
To Become a Better Investor, Think Like Darwin - t23
http://nautil.us/blog/to-become-a-better-investor-think-like-darwin
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acconrad
None of this is new news, this is exactly what _The Intelligent Investor_ and
_Margin of Safety_ are based on: that the market _is_ irrational.

To go further, this is what Warren Buffett made his first few millions off of
what is considered "cigar butt" investing. These are stocks trading below
their Net Current Asset Value (NCAV). That means take all of their cash, real
estate, equipment... those are your net current assets. Now take a subset of
those stocks, and you find some at such steep discounts that they are trading
_below the cash they are holding_. How is that possibly rational?

To put that in perspective with a contrived example would be Apple, currently
trading at $153 with a market cap of nearly $800B, $250B of that is in cash.
Now imagine Apple is trading at $45 a share. That would value Apple at
$235B...but if they liquidated the company, they would have _more_ than that
in the cash alone! And that is exactly the kinds of companies that folks like
Ben Graham and Warren Buffett invested in, because they were so cheap, and
probably not even great businesses, but had "one less puff" (hence cigar butt)
in them before they closed up shop, were acquired, etc.

Now, one retort might be that these guys were investing in two of the worst
markets in the history of the US economy - Ben Graham came out of the Great
Depression and Warren Buffett from the bear market of 61-62. But there are
still examples of this today. Seth Klarman's fund (which still exists today)
has only had 3 down years and is considered to be one of the greatest
investors since Buffett. These investments still exist, and it's all based on
buying cheap when the market has irrationally priced them at a sale.

~~~
Retric
Don't forget your looking at the winners not the median returns for that
category of investor. A company with 100 Million in liquid assets can easily
be facing a 200 Million dollar lawsuit tomorrow.

~~~
tome
Yeah I've never understood how value investors account for hidden liabilities.
Perhaps you have to be very good at reading financial statements.

~~~
valuearb
Public companies are required to report on all of their liabilities. You read
the quarterly and annual reports and intelligently assess which risks are
significant or not, and how to discount for them.

Beyond that you spend time thinking about their business and what could go
wrong. If there is something obvious to you they didn't disclose, that would
tend to mean management is untrustworthy or incompetent, two other huge risks.

Buffett spends lots of hours reading reports away from CNN and computers and
distractions. I'm sure he talks to Charlie and others regularly about things
that concern him and gets different perspectives.

~~~
Retric
Again, a lot can happen in a week let alone 3 months between annual reports.
The secret of Buffet's success is not limited to value investing he had quite
a bit of early leverage and of course is also quite old now which give plenty
of time to compound gains.

~~~
prewett
It's difficult to compound gain at 19% for 50 years--the S&P only did 10%. The
secret of Buffett's success, which he explains in every letter, is that he
bought an insurance company. As long as you are diligent in writing non-money-
losing policies, you get the premiums up front and pay later. So you have all
this float that you can do something with. But he also picks good companies,
picks good managers, and is careful to make sure that the financial incentive
for the manager is the same as the financial incentive for Berkshire, which is
not the case with most executive packages.

~~~
Retric
Exactly, leverage happened to work out really well for him, but true big the
same idea can easily end up with you broke.

~~~
valuearb
Nope.

Leverage is only minor component of his late career success, and insurance
float could never have gotten him broke. It's totally unlikely like a loan
from your broker.

~~~
Retric
His late career has been less impressive vs is early career. Also, float can
dry up if insurance sales drop. So in many ways it's worse than a loan from
your broker it's got totally random size fluctuations. He just happened to be
really lucky / skilled at running an insurance company over time so that this
was not an issue. However, that says more about running an insurance company
than investing.

~~~
valuearb
If his results declined after he bought insurance companies, how does that say
he was lucky/skilled at running them, and how did he gain any benefits from
the leverage they afforded?

The reality is his late career is less impressive only in one way, annualized
returns, and it's more impressive in virtually every other way. He started out
with less than a million in investors money, and his 40% returns with the
Buffett Partnership were probably with an average of $10M to $20M total.

Nowadays his public stock portfolio was $122B at year end 2016. That limits
the stock market investments he can make to a tiny fraction of stocks. He's
not going to buy hundreds of stocks, not even dozens. He wants to focus in his
dozen or so best ideas. So he want to be able to put $10B to work in each and
there are very few public companies with market caps and trading volumes large
enough to allow him to do that. So problem #1 is that he went from a market of
5,000+ stocks he could choose from to maybe a few hundred, reduced
opportunities that directly hurts his returns.

Worse, how can he accumulate $10B worth of a company before he's forced to
publicly disclose his purchases. If he's forced to disclose prematurely, his
future returns dwindle due to free-riders driving the purchase price up before
he's done. That's big problem #2.

The fact that he's still beating the market carrying these heavy chains is
more impressive to me than the fact he whipped it at 3x higher rates when he
could buy anything he wanted.

~~~
Retric
But, take out those 40% years and his returns are much closer to the stock
indexes.

While managing billions at minimal risk he is not making nearly 17% returns.
He is doing OK but again your looking at a statistical outlier so you can't
separate skill and luck as much as you might think.

~~~
valuearb
His returns from Berkshire Hathaway has averaged 19% over the last 52 years
(from 1965), vs a 9.7% market return over the same period.

His 40% returns were in the Buffett Partnerships, which ran for 12 years from
mid 50s to late 60s, and aren't counted in Berkshires results.

Doubling the market return rate over 52 years is huge outperformance. For an
investor it's roughly doubling every 3.5 years instead of 7.5 years.

Add in the fact he crushed the market by nearly 4x a year for an earlier 12
years and his immense skill is undeniable. He would be statistically
implausible if the world had trillions of investors.

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valuearb
I think this is silly gobbledygook. The author seems to argue that you pull
out of stocks when expected volatility rises. Well expected volatility can be
a trailing indicator. The market has low volatility because investors expect
great times, yet it suddenly crashes and loses 20%, and volatility skyrockets
because investors basically believe that patterns continue forever and expect
the market to continue to fall.

So now you sell, at 20% below peak prices. Maybe prices continue to fall,
maybe not, but it's unlikely expected volatility will fall until the market
starts climbing again significantly, say 20%. So then you buy back in, well
above the lows.

Essentially this seems like a sell low, buy high mechanism, sell on dips, and
buy on spikes.

Value investing means you invest in only what you can reasonably estimate a
value for. You buy when the price is substantially less than it's value. You
sell when value and price are similar.

Selling a stock you though was worth $10 and bought at $7, because it goes to
$6 doesn't make sense if you believe in your original valuation. Buying it
back because it goes to $9 doesn't make sense either.

If you cannot confidently assess value, you shouldn't be doing anything but
buying and holding index funds.

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dharma1
The last chapter, to me, was the most interesting, and I would have liked it
if author had expanded on this:

"If we need 100,000 people to cure cancer, to deal with Alzheimer’s, to figure
out fusion energy and climate change…I don’t know of any other way to do that
other than financial markets: equity, debt, proper financing and proper payout
of returns. I think that in many cases [finance] probably is the gating
factor"

How do you attribute finance as an organising/motivating factor to solve some
of these problems? Energy, and patented medicine, yes I can see that - but
pollution and climate change?

~~~
friedman23
I guarantee you that the solution to climate change will come from markets.
Not some utopian ideal of all the countries of the world coming together to
stop polluting but some person trying to get rich that creates a business that
makes non polluting energy more affordable than fossil fuels.

~~~
dharma1
I'm not sure we will have a solution to climate change (or other types of
pollution) before it's too late.

The main problem, in my view, with pollution is that we find ourselves in a
situation where short term gains (or negligence) are creating long term
problems with significant consequences that we have no inherent motivation or
evolutionary reward pathways to address.

In the case of energy one could argue that markets will drive the cost of
solar below fossil fuels, which I agree with, though not convinced about the
time scale, especially on energy storage front. With other types of pollution
I don't see the market doing much at all.

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SirLJ
I don't have the back data to test this, so I would not invest in this
manner...

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jbmorgado
_" The Egyptians built some beautiful pyramids, but they did that with
hundreds of thousands of slaves over decades."_

This is now actually disproved. Made me doubt quite a bit about if the rest of
the article (and his book) is actually based on any evidence or just the
author's personal views.

