the year ahead – maybe even negative inflation and the central bankers having to respond to that! Will that be another “molehill” or will it be “a major setback” – we’ll have to see nearer the time, and act accordingly. (Oil has almost halved in price helping inflation come down. Also the current bank jitters might impact on banker confidence reducing loan activity somewhat so this might help dampen the economy, bringing inflation lower than many expected only a couple of weeks ago. Supply chains have been improved and the volume of cheap renewables and LNG from American is coming in great quantities. All these are ingredients which might make for low/negative inflation. Keep an eye out for it.) Prof Glen Arnold now offers a Managed Portfolio Service at Henry Spain Investment Services under which clients’ portfolios contain the same shares as his (write to Jackie.Tran@henryspain.co.uk) I have lost count of the number of times I’ve observed a company with a pile of cash doing nothing more than earning a pittance with it stuffed in a bank account or two. Many managers do not seem to recognise that their job is to examine all the uses of capital within the business, and ask whether a suitable rate of return is being generated in each.
When it comes to money left in the business by shareholders we expect a rate of return of at least 8% because shareholders money is risk capital. Admittedly, shareholders may not have actually written a cheque and sent it to the company for the managers to place into a deposit account and so the taking of shareholders' money is perhaps not so obvious; more likely, the deposited cash has come from retained profits. Nevertheless, that money is shareholders and they could demand that it be handed over to them to be allocated elsewhere in the stock market to earn at least 8%. So, when managers persuade shareholders that they should hold back on dividends to place cash into yet another deposit they must justify that by saying they can achieve 8% per annum. Of course, they can’t, so they come up with other reasoning. The most popular is the reduction of risk. By having no borrowing and a pile of cash the company is not going to go bust, thus it is good for shareholders, or so goes their logic. But this is poor thinking. Shareholders are already diversified; from their point of view it doesn’t matter if occasionally one or two portfolio constituents flirts with liquidation because of low cash reserves, just so long as the overall portfolio performs well. Here’s an example, Mr S has a portfolio of fifteen shares. We’ll assume Mr S owns 100% of each company’s equity for the sake of simplicity, but the same logic applies with fractions of companies. The portfolio has a market value of £15m. Each company has net assets of £1m, of which £0.3m is cash (that seems a lot of cash, but I know companies with more than this proportion in cash). Total annual earnings across the portfolio is £1m pa. Thus, the PER is 15. Mr S is doing OK, you might say. But he could do much better. Consider this: each company in the portfolio borrows a modest amount of £0.2m at an annual cost of £0.01m, or £0.15m for the fifteen companies. Total annual earnings across the portfolio will henceforth be £1m - £0.15m = £0.85m. Assuming the same PER of 15 applies, the portfolio is worth £0.85m x 15 = £12.75m But each company now has £0.5m of surplus cash. If they all pay this out to the shareholder this will be a total of £7.5m Mr S will have £12.75m in the share portfolio plus £7.5m, a total of £20.25m. Of course, Mr S might buy shares with that cash, and so has grown his portfolio from £15m to £20.25m. So why do companies grow cash balances? A big pile of cash reduces risk for another group of people, other than shareholders. That is the management. Perhaps they choose to have a lot of cash around for that reason?? An excuse often made is along the lines of “We do not see any value-enhancing investments in our existing business at the moment, but something might turn up”. And they push this same message out to shareholders, year after year, rarely finding good ideas, and so the cash accumulates. It’s often the case that the original business actually does have very limited room for value creating growth – incremental capital expenditure will not generate good rates of return even though existing capital stock is making good profits. This has been the case with many of Warren Buffett’s companies. Take See’s Candy. With around 200 stores it is super-profitable, generating very high rates of return on capital employed. But Buffett prevents the managers adding more stores to try and multiply the profit. This has been attempted a few times in the past and what they found was that they have competitive advantage, some brand recognition and pricing power (share of mind), in only a few places (particularly the West Coast). Elsewhere people are not willing to fork out the premium price. It’s a similar rationale that stops the reproduction of the Nebraska Furniture Mart in dozens of cities around the world, or Borsheims. What about share investing? A response I’ve had from directors to the suggestion that they place spare cash in stock market shares is one of shock and horror that I should suggest something so alien. They say something along the lines of “We are engineers. We can’t do things like invest in the stock market. We would be heavily criticised if shares fell in a reporting year, and besides we don’t know anything about investing in the stock market.” Shares in such a portfolio are marked to market each year and capital losses are reported through the P&L. Such losses when they do occur might be much greater than the core businesses profits, so the directors fear that would look really bad – and might even lose their jobs. “No way are we going to do that. We’d rather earn nothing on that cash than risk our careers.” Charlie Munger’s view Charles Munger is the dominant director of Daily Journal as well as being Warren Buffett’s business partner at Berkshire Hathaway, and at DJ’s February’s AGM he spelt out his reasoning for it being different to most companies. He, as Chairman for many decades until 2022, chose neither to hold much cash nor to pay it out to shareholders as special dividends or in share buybacks. Instead he used his expertise in selecting stock market quoted equities – and very successful it has been too: “It’s all very simple. We made a lot of extra money out of the publishing business in its heyday and that was about $30 million. … in the old days we had an information monopoly on publishing the appellate court’s decisions, daily and newsprint. When the internet came along, it destroyed our position. Our circulation went way down, so we’ve had a drastic change in good fortune in our publishing business. The future of this business is not in the publishing side, it’s on the Journal Technologies side [supplying technology to court systems around the world]. The good news is that we’re in a huge market because all the courts of the world are in the stone age still in terms of automating with modern technology, so it’s a big market. The bad news is that it’s a long, slow slog where you deal with a lot of bureaucracies … It’s just a very slow, difficult business. So we’ve got a slow, difficult business of chewing our way [not using a high proportion of the cash generated each year] into a huge market that’s not going away. The only reason we have a lot of marketable securities is we had the extra money and we preferred the marketable securities to cash in an inflationary world. Of course, it’s been a minor miracle that we’ve got as much as we have in marketable securities because our investments have done better than average. The good news is we’ve survived so far and we’ve got some surplus wealth. The bad news is it’s a long, slow slog ahead and the main future is in Journal Technologies.” The lesson is: if you have a good capital allocator, able to wisely select a portfolio of shares for a company, then it might be a good idea to retain the portfolio within the business. But if you have no value-enhancing use for cash then pay it out to shareholders, so they can invest that money themselves. Some Daily Journal data Back in 2007 the revenue of the operating business was $35m and profits after tax were $5.3m. Fifteen years later the operating business had grown its revenue a little to $54m, but profits on that was a mere $1.6m, reflecting the headwinds for this type of business. But over those years Charlie Munger has shifted the cash held by the company into equities, and multiplied it. So, while in 2007 it had $20m of US government bonds and $1m in cash by September 2022 there was over $200m in marketable securities (after deducting borrowings). The dividend on these was $5.5m last year. Capital gains are anticipated to be much more than that in future on top of growing dividend income. This has been excellent capital allocation away from the original business. Prof Glen Arnold now offers a Managed Portfolio Service at Henry Spain Investment Services under which clients’ portfolios contain the same shares as his (write to Jackie.Tran@henryspain.co.uk) One of the golden rules of investing, as opposed to speculation, is to spend significant time really understanding what you are buying. You should not be basing decisions on a “tip” on the assumption that the person who gave you the tip “seems to know what they are talking about”.
You must do the required investigations so that you grow in confidence concerning the company. Also, you should not be investing in sectors that are impossible to be analysed by the ordinary person. Sure, if you have spent years specialising in the technicalities of bio-technology or quantum computer – perhaps you have a PhD in one of those areas - by all means choose the future winners in those fields. But most of us wouldn’t have a clue. Nevertheless, there are thousands who are willing to take a punt in their ignorance, “There seems to be an unwritten rule on Wall Street: If you don’t understand it, then put your life savings into it. Shun the enterprise round the corner, which can at least be observed, and seek out the one that manufactures an incomprehensive product” (Peter Lynch - shown in picture). Warren Buffett tells us to step over one-foot hurdles rather than keep trying to jump six-foot ones - some companies are relatively easy to analyse. Unlike in Olympic diving there are no extra marks for increasing the difficulty. I know, I know….thinking and analysing is hard work and absorbs a lot of time. But it is that effort which separates you from the crowd. The crowd consists of the type of people condemned by Bertrand Russell many years ago “Most men would rather die than think. Many do.” Here are two other thoughts on the roll of thinking and analysing in an investment programme: “The less prudence with which others conduct their affairs, the greater the prudence with which we should conduct our own affairs.” Warren Buffett “Unlike the Lord, the market does not forgive those who know not what they do.” Warren Buffett (B.H. 1982) Prof Glen Arnold now offers a Managed Portfolio Service at Henry Spain Investment Services under which clients’ portfolios contain the same shares as his (write to Jackie.Tran@henryspain.co.uk) Charles Darwin said that it is not the strongest of the species that survives, nor the most intelligent, but the one most responsive to change. So it is with investors: we need above all to have a mind-set that allows us to look at how the world really is, how it works, where it is going, and adapt accordingly.
This requires an openness to seeing the world as it really is, rather than coming at it with a preconceived notion or wishful thinking. As Charlie Munger says “recognise and adapt to the true nature of the world around you: don’t expect it to adapt to you.” Hard work is required to gain a sufficiently good understanding of the way the world is working: You must “commit far more time to learning and thinking than doing” (Charles Munger). Continual action leaves insufficient time for understanding; it's important to spend most time gathering facts and ideas, mental models and perspective and only occasionally buying or selling. In developing your view of the world or of a particular company, the macroeconomy or the stock market try to avoid being too hopeful “It is optimism that is the enemy of the rational buyer" (Warren Buffett). Thus, you need to build in a good margin of safety between the intrinsic value estimated and the price paid so that if your analysis turns out to have been biased towards the optimistic you have some buffer to protect you. Prof Glen Arnold now offers a Managed Portfolio Service at Henry Spain Investment Services under which clients’ portfolios contain the same shares as his (write to Jackie.Tran@henryspain.co.uk) It’s vital that we value investors continue to develop our rationality muscles. This requires both good habits and a willingness to regularly review our thinking. Charlie Munger advises “continually challenge and willingly amend your “best-loved ideas””.
An important input to that process is to identify and reconcile disconfirming evidence. If you are approaching a “conclusion” regarding say the intrinsic value of a company then take time to actively search out information that might contradict that conclusion. This discipline will result in little alteration to your view most of the time, but occasionally the new evidence will blow your idea out of the water, and means you avoid a dreadful error. This hard to do task helps us avoid the common problem of “first conclusion bias” in which we hold tenaciously to a prior belief despite the obvious presence of contradictory evidence. Indeed psychological studies have shown that many people have a tendency to hold an erroneous idea even more closely as they are presented with more and more disproving evidence (need I mention “The Steal” of Trump’s presidency or the economic benefits of Brexit?) John Maynard Keynes, the famous economist and investor was all in favour of challenging one’s ideas but said it’s not easy “the difficulty lies not in the new ideas but escaping from the old ones”. But, despite the diffulty “if you don’t see the world the way it is, it’s like judging something through a distorted lens” (Charlie Munger), so the work has to be done. Rationality and objectivity are so prized by value investors that they place this virtue head and shoulders above intellect or knowledge. Benjamin Graham observed this 100 years ago: “The investor’s chief problem - and even his worst enemy - is likely to be himself....We have seen much more money made and kept by ‘ordinary people’ who were temperamentally well suited for the investment process than by those who lacked this quality, even though they had extensive knowledge of finance, accounting and stock market lore” Rationality is something that can be developed if you have the determination to improve: “If you don’t care whether you are rational or not, you won’t work on it. Then you will stay irrational and get lousy results.” (Charlie Munger) Prof Glen Arnold now offers a Managed Portfolio Service at Henry Spain Investment Services under which clients’ portfolios contain the same shares as his (write to Jackie.Tran@henryspain.co.uk) |
Glen ArnoldI'm a full-time investor running my portfolio. I invest other people's money into the same shares I hold under the Managed Portfolio Service at Henry Spain. Each of my client's individual accounts is invested in roughly the same proportions as my "Model Portfolio" for which we charge 1.2% + VAT per year. If you would like to join us contact Jackie.Tran@henryspain.co.uk investing is about making the right decisions, not many decisions.
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