Monday, June 29, 2015

the secret buy sign?

http://video.cnbc.com/gallery/?video=3000392322

It's the investment equivalent of Pavlov's dog. Each time the S&P 500 has touched its 200-day moving average, a sharp rally has soon followed.

And with the recent selloff, the S&P 500 is hovering just above that key technical level, and that has one top technician banging the table on stocks.

"Take advantage of the fear that's out there right now," said Rich Ross, a technician at Evercore ISI, on Monday's "Fast Money."

Ross noted that since 2011, the market has touched its 200-day moving average three times and each time the market has waged a significant rally. The first time was in 2012 which led to a 15-percent rally in stocks in the following three months and again toward the end of that year, which sparked a nearly 50-percent rally in stocks over the next 10 months. The third time was in October of last year, which has led stocks to another 14 percent in gains since then.

"There is absolutely no subjectivity in moving averages like the 200-day moving average; in contrast to trend lines and horizontal lines of support and resistance, the 200-day moving average is the same for everyone."


"Three big rallies after the dip below [the 200-day moving average], and I think you're going to see history repeat itself," said Ross.

narrow years and shocks to the system

The first half of this year for the S&P 500 was the narrowest in history. In other words, the market’s range from peak-to-trough on a closing basis this year has been a record low, as seen in the table below, courtesy of Bespoke Investment Group (BIG).


If history is a guide, the rest of the year could break to the upside…eventually. In fact, in the prior top-10 narrowest starts to the year, the remainder of the year always had a positive return.

Shocks and stocks

This analysis is in keeping with the history of the stock market around “shocks to the system.”  The data highlighted below should serve to remind investors that although sensational headlines typically garner the most article views and/or reader clicks, market history shows that “crises” often have very quick and limited impact on markets.


[Down only 10.8% for Pearl Harbor and 11.6% for 9-11.]

As you can see, of the 14 crises/shocks in the table above, the average market decline was less than 6% and losses were recovered in about two weeks. S&P did note in the report that accompanied the table that several of the losses were much greater than the average, with longer recoveries. However, those “extreme situations usually occurred with the confines of a long-term bear market and did not precipitate the initial decline. Examples of these include: 1) Pearl Harbor, 2) President Nixon’s resignation, 3) the terrorist attacks on 9/11, and 4) the collapse of Lehman Brothers.”

Saturday, June 27, 2015

active/passive barometer

Few investment topics are as hotly debated as the merits of active and passive investing. The debate will continue to ebb and flow with the regular cycles of active managers' collective out- or underperformance relative to their benchmarks and a fast-growing and rapidly evolving field of passive alternatives. In order to ground this debate with data that reflects investors' shared experience, Morningstar is starting to publish an Active/Passive Barometer. This is a semiannual report that measures the performance of U.S. active managers against their passive peers within their respective Morningstar Categories.

The Active/Passive Barometer finds that actively managed funds have generally underperformed their passive counterparts, especially over longer time horizons, and experienced higher mortality rates (that is, many are merged or closed). In addition, the report finds that failure tends to be positively correlated with fees.

Saturday, June 20, 2015

the flexibility of options

Most people know that options afford the investor many advantages, not the least of which is a guaranteed limited risk when buying calls and puts.

And you can also get a great deal of leverage while using only a fraction of the money you would normally have to put up to get into the actual stocks themselves.

But those are just some of the advantages of options.

The real advantage with options is the opportunity to make money if a stock goes up, down, and depending on your strategy, even sideways.

This flexibility gives the options investor the opportunity to profit in virtually any market condition - even when you're unsure what the market will do.

Even though the popularity of options has soared, they are still not as well known or understood as much as stocks.

But it's all a lot easier than you might think.

1) Are You Bullish?

If you believe the price of a stock will go up, you can buy a call option on it and make money as it goes higher.

The option buyer gets a guaranteed limited risk, which is limited to the purchase price (or premium) plus any applicable commissions and fees.

Essentially, at expiration, your profit is the difference between where the stock price is and your option's strike price, less what you paid.

Example:

Let's say a stock was trading at $50.

You buy a $45 call option with a premium of $6.50, i.e., $650.

At expiration, the stock has shot up to $65.

Your $45 call would now be $20 in-the-money making it worth $2,000.

So the option is worth $2,000.

You paid $650.

That's a gain of $1,350.

All on just a $650 investment.

Worst case scenario: if the stock at expiration closed below your option’s strike price of $45, you could lose the entire $650. But even if the price went down to $0, you could never lose any more than that. Whereas with a stock, you'd be on the hook for it all.

2) Are You Bearish?

If you believe the price of a stock will go down, you can buy a put option on it and make money as the price goes lower.

Once again, the option buyer gets a guaranteed limited risk, which is limited to the purchase price (or premium) plus any applicable commissions and fees.

At expiration, your profit is the difference between where the stock price is and your option's strike price, less what you paid.

Example:

Let's say a stock was trading at $60.

You buy a $65 put option with a premium of $7.00, i.e., $700.

At expiration, the stock has dropped to $40.

Your $65 put would now be $25 in-the-money making it worth $2,500.

So the option is worth $2,500.

You paid $700.

That's a gain of $1,800.

All on just a $700 investment.

Worst case scenario: if the stock at expiration closed above your strike price of $65, you could lose what you paid for the option. But even if the stock went against you even more, you could never lose any more than that.

3) Expecting a Big Move, But Not Sure Which Way?

A straddle is a way to make money when you're not sure which way the market will go, but you believe something big will happen in either direction.

With a straddle, you're buying both a call and a put at the same time, with the same strike price, and the same expiration date.

For example, let's say its earnings season and you expect a big move to occur, either up or down, based on whether the company reports a positive surprise or a negative surprise. Or maybe the charts are suggesting a big breakout could be getting ready to take place in one direction or another.

With this strategy you can make money in either direction without having to worry about whether you guessed correctly or not.

Example:

Let's say a stock was trading at $100 a few days before their earnings announcement.

You buy the front month $100 strike call for $150.

And you buy the front month $100 strike put also for $150.

That's a cost of $300 (not including transactions costs) to put on the trade.

Now let's say the stock shoots up $15 as a result of a positive earnings surprise.

The call option is now worth $1,500

The put option is worth $0.

You paid $300.

That's a profit of $1,200.

All on just a $300 investment.

The best part with this strategy is if the stock had posted a negative surprise and it dropped -$15 instead, you would have been just as profitable. The only difference is that the put would have been the profitable side and the call would have been the loser. (But so what, because you didn't care which way it went, you just expected something big to happen in one direction or the other.)

Worst case scenario: at expiration, if nothing big ever happens, you would have lost the entire $300.

4) Expecting a Stock to Fall (or at Least Not Go Much Higher)?

Writing calls can be profitable in mildly bullish markets, sideways markets and bearish markets.

Buying a call option gives you the right but not the obligation to purchase 100 shares of a stock at a certain price within a certain period of time. The price you pay for the option, let's say $500 for example, is called the premium.

If you write an option, you're collecting that premium. Someone else is buying the right to own 100 shares of a stock at a certain price within a certain period of time. And that premium is paid to you.

If that stock goes down and the option expires worthless, the buyer of the option loses -$500, but the writer of the option makes $500.

Example:

Let's say a stock was at $70.

For whatever reason, you determined the stock would go down or at least not go much higher.

Let's also say that you wrote an $80 call for a premium of $5.00 or $500. That means your account would be credited $500.

If at expiration, the stock is at or below the strike price of $80, you'd keep the entire premium of $500.

Even though the stock didn't go down like you thought, but instead went even higher -- $10 higher in this example -- as long as it stayed below your strike price of $80 by expiration, you'd still profit by the full $500 you collected.

Thought the stock was going down.

Instead it went up.

Still made money: $500.

Pretty exciting.

In fact, at expiration, the stock could literally be above the strike price of $80, plus an amount commensurate with what the writer collected for the premium and still not lose any money. (In this case, the stock could literally be at $85 at expiration and you still wouldn't have lost anything.)

Worst case scenario: if the stock went up past the strike price plus the amount collected in premium, then you'd start losing on the trade. And for every $1 above that level, you'd lose $100.

But if the stock looks like it's breaking out above your price level, you can simply buy that option back to limit your loss, or depending on where you are in the trade, lock in a partial gain.

5) Think a Stock Will Go Up, But You'd Like To Buy It at a Lower Price, Yet Still Make Money Even If You Never Get In?

Writing put options is a great way to make money if the market goes up, sideways and even down (to a limited extent).

This is also a way to potentially get into a stock that you'd like to own at a much cheaper price, and get paid while you wait, even if you never get the stock.

As you know, if you buy a put option, you're buying the right to sell a stock at a certain price within a certain period of time. The buyer pays a premium for this right. He has a limited risk - which is limited to the price he paid for the option.

However, the writer is taking the other side. He has to buy the stock if it's put to him at a certain price within a certain period of time. And for this 'risk', the writer collects a premium.

Example:

Let's say a stock was at $50.

And you decided to write a $40 put option, collecting a premium of $4.00 or $400. (Not to mention, looking forward to potentially getting a chance to own that stock a full $10 cheaper than where it's trading at.)

If at expiration, the stock is trading anywhere above your strike price of $40 or higher, you'd keep the entire premium of $400. You may not have gotten that stock, but you still got paid for your wait.

Thought the stock would go up.

But didn't want to buy it at that price.

Wanted it to go down to buy at a lower price.

Never does.

You still made $400.

If at expiration, the stock price is at $40, the buyer of the option could exercise it and you'd now be obligated to buy that stock for $40 a share, which means you've now got that stock at the price you wanted - plus your $400 premium.

Didn't want the stock at $50.

Wished it would go down so you could get it at $40.

Finally does and you get your stock.

Plus $400.

But even if the stock fell to $36 (i.e., down to your strike price plus an amount commensurate with the premium collected -- this would be your breakeven point), you still wouldn't lose anything.

Worst case scenario: the stock would have to fall below $36 to even begin to lose on the trade. And for every $1 below that level, you'd lose $100 due to the stock you now own.

Of course, if you changed your mind, or if you thought the stock could fall below your strike price and even your breakeven point, you could buy the option back at any time, thus cutting your loss or locking in your gain and ending the trade right there without having to even bother with the stock.

Options give the investor numerous ways to make money in the market. Up, down or sideways, decide to make success your only option.

-- Kevin Matras, Zacks Weekend Wisdom

Thursday, June 18, 2015

too much information

Some recent articles by our favorite writers – Grahamites and Science of Hitting – got us thinking about an issue we write about every three or four years – emotions and data in investing. It seems about the time of every market top (or at least 6 of the last 3….), we write an article on the ability to face down your own fears and make money the only way great investors do – purchasing stocks at a substantial discount to fair value. It seems so easy. Wait for a really significant correction, step in, and purchase some great stocks. The rest is investment history. Or at least that's what they say.

Reality has a way of getting in the way of such elucidated thinking. The bottom line is that the vast majority of investors take in far too much information, overreact far too vividly to too much data, blame others for their poor results, and begin the cycle all over again. For the first instance, in a classic study[1] by Richard Thaler, subjects managed an imaginary college endowment consisting of two mutual funds. They could choose how often they received information about fund performance and how often they could trade. The experiment simulated 25 years of investing. The results were clear - participants who received information once every five years, and could trade only that often, earned returns that were more than twice those of participants who were updated monthly and could trade that frequently. The bottom line was that the frequency and amount of data availability directly correlated to poorer returns.

Not only do investors who receive too much data trade more frequently and obtain worse returns, their emotions generally proceed in a rather standard format, rising from a state of panic to euphoria. You can imagine where the latter leaves us in the market cycle.

Conclusions

We live in an age where information is available 24/7. Most of this information provides absolutely no function in evaluating value of our specific holdings. More importantly, the information is provided in a format as to play on our emotions. Finally, we live with a human brain that looks in every possible way to blame others for our failures yet make us feel like genius for our successes. These three factors play an inordinate role in the truly horrific losses occurred every so often when we face significant market corrections. By limiting our data intake, creating models with our own intellect focused on value, and building systems to minimize emotional responses, we can prevent such losses.

what would Peter Lynch say today?

What would Peter Lynch say about investor sentiment today? Peter described the cycle of a bull market through his experience at cocktail parties. Near the bottom of the market, people at these parties had no interest in talking stocks. They were more interested in hearing what’s going on with the dentist. Halfway through a bull market, everyone at the party wanted to find out what stocks Mr. Lynch was buying. At the end of a bull market, the guest liked to tell Peter Lynch (one of the greatest stock pickers of all time) what stocks they were buying and why.

To gauge where we are in the Peter Lynch bull market continuum, let's take a look at this week's sentiment poll from the American Association of Individual Investors at their website, AAII.com. This is a group of individual investors who pay an annual membership fee and participate in a wide variety of online and in-person events to improve their stock picking and asset allocation prowess. In other words, these are folks that are naturally inclined to the stock market. Here is their latest poll:


As a 35-year student of the U.S. stock market, I am astounded at these figures. These are comparable sentiment numbers to the bottom of the bear market in 2002-03! This was after tech stocks got crushed in the three preceding years and the index had decline more than 40% from peak to trough. When we access the stock market within the context of these numbers and Peter Lynch's continuum, we find it funny that hardly anyone ever asks us what stocks we bought lately.

Putting all of this together, we like where we are.

Lastly, we love what we heard Peter Lynch say in late 2008 on CNBC with the stock market as miserable as it ever gets. They asked him where he thought the stock market was going to go next. He said, "I'm the wrong guy to ask, I'm always bullish."

Monday, June 15, 2015

Long-Term Winners

Imagine if you had invested in Apple in the ’80s or Google a decade ago. Many investors dream of getting in early on the next big thing, an innovative company that changes the world and enriches them.

But a T. Rowe Price study shows that finding these companies is extremely difficult and holding them through rough markets can be even harder. They often are operating not in such dynamic industries as social media and technology but are engaged in such mundane undertakings as bread making.

To identify companies that achieved a 20% or more annualized return over 10 years—a sixfold total gain—the study examined all companies in the Russell 3000 Index with $1 billion to $3 billion in market capitalization over rolling 10-year periods, from 1996 through 2013.

In the 11 different 10-year periods, an average of only 18 companies achieved such stellar performance per period. When not double counting companies that hit the mark in more than one 10-year span, the average dropped to 10.

“The ability to grow revenue at a double-digit pace is really, really hard to do over an extended period of time, and to be able to compound wealth at 20% or more is very rare,” says Henry Ellenbogen, manager of the small-cap New Horizons Fund.

While discovering such potential overachievers may be rare, sticking with them through rough patches can be even more challenging. To reap the outsized rewards these stocks eventually provided, investors had to endure an average decline of 27.1% at some point during that decade.

“It shows you that even during a period when a stock is compounding between six- and eightfold, its price could drop significantly along the way,” Mr. Ellenbogen says. “So you have to be patient and know that you are going to go through a rocky period where the company may be in transition in which it has to reload for the next phase of growth.”

The study also demonstrates that such success is not concentrated in such high-growth sectors as information technology and biotechnology. In fact, the leading sectors for outstanding performance included consumer staples, energy, and industrials.

Flowers Foods, for example, makes bread, snack cakes, and other household staples but was one of the few companies to star in multiple 10-year periods. “Here’s a company whose end market— bread—has had modest growth at best,” Mr. Ellenbogen says. “But it’s a company with good systems and people, runs itself very efficiently, allocates capital well, makes smart acquisitions, and has organically gained market share.”

Success Keys
Not surprisingly, the companies that achieved exceptional performance over 10-year periods exhibited superior financial characteristics. On average, these leaders had median annual sales growth of 19.5%, median annual earnings growth of 17.1%, and average annual return on invested capital of 18.4%—all significantly higher than the average firm in the study.

Value, Too
Exceptional performance does not just come from high-growth companies. Value investors seek the same outcomes but from a different starting place.

“We’re trying to find companies that may offer the same kind of compelling growth prospects but they’re not necessarily fully valued and are actually cheap,” Mr. Wagner says. “These are companies that for whatever reason may have fallen on hard times and their returns may actually be decreasing, but with the strategic moves that could actually make them look like a growth stock down the road.”

“There generally are three ways small companies might achieve outperformance,” Mr. Athey says. “The first is that it is truly a growth company and consistently puts up high-growth numbers. The second is a company that may be near bankruptcy or is really deep value and it comes back from the dead. “The third is a little of both—a company that may be under the radar screen, perhaps with a checkered history, and it’s really cheap, but not because it’s a horrible company. It’s just been neglected and hasn’t performed very well, but maybe new management comes in and the company starts doing better.”

Whether a growth or value investor, Mr. Wagner says, the study’s lessons are the same: “Think long term, be patient, and recognize that even the best companies on the planet will have periods when things don’t look so good.

“Also, when you find something really good that’s working well for you, you should appreciate that’s a rare thing. You have to recognize that you are going to look at a lot of companies before you find one that could be a really big compounder of returns.”

-- T. Rowe Price Report, Summer 2014

Saturday, June 13, 2015

The Buffett-Munger personality

Success in investing doesn't correlate with I.Q. once you're above the level of 25. Once you have ordinary intelligence, what you need is the temperament to control the urges that get other people into trouble in investing. - Warren Buffett

No doubt most of us are familiar with the above quote from Mr. Buffett. Probably most of us, as value investors, also think that we possess the temperament to control the urges. However, does our perception reflect the reality? How can we tell if we have the right temperament or not for investing? How do we define the right temperament?

Things can get complicated once we start asking ourselves these questions. Luckily, following Munger’s idea of simplicity, I think we can greatly simplify the problem by observing who has the right temperament and figure out their personality type through a well-known system. We can then figure out our own personality type and compare ours with those of say Buffett and Munger.

The aforementioned well-known system is called the Myers-Briggs Type Indicator (MBTI) assessment. According to Wikipedia, it is a “psychometric questionnaire designed to measure psychological preferences in how people perceive the world and make decisions.”

Essentially there are four dichotomies of psychological differences with a resulting of 16 possible psychological types. The four dichotomies are
  • Extroversion (E) versus Introversion (I)
  • Sensing (S) versus Intuition (N)
  • Thinking (T) versus Feeling (F)
  • Judging (J) versus Perception (P)
Each person’s type will be typically referred to by an abbreviation of four letters such as ESTJ or INFP.

Each term used for each dichotomy has specific technical meanings and each combination of 4 (i.e. each type) has its own distinctive set of characteristics. For instance, “sensing and intuition are the information gathering (perceiving) functions. They describe how information is understood and interpreted. Individuals who prefer sensing are more likely to trust information that is in the present, tangible, and concrete and they tend to distrust hunches. On the other hand, those who prefer intuition tend to trust information that is more abstract or theoretical, that can be associated with other information. They may be more interested in future possibilities.”

Assuming the MBIT system is a good enough one for the discussion of temperament, let’s see if we know what type of person Buffett and Munger are. A little bit of google search combined with our observation and experience show that Buffett is most likely an ISTJ type while Munger is more likely an INTJ type.

Below are the descriptions of these two types from truity.com:

ISTJs are responsible organizers, driven to create and enforce order within systems and institutions. They are neat and orderly, inside and out, and tend to have a procedure for everything they do. Reliable and dutiful, ISTJs want to uphold tradition and follow regulations.

ISTJs have a serious, conservative air about them. They want to know and follow the rules of the game, and typically seek out predictable surroundings where they understand their role. You may find the ISTJ doing something useful even in social situations (for instance, organizing coats and hats at a party) as they’re often more comfortable taking charge of a task than they are chatting up strangers. When given something to do, they are highly dependable, and follow it through to the end.

INTJs are analytical problem-solvers, eager to improve systems and processes with their innovative ideas. They have a talent for seeing possibilities for improvement, whether at work, at home, or in themselves.

Often intellectual, INTJs enjoy logical reasoning and complex problem-solving. They approach life by analyzing the theory behind what they see, and are typically focused inward, on their own thoughtful study of the world around them. INTJs are drawn to logical systems and are much less comfortable with the unpredictable nature of other people and their emotions. They are typically independent and selective about their relationships, preferring to associate with people who they find intellectually stimulating.

The description may not fit perfectly with Buffett and Munger but I think we can all agree that they are fairly close. Munger and Buffett both share ITJ, which are introversion, thinking and judging. Just for a fun trivia, Bill Gates is also an INTJ type.

A good amount of readers on this forum should be this IxxJ pattern. It’s the F or T that should make the alarm sound for those of us who have more “F” than “T” in our types.

Again, the point of this exercise is not to say which personality type is better or worse. My educated guess is that if you have a personality type of IxTJ, you are likely to possess the right temperament for value investing. But if you don’t, that doesn't mean you don't have the temperament or you won't achieve superior returns. You just need to be more cautious of the weaknesses in your personality type that may lead to investment mistakes.

-- Grahamites, October 18, 2014

Thursday, June 11, 2015

long-term investing

Seth Klarman (Trades, Portfolio) is a self-made hedge fund billionaire. He runs the Baupost Group; the world’s 11th largest hedge fund by assets under management. Seth Klarman’s investing knowledge is highly sought-after. A new copy of his 1991 book, Margin of Safety sells for over $3,000.

Seth Klarman looks for poorly understood or mispriced investments which he can buy for a fraction of their intrinsic value. Klarman has used his conservative style of value investing to average returns of around 20% a year; long-term numbers similar to investing greats Warren Buffett and Shelby Davis.

Seth Klarman has earned his place among investing greats. He is very clear about how investors can gain an edge over Wall Street’s minute-to-minute obsession with stock prices:

“The single greatest edge an investor can have is a long-term orientation”

This is perhaps the most useful quote for individual investors. A long-term orientation frees you from the worries of day-to-day market fluctuations. I find Seth Klarman’s extremely important. In fact, it is the first quote used inThe 8 Rules of Dividend Investing (see rule 1).

Seth Klarman has been referred to as ‘his generation’s Warren Buffett (Trades, Portfolio)’. The actual Warren Buffett has many excellent quotes about investing for the long run as well. Three of Warren Buffett’s quotes on long-term investing are below:

“Only buy something you’d be perfectly happy to hold if the market shut down for 10 years”

“Our favorite holding period is forever”

“If you aren’t willing to won a stock for 10 years, don’t even think about owning it for 10 minutes”

Both Seth Klarman and Warren Buffett are very clear that investors should invest in stocks for long periods of time. When two of the most well-respected and successful investors of the past several decades emphasize an investment idea so clearly and consistently, it is wise to take notice.

Thursday, June 04, 2015

Amancio Ortega

A practically unheard-of billionaire, Amancio Ortega, just blew past household name Warren Buffett to be the second-richest man in the world, according to Bloomberg. Microsoft founder Bill Gates, who is worth $85.5 billion, remains first.

Oretega, who has amassed a net worth of $71.5 billion, is the founding chairman of the Inditex fashion group, the world’s largest apparel retailer. Inditex is best known for its chain of Zara clothing and accessories shops, which had sales of $19.7 billion in fiscal 2014.

Worth noting is that Warren Buffett, whose net worth of $70.2 billion puts him at third place, would be in second-place if not for his philanthropic giving.

A native of Spain, Ortega refuses almost all interview requests and until 1999, no photograph of him had ever been published. However, Zara is not so low-profile. The world’s biggest fashion retailer operates over 6,600 stores in more than 88 countries.

Inditex has shown strong growth year over year. In March, it reported net profit up 5 percent from the previous fiscal year. In addition, the company said it planned to open up 480 more stores this year.

Key to Ortega’s success has been keeping Zara’s manufacturing close to its home base in the ancient port city of La Coruña, rather than outsourcing production to China to cut costs. This allows Zara to act quickly on new trends and put new products into stories right away. Zara shops receive new shipments of clothing twice a week, virtually unheard of among retail stores.

If Inditex brands continue to grow and Zara’s popularity extends to millennials and beyond, the mysterious billionaire’s wealth could eventually push him to number one on the list.

Wednesday, June 03, 2015

Investment Mistakes

BeyondProxy asks fund managers about investment mistakes

Howard Marks, co-chairman of Oaktree Capital Management: “…people tend to get in trouble in investing when they have unrealistic expectations, especially when they have the expectation that higher returns can be earned without an increase of risk. That is a very dangerous expectation. Which is the thing which is most dangerous to omit? I think it is risk consciousness. I think that the great accomplishment in investing is not making a lot of money, but is making a lot of money with less-than-commensurate risk. So you have to understand risk and be very conscious of it and control it and know it when you see it. The people that I think are great investors are really characterized by exceptionally low levels of loss and infrequency of bad years. That is one of the reasons why we have to think of great investing in terms of a long time span. Short-term performance is an imposter. The investment business is full of people who got famous for being right once in a row. If you read Fooled by Randomness by [Nassim] Taleb, you understand that being right once proves nothing. You can be right once through nothing but luck. The law of large numbers says that if you have more results, you tend to drive out random error. The sample mean tends to converge with the universe mean. In other words, the apparent reality tends to converge with the real underlying reality. The great investors are the people who have made a lot of investments over a long period of time and made a lot of money, and their results show that it wasn’t a fluke — that they did it consistently. The way you do it consistently, in my opinion, is by being mindful of risk and limiting it.

Larry Sarbit, chief investment officer of Sarbit Advisory Services: “[Investors] allow emotion take over their investment decisions. That is undoubtedly the biggest problem. They don’t think very much at all. There’s not a lot of thought going on and so therefore don’t be surprised if things don’t work out well. They’re their own worst enemy. Investors do more damage to themselves than anybody else could do to them. If they would just think like they were going to the grocery store, again that’s Ben Graham, if you think about buying stocks, like he said, like groceries instead perfume, you’ll do a lot better. But people don’t and there’s not a heck of a lot you can do for them. The truth is that most people are not going to make money in the stock market. The vast majority of people don’t make money. It’s unfortunate but it’s almost a law that that’s the way it is. The money comes in at the wrong time and it goes out at the wrong time.

If the markets keep going down or if they go nowhere for the next three years, I can see exactly what investors are going to do. They’re going to get out, they’re going to stop investing, and they’re going to get out. They keep doing this over and over and over again, generation after generation, decade after decade, century after century. The behavior just repeats over and over and over again. Not much you can do about it. But that’s what creates the incredible opportunities to buy things. It creates it for us – it’s that people don’t think.

Richard Cook and Dowe Bynum, principals of Cook & Bynum Capital Management: “While we would typically list a few (e.g., having a short-term perspective, overestimating the strength and longevity of competitive entrenchment/advantages, investing with inadequate information), the single biggest mistake has to be investing without a margin of safety (i.e. not buying a company at a large discount to a conservative appraisal of its intrinsic value). By the way, full credit for this idea goes to Ben Graham, who once wrote: ‘Confronted with a challenge to distill the secret of sound investment into three words, we venture the motto, ‘Margin of Safety.’’

Ori Eyal, founder of Emerging Value Capital Management: “The key to long-term wealth creation is not earning high returns. Rather, it is earning good returns while avoiding (or minimizing) the blow-ups. The biggest mistake that investors make is not investing in a conservative enough manner. The world is a dangerous place for capital. Inflation, expropriation, revolution, currency devaluation, industry declines, wars, natural disasters, depressions, market meltdowns, black swans, theft, fraud, and taxes all pose a constant and lurking threat to growing (or even just maintaining) wealth over time. In any given year, the probability of disaster is small. But over many years and decades anything that can go wrong eventually will.

Guy Spier, chief executive officer of Aquamarine Capital Management: “The biggest mistake is when we as investors stop thinking like principals. I think that when we think as principals, when we apply Ben Graham’s maxim that we should treat every equity security as part ownership in a business and think like business owners, we have the right perspective.

Pat Dorsey, chief investment officer of Dorsey Asset Management, on the mistake of confusing growth for competitive advantage: “…people mistake growth for having a moat. Anyone can grow. Anyone can grow by building new stores, by underpricing a product. That doesn’t mean it’s sustainable and as investors, we’re buying a future and so that’s sustainability that really matters.

Mark Massey and wide moat investing

The Manual of Ideas interview with Mark Massey of AltaRock Fund:

The Manual of Ideas: How did you get interested in investing?

Mark Massey: Like any son, I was greatly influenced by my Dad. Fortunately for me, one of his real passions in life was investing. He always talked about his stocks around the dinner table and as time went by his enthusiasm stoked a curiosity in me to learn more. During high school and college, I got non-paying “jobs” at the local Merrill Lynch office which gave me some important insights into the ecosystem of Wall Street. By the time I graduated from college in 1986, I had decided that I wanted to be on the “buy side of the street.” Thankfully, with a bit of patience and perseverance, I was able to land a dream job as an equity analyst with Fidelity Investments in Boston.

MOI: Why wide-moat investing as opposed to other value approaches?

Massey: We think it’s a very safe way to generate superior returns over the long term. “Wide-moat investing” is just another way of saying that we try to buy, at a rational price, great businesses whose earnings are almost certain to be much higher in ten and twenty years. Great businesses, by definition, stand the test of time and as a consequence they are always compounding in value — like a savings account, but with a much better yield.

To me, deep value “investing” means buying a less than great business or a pile of assets trapped inside of a corporation at a (hopefully) big discount to some estimate of intrinsic worth. My problem with this approach is that no matter how cheaply you buy, time is working against you. In other words, your risk/return equation is highly dependent upon how quickly you can turn around and sell at a profit. With poor companies and cheap assets, the values can melt away while you are waiting for the market to see things your way. Buffett said it well, “Time is the friend of the wonderful business and the enemy of the mediocre.”

MOI: How do you generate wide-moat investment ideas?

Massey: It’s all qualitative stuff. We really don’t do screens. In fact, the only screen that I find useful is one that spits out companies that have been buying back a high percentage of shares. This MAY be indicative of a well-aligned management team that has great conviction in the durability of its competitive moat… but it could be the opposite, too… so you always have to do a lot of work to get to the truth.

I really think the key to our success has to do with our love for the game. We absolutely love coming to work every day. I literally spend almost all of my time reading. And while it, no doubt, makes me a bit of an oddball, my greatest pleasure is to be constantly searching for wonderful businesses that, for whatever reason, are mispriced. Having done this for nearly thirty years, I have built up a lot of knowledge and understanding about many different businesses, moats and business models. The result is a long list of companies that we would like to own at the right price. And we know from experience that if we continue to be patient and disciplined, a few mouth-watering opportunities will eventually come our way.

MOI: You refer to your portfolio as a “Conglomerate.” Please elaborate.

Massey: I realize it sounds kind of funny, but we really do refer to our portfolio in-house and in our letters to partners as “The AltaRock Conglomerate.” The reason we do this is to reinforce what we believe is the correct way of thinking about stocks, which after all are ownership positions in real operating businesses. I think many investors can lose sight of this when all they ever see are ticker symbols and flashing prices on a computer screen. To counter this tendency, we think of, and speak of, each business in our portfolio as a subsidiary that we own outright. And we try to acquire each one at a price that reduces our risk of loss to zero, while also guaranteeing that our rewards from long-term ownership will be bountiful. If we truly ran a conglomerate, we would always be exceedingly careful that we understood exactly what we were buying before making any acquisition. And we would never sell or trade one of our subsidiaries unless we were absolutely convinced that we were getting significantly more than we were giving up.

MOI: Your portfolio is one of the most concentrated we have come across. Do you target a specific number of “subsidiaries?” Could you also tell us how you came to embrace such a focused investment philosophy?

Massey: There is no target, but most of the time we end up owning between five and ten businesses (stocks) at any one time, and we really try to buy for keeps. Right now we own seven “subsidiaries” and I’d say that’s pretty typical.

As for AltaRock’s investment philosophy, I am afraid I can’t take much credit. We really just copied it from Warren (Buffett) and Charlie (Munger). And I think they borrowed it from Phil Fisher and Lord (John Maynard) Keynes. Buffett likes to joke that the wisdom of concentrating in one’s best ideas has been around since 600BC when Aesop uttered, the now famous words, “A bird in hand is worth two in the bush.”

While I had always been drawn to concentrated, wide-moat investing, there was an important crystallization moment for me. Back in January 2002 my wife and I decided to squeeze in a quick vacation before the coming birth of our second child and the April launch of AltaRock. So there I was, sitting on the beach in Jamaica with my wonderful wife and our beautiful three-year-old daughter… and I start reading this book, The Warren Buffett Way, by Robert Hagstrom…and I am literally dumbstruck. Buffett’s words really spoke to my investment soul. I was so excited by what I read… and I wanted more. So when we returned from vacation, I literally spent the next two months reading everything I could get my hands on about Buffett and Munger… every book, every Berkshire Hathaway Annual Report, every yearend Buffett Partnership letter, every speech, etc.

MOI: Taking John Malone as a proxy for great capital allocators/investors…do you think great investors are born or can you become one with hard work? What key attributes are necessary for success?

Massey: I think you can learn a lot of it, but you probably won’t unless it really appeals to you. I think Charlie Munger said that he has never met anyone wise in any field that did not read all the time, and that is certainly true of great investors. They read and read and read, and of course nobody could sustain that kind of reading about anything unless they found it incredibly fascinating. So I think you need to be someone who finds businesses extremely interesting. And you have to have an innate curiosity about everything, wanting to know the truth about how things really work. So I think there needs to be a little scientist inside of you. I think you also need to have a personality that tends toward rationality, particularly in situations where most people’s decision-making becomes polluted by emotion – like when all hell is breaking loose and the market is going down fast, every day.

You also need to really know yourself, meaning that you need to be aware of, and completely okay with, your own limitations. Otherwise you are likely to start doing things outside of your circle of competence. If you are someone who tends to fool yourself into believing that you know more than you really do, you are going to run into trouble in the investment realm.

Also, believe it or not, feeling comfortable doing nothing for a long time is important. This requires a lot of self-conviction, as there are lots of psychological forces, both external and internal, conspiring you toward action when, in fact, much of the time sitting tight is the most sensible thing to do.

I am also reminded of comments by Seth Klarman and George Soros. Seth once said that you need to have a certain arrogance to be an investor, which is true. If you think about it, every time you buy or sell, there is somebody on the other side of the transaction that thinks he’s right. So you have to be somewhat arrogant to think you know more than that other guy all the time. But then George Soros…when an interviewer referred to him as a security analyst, he laughed and said that he felt more like an insecurity analyst. He went on to explain that whenever he bought a new position he was always terrified that he was going to be proven wrong. So before buying anything, he did an incredible amount of work, and after investing he was always checking his facts, and he kept on trying to learn as much as possible about whatever it was – all because of his fear of being exposed as a fool. And so, counter-intuitively, I think both of these concepts are right. You need to be arrogant and insecure at the same time.

MOI: What do you think is the biggest mistake that investors make?

Massey: Several things come to mind as I think about it… making emotional decisions… short-term thinking instead of long… a lack of thoroughness in due diligence… These are all issues, but I think the best answer to the question is a little more subtle… and it’s that most investors fail to properly weigh and adequately take into account that they are players in a pari-mutuel betting game.

So you probably know what I mean by that, but let me elaborate. So most people know how horse betting works, right? So before the race begins, all the bets are tallied up, and based upon all the bets, the odds are calculated… and so what ends up happening is that the top horses – the ones with the best pedigrees, the best jockeys, and the best track records – end up paying out very little profit when they win, which is most of the time. And while the payoff can be great when the worst horses win, the fact is, they rarely do.

Investing is very much the same. Great businesses – the ones that have demonstrated competitive advantages and which have enjoyed long records of success – are almost always priced very expensively, while poor businesses are almost always correctly cheap. Consequently, it is hard to do better than average betting on either. The secret to winning in horses and in securities is the same. You need to study like mad and be really patient. Every now and then you will come across a really great business (or horse) that for one reason or another is mispriced, sometimes severely so, and this is when you invest (make a bet). The rest of the time you just keep working hard and waiting. You only bet when you are convinced that you have a near cinch.

MOI: Are there any books or other investment resources that have helped you become a better wide-moat investor?

Massey: For someone starting out I would submerge myself in as much Munger and Buffett as possible and I would certainly subscribe to The Manual of Ideas. Here are some books, etc. that I have found quite interesting and useful: