The mistake we often make when valuing a stock is overestimating the business growth potential, how much free cash flow it can generate, and so on. We extrapolate a spurt of excellent performance caused by temporary changes such as a brief supply and demand tailwind into the distant future. Or sometimes, we just fail to anticipate the actions of other competitors, new entrants, and changes in the industry.
Imagine you’re about to make a bet on a soccer game. What do you do? You either pick your favourite team, or pick the one you’re familiar with if you don’t have…
When Genius Failed: The Rise and Collapse of Long-Term Capital Management by Roger Lowenstein
Long-Term Capital Management’s demise comes from a mix of how their perfect models quantify risks in an uncertain world, a sense of infallibility, 30 to 1 leverage, illiquid trades, and basic greed. It is like betting on the outcome of a coin flip and if you lose, keep doubling down on the bet until you make it. Except for the fact that markets are often irrational. Or put it differently, even if something has a 0.1% chance of ruin, do it long enough, the chance of ruin is 100%. By using past trends and volatility to model future risks, LTCM…
I think it is easier to figure out what not to buy than what to buy. If we can weed out the stocks to avoid, we’ll be a step closer to figure out what to buy. What are some stocks you should avoid? Generally, hot stocks that everyone is talking about. Some are ‘momentum’ stocks where the share price has gone into the stratosphere over a short-period without any solid reason. Some are promising startups growing revenue at a very high rate but barely profitable. Buying these stocks doesn’t necessarily mean you’ll lose money; Amazon.com was such a stock back…
How do we attain wisdom? It starts with knowledge. What kind of knowledge should we acquire? Peter Kaufman’s three buckets of knowledge can guide us.
“ Every statistician knows that a large, relevant sample size is their best friend. What are the three largest, most relevant sample sizes for identifying universal principles? Bucket number one is inorganic systems, which are 13.7 billion years in size. It’s all the laws of math and physics, the entire physical universe. Bucket number two is organic systems, 3.5 billion years of biology on Earth. And bucket number three is human history, you can pick…
What is value investing? It is to buy a business for less than what it’s worth. We can break this into three parts.
Buy a business
Buying a stock is the same as owning a fraction of the underlying business. If you buy a share of Apple (AAPL), you own the business that produces things from iPhone, iPad, Macintosh, macOS to Apple Watch, app store, Apple TV+ and etc.
What it’s worth
A company is worth the present value of its future cash flow. …
Overshoot
Howard Marks of Oaktree Capital described the market as a pendulum that rarely stays in the middle “The mood swings of the securities markets resemble the movement of a pendulum. Although the midpoint of its arc best describes the location of the pendulum “on average,” it actually spends very little of its time there. Instead, it is almost always swinging toward or away from the extremes of its arc.”
What causes the market to behave this way? Delayed feedback. Most complex systems have a time delay between the inputs and the outputs. A seed in the soil takes years to…
Tesla at $1,000 per share. Topglove, one of the largest glove manufacturers, is trading at MYR$17 per share, up 360% so far this year due to COVID19. Afterpay, Australia’s leading buy now pay later, has a $15 billion market capitalization after a 560% rally since March. What do they tell you? Will they keep going up or down? For how long? Should you buy them? These are million-dollar questions.
In The Intelligent Investor, Benjamin Graham explains there are two possible ways to profit from share price — timing and pricing.
“ By timing we mean the endeavor to anticipate the…
Charlie Munger’s speech “Academic Economics: Strengths and Faults After Considering Interdisciplinary Needs” at Herb Kay Undergraduate Lecture in 2003 gives me insights into how he thinks and what investors should learn.
Fatal unconnectedness, leading to ‘man with a hammer syndrome,’ often causing overweighting what can be counted
Munger’s first objection to economics is that it doesn’t grab models from other disciplines, which leads to them to see every problem as a nail. An example of the hammer syndrome is overweighting the countable. Economics and business are complex systems that throw out a lot of wonderful numbers. But “there are other factors that are terribly important, yet there’s no precise numbering you can put to these factors.”…
What differentiates a good business that earns a long-term above-average return from a mediocre business that, at best, only earns a return close to its cost of capital? A good business can control its supply while a mediocre business can’t.
Take Ferrari. Ferrari has a 24% operating margin with above-average return on capital, higher than most car manufacturers like Porsche, McLaren, and Lamborghini. Economics 101 teaches you supply follows demand. If there is a high demand for Ferrari cars, then the industry will increase supply to fulfill those demands. Eventually, Ferrari’s return on capital and operating margin should fall in…
Hunting Ground
hʌntɪŋ ɡraʊnd/
a place likely to be a fruitful source of something desired or sought.
Imagine if you’re going on a fishing trip, what do you need? You need a location, fishing rods, reels, lures, etc. That’s the plan. But a plan doesn’t equal success. You might catch some fish if you’re lucky, but you’re more likely to go home empty-handed.
What else do you need? If you’re going to fish in a river, you have to know the types of fish because that determines the bait you use. Do you go upstream or downstream? What’s the topography of the river? Topography tells you where the fish are. What’s the water temperature? What’s the season…
