It’s been a while.
About 3 years since we’ve had any sort of market correction. Is it over?
And because it’s been so long, you’ve probably forgotten how it feels to see your portfolio drop 10%.
So whenever markets get choppy with uncertainty or I feel like I’m falling into a worrying or fearful state of mind, I pull out my set of “emergency” articles that helps put things back into perspective and gets me back into the right frame of mind.
These articles, letters or memos act as my investing compass.
- The Super Investors of Graham and Doddsville
- Walter Schloss 16 Factors Needed to Make Money in the Stock Market
- Seth Klarman on the Painful Decision to Hold Cash
- Seth Klarman on the Value of Not Being Sure
- Ditto by Howard Marks
Shut out the noise, grab a soothing beverage, and read these papers.
Here are my favorite parts from each of the papers.
The Super Investors of Graham and Doddsville
The common intellectual theme of the investors from Graham-and-Doddsville is this: they search for discrepancies between the value of a business and the price of small pieces of that business in the market. Essentially, they exploit those discrepancies without the efficient market theorist’s concern as to whether the stocks are bought on Monday or Thursday, or whether it is January or July, etc.
Our Graham & Dodd investors, needless to say, do not discuss beta, the capital asset pricing model, or covariance in returns among securities. These are not subjects of any interest to them. In fact, most of them would have difficulty defining those terms. The investors simply focus on two variables: price and value.
I can only tell you that the secret has been out for 50 years, ever since Ben Graham and Dave Dodd wrote Security Analysis, yet I have seen no trend toward value investing in the 35 years that I’ve practiced it. There seems to be some perverse human characteristic that likes to make easy things difficult. The academic world, if anything, has actually backed away from the teaching of value investing over the last 30 years. It’s likely to continue that way. Ships will sail around the world but the Flat Earth Society will flourish. There will continue to be wide discrepancies between price and value in the marketplace, and those who read their Graham & Dodd will continue to prosper.
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16 Factors Needed to Make Money in the Stock Market
Following on from the article on Walter Schloss’ profoundly simple wisdom, Schloss wrote down 16 golden rules to make money in the stock market.
1. Price is the most important factor to use in relation to value.
2. Try to establish the value of the company. Remember that a share of stock represents a part of a business and is not just a piece of paper.
3. Use book value as a starting point to try and establish the value of the enterprise. Be sure that debt does not equal 100% of the equity. (Capital and surplus for the common stock).
4. Have patience. Stocks don’t go up immediately.
5. Don’t buy on tips or for a quick move. Let the professionals do that, if they can. Don’t sell on bad news.
6. Don’t be afraid to be a loner but be sure that you are correct in your judgment. You can’t be 100% certain but try to look for weaknesses in your thinking. Buy on a scale and sell on a scale up.
7. Have the courage of your convictions once you have made a decision.
8. Have a philosophy of investment and try to follow it. The above is a way that I’ve found successful.
9. Don’t be in too much of a hurry to sell. If the stock reaches a price that you think is a fair one, then you can sell but often because a stock goes up say 50%, people say sell it and button up your profit. Before selling try to reevaluate the company again and see where the stock sells in relation to its book value. Be aware of the level of the stock market. Are yields low and P-E ratios high. If the stock market historically high. Are people very optimistic etc?
10. When buying a stock, I find it helpful to buy near the low of the past few years. A stock may go as high as 125 and then decline to 60 and you think it attractive. 3 years before the stock sold at 20 which shows that there is some vulnerability in it.
11. Try to buy assets at a discount than to buy earnings. Earnings can change dramatically in a short time. Usually assets change slowly. One has to know how much more about a company if one buys earnings.
12. Listen to suggestions from people you respect. This doesn’t mean you have to accept them. Remember it’s your money and generally it is harder to keep money than to make it. Once you lose a lot of money it is hard to make it back.
13. Try not to let your emotions affect your judgment. Fear and greed are probably the worst emotions to have in connection with the purchase and sale of stocks.
14. Remember the word compounding. For example, if you can make 12% a year and reinvest the money back, you will double your money in 6 yrs, taxes excluded. Remember the rule of 72. Your rate of return into 72 will tell you the number of years to double your money.
15. Prefer stocks over bonds. Bonds will limit your gains and inflation will reduce your purchasing power.
16. Be careful of leverage. It can go against you.
The Painful Decision to Hold Cash
It’s painful until it isn’t.
The alternative is to remain liquid, defy the steady drumbeat of performance pressures, and wait for the prices of at least some securities to drop. (One doesn’t need the entire market to become inexpensive to put significant money to work, just a limited number of securities.) This path also involves risk in that there is no certainty whether or when this will occur; indeed, securities prices could rise further from today’s lofty levels, making the decision to hold cash even more painful. Meanwhile, holding out for better returns involves a (potentially lengthy) period of very low (albeit certain) positive returns available from today’s short-term U.S. Treasury instruments.
Betting that the markets never revert to historical norms, that we are in a new era of higher securities prices and lower returns, involves the risk of significant capital impairment. Betting that prices will fall at some point involves opportunity cost of uncertain amount. By holding expensive securities with low prospective returns, people choose to risk actual loss. We prefer the risk of lost opportunity to that of lost capital, and agree wholeheartedly with the sentiment espoused by respected value investor Jean-Marie Eveillard, when he said, “I would rather lose half our shareholders. . . than lose half of our shareholders’ money….”
The Value of Not Being Sure
This was written in early 2009 just before the start of the bull period we have experienced.
You’ll notice how familiar things felt back then to the current jitters the market is experiencing.
The greatest challenge of investing in this environment is neither the punishing price declines nor the extraordinary volatility. Rather, it is the sharply declining economy, which makes analysis of company fundamentals extremely difficult. When securities decline, it is crucial to distinguish, as possible causes, legitimate reaction to fundamental developments from extreme overreaction.
Buying early on the way down looks a great deal like being wrong, but it isn’t. It turns out you won’t be able to accurately tell who’s been swimming naked until after the tide comes back in.
If you look to “Mr. Market” for advice, or if you imbue him with wisdom, you are destined to fail. But if you look to Mr.Market for opportunity, if you attempt to take advantage of the emotional extremes, then you are very likely to succeed over time.
Controlling your process is absolutely crucial to long-term investment success in any market environment.
Successful investing requires resolve. When taking a contrary approach, one has to be able to stand one’s ground, be unwavering when others vacillate, and take advantage of others’ fear and panic to pick up bargains. But successful investing also requires flexibility and open-mindedness. Investments are typically a buy at one price, a hold at a higher price, and a sale at a still higher price.
No asset is so good that it can’t be bid up to the point where it’s overpriced and thus dangerous. And few assets are so bad that they can’t become underpriced and thus safe (not to mention potentially lucrative).
The riskiest thing in the investment world is the beliefe that there’s no risk. On the other hand, a high level of risk consciousness tends to mitigate risk. I call this the perversity of risk.
1. When economic growth is slow or negative and markets are weak, most people worry about losing money and disregard the risk of missing opportunities. Only a few stout-hearted contrarians are capable of imaging that improvement is possible.
2. Then the economy shows some signs of life, and corporate earnings begin to move up rather than down.
3. Sooner or later , economic growth takes hold visibly and earnings show surprising gains.
4. This excess of reality over expectations causes security prices to start moving up.
5. Because of those gains – along with the improving economic and corporate news – the average investor realizes that improvement is actually underway. Confidence rises. Investors feel richer and smarter, forget their prior bad experience, and extrapolate the recent progress.
6. Skepticism and caution abate; optimism and aggressiveness take their place.
7. Anyone who’s been sitting out the dance experiences the pain of watching form the sidelines as assets appreciate. The bystanders feel regret and are gradually suckered in.
8. The longer this process goes on, the more enthusiasm for investments rises and resistance subsides. People worry less about losing money and more about missing opportunities.
9. Risk aversion evaporates and invests behave more aggressively. People begin to have difficulty imagining how losses could ever occur.
I have no idea what the market will do tomorrow, next week or next year.
All I can do is rely on the experience of these great investors and take their wise words and put it into action while the world around us is consumed with what is happening this very second.
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