Saraogi, Rahul – Investing in India

Wiley, 2014 [Equity Investing] Grade 4

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India is a country of interest to investors as it offers many of the characteristics that made the West such a fertile place for business and investing during the 20th century: young demographics, a rapid rate of urbanization and improving education. The best investors have often prospered from using a bottom-up approach, investing in stable countries with a clear rule of law, a strong financial infrastructure and with capitalism and not socialism as the ruling principle. The question is if the opportunities in India outweigh the risks for investors. Judging by the title of this book from Rahul Saraogi, Investing in India: A Value Investor's Guide to the Biggest Untapped Opportunity in the World, the answer is a clear yes!

Saraogi is a value investor who was born in India and moved to the US to study. It was at that time he became interested in economics and investing. He also became enthralled by Indian economic history and realized that both Indians and Westerners had problems with understanding India. He saw an edge that he decided to pursue. He moved back to India to become an investor and now manages Atyant Capital. Saraogi wrote the book in 2014 – a time when the Indian markets had suffered from a severe downturn.

Investing in India is structured in six chapters where the first four focus on giving the reader an understanding of India from a social, political and economic perspective. The fifth chapter is about value investing in India where the author presents examples of what businesses to avoid (those with bad governance and poor capital allocation) and what to look for. Throughout the book the author presents case studies to describe and strengthen the points made.

Some quirks that may be surprising for the reader is that Indians avoid buying property and machinery at certain times during the year due to spirituality and superstition. Another is that debts in Indian villages are not forgiven by death but is left with the heirs. Another central theme is that of the important roles of land, property rights and gold. It's not allowed to lend for land-buying, but prices are still high as it’s seen as a valuable consumption item. Gold has been a good store of value, as it often is in countries suffering from currency debasement and instability. The country imports gold worth $60 billion a year. Strong property rights are central to a free-market system but also act as a hindrance for building infrastructure, an area where India has huge needs of improvement.

India should not be seen as one country as the differences between the 28 states are huge - some states are likely to prosper in the near- and long-term while others have worse outlooks (the richest state has seven times the GDP per capita of the poorest). In terms of sectors, agriculture is the largest measured in people employed while services are largest in terms of GDP. On the macro side the country has a large current account deficit but at the same time a low level of external debt.

The Indian markets have often traded higher than the other “BRIC” countries. While Brazil, Russia and China have lots of cyclical and commodity companies, India has strong franchises which according to the author should command higher valuations. Saraogi is certainly bullish on the future of India, a view he shares with great investors such as Mohnish Pabrai and Prem Watsa. He thinks the groundwork has been laid and compares it with a bamboo plant that grows very slowly during the first four years while it develops its root system. In the fifth year it grows 80ft in 6 weeks! The future will tell if something similar can occur in India.

One should always invest within one’s circle of competence. The book is a comprehensive guide to one of the most important countries in the world and a great start for the investor who wants to know more about the ins-and-outs of investing in India. The reader will certainly get a better understanding of interesting sectors and might even pick up some stock-tips.

Niklas Sävås, December 04, 2018

Tsoi, Tony - Living Value Investing

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Right off the bat, it would be appropriate to bring some preconditions to this review out in the open: The author of the book, Tony Tsoi, has previously worked at Value Partners, the investment boutique founded by Cheah Cheng Hye – the very person profiled in Living Value Investing. And it is obvious he holds Mr. Cheah in very high regard. Furthermore, this reviewer owns shares in Value Partners in his day job as a fund manager – in no little regard due to the appreciation of Mr. Cheah’s capabilities and the brand name Value Partners has built. So, with that out of the way: this is a fascinating rags-to-riches story, profiling a person that have built a company labelled ”The Temple of Value Investing in Asia” and been invited to hold the keynote presentation at The Ben Graham Centre as the first person from Asia to do so. But this outcome was certainly not written in the stars. It is perhaps his ability to surprise in his success that has left people around him - including the author - the most impressed. As he states early on: ”Throughout the history of Value Partners, there has never been a shortage of doubters - not even now”.

Living Value Investing was originally published in Chinese in 2016 but after some persuasion an English version came out early this year. The first half of the book is broadly organized in chronological order, starting with Cheah’s early life in a poor Malaysian rural area, through the 17 years as a journalist in both Malaysia (editor at age 19!) and for WSJ in Hong Kong, concluding with the formative period of building Value Partners. The remaining four chapters then deal with certain aspects of Value Partners, including the decision to go public, its focus on China and Cheah’s evolving role at the company he created. This last part was no walk in the park as many founders can attest to - particularly after trying to sell the company a couple of years ago, but then reversing course as the take-over price could not be agreed upon. Probably because of the ”currentness” of the situation, but also due to my appreciation of the other topics covered in the latter half of the book, I tended to like that part more than the biographical chapters. In no way should they be viewed as fly-over chapters however. The experiences Cheah made in early life has certainly had a tremendous impact on his investing beliefs and how Value Partners was built. The feeling of always being the outsider wherever he went, the lone wolf, looking in from the outside – isn’t that the perfect description of a dyed-in-wool value investor? 

One of the more fascinating discussions revolve around the future role of Hong Kong, its diminishing role since 1997 and what its competitive edge ought to be going forward. The author argues convincingly that what the island needs is not another Li Ka-shing (property and trade) but rather several new Cheah Cheng-Hye’s (financial services). A part I have re-read several times. Another topic that the author covers well is the corporate culture Cheah and the early partners have (figuratively) built into the walls of Value Partners. The pragmatic says ”performance is all that matters”, but as everybody working in the industry knows, performance is far from everything and the examples and standards you set early on impact the quality of people you attract. There is much to learn from the examples set forth in the book, despite the obvious translational differences in business conduct between East and West.

Another trait of Cheah, avidly described throughout the book, is his image as a bookworm. Almost every person interviewed brings this up. At no time is Cheah not reading something, even occasionally in the shower. To no surprise, this certainly adds to our appreciation of the man! He and VP has surely come a long way since having to sneak into an invitation-only seminar behind the back of a good friend working for Fidelity. Today, $17bn later, Cheah and Value Partners are working hard to be the ones leading the way, creating the Asian version of Fidelity. ”Today in China is similar to the US (financial markets) in the 1950s. The opportunity-set is there”.

Henrik Andersson, November 25, 2018

Bernstein, Peter L. - Against the Gods

Wiley, 1996 [Equity Investing] Grade 5

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The sharpest minds of ancient times had a major advantage against modern thinkers. When faced with unexpected outcomes they could answer by reverting to faith or superstition. Greeks, Romans and Arabs came far in many other aspects but failed to develop the theory of probability. Instead, it was two Frenchmen, Blaise Pascal and Pierre Fermat, who made the breakthrough in the 17th century. The impact of the discovery has been massive, not only to mathematicians but also to all those who deal with matters with uncertain outcomes. In the best-selling Against the Gods the reader is taken on a remarkable journey through human history to clarify the subject of risk - which still can't be explained fully.

The author, Peter L. Bernstein was both an investor, a financial historian and prominent within academia. Having been an active investor and an economist is a feat he shares with John Maynard Keynes, an oft-cited character in Against the Gods. Bernstein published ten books and countless articles during his long career and is renowned for his supreme writing skills.

The main difficulty with investing originates from the notion that all the answers are in the past and all the questions are in the future. Many are those trying to predict the future - causing them to expose themselves to risk - or according to Bernstein "the chance of losing money". The author's main idea with the book was to explore the lessons of history to judge the current methods of handling risk. He therefore portrays those who have contributed the most to form the modern theory. This includes ancient thinkers as Aristotle and Al-Khwarizmi, later intellectuals as Pascal, Thomas Bayes and Francis Galton and modern theorists as Keynes and Daniel Kahneman. It's a remarkable history lesson.

Galton's discovery of regression to the mean during the 19th century - covered in one chapter -may be the most important for investors. It can be summed up with these timeless words from the author: "When investors overreact to new information and ignore long-term trends, regression to the mean turns the average winner into a loser and the average loser into a winner." By being contrarians, value investors have used the idea successfully over the last century. Another enticing chapter covers Amos Tversky's and Kahneman's creation of Prospect Theory. They managed to disprove that humans are the rational beings as depicted by traditional economists, by showing that people occasionally make irrational decisions. Keynes was one of the few who had earlier criticized the view of the rational man, as he viewed humans as being driven by animal spirits. Benjamin Graham was definitely another - something he is not credited for in the book. Graham also emphasized diversification as a tool for managing risk, which is not mentioned either in the chapter dealing with Harry Markowitz and his mathematical model of diversification. Overall, I think Bernstein's coverage of the 20th century gives too much credit to academia and too little to practitioners.

The main takeaway from the book is that the lessons of history support today’s preferred method of how to tackle problems involving both skill and luck. Using objective data from the past as the base rate and adjusting the probability by critical reasoning should lead to better decisions - and therefore lower risk. This is highlighted by current thought-leaders as Michael Mauboussin and Howard Marks. The best investors have a tendency to think probabilistically and relate declining prices (without impairments to the intrinsic value of the business) to improved odds. It should be a good way to approach investing for all.

The book is certainly no walk in the park as it takes a lot of effort to grasp the ideas.  It is nonetheless a great start for those who want to join Mauboussin and Marks in making better decisions. Most of all it's a very interesting book - not only for investors but for all interested in acquiring timeless wisdom. The odds are favorable that you will enjoy it.

Niklas Sävås, October 25, 2018

Gray, Wesley R. & Vogel, Jack R. - Quantitative Momentum

Wiley, 2016, [Equity Investing] Grade 5

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Momentum investing works - period. I thought momentum was all about buying stocks that have gone up, and coming from a value background I found it a bit idiotic, but little did I know about the quantitative world behind all of this. This might not be as much of an epiphany for you as it was for me, but this book opened my eyes to a world that I was extremely unfamiliar with. If you, like me, find yourself reading the same old Graham-mantras over and over just reiterated by different authors, this is most probably something you should read.

The book is split in two parts where the first part is all about understanding momentum - what momentum really is, why it works and why it should continue to provide a sustainable edge going forward. The second part is all about the craft of constructing a momentum-based portfolio based on academic proof. To be fair Quantitative Momentum is a…quantitative book. It’s packed with graphs, tables, numbers and references to academic studies. Although its academic nature, the book is written by two PhD’s – go figure, the book is an unexpectedly pleasant read. I had no problem keeping up despite generally reading the book on my busy and chaotic morning commute.

The authors start off with explaining what momentum is, and more importantly, why momentum works. They argue that momentum investing and value investing both work because they are essentially just two different sides of the same behavioral bias-coin. Maybe the reason that active portfolio management actually works is that we humans are overly skeptic in nature. The authors write: “Value investing's edge is often characterized as pessimism in the presence of poor short-term fundamentals, which causes stocks to become too cheap relative to future expectations. Perhaps momentum investing's edge could be characterized as pessimism in the presence of strong short-term fundamentals, which causes stocks to remain too cheap relative to future expectations."

The authors are not trying to make people pick sides with this book, rather they are trying to convince value investors that a quantitative momentum approach would bring great balance to the overall portfolio composition.

The book is packed with “good stuff” but one of my favorite takeaways is the concept of “frog-in-the-pan-momentum” where the path a momentum stock takes makes a big difference going forward. The point is that a stock with lower volatility, but strong uptrend, can continue to have a strong trend while staying under the radar of most value investors. On the opposite side, a volatile stock which spends every other day on the scoreboard of best/worst performers will constantly be in the eye of investors and will therefore have a higher probability of having its trend interrupted by active investors trying to correctly value the asset.

Another key concept for me was that of mean reversion in different time series. That things mean revert in nature is hardly news, but shouldn’t mean reversion work against momentum to cancel out the effect? Well, yes and no. The authors find that stocks mean revert in shorter and longer time periods (under 1 month and over 1 year) but follow the momentum trend in medium-term time periods. Basically, stocks that have gone up the most the last month will tend to mean revert and go down the most in the coming month, and vice versa. On the other hand, stocks that have performed the best over the last 12 months will typically continue to perform well over the coming month or months. In the authors’ stock-selection-model they solve these contradictory concepts by looking at momentum for the past 12 months, while ignoring the last month, thereby using both the medium-term-momentum while also taking the mean-reversion-effect into account.

For those already praying to the momentum god, this is a great book filled with ideas and proofs to improve their momentum stock selection. For the community of Graham-believers, me included, this book is a definite must-read.

Olle Qvarnström, August 22, 2018

Graham, Benjamin & Meredith, Spencer B. - The Interpretation of Financial Statements

Harper & Brothers Publishers, 1937 (2 ed.) [Equity Investing] Grade 4

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A typical way of valuing a business is with the discounted cash flow (DCF) method. Some value investors don't agree with the use of the method due to the need for forecasting uncertain future corporate prospects. Small changes in input values often result in huge swings in the estimated corporate value. Forecasting is deemed futile by investors such as Warren Buffett, Charlie Munger, Bruce Greenwald and James Montier among others. In today's world of competitive disruption there may be alternatives or complements to the DCF method with less dependency on the future that can be used. By studying the current state and the development of the balance sheet and income statement it's possible to understand the health of the business which, in turn, is essential for the firm’s future prospects.

Benjamin Graham, the father of value investing, needs no further introduction. His co-author Spencer B. Meredith was an instructor in security analysis at the New York Stock Exchange Institute together with Graham. In this book written before Graham's more influential books, Security Analysis and The Intelligent Investor, the authors describe how to understand a business and its health by studying the financial statements.

A quote from The Interpretation of Financial Statements concludes the authors’ view on forecasting: "Of course, the success of an investment depends ultimately upon future developments, and the future may never be forecast with accuracy. But if you have precise information as to a company's present financial position and its past earnings record, you are better equipped to gauge its future possibilities. And this is the essential function and value of security analysis."

The Interpretation of Financial Statements is written for those who want to understand the language of business that consists of the financial statements. In the book, the authors describe the most important constituents of balance sheets and income statements one-by-one. The text is structured in three parts. The first part introduces the reader to balance sheets and income statements. Each chapter covers one piece of a financial statement. The authors explain the item and its significance which is essential to know for the security analyst. They also describe different key ratios that are of practical use in order to distinguish if the business is in a favorable condition or in bad shape. In the second part the authors present different financial ratios while the third part is a description of financial terms and phrases.

This is a book for those who would like to understand concepts such as earnings power and book value, which is of essence in the fundamental analysis of a company. By only considering the qualitative aspects of a business the investor is at risk of missing important details that are necessary in order to set a reasonable intrinsic value range. In order to get further guidance on how to use the knowledge in practice, Graham’s Security Analysis is a great place for further study.

If I were to mention anything negative about the book it would be that the examples drawn are from a different time, meaning that they are typically limited to industrials, railroads and utilities. This is of course no criticism of the authors as the mix of listed companies was truly different in 1937. However, it's important to convert the reasoning and language to a broader set of modern businesses. Even more importantly, the financial statements were arguably more easily structured and read in the first half of the 20th century compared to today's often complex reports. This is also commented upon in the introduction.

I would like to conclude with a timeless statement from the book that summarizes the difficult challenge all investors face: "Common stock selection is a difficult art - naturally, since it offers large rewards for success. It requires a skillful mental balance between the facts of the past and the possibilities of the future."

Niklas Sävås, June 07, 2018

Marshall, Kenneth Jeffrey - Good Stocks Cheap

McGraw Hill, 2017, [Equity Investing] Grade 4

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Value investing might be described as the practice of buying and holding stocks that according to the investor’s best judgment have a suitable probability of having a substantially higher value than current price. The insistence on such a margin of safety is in part a philosophical issue but – similar to the requirement of tilting probabilities in one’s favor – is also a very practical issue of applying a suitable and rational investment process. In Good Stocks Cheap Kenneth Jeffrey Marshall, an investor and academic who teaches value investing and asset management at the Stockholm School of Economics and at University of California, shares his personal value investing process.

Although the author covers the basics of value investing it has to be said from the outset that this is not a book for anyone seeking deeper knowledge of finer nuances on the topic. This is a book on process. And mainly the process of selecting stocks to invest in. As such, important topics worthy of entire books in themselves, such as capital allocation, insider dealings, selling positions, moats etc. are covered in one or a few pages each. The benefit of this book instead lies in how explicit it is in penciling out how to actually perform the craft of value investing. Execution matters greatly in the potential success of investing.

The title is an apt description of the content as value investing in this case refers to the currently popular quality-compounding genre, not investing in low valuation multiple, bombed out, deep value stocks. This is a Joel Greenblatt Magic Formula-type of stock selection but with a quality bent.

The author suggests a sequential process of analytical steps for a stock to pass to qualify as a portfolio holding. Firstly, by looking to a number of angles the investor must be able to say that he truly understands the business of the company. If not, he should move on to another candidate. Secondly, it must qualify as a good business. In this Marshall looks to the historical financial success of the company, the indications of whether this success will continue into the future and of how shareholder friendly the management is. After weeding out bad businesses the next needle(s) to pass is the parallel decision on if this good stock is also cheep judging from the absolute level of a number of valuation multiples and if the investor in the process of analyzing the qualities and inexpensiveness of the stock has been free from biases. If all boxes are ticked it could be warranted to allocate 10% of the portfolio to the stock. It’s quite easy to visualize what a flowchart of the process would look like - and Marshall offers his version. He subsequently presents a short chapter on idea generation that logistically perhaps should have been placed earlier in the book. Further, there is no advice on what to do during the times when no stocks qualify, as all good stocks are expensive. Is cash then the preferred option?

The text is written in an accessible language making it suitable for the novice investor, but is not at all dumbed down due to this. Writers who have taught value investing – such as Ben Graham and Bruce Greenwald – have often had the chance to refine how they explain topics to an audience and this gives great clarity to their texts - so also in this case. The one section that doesn’t come out as well is chapters 6 to 10 that gives a combination of a basic accounting course and further shows which adjustments to the accounting Marshall thinks necessary to render the financial ratios best suited for his process. This section would have benefited from incorporating a case study to be followed throughout the chapters. Instead the reader in appendices and 10-K’s online get to work with the accounting of GAP, but few readers ever read appendices or look up online annual reports in parallel to reading a book. Still, this section is already a quarter of the book – perhaps Marshall didn’t want to burden the text further?

Growth and momentum has ruled this investment cycle. Value investing isn’t chic anymore. Thus, now might be the time to catch the turning tide. This book shows one way forward.

Mats Larsson, May 6, 2018

Miemietz, Marietta / CFA Institute - The Pharmaceutical Industry

CFA Institute, 2013, [Equity Investing] Grade 3

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Together with the CFA Institute Belgian financial analyst and consultant Marietta Miemietz delivers a knowledgeable but quite short first introduction into the art of analyzing pharmaceutical companies. This sub-50 page booklet first explores the industry basics in the introduction and a chapter each on the lengthy drug development and on the protection of intellectual property. Then the investment and business topics take over with chapters covering business models, financial analysis and pharmaceutical company valuation.

Skillful bottom-up investing is hard work. There are several skills and competences needed and knowledge of a number of areas required. There is a vast amount of investment literature but also business literature that can aid an investor in gaining required understanding. One of the required sets of knowledge is the understanding of the industries in which investments are made. Still, there are surprisingly few publications that attempt to give a broad overview over the full set of industries represented by the companies on listed exchanges. There are books covering industries but they often focus on the most spectacular ones and often they also push an opinion like anti-Big Oil books or books that argue for or against Big Tech. From what I know Fisher Investments is the only firm that has published a series of books to help investors to understand the full range of sectors from an analytical point of view. The CFA Institute should be well placed to do the same and this book is one in a series of such introductions. Still, there are so far few books published in the series and it is unclear if there is an ambition to issue a comprehensive set of texts.

Most large companies sustain a collection of current commercial products that at some future point in time will be phased out, plus a pipeline of future product candidates that hopefully will take the place of the existing ones. This portfolio approach is however seldom as obviously important as with pharmaceutical companies. The long lead-times in developing a drug, the unpredictable ebb and flow of blockbuster drug sales, the patent cliffs and looming danger of competition from generica (and more recently biosimilars) make the pharmaceutical industry an unusual place.

Because of this the author’s opinion is that it is critical to build bottom-up models of each drug and drug candidate that a company has. Even though I probably agree that it has to be done by some, I’m not sure if there is much edge in doing it – even corporate insiders usually have a very hard time estimating the future commercial success of prospective drug candidates. Large companies with broad diversified drug portfolios will at times experience relative headwinds compared to their competitors due to low R&D-productivity or others breaking into their markets with novel treatments. Still, these headwinds generally will shift into tailwinds. For the long-term investor it should be a good strategy to buy diversified companies in times of investor pessimism and then wait for the reversal of fortunes. I also think it is a strategy well worth perusing to bet on the better R&D-productivity of the smaller company. Hence, all else alike a portfolio of 15 companies with 1 drug candidate each will probably yield more success than investing in one company with 15 drug candidates.

Miemietz has produced a well-crafted text. Even though the booklet is short the novice investor in the pharmaceutical industry will come away better prepared after reading The Pharmaceutical Industry. For a higher-grade rating a more thorough coverage would have been needed – the writing on intellectual property is for example very summary. The text could also have benefited from including more illustrations, partly for enhanced understanding but also to simply make the text less dense.

Books like these are well needed. If the CFA Institute upped their ambition for the texts just a bit this series would fill a void for many investors.


Mats Larsson, April 8, 2018

Mobius, Mark - Passport to Profits

Warner Books, 1999, [Equity Investing] Grade 3

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For 30 years emerging markets equities have been synonymous with the bald, Yul Brynner-like head of Mark Mobius, the portfolio manager of The Templeton Emerging Markets fund. Over the period Mobius, often called the global nomad for his relentless 250 travelling days a year, managed to return 12.6% per year – an outperformance of about 2 percentage points per year. Mobius, now aged 81, has recently announced his retirement from Templeton – but only to launch his own ESG-funds. Some of the tireless energy remains.

The legendary investor John Templeton hired Mobius in 1987. Apart from being one of the truly iconic value investors Templeton, less well known, has also sometimes been called the godfather of emerging markets investing. This book is written just one third into Mobius’ fund manager career. Still, since the author prior to his fund management vocation, had run several companies, he possesses the oversight and perspective of a much more seasoned emerging markets PM. In Passports to Profits (perhaps a bit clichéd title?) the reader gets to accompany Mobius and his team on their travels to Estonia, Russia, Hong Kong, Thailand Brazil, Nigeria and South Africa. In each part of the world the author meets a string of companies and uses these case studies to discuss the development of the region at hand – this is written only a year or two post the 1990’s Asian crisis - and to teach the reader the investment lessons needed to invest in less mature equity markets.

Mobius clearly has emulated Templeton with regards to his investment style. The focus is on the change in fundamentals on a five-year time frame with a well-defined contrarian stroke as crashes are seen as buying opportunities instead of something negative. Since EM countries often differ substantially when it comes to inflation levels Mobius adjusts for this when looking to valuation multiples. Due to the relative lack of corporate information and the sometimes shaky shape of the corporate governance in many emerging market countries, visiting management is absolutely vital. On top of the managerial sales pitch Mobius tries to overlay a less emotional view of the environment, history and situation of the company.

Mobius hasn’t always been popular in all camps as he’s flamboyant, cocky and self-confident and seldom holds his punches when it comes to advocating the free market economy as a force of positive change or in criticizing the crony capitalism of many corrupt third world leaders that often labeled themselves socialist. In fact, many of Mobius’ best investments have been in recently privatized companies liberated from centrally planned corporate governance that induced a destructive land grab mentality instead of creating values for the customers. Mobius’ record is great overall but it has been volatile, giving his critics ammunition during less successful times.

The author’s elevated self-image isn’t always fully beneficial for this book. Most of the investment lessons are given in the form of sometimes a bit pompous “Mobius Rules”. The ting is, there are 84 rules listed throughout the book and they are of quite different depth and often overlap. If all these rules had been distilled down to perhaps 20 rules they would in my view have been more memorable. There are numerous rules and also case studies throughout the book, sometimes at the expense of more generalized lessons. Reading this text almost 20 years after publication gives a useful reminder of the end-of-history-sentiment at the time. The potential of Russia and Eastern Europe is on par with that of China and the Asian tigers. The liberal democratic market economy was to lift all boats into prosperity. It was at the time obviously hard to forsee how different these regions would develop going forward.

Mobius delivers a well-crafted story of fundamental kick-the-tires fund management well worth reading for those that are into EM stocks.

Mats Larsson, March 10, 2018

Dorsey, Pat - The Little Book that Builds Wealth

Wiley, 2008, [Equity Investing] Grade 4

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Warren Buffett has four main principles for investing in businesses. They need to be within his circle of competence, run by good management, have good long-term prospects and be available at a fair price. The little book that creates wealth gives the investor some well needed filters for how to think about good long-term prospects. In order to achieve high returns over the long term the business needs to have some type of competitive advantage or in Buffet terms, moat. A book that is most often recommended for readers who want to understand the concept of a moat is Michael Porter’s book Competitive Advantage. However, this is a book for corporate managers. Dorsey wanted to write a book for investors and it doesn't disappoint.

Pat Dorsey has had a long career at Morningstar where he was Director of Equity Research and where he was one of the main contributors to the firm’s economic moat ratings. Morningstar follows businesses and rank them in terms of the strength of the moat and an ETF has even been created to track these businesses. For a long-term investor that wants to create wealth without having to continuously find new investment opportunities the business then needs to have some kind of moat. Munger refers to this as "sit on your ass investing" in his usual witty way.

Businesses that are undervalued for the short term may give the investor gains but the challenge is that these gains need to be re-invested, causing the need for continuously making good stock picks. It takes time to find good investments, meaning that it's important to benefit from the opportunities that come up. Having a large analyst team makes it possible to analyze a broad set of companies leading to a higher chance of finding continuously good opportunities. This might be harder for the individual investor.

Dorsey divides moats into four categories: intangibles (brand, patents, licenses), switching costs, network effects and economies of scale. The moat can either be strong, wide moat, or weak, narrow moat. It's rather self-explanatory that a business can't be prosperous over the long term without having some kind of advantage against the competitors. A business may have a patent that shuts out the competition for a set period of time or it may have a brand that enables the business to set a price that is above the cost of production. Some businesses have historically had a high degree of customer retention meaning that the switching costs are high. A typical example of a business with high switching costs are banks. An example of a business with high network effects is Facebook where existing users benefit from having more users on the platform. Interestingly, Dorsey explained during a presentation that it's not always a benefit for a company to have all or many types of moats; a really wide moat in any of the categories may well be better.

The book is focused on the US in terms of the majority of businesses examples that is brought up and especially in terms of how to think about taxation which disturbs the flow a bit for a non-US investor. A topic in the book where value investors often have different opinions is about moat versus management. Dorsey is of the view that moat is more important and uses the quote from Buffett: "When a management with a reputation for brilliance tackles a business with a reputation for bad economics, it is the reputation of the business that remains intact".

I tend to agree with this as there are so many examples of great managers working in tough industries without being able to create sustainable high returns on capital.  However, I would also like to emphasize that an excellent manager may well create a corporate culture that could work as a moat in certain instances and through this achieve extraordinary results in highly competitive industries.

For investors who want to understand the concept of moats this book is a great start. It's short but packed with insights and I have already started to benefit from the book in terms of how I think about barriers to enter an industry. I didn't pick that up the first time I read Porter's Competitive Advantages which is why I have to give a lot of credit to Pat Dorsey for helping me to grasp this important concept better. If the concept of moats isn’t part of your set of mental models yet, then begin with reading this book.

Niklas Sävås, December 30, 2017

Schneider, David - The 80/20 Investor

The Writingale Publishing, 2016, [Equity Investing] Grade 4

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I’m not sure this is the best way for a private person to invest his money but it is one that I feel very sympathetic towards. Fortunately life is so much more than investing. Thus, there is a need of rational investing that occupies very little time and this is where The 80/20 Investor by the entrepreneur and former banker plus asset manager, David Schneider enters the picture. This is a book that takes the private investor seriously. Not because it is a complex book, on the contrary – but because it trusts him to do the right thing, thinking long term.

The author’s 80/20-investment method is as they say simple but not easy. In a nutshell you are advised to get a steady and regular source of cash flow for example from a job or a business venture you enjoy. Then as early as possible in life start the habit of automatically saving 10% of all your income and put the money aside in an easily accessible account. Further, when – but only when – “no-brainer” investment opportunities present themselves, as good assets sell at low prices, a good chunk of the cash should be invested in these. Diversify somewhat. Live your life in peace. Check up on you portfolio with long-between intervals. Only sell if you realize you have made a mistake, if you feel very uncomfortable with a position, if the asset is severely overvalued or if you are forced to do so due to personal emergencies.

The structural advantage of the method is the ability to go against the general market psychology by using a longer time frame. The investor must bide his time, wait for the right moment and let the market come to him - not the reverse. Risk in investments is real loss of money. Mostly these losses come from overpaying for an asset. The main lurking danger is therefore that the investor’s impatience makes him invest his money before there are any no-brainers offered by motivated sellers that need the liquidity the 80/20-investor has available. To avoid being lured into the short-term competitive rat race, discussions around benchmarks, the performance of friends etc. should be avoided like the plague.

To build wealth it is vital to start saving and investing as early as possible to get the force of compound interest on your side. Investment action is only needed very infrequently so the investor should use the time in-between to read up on prospective investments. Schneider suggests to start looking for investments within one’s personal circle of competence, for example in the sector where one works or in an area of special interest. Otherwise other no-brainers could be found during a global market crisis, a country crisis, an industry crisis, an asset class depression and during a single company crisis. Just read the paper and the leads to an idea will probably be on the front page. Don’t time the bottom, simply buy at good prices.

The book is not without its objections. There is a bit too much space in the first half of the text that makes glorious promises of what will come later and that tries to create cliffhangers, instead of just getting to the point immediately. Perhaps the now 195 pages book would have been considered too short otherwise? Given the intended private investor audience I think the next edition should be 150 pages – it would only add to the book’s impact. Also, please make the print and the pictures somewhat prettier.

I’m not sure if the method actually beats simply constantly investing 10% of your income in an index fund ignoring the timing of the investments. Still, the methodology fits well with how I think and with how I would want to say that I invest. I would claim I pass the test when it comes to keeping a long time horizon and letting the market come to me, but I probably should save more while waiting. Instead I have prioritized paying back mortgage loans. It might not be that rational when interest rates are close to zero but for me it’s a matter of gaining independence.

There might be a specific time to sow and a different time to harvest in the financial markets but the time for buying this book is always.

Mats Larsson, December 20, 2017

Tian, Charlie - Invest Like a Guru

Wiley, 2017, [Equity Investing] Grade 3

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For the last decade of declining interest rates traditional low valuation multiple, deep value investing has not fared at all well. Thus, value investing has gradually migrated to a position of investing in quality growth, compounding franchise types of stocks. Charlie Tian, the founder of the popular value investing website GuruFocus.com, has written a useful beginner’s guide to this value investing 2.0 style. Quite fittingly Tom Russo has written one of the recommendations on the cover, as he is probably the closest to the ideal investor in the genre that Tian advocates.

Tian gives the largest credit to Peter Lynch, Warren Buffet, Donald Yacktman and Howard Marks in shaping his thinking. I would argue that the largest impact might instead have been the TMT-crash of 2000/02. The author who is a physicist by training and who used to work with fiber optic communication lost his shirt on investing in the companies he thought had a great future and where he knew the technology inside out. Like all good learners Tian turned this setback and defining moment to something positive and he immersed himself in the ways of successful value investors and soon started his website – which must be said, is now a great resource for value investors.

Invest Like a Guru contains numerous wise thoughts from the obviously very learned author. Still the level is quite basic and I sometime miss the nerve of the writing of Tian’s heroes such as Howard Marks. The structure is also fairly basic with a description of what the author has picked up from his role models, why an investor should chose the franchise value type of investing and how to execute it, including the selection of holdings and the portfolio construction. Tian advocates quite categorically for investing in a fairly thin slice of the equity market but he describes the process well. Perhaps somewhat too much attention is given to the historic performance of companies and too little to how to secure that they will perform equally well in the future. A chapter on barriers-to-entries and competitive advantages wouldn’t have been out of place.

At times there are a bit too many references to the author’s web site, which some readers can potentially find disturbing. This isn’t my main objection to the text however. It is the grudge the author seems to hold against deep value investing. Chapter 2 is dedicated to arguing against this “value investing 1.0” and correctly points to the many difficulties it entails. Then later on in the book Tian returns to discuss the main problem with deep value investing – the problem with value traps. Again it is a fair or even good description of the topic but it is to me quite unclear why it’s there. Why discuss the problem of an investment style that you are not writing a book about when you leave out the main difficulty when it comes to investing in high quality growth companies – the gravity of the reversal-to-the mean in performance that so often creates a double whammy when valuation multiples follow the profitability south? What is Tian’s advice in differentiating between temporary problems and a decline that is really the first phase of a secular return to normality for a once great company?

One further unaddressed issue in this is how the allegedly contrarian value investors reconcile their 2.0 style choice with the fact that all value investors now are quality growth investors and almost non – save Seth Klarman – are deep value investors. This makes most value investors more mainstream investors than they should really be comfortable with. This is an okay book. However, it needs to be more forward looking.

Mats Larsson, December 02, 2017

Bruner, Robert F. & Carr, Sean D. - The Panic of 1907

John Wiley & Sons, 2007, [Equity Investing] Grade 4

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When historic financial crashes are discussed the US Wall Street crisis of 1929 to 1932 often springs to mind. The less well-publicized crisis of 1907 might not have been just as brutal but it was still severe. The stock market declined by 37%, 42 banks and financial institutions went under and in 1908 the US and many other areas around the world saw an “intense” depression. It was a crisis with classic bank runs that had a long lasting effect on the organization of the American financial system. Robert Bruner and Sean Carr of the University of Virginia set out to explore what we can learn from the 1907 events.

In the introduction the authors propose a loosely held framework for how financial crises can be understood and explained. They offer a model with multiple factors that influence the development, instead of succumbing to the one-trick-pony rationalizations of many pundits – “it was the greedy bankers” or “it was the stupid politicians” etc. The major part of the book describes the historical events but in a concluding analytical chapter Bruner and Carr return to their model.

It is obviously a good thing to bring these perhaps too forgotten events into the spotlight. The historical account is despite its sometimes-complex content very readable. The main character of the book is undoubtedly John Pierpont Morgan. Even if the details, companies and persons of this crisis are specific to 1907 the chain of events are easily recognizable from other late day crashes. One thing is however different, the US had no central bank in today’s meaning. J.P. Morgan accompanied by George Baker at the First National Bank and James Stillman at the National City Bank instead shouldered the role as the lender-of-last-resort, in the end - and after many late night sessions - bringing calm to the markets.

The public reactions to the rescue endeavors were however mixed. Some hailed Morgan as a hero. In an increasingly radicalized US where the public opinion often was against Big Finance others accused the “money trust” to have exploited the crisis to their own gain. Morgan had to appear in a number of hostile congressional hearings. In 1913 the Federal Reserve System was formed to take on the role that Morgan and his partners had had previously. Ironically the FED was formed from a blueprint drawn up by much the same investment bankers the bank was set to replace.

So what are the components of the authors’ model of financial crises? They start with the statement that the financial market must be seen as a system where the actors interact with each other by decisions taken on imperfect information. This opens up for contagion where trouble will travel and the chain of events are more often than not non-linear and thus impossible to predict. Some pre-conditions for a bust is a preceding economic boom with increasingly voluminous and loosely controlled credit growth and add to this political decisions within financial and monetary policies that too often affect the market pro-cyclically. An economic shock that manages to reverse the psychological climate then triggers the crisis and greed turns into fear. When collateral values and trust disappear, liquidity quickly does the same. Collectively beneficial calmness is tossed aside as everyone runs for the exit simultaneously.

This book is published pretty much on the top of the 2002 - 2007 bull market. Yet, even if the authors in my opinion identify the components of a crisis correctly the forward looking part that rounds up the concluding section is completely devoid of the factors that only a few months later will create an even worse crisis than the one in 1907. This is no critique but only serves to show how hard it is to foresee financial calamities in advance. For anyone that wants to understand the coming financial crisis – whenever it arrives – it will be beneficial to read this well written account of the events that helped to shape the world we live in today.

Mats Larsson, October 19, 2017

Sharma, Anurag - Book of Value: The Fine Art of Investing Wisely

Columbia Business School Publishing, 2016, [Equity Investing] Grade 4

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The background here is that a business professor, the author Anurag Sharma, grows increasingly puzzled over the discrepancy between the teachings on finance he meets in his academic environment and the investment customs he witnesses among successful practitioners. After reading up on the subject he rejects his fellow scholars, starts a class in value investing and later writes Book of Value, a book along the lines of Ben Graham’s The Intelligent Investor. Sharma’s thesis is that wise investing comes from making good choices and that investors can learn and internalize the practice of making these. Thus, the aim of the book is to present a framework that helps investors to make better choices.

There are five parts to the book that build up the author’s combined narrative. After the introduction has given the reader a glimpse of academic so-called modern portfolio theory the author in the first part presents a different take on the story, i.e. the behavioral biases witnessed in real life investing, the tendencies of market participants to herd and by the subsequent correlation of faulty opinions create market mispricings. Further, Sharma shows how psychologically shrewd operators – noise producers, fraudsters etc. - can induce behavior that benefit them at the expense of the financial health of investors. In part two a case is made for using the scientific method of falsification in investing. The investor should come up with investment ideas and then have a process to try to shoot them down using logic and data. If they cannot be falsified through a sound process they may constitute an investable idea. The author’s reasoning ends up in a similar place as Charlie Ellis’ views in his classic book The Loser’s Game. In my view Sharma’s text here benefits from systematic thinking of an academic mind but, not being a seasoned practitioner, the examples feel a bit theoretical and the writing in these segments lacks some nerve.

The next two parts of the book bring forward the author’s suggested framework for falsifying an investment idea. First he takes a more quantitative approach in trying to ensure that a company has a satisfactorily strong business and financial standing and that the price of the stock is sufficiently low compared to its value. Then there is a qualitative follow-through of the same areas. The financial strength is checked by controlling the quality of assets and liabilities, reviewing operating leases, pension obligations, off-balance sheet items, lawsuits etc. Business strength is evaluated by Du-Pont analysis, assessment of the business model and the quality of management. Although the writing at times is very basic – in discussing valuation for example – the combined effort of an investor going through all the steps discussed will result in a quite comprehensive picture of the company analyzed. The author is clearly on his home turf discussing business models and management but also in my view shows some good understanding of investment psychology.

In the fifth part of the Book of Value Sharma shows how to assemble a portfolio of stocks that have survived the process of trying to discard them. Essentially a focused portfolio of stocks, each with an asymmetric risk-reward potential and where the investment cases for the stocks depend on a diversified set of drivers, is advocated. After exemplifying this type of portfolio with Berkshire Hathaway’s portfolio of publicly listed stocks the author’s reasoning on how to become a wise investor is summarized in a conclusion with five well-argued main points.

So does Sharma’s sketched framework have the potential to facilitate better investment choices? Yes, clearly. Even if not all details are explicit, it provides the basis for a workflow that will help the investor narrowing down the investment universe, form an opinion on relevant investment considerations and shield him from at least some of the psychological traps of the stock market. Even though nothing new is presented and some text is even a bit basic, in combination I think the author delivers on what he promised.

Mats Larsson, September 04, 2017

Partridge, Matthew - Superinvestors

Harriman House, 2017, [Equity Investing] Grade 3

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This book is at the same time in a rewarding but ungrateful genre. Learning from the best is always worthwhile and getting to know the secrets of those who have been the most successful in equity markets never fails to interest a wide audience. Still, profiling a collection of famous investors and turning this into a book has been done numerous times before – it is hard to add much to what has been written previously. In Superinvestors Matthew Partridge, a UK financial journalist, historian and previous investment bank employee, presents his selection of 20 investors to study. Further, the author takes on the hard task of rating those profiled and name the “best” investor of all times.

The structure of the book is – as expected – fairly simple. After a brief introduction 20 “super investors” are portrayed and the book finishes off with the conclusions the author draws from the many individual fates and fortunes. For each investor the reader is served with a short personal and professional history, a discussion on the investor’s method, his performance and potential mistakes made. Then Partridge seeks to distill some learnings from the above and ends the section with a rating where the investor gets a score from 1 to 5 on performance, longevity, influence and ease of replication for the private investor. Many of the profiled names like George Soros, Warren Buffett, Benjamin Graham and Peter Lynch will be well known to many readers.

Although it’s always arguable who should be included in such an illustrious group I would have made some different choices. Even if it is quaint that Paul Samuelson privately acted at odds with what he preached as the high priest of efficient market theory I don’t think that his profile, nor the one on fellow economist David Ricardo (1772-1823), adds much to the discussion and the venture capital pioneers of George Doriot and Kleiner & Perkins feels a bit misplaced. Further, there is obviously much to learn from Jack Bogle but he is more successful as a businessman and advocate of an idea than a successful stock market investor. Who would I want to see instead? Jim Simons, James Chanos and Seth Klarman could in my view be fair alternatives. On the other hand the book benefits from the author’s deep knowledge of UK investors who are less documented in literature and Anthony Bolton’s track record in China will come as a surprise to many – as it did to me.

In my opinion the texts on UK investors Neil Woodford and Nick Train were the most interesting. Also, even though I had heard of Robert Wilson as an early short seller, I knew nothing of him. Overall Partridge, with some minor disagreements, in my view gives a short but fully accurate picture of the investors I had previous knowledge of. The author is clearly well read and even the cover is inspired by Ken Fisher’s 1984 book Super Stocks. My only objections are that I think George Soros’ concept of reflexivity is too vaguely described and given its huge influence on the hedge fund community and its closeness to the current concepts of complexity theory and adaptive markets it is a bit harsh to say that the theory has left little mark. Further, to describe what Ed Thorp did as “nothing new, but more systematic” is to diminish a person who long before academics Black and Myron Scholes came up with an option pricing model that allowed rational derivatives trading.

Even though the book is over 200 pages long it is an easy read and it is quite tempting to time after time read “just one more profile”. The conclusions at the end are sound but hardly novel. So who does Partridge rank as the best investor of all times? Those on the short list are Philip Fisher, Buffett, Bogle and Graham (skip Bogle and add Soros and Thorp and I would have agreed). The winner is Graham, much thanks to his huge influence on later day investors. A good choice.

It is never possible to do an investor justice over 6 to 8 pages. However, it is through books like this that many up and coming investors have gotten a glimpse of their role models for the first time.


Mats Larsson, August 8, 2017

Clark, David - The Tao of Charlie Munger

Scribner, Inc., 2017, [Equity Investing] Grade 4

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If you collect quotations from one of the broadest thinkers in business who for decades has delivered witty and wise sayings, you cannot really go wrong. The Tao translates as “the way” or “the path” and what we are served here is the way of Charlie Munger, vice Chairman of Berkshire Hathaway and long business partner to Warren Buffett. Munger’s many sayings have over time gained enough status to be christened as “Mungerisms.”

The reference to Taoism is equally apt when it comes to the format of the book. Just as Lao-tzu, the Taoist collection of saying and proverbs, this is a commented assortment of quotations where David Clark, co-writer of the many Buffettology books does the observing and deciphering of the wise musings of the old master. Buffett obviously has a wonderful way with words but I have always enjoyed Munger’s shorter, sharper and more cynical statements more and Clark has done us all a huge service collecting these quotes. It is a book possible to read in one, albeit long, sitting – but please don’t. Take the time to scribble down how Munger’s thoughts reflect on your investments, business and being. Does this make sense to you? If so, how are you living up to it? What can you change? What can you improve?

The selected quotations are grouped into four parts covering investing, banking and the economy, business and philosophizing on life at large. Sections one and three are delivered with authority and Ben Graham’s saying that investing is the most intelligent when it is most businesslike springs to mind. At the same time the investing of Munger and Berkshire Hathaway is hardly unknown material due to the vast coverage of Buffett’s investing success.

The danger with adding commentary is that it isn’t always better to say something in a lengthier format when it has already been delivered crisp and clear in a short pitchy way. There is a balance to be kept to not over-explain things. Clark is mostly on the right side of the tracks but he delivers rather similar explanations to many of the quotes and is forced to add quite a few “as we have said earlier”.

Further, just as it comes to later commentary of, say old Taoist texts, it is always possible to debate if the interpretation of the original scriptures from one specific scholar is optimal. Occasionally I would have chosen to make alternative reflections. I think the selection of quotes Clark has made is a good one. Perhaps it could have hade been tilted a tad more towards psychology given Munger’s wisdom in the area. There are few real gems missing apart from this favorite on investing “It’s not supposed to be easy. Anyone who finds it easy is stupid.” – a typical Mungerism in it’s lack of flattery.

The second part of the book is the least interesting - but every time one hears figures about the gross exposure of global derivatives one marvels. The best and most inspiring part is the fourth, on Life, Education and the Pursuit of Happiness. Below are some of our favorites. “Being rational is a moral imperative. You should never be stupider than you need to be”; “Spend each day trying to be a little wiser than you were when you woke up. Discharge your duties faithfully and well. Slug it out one inch at a time, day by day. At the end of the day – if you live long enough – most people get what they deserve” and especially close to our heart “In my whole life, I have known no wise people who didn’t read all the time – none, zero. You’d be amazed at how much Warren reads – and how much I read. My children laugh at me. They think I’m a book with a couple of legs sticking out.” Amen. If you ever find yourself hesitating over a decision, simply ask yourself “What would Charlie Munger do?”

Mats Larsson, May 14, 2017

Cassidy, Donald - It's When You Sell That Counts

Global Professional Publishing, 2011 (3rd ed.), [Equity Investing] Grade 3

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Selling stocks is less fun and less easy than buying them. Also, you can get plenty of advice on how to buy stocks and which stocks to buy, but few tell you when to sell. Therefore, a sell strategy is vital for investment success. Donald Cassidy who has been a research analyst since the mid 1970s aims to give the trend following investor with a medium term investment horizon of 6 – 18 months the tools to develop this sell strategy.

I first want to dig into the main problem of the text before turning to the positive sides. The four sections are named 1) Understanding the Selling Problem in Depth, 2) Developing the Proper Mindset, 3) Mastering the Contrarian Approach and 4) Using Smart Selling Tactics. Although this looks like an organized setup where the first part discusses the difficulties of selling, the two in the middle cover how this could be mended and the final part gives hands on advice on the execution of selling, structure isn’t what comes to mind when reading the text.

There are 30 very short chapters and it’s hard to see the logic of many of them as a number of recurring themes are repeated multiple times in basically all sections of the book. For someone advising on how to set up a well-thought-out sell strategy this doesn’t inspire confidence - and this is the 3rd edition of the book.

A large number of reasons for selling and methods of selling are discussed but there are few attempts made to connect them or direct specific investors to tools that are more suitable for them. Further, many of the pictures of the book – at least in my print - are sadly of such low quality that it is virtually impossible to interpret them.

All this is a shame since there are some definitive qualities to the book. Fist and foremost the strength of the text is the author’s understanding of trading psychology. The keen psychological interest makes the book come to life and the reader can very easily relate to what is said. The topic of trading psychology is also covered broadly, it describes buying as well and pops up at various places in the book but this is more easily forgiven by the shear enthusiasm Cassidy shows for the topic.

Apart from the apt account of trading psychology the author, benefitting from 4 decades in the financial markets, delivers plenty of sound advice and insights into the investing world. His account of the brokerage industry and why sell-side analysts don’t give the recommendation “sell” very often is clearly cynical but probably not entirely wrong. It simply hasn’t been good for business with the business model that has been in use.

Further, while I above noticed that the author had a mid-term investment horizon the methods portrayed could also be quite useful to longer-term oriented investors (or stale buy-and-holders and stock collectors as the author describes them – I’m always surprised how different types of market participants form separate religions), as they are to sell their winners. Especially, value investors tend to buy too early and sell (winners) too early and could do well by studying techniques such as for example trailing stop losses. Finally, the checklist in chapter 29 starts to bring everything that has been said in the book into order.

There is much to learn in this book for the retail investor with a medium term horizon. Unfortunately it takes some serious work to distill a clear selling strategy out of this text. A forthcoming edition slimmed down from 280 pages to 180 with more structure and less duplication would be a real winner in my mind.

Mats Larsson, May 7, 2017

Elder. Dr. Alexander - Sell & Sell Short

John Wiley & Sons, Inc., 2008, [Equity Investing] Grade 4

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This book isn’t really for me or any other more fundamental and long-term investor – but it is excellent. Short sellers come in many forms and just as there are short term contrarian traders on the long-only side there are those on the short side. Dr. Alexander Trader is one such swing trader with an investment time horizon that is probably between a few days up to a month. The strategy is to trade the short fluctuations around a trend. To profit from these price wiggles it is only natural to try to exploit movements both as prices go up and as they go down.

Apart from being an active trader the author is since long a teacher of other traders and has written a large number of books on trading and trading psychology. The last angle is important since Sell & Sell Short clearly excels when it comes to the description of the psychology of being invested in the financial markets. Interestingly, the experienced mental joys and pains of putting on short-term trading positions and holding a longer-term fundamentally based portfolio are remarkably similar.

Despite being a book on selling and short selling, those two subjects are complemented by one section on buying. They probably cover one third each of the books volume. In many cases this kind of branching out from the main subjects detracts from the worth of a book. This time it adds to the worth since the reader gets a feel for all the necessary angles of succeeding in markets, be it knowing ones edge, keeping records to learn from mistakes or handling money management, i.e. portfolio risk.

Paradoxically, Elder describes his trading strategy as a value strategy. He buys when the price is lower than the value and the price is looking as it is about to turn up. He sells when the price reaches the value zone, or he might ride it a little further into overvalued territory if the momentum of the share price is really strong. He sells short when the stock is in expensive territory and has started to decline and then covers his position when the stock is back down in the value zone. The thing is, what the author calls “value” is the zone between two rolling averages, i.e. the underlying medium term trend of the share price, rather than the intrinsic worth of the company.

While buying is fun and offers opportunities, selling is an unsmiling business. This is why books on selling are important but rare. If a stock goes in the wrong direction doubts start to swirl in the back of the trader’s mind. If it goes in the right direction he is torn between taking profits but then risk not taking part in potential further profits.

Selling situations can according to Elder be split into three categories: a) selling with a profit at a pre-determined profit target, b) selling with a loss using a protective stop and c) selling between the profit target and the stop level since conditions have changed and you no longer want to hold the position – “when in doubt, get out”. Covering short positions very much follows the same logic only with the price trend turned on its head.

A long teaching career, trying to explain something to others, makes wonders when it comes to how illuminating and clear this text is in explaining Elder’s very hands-on method to trading. I also appreciate the author’s wide knowledge of other investment styles as he can readily discuss similarities, differences, advantages and disadvantages of what he is doing himself compared to quants, fundamental investors, momentum traders, short sellers, long-onlies and so on. The key message is that to succeed any investor must do what suits his own disposition.

This book is highly recommended for the swing trader looking to profit from all types of short-term price movements – but also for those interested in understanding equity markets and investment psychology at large.

Mats Larsson, May 05, 2017

Kumar, Amit - Short Selling

Columbia Business School, 2015, [Equity Investing] Grade 3

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Columbia Business School is the academic home of value investing so it’s only fitting that it is their publishing company that provides Amit Kumar’s expose of short selling. Fundamental shorting of stocks is a discipline related to value investing since it is based on detecting a discrepancy between price and value through research of business fundamentals. But where value investing focuses on the situations where the value is deemed to be higher than the price, short selling zooms in on the opposite situations.

The author Amit Kumar who is a portfolio manager at Columbia Threadneedle Investments and a business professor at Rutgers Business School, has also written a book that is clearly influenced by the value investing discipline. The text has three sections. In the first Kumar lays out a framework to identify short selling opportunities, then he presents a number of interviews with investors and in the finishing third section he covers the risks and mechanics of shorting.

In short the presented categories of structural short opportunities are in companies 1) with business model issues, 2) that are unsustainably leveraged, 3) in structural decline making them value traps, 4) that are broken growth stories and 5) with accounting issues. The chapters in part 1 loosely follow this setup and the author develops his thoughts, provides some detail and present a large number of case studies – all more or less successful for the short seller.

If there is an overriding theme to the author’s short cases I would say that the core of a case is centered on businesses model problems. High leverage, high valuations, accounting warning flags etc. are secondary factors. There has to be a fundamental shift to the worse in business fortunes acting as a catalyst. And it is definitely a no-no to short open-ended growth stocks on the fact alone that they are overvalued.

The interview section is clearly interesting but considering the theme of the book, not very well aligned. First there is a section on the value investor icons Ben Graham, Warren Buffett and Charlie Munger and although Graham at least did some shorting (is there something he didn’t do?) this is hardly where his legacy lies. Then follows an interview with famed value investor Jean-Marie Eveillard who doesn’t short stocks at all and the activist investor Bill Ackman that only occasionally (but very publicly) take short positions. Finally, in the last interview with Mark Roberts, analyst at Off Wall Street, there is a contribution from a dedicated short seller. Names like Ackman and Eveillard clearly sell books but it really would have been more appropriate to seek other interviewees.

The finishing section with one chapter on when to cover short positions and one on the mechanics of short selling would probably fit equally well as a part of the first section. At least the basic knowledge of how to actually short a stock should have been presented in the very beginning, for the benefit of those less familiar with the process.

Most investment books explore the angle of finding winning (long-only) stocks as the road to success, but a portfolio that avoids losers will almost certainly also outperform. Short Selling will as such not only instruct those who are interested in short positions, but also help long-only investors avoid disaster positions. Success is often about sidestepping the stupid actions. However, although perfectly fine, in my opinion this is not the definite primer on short selling.

All investors benefit from learning about stocks that risk failure. This book provides some clues.

Mats Larsson, May 1, 2017

Staley, Kathryn F. - The Art of Short Selling

John Wiley & Sons, 1997, [Equity Investing] Grade 3

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There are very few books on fundamental short selling of stocks but this is one of the more well-known ones. It covers many aspects of the trade very well but leaves others out. Unfortunately we are still waiting for the definite book on shorting, preferably written by some of the veterans of the game.

There are three parts to the book where the first gives an okay background to the area and its practitioners. Short candidates are categorized into companies that a) lie to investors through their accounting, b) have expensive valuations and c) will be negatively affected by external events. Signals used by those shorting are according to the author a) accounting warning flags, b) signs of “insider sleaze”, c) stellar stock price rises, d) cash consuming companies and e) overvalued assets or ugly balance sheets.

Then the absolute bulk of the book is a number of rather old case studies meant to exemplify different types of short selling cases – although not exactly linking to the categories in part one. The author has had good access to commentary from a number of veteran short sellers through interviews. I still think the author could have drawn more explicit deductions from these, as they now mostly resemble a line-up of successful war stories.

The storyline is that clever short sellers first see something that daft Wall-Street analysts or long-only investors couldn’t detect. Then the investment case either takes longer to pan out than expected or the short sellers are tormented by violent short squeezes causing pain but in the end they are always vindicated and the company lead by the evil managers dwindles into disaster. Finally, there is a short wrap up where Staley draws some general conclusions about the field but also gives a historical account of shorting.

Kathryn Staley have, as I understand it from the sleeve of the book, worked with both hedge funds and brokerages in trying to find stocks to short. She has taught financial statement analysis for AIMR, the Association for Investment Management Research and “reads balance sheets and footnotes for fun and profit”. Despite her experience as a short seller there is very little of technical detail in the book as it is written in an anecdotal, almost journalistic, style. As an example, if Days Sales of Inventory is one of the most reliable signs of trouble as is claimed, how is the ratio calculated, what are the pros and cons of using it and which other indicators are useful to complement it with? Even though the title points to the “art” or short selling I think the “craft” could have deserved some space.

Even though the tone can sometimes become a bit too idolizing the strong aspect of the book is that you get a fair grip of the psychology of shorting and above all of the character of short sellers. Their contrarian nature is described as ambitious, cynical, driven, single minded – even pigheaded – and sometimes frugal and anti-social. They are curious, hard working and find pleasure in finding the truth and being smarter than the gullible investment crowd as stocks blow up. The author describes an almost moralist disposition since short sellers enjoy exposing the corporate fraudsters who waste the shareholders money. I also like how the book defuses short selling and shows how very similar the research into investment cases is on the short side and the long side. Long-only investors can actually learn plenty from the attention to accounting detail among short sellers.

Despite the mixed review the unfortunate truth is that there aren’t many other books to recommend instead so the book could still be worth purchasing. We are still waiting for the definite reference book on shorting.

Mats Larsson, April 23, 2017

Madura, Jeff - What Every Investor Needs to Know About Accounting Fraud

McGraw-Hill, 2004, [Equity Investing] Grade 2

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Reading this book I went from mildly pleased, to incurious and finally downright irritated. The subtitle is “Proven Techniques to Avoid Questionable Stocks”. In reality Jeff Madura, a finance professor at Florida Atlantic University and an author of several finance textbooks, provides nothing of the kind in this book written after the Enron and WorldCom scandals burst in the early 2000s.

The author has divided the text in 5 different parts and the book starts off by displaying a number of ways that companies historically have used to look more profitable - by increasing sales alternatively decreasing costs - or look more financially stable than they actually were and Madura clarifies with some of the then recent examples from the bust after the TMT-bubble. It is fairly basic but illuminating and written in good spirit. It’s an okay introduction to the subject of financial deception.

In the next chapter Madura tries to explain why so few have the ability but more importantly the incentive to uncover the shenanigans. The short answer is that they are all on the payroll of the corporations who cheat. Auditors are paid by the companies and apart from doing audits earn money on doing extra corporate consulting. The firms that Wall-Street analysts work for earn the big bucks from corporate finance services for the companies and the analysts are dependent on the goodwill of the companies for their flow of information. Credit rating agencies depend on the audited accounts prepared by the auditors who are on the take. This was prior to the debacles of the rating agencies in the GFC so the fact that companies pay for the rating agencies’ ratings as well isn’t discussed. Still the bottom line is that no one wants to bite the hand that feeds them.

Then follows two sections on how board practices should serve the owners of the companies and governmental regulatory initiatives and bodies related to financial supervision. These sections are fairly basic (SEC should get more resources), they have a kind of academic ivory tower touch to them (FASB should be allowed to write really detailed accounting rules), also they are a bit dull and don’t really speak to the investor who wants to understand how to protect himself from investing in the wrong kind of stocks.

The last part is called “How Investors Can Cope With Deceptive Accounting” and at last we should presumably in the six chapters that follow learn how to “protect your investing portfolio from accounting fraud”. I expected some discussion on how to use financial tools like cash conversion, change in accruals, change in Days Sales Outstanding, Days Sales in Inventory or other less frequently used metrics perhaps in combination with other more subtle signs of ethical collapse in companies.

One of the chapters can be summed up with that the reader shouldn’t trust anyone. This is a rather superfluous message since it has to a large extent been the overall message so far. However, Madura now also adds that the reader shouldn’t even trust his own ability to uncover financial tricksters. Consequently the advice in three of the other chapters is “give up”! Invest in mutual funds, ETFs, T-bills and bonds instead of individual stocks. Talk about a let down! Yes, by investing in bonds the investor clearly “avoids questionable stocks” but that was probably not quite the type of advice that people expected to get and what got them interested in purchasing the book.

In all honesty there are two other chapters that look into investing in stocks. The author advices the reader to look for corporate management teams that run their companies for the long term and to do detailed fundamental research on all aspects of the company’s business operations, sector and management and then make common sense judgments on the corporate quality. This is fair advice, but it’s hardly very specific.

Buy Howard Schilit’s Financial Shenanigans or Thornton O’glove’s Quality of Earnings instead.

Mats Larsson, March 25, 2017