Old School Value Nugget Fest (Jan 10th Edition)

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What We’re Reading in the Media

This week, we saw a number of articles attempt to put the recent market swings in context. Generally, they found that draw-downs like the ones we’ve seen are pretty common. After another down day yesterday (Monday), read these and keep calm.

  • The One Constant in the Stock Market – Ben Carlson, A Wealth of Common Sense
    “The index has experienced a double-double-digit drawdown… for the first time since 1990. That means the S&P 500 fell 10%, made those losses back, only to fall 10% yet again. The only other years on record I could find when this happened were in 1946 and 1947… 
    What’s interesting is that although 36 of the past 68 calendar year periods has experienced a double-digit drawdown at some point, only 14 of those instances ended the year in negative territory. That means more than 60% of the time when stocks fall 10% or more intra-year, they’ve still finished the year with gains…
    The point is losses in the stock market are nothing new. And trying to guess their timing or magnitude in advance is a fool’s game. Knowing what we know today doesn’t help predict what’s going to happen next.”
  • Corrections always feel like the start of a new bear market – The Fat Pitch blog
    “Annual falls of 10% are normal during the course of any year. Even 14% falls are within the normal range. But in real time, corrections always feel like they are the end of the bull market: the price pattern is bearish and the news emphasizes stories about a likely recession, poor forward earnings and geopolitical risks.”

Ben Carlson’s point that it’s impossible to guess the timing and magnitude of market movements is a good one, and is a reminder as I get ready for 2019 of some of my investing principles. I was going to write about them here, but then Ben beat me to another article that includes many of them:

  • Prediction vs. Preparation – Ben Carlson, A Wealth of Common Sense
    “Prediction is about trying to be right while preparation is about setting the right expectations. And investing has a lot more to do with setting reasonable expectations than being right all the time because it’s hard to be right in the markets. “
    In this article, many of his statements about preparation reflect some of my core investing principles. E.g.:
    • “Higher than average returns will eventually lead to lower than average returns, but it’s impossible to guess the timing of that mean reversion.”
    • “Diversification means never having to guess the best performing strategy, region or asset class.”
    • “What’s the right amount of money I should have in stocks based on my risk profile and time horizon?”
    • “No one can guess the path of rates. Rising interest rates mean short-term pain in bonds but higher expected returns from the improved yields.”

We also saw several articles reflecting on the broader course of value investing history, with an emphasis on Buffett. The first article is very well done, and for me, harkens back to my corporate strategy days at McKinsey and Microsoft. We spent a lot of time diving deep into a company’s assets and core capabilities, some of which you can read about, with an emphasis on understanding a business’s growth flywheel. It’s a good reminder that your investing journey can’t start and end with financial analysis, and it’s a helpful way to think about these new-fangled tech companies.

  • An Evolve-or-Die Moment for the World’s Great Investors – Fortune, 11/21/18
    Summary: walks through 3 historic periods of value investing, from asset liquidation value analysis to understanding asset-light branded companies and now to asset-light digital platform companies.
    “From the beginning, value investing focused on the quantitative and tangible aspects of a business… With his focus on liquidation value, Graham tended to buy boring, beaten-down businesses—cigar butts, they came to be known, good for only a few extra puffs…
    “Value 2.0 [was about] finding a superior business and paying a reasonable price for it. The margin of safety lies not in the tangible assets but rather in the sustainability of the business itself. ..
    “If the postwar era was about consumer brands operating at scale, the early 21st century is about what we might call digital platforms. Like the branded enterprises before them, they have the permanence and probability that make for a good long-term value investment…
    “Unlike branded companies, digital businesses often benefit from network effects: the tendency of consumers to standardize on a single platform, which reinforces both consumer preference and the platform’s value. Because of this, the market shares of these platform companies dwarf those of the consumer products giants; software businesses like these are often characterized by a ‘winner take all’ or ‘winner take most’ dynamic. Combine this with the fact that they require little to no capital to grow, and you have Value 3.0—business ­models that are both radically new and enormously valuable.”
  • What You Can Learn From How Warren Buffett’s Investment Process Evolved – Forbes, 12/7/18
    Summary: Traces Buffet’s approach to investing from his early days as a Graham acolyte, to his See’s Candy investment, to his Geico one. 
    “When he started the Buffett Partnership in the late 1950s, Warren Buffett’s … focus was on the value of the business right now, either based on assets on the balance sheet or due to the earnings power of an established business with a long track record of similar results…
    “The next phase in Buffett’s evolution as an investor was to place a far greater emphasis on the intangible assets of a business. Intangibles include things such as brands, entrenched competitive position and intellectual property…
    “Buffett considered it exceptionally rare for a business with a strong competitive advantage and the resulting high return on capital to be able to redeploy capital back into the business at similar rates of return. If such a business could be found it would be the perfect business… The result would be a compounder – a business that could both generate sustainably high returns and grow at above-average rates for a long time.”



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