Investomania !

From Buffett and Charlie of Berkshire to Raamdeo of Motilal Oswal

What is investing ?

Investing is an activity in which consumption today is foregone in an attempt to allow greater consumption at a later date. “Risk” is the possibility that this objective won’t be attained. By that standard, purportedly “risk-free” long-term bonds in 2012 were a far riskier investment than a longterm investment in common stocks. At that time, even a 1% annual rate of inflation between 2012 and 2017 would have decreased the purchasing-power of the government bond.

“Investment is most intelligent when it is most businesslike.” — The Intelligent Investor by Benjamin Graham

Warren tells his investment journey starting from purchasing farm in Omaha and explains how simple decisions if allowed to compound can turn rags to riches.

“The investment had no downside and potentially had substantial upside. There would, of course, be the occasional bad crop and prices would sometimes disappoint. But so what? There would be some unusually good years as well, and I would never be under any pressure to sell the property.”

The riskiness of an investment is not measured by beta but rather by the probability – the reasoned probability – of that investment causing its owner a loss of purchasing-power over his contemplated holding period. Assets can fluctuate greatly in price and not be risky as long as they are reasonably certain to deliver increased purchasing power over their holding period. And as we will see, a non-fluctuating asset can be laden with risk.

Investment possibilities

1. Money-market funds, bonds, mortgages, bank deposits, and other instruments – Destroyed purchasing power capacity now as interest rates are very low.

2. Hope assets - assets that will never produce anything, but that are purchased in the buyer’s hope that someone else. Eg gold “If you own one ounce of gold for an eternity, you will still own one ounce at its end.”

Warren compares a pile of all gold to dividend generating assets.

The world’s gold stock is about 170,000 metric tons. If all of this gold were melded together, it would form a cube of about 68 feet per side. Total value say $ 1900/ounce i.e. Beyond the staggering valuation given the existing stock of gold, current prices make today’s annual production of gold command about $160 billion. Buyers – whether jewelry and industrial users, frightened individuals, or speculators – must continually absorb this additional supply to merely maintain an equilibrium at present prices.

Gold and currency related instruments, bonds gives maximum returns during fearful times.

3. Investment in productive assets, whether businesses, farms, or real estate. These assets should have the ability in inflationary times to deliver output that will retain its purchasing-power value while requiring a minimum of new capital investment.

Fundamentals of investing

1.  You don’t need to be an expert in order to achieve satisfactory investment returns. But if you aren’t, you must recognize your limitations and follow a course certain to work reasonably well. Keep things simple and don’t swing for the fences.

2. When promised quick profits, respond with a quick “no.”

3. Focus on the future productivity of the asset you are considering. If you don’t feel comfortable making a rough estimate of the asset’s future earnings, just forget it and move on. No one has the ability to evaluate every investment possibility. But omniscience isn’t necessary; you only need to understand the actions you undertake.

4. If you instead focus on the prospective price change of a contemplated purchase, you are speculating. Half of all coin-flippers will win their first toss; none of those winners has an expectation of profit if he continues to play the game. And the fact that a given asset has appreciated in the recent past is never a reason to buy it.

5. Games are won by players who focus on the playing field – not by those whose eyes are glued to the scoreboard. If you can enjoy Saturdays and Sundays without looking at stock prices, give it a try on weekdays.

6. Forming macro opinions or listening to the macro or market predictions of others is a waste of time. Indeed, it is dangerous because it may blur your vision of the facts that are truly important.

7. Tumbling markets can be helpful to the true investor if he has cash available when prices get far out of line with values. A climate of fear is your friend when investing; a euphoric world is your enemy.

8. The antidote to of mistiming is for an investor to accumulate shares over a long period and never to sell when the news is bad and stocks are well off their highs.

Warren gives the basic mantras, what and when of investing for non professional investors and many well educated professional ones who continuously underperforms S&P 500.

Warren’s Wisdom in management selection

Berkshire offers a  choice to the business owner who wishes to sell: a permanent home, in which the company’s people and culture will be retained (though, occasionally, management changes will be needed)

Warren shares with investors how he bought Berkshire as cigar butt bet and failed miserably, followed by NICO and Waumbec Mills

Warren met Charlie in  1959. In 56 years, however, they’ve never had an argument. When they differ, Charlie usually ends the conversation by saying: “Warren, think it over and you’ll agree with me because you’re smart and I’m right.” And gave the idea to “Forget what you know about buying fair businesses at wonderful prices; instead, buy wonderful businesses at fair prices.”

BPL and Berkshire have never invested in companies that are hell-bent on issuing shares. That behavior is one of the surest indicators of a promotion-minded management, weak accounting, a stock that is overpriced and – all too often – outright dishonesty

A CEO with capital employed in a declining operation seldom elects to massively redeploy that capital into unrelated activities

”In truth, business is too unpredictable for the numbers always to be met. Inevitably, surprises occur.” When they do, a CEO whose focus is centered on Wall Street will be tempted to make up the numbers. CEOs who overtly look for ways to report high numbers tend to foster a culture in which subordinates strive to be “helpful” as well. Goals like that can lead, for example, to insurers underestimating their loss reserves, a practice that has destroyed many industry participants.

Charlie Munger and Investing

Charlie in his book Poor Charlie's Almanack sums up his entire life, personal and professional, investments and cognitive biases. Its summary will be available soon. In an interview Charlie sums up what worked for him. It does not guarantee that it would work for you but lays down a basic framework “how to think”

1) Practicing the ideas matters the most.
2) The safest way to get what you want is to try and deserve what you want.
3) There is no love so right as admiration based love.
4) Quoting Confucius he said “wisdom acquisition is a moral duty” and you are hooked to life time learning. Simple habit to go to sleep a bit wiser then you are today.
5) Skills which you have today are not enough and you need to be a continuous learning machine to be consistent and do well in life in general.
6) Picking up all the big ideas from major disciplines and making them a part of your mental routine that is reading wide and using it in real life.
7) Inversion can help solve problems just like in algebra, Same way in real life-What to avoid in life -sloth and unreliability, Extremely intense ideology, Envy, resentment, revenge and self pity, Self serving bias, Perverse associations (to avoid working with someone whom you don’t admire)
8) Planks knowledge over chauffeurs knowledge To reach the peak of the civilizational foundations.
9) Have assiduity.
10) “Every mischance in life is to behave well” in personal as well as professional sphere.

Quotes and Questions from his interviews

“People who believe infinite growth in finite world are either madmen or economists.”

Why not buying post 2020 ?

“The prices are to high to pay for and major buying is just to get extra fees and bring more AUM.”

-Inflation driven by printing currency endlessly is one of the biggest problem going on and can explode with time.

Do you prefer holding cash?

“Instead of cash I prefer deploying the money in the best place i can find but current market offers no such offer.”

Is value investing dead ?

“The idea of investing is to get more value than you pay for and human psychology helps in this. It can never die.”

Rise of interest rate likely ?

Printing too much money can cause terrible trouble but to time it is almost impossible. New troubles will be different than old ones.

1922-2022 Most of the modernity came in these 100 years.

"The world is not driven by greed but envy." -Life was tougher 100 years back but now people are less happy thinking someone else has more now. Everything has improves 6x from 1930 but still people are not happy thinking others have more.

On diversification-

Your lucky if you got 4 good assets. Take a simple basic idea and stick to it.

Some are gifted to invest in hard to figure out industries, others should stick with basic stocks they know of and continue to hold.

Buffettology and Mungerism

BUFFETT FROM THE LENS OF MUNGER – Wisdom of the “wisest man alive”!

What was Buffett aiming at as he designed the Berkshire system?

(1) He particularly wanted continuous maximization of the rationality, skills, and devotion of the most important people in the system, starting with himself.

(2) He wanted win/win results everywhere--in gaining loyalty by giving it, for instance.

(3) He wanted decisions that maximized long-term results, seeking these from decision makers who usually stayed long enough in place to bear the consequences of decisions.

(4) He wanted to minimize the bad effects that would almost inevitably come from a large bureaucracy at headquarters.

(5) He wanted to personally contribute, like Professor Ben Graham, to the spread of wisdom attained.

Why did Berkshire under Buffett do so well?

1)      The constructive peculiarities of Buffett,

2)      The constructive peculiarities of the Berkshire system,

3)      Good luck, and

4)      The weirdly intense, contagious devotion of some shareholders and other admirers, including some in the press

THE ONE THING - Buffett’s decision to limit his activities to a few kinds and to maximize his attention to them, and to keep doing so for 50 years, was a lollapalooza. Buffett succeeded for the same reason Roger Federer became good at tennis.

And Buffett much out-Woodened Wooden, because in his case the exercise of skill was concentrated in one person, not seven, and his skill improved and improved as he got older and older during 50 years, instead of deteriorating like the skill of a basketball player does.

Even when Berkshire was getting much better opportunities than most others, Buffett often displayed almost inhuman patience and seldom bought. For instance, during his first ten years in control of Berkshire, Buffett saw one business (textiles) move close to death and two new businesses come in, for a net gain of one.

What were the big mistakes made by Berkshire under Buffett? (Error of Omission)

While mistakes of commission were common, almost all huge errors were in not making a purchase, including not purchasing Walmart stock when that was sure to work out enormously well. The errors of omission were of much importance. Berkshire’s net worth would now be at least $50 billion higher if it had seized several opportunities it was not quite smart enough to recognize as virtually sure things.

Buffett’s Analogies - A CEO who is 64 and plans to retire at 65 may have his own special calculus in evaluating risks that have only a tiny chance of happening in a given year. He may, in fact, be “right” 99% of the time. Those odds, however, hold no appeal for us. We will never play financial Russian roulette with the funds you’ve entrusted to us, even if the metaphorical gun has 100 chambers and only one bullet. In our view, it is madness to risk losing what you need in pursuing what you simply desire.

In their glory days, General Motors, IBM, Sears Roebuck and U.S. Steel sat atop huge industries. Their strengths seemed unassailable. But the destructive behavior I deplored above eventually led each of them to fall to depths that their CEOs and directors had not long before thought impossible.

More on Warren Buffett’s letter to shareholders blog -

Raamdeo Agrawal  -

With Bloomberg Raamdeo did a 4 part series which is one of the most fine tuned and refined conversations on capital markets available for free. The knowledge which Raamdeo shares with the views not only covers the lures and risks involved in the business but also covers the quantitative and qualitative aspect.

Some of the key learnings :

1.  “QGLP” - Quality Growth Longevity and favorable Price - investment process and its ‘Buy Right, Sit Tight’ investing philosophy.

2.  On diversification – Large allocation on what you understand and what you know. Most of the big money is made in single equity by top businesspersons.

3.  How to measure quality – Narrative and numbers must marry .One must look at return on capital employed and return on equity followed by cash flow, industry and company growth rate. RoE on quarterly basis and extrapolation for sustained numbers. Some other include- Debt ratios, debtor days etc.

4.  On price to perfection bets- If the stock is overtly priced to perfection for a long period (say 20+ years then such prices can be avoided). It depends on number of factors- what is your cost of capital vs cost of capital for some guy sitting in Japan and what is the respective IRR. (Role of Globalization in financial markets.)

5.  Vadapav mental model for FMCG industry- A good and bad Vada pav sells at the same price but good one is lifted organically while bad ones experimentally. 

6.  Invest in the business when you get to know the quality – business followed by management.

7.  On management quality – Competence, hunger for growth and integrity which can be cross checked by simple parameters like narrative and numbers, tax paid, concall analysis etc.

8.  Asian Paints Case study – 1985 came in radar but looked a bit expensive and was a missed opportunity same is the case with HDFC Bank. 

9.  Margin of safety in quality is much better than in price.

10. Great Companies are the ones which make money without using capital.(Letter to shareholder 2007). Eg FAANG

11. Compounding – Sales, earnings and Cash flows – How well you know the business helps you to decide how much to allocate. Eg Nifty compounding rate for 10yr is 15% whereas X business has 25% compounded growth rate estimation (subjective), then Margin of safety is (25-15=10/4 = 2.5 which implies X is 2.5x better for 10yr period. Here, role of circle of competence and subjective estimations guide your number for fair value of the business. (Fair value = how much you expect it to compound and for what time frame.)

12. Today’s price of the stock extrapolates the future earnings. The subjectivity of price can be different for market and particular investor. Eg Market price the stock at 15% growth while you think the business can grow 20-25%.

13. Book Recommendation – Warren’s letter to shareholders, Common stocks and uncommon profits, Intelligent Investor, Competitive Advantage by Michael Porter, Snowball, Value Migration (Adrain Slywotsky)

The 4 episode series provide simple ideas like quality, focus, compounding and price each explained by Mr. Raamdeo Agrawal in 4 hour session. Also the 25th Wealth Creation Study presentation beautifully condenses the knowledge which the legend has practised and preached over years. The episodes are available on Motilal Oswal Fin Services Youtube channel.

A different approach ? 

The paper (The Known, the Unknown, and the Unknowable in Financial Risk Management) gives an overview of the risk which the markets bring and explains some of its speculations. It is quite tough to understand at first glance and requires a lot of prerequisites. Paper showcases how to manage emotions and dampen the uncertainty waves which arise out of the general market conditions using case studies and investment principles of Warren Buffett, David Ricardo. I have tried to highlight certain points and suffice the paper.

1) Just as traditional finance theory hits the wall when it encounters uncertainty, modern decision theory hits the wall when addressing the world of ignorance.

2) uU(unknown unknowable)--Eg Waterloo Bond purchase by Ricardo
Buffetts-See's Candy and Nebraska Furniture + Insurance Business
Buffett compares Investment to playing Bridge -"playing contract bridge is the best training for business. Bridge requires a continual effort to assess probabilities in, at best, marginally knowable situations, and players need to make hundreds of decisions in a single session, often balancing expected gains and losses."

Speculation 1: uUU investments-unknown, unknowable, and unique-drive off speculators, which creates the potential for an attractive low price.

Speculation 2: Individuals who are overconfident of their knowledge will fall prey to poor investments in the uU world. Indeed, they are the green plants in the elaborate ecosystem of finance where there are few lions, like Warren Buffett; many gazelles, like you and me; and vast acres of grass ultimately
nourishing us all.

Speculation 3: uU situations offer great investment potential given the combination of information asymmetries and lack of competition

3) Where Math fizzles:
Kelly's Criterion, as it is called, is to invest an amount equal to W -(1 -W)/R, where W is your probability of winning, and R is the ratio of the amount you win when you win to the amount you lose when you lose.23 Thus, if you were 60% likely to win an even money bet, you would invest 0.6 -(1-0.6)11 = 0.2 or 20% of your capital.
Kelly criterion, though mathematically correct, does not tell us how much to invest when one has an edge, since it ignores the structure of preferences.

4) Movements in financial markets and of investments in general appear to have much thicker tails than would be predicted by Brownian motion, the instantaneous source of bell curve outcomes. That may be because the fundamental underlying factors produce thicker tails, or because there are rarely occurring anomalous or weird causes that produce extreme results, or both.

5) Money management is a challenging task in uUproblems. It afflicts even those with a substantial edge when making such investments. And when the unknowable happens, as it did with the air-pocket plunge in the 1987 stock market or the 1997 Asian crisis, unforeseen short-term money-management problems-e.g., transferring monies across markets in time to beat margin calls-tend to emerge.

6) The general lesson is that people are naturally very poor at drawing inferences from the fact that there is a willing seller on the other side of the market. Tversky and Kahneman (1974) discovered that individuals tend to extrapolate heuristics from situations where they make sense to those where they do not

In a situation where probabilities may be hard for either side to assess, it may be sufficient to assess your knowledge relative to the party on the other side (perhaps the market).

7) Do not engage in the heuristic reasoning that just because you do not know the risk, others do. Think carefully, and assess whether they are likely to know more than you. When the odds are extremely favorable, sometimes it pays to gamble on the unknown, even though there is some chance that people on the other side may know more than you.

8) Understanding the uU world presents great opportunity, but it also suggests some cautions:
A)HERDING - Which eventually end up in index level or even worse returns overtime.

B) INFORMATION CASCADES - Information cascades occur when individuals draw inferences about the information that others possess from the actions they take

C) MELTDOWNS -"Prices went up by roughly 8% each of the last three years. Thus, the price I should pay should depend not only on some multiple of rent-a normal metric-but must incorporate how much prices will go up next year. Others think that $300,000 is an appropriate price for such a house.

You can prepare your own thesis antithesis using above mentioned ways and let the eight wonder do the rest for itself.

Link -https://www.youtube.com/watch?v=R2U1F_OYxLc 

Source-The Known, the Unknown, and the Unknowable in Financial Risk Management: Measurement and Theory Advancing Practice, Francis X. Diebold, Neil A. Doherty, Richard J.
Herring (eds.), Princeton, NJ: Princeton University Press, 2010, 304-346.