Review – Common Stocks And Uncommon Profits

Common Stocks and Uncommon Profits: And other writings by Philip A. Fisher

by Philip A. Fisher, published 1996, 2003

Stock market investors who have studied Warren Buffett in detail know that he has cited two “philosophers” of investment theory more than anyone else in being influential in the formation of his own investment approach: Benjamin Graham and Phil Fisher. Graham represents the cautious, conservative, balance sheet-driven Buffett, while Fisher represents the future-oriented, growth-focused, income statement-driven Buffett. If you ask Buffett, while Graham got him started and taught him key lessons in risk management (Margin of Safety and the Mr. Market metaphor), Fisher was the thinker who proved to have the biggest impact in both time and total dollars accumulated. Buffett today, whether by choice or by default due to his massive scale, is primarily a Phil Fisher-style investor.

And yet, in my own investment study and practice, I have dwelled deeply on Graham and did little if anything with Fisher. I tried to read Fisher’s book years ago when I was first starting out and threw my hands up in disgust. It seemed too qualitative, too abstract and frankly for a person of my disposition, too hopeful about the future and the endless parade of growth we’ve witnessed in the markets for several decades since the early 1980s. Surely there would be a time where the Fisher folks would hang their heads in shame and the Grahamites would rise again in the fires of oblivion! After all, “Many shall be restored that are now fallen and many shall fall that are now in honor.”

As my professional career wore on, however, I found there was less and less I could do with Graham and more and more of what Fisher had said that made sense. And if you’re in business, you can’t help but be growth oriented– buying cheap balance sheets isn’t really the way the world works for the private investor. So, I decided it was time to take another look at Fisher’s book and see what I could derive from it as an “older and wiser” fellow. What follows is a review of Part I of the book; I plan to read and review Part II, which is a collection of essays entitled “The Conservative Investor Sleeps Well At Night”, separately.

Keep Your Eye On The Future

One thing I noticed right away is the consistent theme of future-orientation throughout Fisher’s book. Whereas balance sheets and the Graham approach look at what has happened and what is, Fisher is always emphasizing a technique that involves conceptualizing the state of the future. For example, in the Preface he states that one of the most significant influences on his own investment results and those of other successful investors he was aware of was,

the need for patience if big profits are to be made from investment.

“Patience” is a reference to time preference, and time preference implies an ability to envision future states and how they differ from the present and therein see the arbitrage available between the two states. The other key he mentions is being a contrarian in the market place, which sounds a lot to me like the lesson of Mr. Market.

Fisher also says that market timing is not a necessary ingredient for long-term investment success,

These opportunities did not require purchasing on a particular day at the bottom of a great panic. The shares of these companies were available year after year at prices that were to make this kind of profit possible.

While he cites the structural inflationary dynamic of the modern US economy and seems to suggest the federal government’s commitment to responding to business cycle depressions with fiscal stimulus puts some kind of ultimate floor under US public company earnings (unlike in Ben Graham’s time where large companies actually faced the threat of extinction if they were caught overextended in the wrong part of the cycle, Fisher suggests the federal government stands ready to create conditions through which they can extend their debt liabilities and soldier on), he says that the name of the game over the long-term is to find companies with remarkable upside potential which are, regardless of size, managed by a determined group of people who have a unique ability to envision this potential and create and execute a plan for realizing it. In other words, the problem of investing is recognizing strong, determined management teams for what they are, that is, choosing superior business organizations in industries with long runways.

Getting the Goods: The Scuttlebutt Approach

People who know about Fisher typically identify him with the “scuttlebutt approach”. Fisher says scuttlebutt can be generated from:

  • competitors
  • vendors
  • customers
  • research scientists in universities, governments and competitive companies
  • trade association executives
  • former employees (with caveats)

Before one can do the scuttlebutt, however, one has to know where to look. Fisher says that “doing these things [scuttlebutt] takes a great deal of time, as well as skill and alertness […] I strongly doubt that [some easy, quick way] exists.” So, you don’t want to waste your time by going to all the trouble for the wrong idea. He says that 4/5 of his best ideas and 5/6 of the total gains generated over time that he could identify originated as ideas he gleaned from other talented investors first, which he subsequently investigated himself and found they fit the bill. Now, this is not the same thing as saying 4/5 ideas he got from others were worth investing in– the proportion of “good” ideas of the “total” he heard about is probably quite low, but the point again is not quantitative, but qualitative. He’s talking about where to fish for ideas, not how successful this source was.

When I thought about this section, I realized the modern day equivalent was investment bloggers. There are many out there, and while some are utter shit (why does this guy keep kidding himself?) some are quite amazing as thinkers, business analysts and generators of potential ideas. I have too many personal examples of my own here to make mention of them all. But I really liked this idea, cultivating a list of outstanding investment bloggers and using that as your primary jumping off point for finding great companies. The only problem for me in this regard is most of my blogroll are “value guys” that are digging in the trash bins (as my old boss sarcastically put it), whereas to find a Fisher-style company I would need to find a different kind of blogger interested in different kind of companies. But that’s a great to-do item for me to work on in this regard and should prove to be highly educational to boot!

So, assuming you’ve got a top notch idea, what’s next? Fisher is pretty clear here: do not conduct an exhaustive study of the company in question just yet. (In other words, don’t do this just yet, though I loved SoH’s follow-up where he explained what kind of things would get him to do that.) What he does do is worth quoting at length:

glance over the balance sheet to determine the general nature of the capitalization and financial position […] I will read with care those parts covering breakdown of total sales by product lines, competition, degree of officer or other major ownership of common stock […] all earning statement figures throwing light on depreciation, profit margins, extent of research activity, and abnormal or non-recurring costs in prior years’ operations

Then, if you like what you see, conduct your scuttlebutt, because,

only by having what “scuttlebutt” can give you before you approach management, can you know what you should attempt to learn when you visit a company […] never visit the management of a company [you are] considering for investment until [you have] first gathered together at least 50 per cent of all knowledge [you] would need to make the investment

This is the part that really gives a lot of investors pause about Phil Fisher’s approach, including me. Can you really do scuttlebutt, as he envisions it, in the modern era? Can the average investor get the ear of management? Does any of this stuff still apply?

First, some skepticism. Buffett’s biographer Alice Schroeder has said in interviews that much of what made Buffett successful early on in his career is now illegal and would amount to insider trading. The famous conversation with the GEICO chief is one of many that come to mind. This was classic scuttlebutt, and it worked amazingly well for Buffett. And even if it wasn’t illegal, most individual investors are so insignificant to a company’s capital base that they can’t expect nor will they ever receive the ear of management (unless they specialize in microcap companies, but even then management may be disinterested in them, even with significant stakes in their company!) And, assuming they DO somehow get management’s ear, they aren’t liable to learn much of value or interest specifically because most managements today are not only intellectually and politically sophisticated, but legally sophisticated and they are well aware that if they say anything more general than “We feel positive about our company” they’re liable to exposure under Reg FD. This seems like a dead end.

But let me try to tease the idea out a little more optimistically. Managements do provide guidance and color commentary on quarterly earnings calls, and if you are already dealing with a trustworthy, capable management (according to the 15 points outlined below), then there is opportunity to read between the lines here, even while acknowledging that there are many other people doing the same with this info. And people who do get managements’ ear are professional analysts employed by major banks. Again, lots of people read these reports, but there is some info here and it adds color and sometimes offers some “between the lines” information some might miss. And while the information you can get from any one company may be limited, by performing this analysis on several related companies you might be able to fill in some gaps here and there to the point that you can get a pretty fair picture of how the target company stacks up in various ways.

I hesitate a little, but I think the approach can be simulated to a fair degree even today. It’s still hard work. It can’t be done completely, or perhaps as Fisher imagined it. But I think it can be done. And it still comes down to the fact that, even with all this info that is out there, few will actually get this up close and personal with it. So, call it an elbow-grease edge.

After all,

Is it either logical or reasonable that anyone could do this with an effort no harder than reading a few simply worded brokers’ free circulars in the comfort of an armchair one evening a week? […] great effort combined with ability and enriched by both judgment and vision [are the keys to unlocking these great investing opportunities] they cannot be found without hard work and they cannot be found every day.

The Fisher 15

Fisher also is known for his famous 15 item investment checklist, a checklist which at heart searches for the competitive advantage of the business in question as rooted in the capability of its management team to recognize markets, develop products and plans for exploiting them, execute a sales assault and finally keep everything bundled together along the way while being honest business partners to the minority investors in the company. Here was Fisher’s 15 point checklist for identifying companies that were highly likely to experience massive growth over decades:

  1. Does the company have sufficient market scale to grow sales for years?
  2. Is management determined to expand the market by developing new products and services to continue increasing sales?
  3. How effective is the firm’s R&D spending relative to its size?
  4. Is the sales organization above-average?
  5. Does the company have a strong profit margin?
  6. What is being done to maintain or improve margins? (special emphasis on probable future margins)
  7. What is the company’s relationship with employees?
  8. What is the company’s relationship with its executives?
  9. Is the management team experienced and talented?
  10. How strong is the company’s cost and accounting controls? (assume they’re okay unless you find evidence they are not)
  11. Are there industry specific indications that point to a competitive advantage?
  12. Is the company focused on short or long-term profits?
  13. Can the company grow with its own capital or will it have to continually increase leverage or dilute shareholders to do it?
  14. Does the management share info even when business is going poorly?
  15. Is the integrity of the management beyond reproach? (never seriously consider an investment where this is in question)

What I found interesting about these questions is they’re not just good as an investment checklist, but as an operational checklist for a corporate manager. If you can run down this list and find things to work on, you probably have defined your best business opportunities right there.

In the chapter “What to Buy: Applying This to Your Own Needs”, Fisher attempts to philosophically explore the value of the growth company approach. First, he tries to dispel the myth that this approach is only going to serve

an introverted, bookish individual with an accounting-type mind. This scholastic-like investment expert would sit all day in undisturbed isolation poring over vast quantities of balance sheets, corporate earning statements and trade statistics.

Now, this is ironic because this is actually exactly how Buffett is described, and describes himself. But Fisher insists it is not true because the person who is good at spotting growth stocks is not quantitatively-minded but qualitatively-minded; the quantitative person often walks into value traps which look good statistically but have a glaring flaw in the model, whereas it is the qualitative person who has enough creative thinking power to see the brilliant future for the company in question that will exist but does not quite yet, a future which they are able to see by assembling the known qualitative facts into a decisive narrative of unimpeded growth.

Once a person can spot growth opportunities, they quantitatively have to believe in the strategy because

the reason why growth stocks do so much better is that they seem to show gains in value in the hundreds of percent each decade. In contrast, it is an unusual bargain that is as much as 50 per cent undervalued. The cumulative effect of this simple arithmetic should be obvious.

And indeed, it is. While great growth stocks might be a rarer find, they return a lot more and over a longer period of time. To show equivalent returns, one would have to turnover many multiples of incredibly cheap bargain stocks. So this is the philosophical dilemma– fewer quality companies, fewer decisions, and less room for error in your decisions with greater return potential over time, or many bargains, many decisions, many opportunities to make mistakes but also less chance that any one is critical, with the concomitant result that your upside is limited so you must keep churning your portfolio to generate great long-term results.

Rather than being bookish and mathematically inclined (today we have spreadsheets for that stuff anyway), Fisher says that

the successful investor is usually an individual who is inherently interested in business problems. This results in his discussing such matters in a way that will arouse the interest of those from whom he is seeking data.

And this still jives with Buffett– it’s hard to imagine him boring his conversation partner.

Timing Is Everything?

So you’ve got a scoop on a hot stock, you run it through your checklist and you conduct thorough scuttlebutt-driven due diligence on it. When do you buy it, and why?

to produce close to the maximum profit […] some consideration must be given to timing

Oh no! “Timing”. So Fisher turns out to be a macro-driven market timer then, huh? “Blood in the streets”-panic kind of thing, right?


the economics which deal with forecasting business trends may be considered to be about as far along as was the science of chemistry during the days of alchemy in the Middle Ages.

So what kind of timing are we talking about then? To Fisher, the kind of timing that counts is individualistic, idiosyncratic and tied to what is being qualitatively derived from one’s scuttlebutt. Timing one’s purchases is not about market crashes in general, but in corporate missteps in particular. Fisher says:

the company into which the investor should be buying is the company which is doing things under the guidance of exceptionally able management. A few of these things are bound to fail. Others will from time to time produce unexpected troubles before they succeed. The investor should be thoroughly sure in his own mind that these troubles are temporary rather than permanent. Then if these troubles have produced a significant decline in the price of the affected stock and give promise of being solved in a matter of months rather than years, he will probably be on pretty safe ground in considering that this is a time when the stock may be bought.

He continues,

[the common denominator in several outstanding purchasing opportunities was that ] a worthwhile improvement in earnings is coming in the right sort of company, but that this particular increase in earnings has not yet produced an upward move in the price of that company’s shares

I think this example with Bank of America (which I could never replicate because I can’t see myself buying black boxes like this financial monstrosity) at Base Hit Investing is a really good practical example of the kind of individual company pessimism Phil Fisher would say you should try to bank on. (Duh duh chhhhh.)

He talks about macro-driven risk and says it should largely be ignored, with the caveat of the investor already having a substantial part of his total investment invested in years prior to some kind of obvious mania. He emphasizes,

He is making his bet upon something which he knows to be the case [a coming increase in earnings power for a specific company] rather than upon something about which he is largely guessing [the trend of the general economy]

and adds that if he makes a bad bet in terms of macro-dynamics, if he is right about the earnings picture it should give support to the stock price even in that environment.

He concludes,

the business cycle is but one of at least five powerful forces [along with] the trend of interest rates, the over-all government attitude toward investment and private enterprise [quoting this in January, 2017, one must wonder about the impact of Trump in terms of domestic regulation and taxation, and external trade affairs], the long-range trend to more and more inflation and — possibly most powerful of all — new inventions and techniques as they affect old industries.

Set all the crystal ball stuff aside– take meaningful action when you have meaningful information about specific companies.

Managing Risk

Fisher also gives some ideas about how to structure a portfolio of growth stocks to permit adequate diversification in light of the risk of making a mistake in one’s choices (“making at least an occasional investment mistake is inevitable even for the most skilled investor”). His example recommendation is:

  • 5 A-type, established, large, conservative growth companies (20% each) -or-
  • 10 B-type, medium, younger and more aggressive growth companies (10% each) -or-
  • 20 C-type, small, young and extremely aggressive/unproven growth companies (5% each)

But it is not enough to simply have a certain number of different kinds of stocks, which would be a purely quantitative approach along the lines of Ben Graham’s famous dictums about diversification. Instead, Fisher’s approach is again highly qualitative, that is, context dependent– choices you make about balancing your portfolio with one type of stock require complimentary additions of other kinds of stocks that he deems to offset the inherent risks of each. We can see how Buffett was inspired in the construction of his early Buffett Partnership portfolio weightings here.

For example, he suggests that one A-type at 20% might be balanced off with 2 B-type at 10% each, or 6 C-type at 5% each balanced off against 1 A-type and 1 B-type. He extends the qualitative diversification to industry types and product line overlaps– you haven’t achieved diversification with 5 A-types that are all in the chemical industry, nor would you achieve diversification by having some A, B and C-types who happen to have competing product lines in some market or industry. For the purposes of constructing a portfolio, part of your exposure should be considered unitary in that regard. Other important factors include things like the breadth and depth of a company’s management, exposure to cyclical industries, etc. One might also find that one significant A-type holding has such broadly diversified product lines on its own that it represents substantially greater diversification than the 20% portfolio weighting it might represent on paper. (With regards to indexation as a strategy, this is why many critics say buying the S&P 500 is enough without buying “international stock indexes” as well, because a large portion of S&P 500 earnings is derived from international operations.)

While he promotes a modicum of diversification, “concentration” is clearly the watchword Fisher leans toward:

the disadvantage of having eggs in so many baskets [is] that a lot of the eggs do not end up in really attractive baskets, and it is impossible to keep watching all the baskets after the eggs get put into them […] own not the most, but the best […] a little bit of a great many can never be more than a poor substitute for a few of the outstanding.

Tortured egg basket metaphors aside (why on earth do people care what their egg baskets look like?!), Fisher is saying that the first mistake one can make is to spread your bets so thin that they don’t matter and you can’t efficiently manage them even if they did.

Aside from portfolio construction, another source of risk is the commission of errors of judgment.

when a mistake has been made in the original purchase and it becomes increasingly clear that the factual background of the particular company is, by a significant margin, less favorable than originally believed

one should sell their holdings, lick their wounds and move on. This needs to be done as soon as the error is recognized, no matter what the price may be:

More money has probably been lost by investors holding a stock they really did not want until they could “at least come out even” than from any other single reason. If to these actual losses are added the profits that might have been made through the proper reinvestment of these funds if such reinvestment had been made when the mistake was first realized, the cost of self-indulgence becomes truly tremendous.


Sales should always be made of the stock of a company which, because of changes resulting from the passage of time, no longer qualifies in regard to the fifteen points… to about the same degree it qualified at the time of purchase […] keep at all times in close contact with the affairs of companies whose shares are held.

One vogue amongst certain investors is to be continually churning the portfolio from old positions to the latest and greatest idea, with the assumption being that time has largely run its course on the earlier idea and the upside-basis of the new idea is so much larger that liquidity should be generated to get into the new one. Fisher advises only using new capital to pursue new ideas rather than giving in to this vanity because,

once a stock has been properly selected and has borne the test of time, it is only occasionally that there is any reason for selling it at all

The concept of “investment” implies committing one’s resources for long periods of time. You can’t emulate this kind of trading activity in the private market, which is a very strong indication that you should try to avoid this behavior in public markets. A particularly costly form of this error is introducing macro-market timing into one’s portfolio management, ie, this stock has had a big run up along with the rest of the market, things are getting heady, I will sell and get back in at a lower cost. I’ve done this myself, most recently with Nintendo ($NTDOY) and even earlier with Dreamworks ($DWA). Fisher says it’s a mistake:

postponing an attractive purchase because of fear of what the general market might do will, over the years, prove very costly […] if the growth rate is so good that in another ten years the company might well have quadrupled, is it really of such great concern whether at the moment the stock might or might not be 35 per cent overpriced? That which really matters is not to disturb a position that is going to be worth a great deal more later.

It plays to a logical fallacy that a company that has run up has “expended” its price momentum, while a company that has not had a run-up has something “due” to it. On the contrary, Fisher points out that many times the material facts about a company’s future earnings prospects change significantly over time from the original purchase, often to the good, such that even with a big run-up, even more is in the offing because the future is even brighter than before– remember, always keep an eye on the future, not the present or the past!

And similarly, if one has an extremely cheap cost basis in a company, one has an enormous margin of safety that should give further heed to trying to jump in and out of the stock when it is deemed to be overvalued.

He adds that, like wines, well-selected portfolio holdings get better with age because,

an alert investor who has held a good stock for some time usually gets to know its less desirable as well as more desirable characteristics

and through this process comes to develop even more confidence in his holdings.

If you’ve read some of my thinking about the philosophy of building multi-generational wealth through a family business, you’ll see once again the direct parallel to private market investing in Fisher’s conclusion:

If the job has been correctly done when a common stock is purchased, the time to sell it is– almost never.


Distilling Part I down to its essence, I concluded that the most important skill for generating long-term gains from one’s investing is still about having a disciplined and consistent investment program followed without interruption and in the face of constantly nagging self-doubt (“In the stock market a good nervous system is even more important than a good head.”) The particular program that Fisher recommends be followed is to:

  1. Create a network of intelligent investors (bloggers) from which to source ideas
  2. Develop a strong scuttlebutt skill/network to develop superior investment background
  3. Check with management to confirm remaining questions generated from the 15 step list
  4. With the conviction to buy, persevere in holding over a long period of time

If you can’t do this, you probably shouldn’t bother with the Fisher approach. Whether it can be done at all is an entirely separate matter.

Notes – Horizon Kinetics 2015 Compendium

For the last two years, Murray Stahl and Steve Bregman of Horizon Kinetics have published a “Compendium Compilation” of their various research pieces and market commentaries throughout the year. I recently requested copies of the 2014 and 2015 compendiums and just completed reading through the 2015 compendium. What follows are “stitched together” quotes from several of the essays.

The Indexation Experience

An active manager always can be found to be deficient if underperformance relative to an appropriate index is discovered. In fact, a manager can be found to be deficient if a return generated is equivalent to the appropriate index… one could always purchase the index as the less expensive investment alternative.

How does one judge an index to be deficient?

Since short-term interest rates approach zero in most regions of the world, the valuation environment is very benign… most governments during this period have embarked upon grand fiscal stimulus efforts that are now becoming unsustainable.

When one measures a manager relative to an index, is one measuring investment acumen or marketing ability?

The manager… will purchase a security until the expected excess rate of return is zero. The index… is marketed until the marginal revenue from a product is zero, which is an entirely different concept.

The index is not constrained by valuation.

Most indexes, in the fullness of time, do not earn impressive rates of return.

Problems With Indexation

When indexation excludes the so-called marginal securities, two things happen. The marginal securities are the stocks where the volatility really resides, which means the index is going to lose its volatility. Second, the marginal securities are an important contributor to what would have been the return… their negative impact gets captured on the way down– but the positive return impact does not get captured on the way up.

It is the nature of a market capitalization weighted index that it is always un-diversifying.


The problem with such an approach [wide diversification] is that it is quite impossible for any individual, or even a team of individuals, to have a good working knowledge of the individual investments at a security level. The portfolio can only be understood in terms of its statistical attributes… CalPERS… has about 20,349 individual investments.

If a team of 10 analysts were to work eight hours a day for three months, which is 22 business days per month, with no interruptions, the team would have at its disposal 10 x 8 x 3 x 22 man-hours to read 20,349 quarterly reports. This amounts to 5,280 man-hours available to read 20,349 quarterly reports, which equates to slightly more than 15 minutes per quarterly report… It should be obvious that success or failure in this endeavor must depend upon whether the statistical attributes of the portfolio provide the data necessary to make intelligent asset allocation decisions… it is impossible to devise a simple list of fundamental statistics to be used to comprehend a portfolio… because of differences in corporate expenditure practices, depreciation policies, tax laws in various jurisdictions, and GAAP vs. IFRS accounting.

The many diversified funds that purchase the most liquid securities must by definition generally own the same securities, since there is only one set of liquid securities. If the diversified institutions, therefore, own the same securities, when studying the price behavior of those securities, those institutions are, in reality, studying themselves.

If one believes in the Efficient Markets Hypothesis, then securities prices must reflect the beliefs of the holders of the securities. Yet, as shown above, the holders of securities do not study the securities. In fact, given diversification practices, it is not possible to study the securities. It is only possible that the investors study one another. Thus, one is confronted with a feedback loop or a huge self-reference paradox, as one may see in the paintings of M.C. Escher, such as Waterfall or Drawing Hands.

Another interesting case is the Singapore Index… returned 3.2% per annum. The mere fact that the economy of Singapore grew at over 6% per annum for more than 18 years does not correlate well with the stock market return for the simple reason that the Singaporean companies in the index are global companies. These results reflect many factors apart from the economy of Singapore.

Similarly, the Swedish index does not necessarily reflect the economy of Sweden. And the UK index does not necessarily reflect the economy of the UK.

The thrust of these facts is to question, if not actually reject, the geographical form of classification as an asset allocation building block. That calls into question the entire international method of investing. The characteristics of equities have little to do with the legal place of domicile of a given firm. However, on a weekly basis the Investment Company Institute records $3 billion to $4 billion withdrawn from domestic equity funds and deposited into international equity funds in search of diversification and risk control attributes that simply do not exist. As has been the case with many widely held investment beliefs without foundation, this will not have a good outcome.

Inefficient Markets

[Fischer Black] said that there are people who are highly knowledgeable about certain companies– the information traders– and when they trade, they are very well informed. Most others, however, are not so well informed; they are the noise traders.

[Fischer Black’s concept of] efficient markets was that if the bulk of investors were in an index that, as he defined it, would include every stock out there– everything– the noise traders would go there. That would eliminate the bulk of the noise traders from the active marketplace, so only the information traders would be trading. They would not go into the index, because they are highly informed, and the market would be much more efficient in the sense that it would reflect the judgments of informed participants.

If one reflects upon this matter [Carl Icahn’s letter to Apple], one will see that Mr. Icahn has posed an exceedingly profound question to all investors, and especially academics. Apple is the largest company in the world. It is arguably the most ubiquitous company in the world. Billions of people use Apple products daily and are very familiar with those products. If there is any equity in the world that should be priced efficiently, it should be Apple.

Yet, Apple has a lower P/E than companies such as Exxon, Coca-cola, and even Philip Morris International. One might debate the future prospects for Apple, but surely these are more robust than those of Philip Morris International. Does anyone assert that demand for cigarettes will increase?

The money manager industry is not populated by Homo Economicus, carefully and rationally evaluating different investment opportunities. The money manager can only survive by attracting assets to manage for a fee.

Modern financial theory cannot explain momentum because, if the stock market is efficient, there should be no serial correlation observed in securities… momentum investing is not a new innovation. It is a concept virtually as old as the idea of a stock market, although it has not always been called “momentum.” Technical analysis is essentially a search for securities with momentum.

It is now possible to raise substantial sums for almost any index if the rate of return is sufficiently high. It is nearly impossible to raise money for any index if the rate of return is insufficiently high, let alone if that return happens to be negative. This is not the asset allocation process. This is the momentum process. The industry makes use of a substantial marketing budget, It clearly influences the valuations not only of individual securities but of entire sectors, and it dominates, for the time being, the investment process.

Other Remarks

  • Is modern risk control methodology actually serving to reduce risk or is it merely convincing professional investors to accept, perhaps unwittingly, another type of risk?
  • It should be noted that the real was not always the currency of Brazil. There were cruzeiros, there were cruzadoes, and now we have the real. That in itself should tell the reader something about the stability of the currency.
  • Historically, that is what emerging market debt was: questionable claims against governments.
  • Bonds should be thought of in the following way: they offer risk with no possibility of reward, especially if you are a taxable investor.


Review – Losing My Virginity

Losing My Virginity: How I Survived, Had Fun and Made a Fortune Doing Business My Way

by Richard Branson, published 2011

Spoiler alert– this book is choppy and inconsistent in the pacing and entertainment factor of its narrative. You really need to read between the lines a bit to get the most value out of it. That being said, it’s surprisingly literary for a dyslexic former publisher of a student magazine and I found Branson’s repeated reference to his high-altitude balloon voyage trials to be an outstanding metaphor for his life as a businessman and entrepreneur.

You see, in Branson’s ballon journeys, the key factors of any consistency were that: a.) Branson was knowingly and openly taking what he perceived to be a potentially life-threatening risk b.) Branson was almost always underprepared for it, or decided to go ahead with his attempt despite early warnings that something was amiss and c.) nonetheless, he somehow managed to survive one disaster after another, only to try something bigger and bolder the next time around.

And this is quite similar to the way he comported himself as an entrepreneur on so many occasions. Again and again, he’d make a daring foray into a business, market or industry he didn’t quite understand, the company would stumble after an early success leaving them all on the brink of failure and yet, each time they’d double down and somehow win.

In that sense, Branson is a perfect example of survivorship bias. On the other hand, having so many narrow misses that turn into massive accelerators of a person’s fortune start to make you wonder if isn’t mostly luck but rather mostly skill.

As an entrepreneurial profile, “Losing My Virginity” is full of all kinds of great successes and astounding failures. With regards to the failures, something I found of particular interest was the fact that Branson’s company were victims of some of the most common pitfalls of other businesses throughout its early history: taken for a ride by indomitable Japanese owners/partnerships in the 80s, repeated victim of the LBO-boom and the private/public buyout-cycle in the 80s and 90s. When you read these stories in the financial press it always seems to happen to the rubes of the business world, but Branson’s foibles help one to realize even rather sophisticated types can get taken in now and then.

The volatility in Branson’s fortunes do leave one with a major question though, namely, why did Branson’s company ultimately survive?

This isn’t a Harvard Business School case study so I don’t mean to pass this off as a qualified, intelligent answer to that question, but I will attempt a few observations and, in typical HBS fashion, some or all of them may be contradictory of one another and none will be provided with the precise proportional contribution they made to the end result:

  • the group had a cultural commitment to change and dynamism; they were not so much their businesses, but a culture and group of people who did business a particular way, a true brand-over-merchandise, which allowed them to reinvent themselves numerous times
  • the group strategically focused on being the low-cost provider in their industry, usually while simultaneously attempting to pursue the seemingly mutually exclusive goal as being seen as the highest quality offering as well
  • the group focused on serving customers but equally saw treating its employees with concern as an important value
  • the group consciously created a brand that could be applied to diverse businesses (see point #1)
  • the group pursued businesses that seemed “interesting” or sensually appealing to it, which ensured that everyone involved was motivated to do well because they liked the work they had chosen

Another thing I noticed about Branson and the development of his company was the attention he paid to the composition of management and owners and his dedication to weeding out those who were not good fits in a charitable way. Channeling the “best owner” principle, Branson made a conscious effort to buy out early partners whose vision and tastes did not match the current or future vision of the group. In this way, the company maintained top-level focus and concentration on a shared strategic vision at all times, sparing itself the expense and distraction of infighting and wrangling over where to go next and why.

Another aspect of the company’s resilience had to do with its operational structure. Branson built a decentralized company whose debts and obligations were kept separate. In an environment where new ventures were constantly subject to total failure, this arrangement ensured that no one business failure would bring the entire group down.

The final lessons of the Branson bio were most instructive and had to do with the nature and value of forecasting.

The first lesson in forecasting has to do with the forecasts others make of us, or the world around us. For example, Richard Branson had no formal business training, he grew up with learning disabilities (dyslexia) and he was told very early on in his life by teachers and other adult and authority figures in his life that he’d amount to nothing and his juvenile delinquency would land him in prison. Somehow this worthless person contributed a great deal to society, through business and charity, and by most reasonable measures could be considered a success, making this forecast a failure. If one had taken a snapshot of the great Warren Buffett at a particular time in his adolescence, when the young boy was known to often take a “five-finger discount” from local department stores, it might have been easy to come up with a similar forecast about him.

I’m not sure how to succinctly sum up the concept there other than to say, “Things change.” Most forecasts that involve extrapolating the current trend unendingly out into the future will probably fail for this reason.

The second lesson in forecasting has to do with how we might attempt to forecast and plan our own lives. When we have 50, 60, 70 or more years of a person’s life to reflect on, it is easy to employ the hindsight bias and see how all the facts of a person’s life were connected and led them inexorably to the success (or infamy) they ultimately achieved. And certainly there are some people, again using Buffett as an example, who from an early age were driven to become a certain something or someone and so their ability to “predict their future selves” seemed quite strong.

But the reality is that for the great many of us, the well-known and the common alike, we really don’t have much of a clue of who we are and what we’ll ultimately become. The future is uncertain and, after all, that’s the great puzzle of life that we all spend our lives trying to unravel. Richard Branson was no different. He was not born a billionaire, in a financial, intellectual, personal or other sense. He had to learn how to be a businessman and how to create a billion dollar organization from scratch. Most of the time, he didn’t even know he was doing it. In other words, HE DID NOT KNOW AHEAD OF TIME that he would become fabulously wealthy, and while he was hard-working and driven, it doesn’t even appear he purposefully intended to become so.

Maybe we should all take a page from Branson’s book and spend less time trying to figure out what’s going to happen and more time just… happening. We could sit around all day trying to figure life out, or we could follow the Branson philosophy where he says, “As for me, I just pick up the phone and get on with it.”

Review – The Intelligent Investor

The Intelligent Investor: A Book Of Practical Counsel; The Definitive Book On Value Investing

by Benjamin Graham, published 1973, 2003, 2006

All you need to know about intelligent investing

Graham’s layman’s manual for thoughtful investing in common stocks and bonds is a long book, chock full of useful theory and wisdom-gained-by-experience as well as numerous “case studies” which serve to illustrate Graham’s points. While it’s all worth considering, the truth is that certain parts of the book shine more brightly than others and, following the 80/20 principle, are clearly more valuable overall.

Starting out

The Intelligent Investor is of course a practical guide to sound investment, but it is also a work of philosophy. Buried throughout the book are invaluable caveats that are easy to overlook yet deserve to get full billing because they can spare an amateur a lot of headaches down the road. In the book’s introduction, there are two such provisos quite nearby one another, the first being,

be prepared to experience significant and perhaps protracted falls as well as rises in the value of [your] holdings

and the second being,

while enthusiasm may be necessary for great accomplishments elsewhere, on Wall Street it almost invariably leads to disaster

Subtle, but profound, these two warnings are Graham’s opening salvo on the subject of investor psychology, or more accurately, the investor’s own psychology. It will be a common thread running throughout TII— your biggest risk in investing is yourself and your psychological reaction to events impacting your portfolio.

Translating the first message, Graham is trying to gird the investor for the inevitabilities of the market, where volatility is constant in both directions. The key, as you will see, is to master volatility by recognizing that the upward variety is not necessarily proof of a good decision and the downward variety is not punishment but an opportunity to buy at bargain prices.

The second message is even more important– successful investing requires an even-keeled temperament and reasonable expectations about long-term success. The game is about expecting little and learning to be pleasantly surprised, rather than expecting a lot and constantly being disappointed. Most of your fellow market participants are excitable folks and their optimistic expectations will work with yours to crowd out any chance at realizing value, while you’ll always have plenty of room to maneuver on your own if you seek out the waters everyone of which everyone else has become bored.

The last warning is to be consistent and disciplined, to never abandon your principles in dire times because that is in fact when they become most valuable:

Through all their vicissitudes and casualties, as earth-shaking as they were unforeseen, it remained true that sound investment principles produced generally sound results

This is again a psychological appeal. When everyone else is losing their shirts, and their minds, forgetting what they’re doing and why, it will pay the long-term investor great dividends to be mindful of who he is and by what principles he invests as his conservatism is always in due time rewarded.

Security analysis 101

While the best treatment of Graham’s principles of security analysis are given in great detail in his treatise of the same name, [amazon text=Security Analysis&asin=0070140650], The Intelligent Investor does come with several basic recommendations on how to perform basic security analysis for issues under consideration for inclusion in one’s portfolio.

Bond analysis

The key to bond investing is interest coverage, as without it a bond is in default and its principal value is imperiled. Therefore, the primary analytical factor is the number of times total interest charges have been covered by available earnings in years past. Typically two values are consulted:

  1. average coverage for a period of years (7)
  2. minimum coverage in the poorest year

Graham recommends 4x for public utilities, 5x for transportation companies, 7x for industrials and 5x for retail concerns, before income taxes on an average of 7 years basis, and 3x, 4x, 5x and 4x, respectively, measured by the poorest year.

On an after-tax basis, Graham recommends 2.65x for public utilities, 3.2x for transportation companies, 4.3x for industrials, and 3.2x for retail companies on an average of 7 years basis, and 2.1x, 2.65x, 3.2x and 2.65x, respectively, measured by the poorest year.

Additional factors for consideration are:

  1. size of the enterprise – something large and robust, so that depletions in revenue do not imperil the business as a whole
  2. equity ratio – the market price of equity versus the total debt, which shows the amount of “cushion” for losses standing in front of the debt
  3. property value – this is the asset value on the balance sheet, though “experience has shown that in most cases safety resides in the earning power”

Stock analysis

Some basic principles of stock selection and analysis are considered in more detail below, based upon whether one is determined to be a defensive or an enterprising investor. For now, it is sufficient to quote Graham on the subject in the following manner:

The investor can not have it both ways. He can be imaginative and play for the big profits that are the reward for the vision proved sound by the event; but then he must run a substantial risk of major or minor miscalculation. Or he can be conservative, and refuse to pay more than a minor premium for possibilities as yet unproved; but in that case he must be prepared for the later contemplation of golden opportunities for gone

In essence, Graham is outlining the philosophy of “growth” versus “value” investing and stock analysis– attempting to forecast the future, or being content one is not paying too much for what he’s got based on an assessment of the past.

Keeping the shirt you have: the defensive investor

In Graham’s mind, there are two kinds of investors– the defensive investor, who is passive and seeks primarily to protect his capital, and the enterprising investor, who treats his investing like a professional business and expects similarly profitable results for his efforts. First, let’s talk about the defensive investor.

The defensive investor must confine himself to the shares of important companies with a long record of profitable operations and in strong financial condition

Specifically, Graham lists 4 criteria for selecting common stocks for the defensive investor’s portfolio:

  1. diversification – minimum of 10, maximum of 30 separate issues
  2. standing – companies which are large, prominent and conservatively financed (over $10B mkt cap and in the top third or quarter of their industry by market share or some other competitive metric)
  3. dividends – a long record of continuous payments
  4. price – no more than 25x avg earnings of past 7 yrs, nor 20x LTM earnings

Additionally, Graham warns against excessive trading or portfolio turnover:

if his list has been competently selected in the first instance, there should be no need for frequent or numerous changes

Graham also defines risk early on, saying,

the risk attached to an ordinary commercial business is measured by the chance of its losing money

and that further, a defensive investor should never compromise their standards of safety and quality in order to “make some extra income.” Safety first, income/returns second, or you’re likely to wind up with neither in the long run.

In terms of selecting individual stocks for the defensive investor’s portfolio, Graham suggests 7 criteria:

  1. adequate size of enterprise – generally speaking, small companies are excluded and medium size companies are included if their market/industry position is robust
  2. sufficiently strong financial condition – 2:1 current ratio, and LT debt < net current assets (working capital)
  3. earnings stability – some earnings for the common stock in each year over the past decade
  4. dividend record – uninterrupted payments for the past 20 years
  5. earnings growth – minimum of 1/3 increase in per-share earnings in the past ten years using three year average at the beginning and end
  6. moderate P/E – no more than 15x avg earnings of past 3 years
  7. moderate P/A – price should be < 150% of TBV, though may be higher if earnings multiplier is below 15, never to be greater as a combined ratio than 22.5 ( P/E * P/B <= 22.5)

The purpose is to eliminate companies which are: too small, with a weak financial position, with earnings deficits or with inconsistent dividend histories. In general, these factors should combine to create a stock portfolio which, in the aggregate, has an earnings yield (earnings/price) at least as high as the current high-grade bond rate.

At all times, remember that the defensive investor is

not willing to accept the prospects and promises of the future as compensation for a lack of sufficient value in hand

and that, generally speaking, rather than emphasizing the “best” stocks,

let him emphasize diversification more than individual selection

Making more and better shirts: the enterprising investor

Like the defensive investor, Graham counsels the enterprising investor to think firstly of not losing what they’ve got. But in this sense, the enterprising investor has a new tool in his kit that expands his realm of possible investment options while still maintaining safety of principal– the search for “bargain” priced opportunities, the idea here being that the price being offered for a security is a steep discount (generally 30% or greater) than the indicated “intrinsic” or underlying value of the security itself based upon its asset or earnings power fundamentals (with any luck, both).

About bonds and preferred stocks, Graham suggests that preferreds never be bought without at least a 30% discount, and a similar discount on a high-yield bond. More importantly,

experience clearly shows that it is unwise to buy a bond or preferred which lacks adequate security merely because the yield is attractive […] it is bad business to accept an acknowledged possibility of a loss of principal in exchange for a mere 1 or 2% of additional yearly income

About IPOs, Graham says to never touch them, however, busted IPOs can present interesting opportunities later on down the line:

Some of these issues may prove excellent buys– a few years later, when nobody wants them and they can be had at a small fraction of their true worth

With regards to selecting equity securities, Graham lays out three “recommended fields” for enterprising investors:

  1. large cap contrarianism
  2. “bargain” issues
  3. special situations

Digging in further, let’s take a closer look at large cap contrarianism. The idea here is to focus on companies that are well-known but are currently experiencing an earnings hiccup or some other negative news or general investor boredom that leaves them unpopular and trading at a lower than average multiple. The value in these companies are that,

they have the resources in capital and brain power to carry them through adversity and back to a satisfactory earnings base [and] the market is likely to respond with reasonable speed to any improvement shown

A good example of this principle in practice would be a situation such as buying well-known, large cap companies whose shares had strongly sold off during the financial panic of late 2008, early 2009.

According to Graham, a bargain issue is one in which the indicated value is 50% higher than the current price. Bargains can be detected one of two ways, either by estimating future earnings potential and applying an appropriate multiple and comparing this to current trading price for shares, or else by studying the value of the business for a private owner, which involves particular emphasis on the value of the assets (or the tangible book value of the shares).

For an earnings-based bargain, Graham adds some further criteria, such as:

he should require an indication of at least reasonable stability in earnings over the past decade or more — ie, no year of earnings deficit — plus sufficient size and financial strength to meet possible setbacks in the future

with the ideal being a large, prominent company selling below its past average price and P/E multiple.

Special situations encapsulate a range of investment activities, from liquidations (workouts), to hedging and merger arbitrage activities. While Graham sees this area as one offering special rewards to dedicated and knowledgeable investors, he advises that the trend is one towards increasing professionalization and thus even the enterprising investor is best to leave this area alone unless he has special confidence and competence in the area.

Of special emphasis is the idea of focus and dedication, that is to say, one is either an enterprising investor or a defensive one, but not some of both:

The aggressive investor must have a considerable knowledge of security values– enough, in fact, to warrant viewing his security operations as equivalent to a business enterprise. There is no room in this philosophy for a middle ground, or a series of gradations, between passive and aggressive status. Many, perhaps most, investors seek to place themselves in such an intermediate category; in our opinion that is a compromise that is more likely to produce disappointment than achievement

When considering individual stock selections for the enterprising investors portfolio, Graham reminds the reader that

Extremely few companies have been able to show a high rate of uninterrupted growth for long periods of time. Remarkably few, also, of the larger companies suffer ultimate extinction

To the last point, it is fascinating to see in the footnote commentary by Jason Zweig how many of Graham’s various example companies used throughout the book disappeared not due to bankruptcy, but because they were at some point acquired and absorbed wholesale into the operations of another business.

Several categories of equity selection stand out as particularly valuable for the enterprising investor in Graham’s eyes:

  1. arbitrages – purchase of one security and simultaneous sale of one or more other securities into which it is to be exchanged under a plan of reorganization, merger or the like
  2. liquidations – purchase of shares which are to receive one or more cash payments in liquidation of the companies assets; should present a minimum of 20% annual return w/ 80% probability of working out or higher
  3. related hedges – purchase of convertible bonds or convertible preferred shares and simultaneous sale of the common stock into which they are exchangeable
  4. NCAV – 2/3 or less of net current asset value (current assets – TOTAL liabilities); portfolios should have wide diversification, often of 100 securities or more, and require patience
  5. contrarian cyclical investing – buying important cyclical enterprises when the current situation is unfavorable, near-term prospects are poor and the low price fully reflects the current pessimism

Graham also recommended a special set of 5 criteria for selecting “bargain” issues of small or less well-known enterprises, which can be generated from lists from a stock guide or a stock screen beginning with companies trading for a P/E multiple of 9 or less:

  1. financial condition – current ratio of 1.5:1 and debt <= 110% of working capital
  2. earnings stability – no deficit in the last five years
  3. dividend record – some current dividend
  4. earnings growth – last year’s earnings greater than 5 years ago
  5. price – less than 120% of TBV

Graham notes that diversity is key to safety in these operations and such companies should be bought on a “group basis”.

A balancing act: the portfolio

As a broad strategic principle, Graham recommended that defensive and enterprising investors alike seek to allocate a minimum of 25% and a maximum of 75% of their portfolio into stocks and the remaining amount into bonds. In most cases, an even 50-50 split is recommended. The rule of thumb used to guide allocations above or below 50% is that, as the investor determines the “general price level” of the market to be higher than is prudent, he should allocate toward 75% bonds and 25% stocks, whereas when he determines this price level to be much lower than is reasonable (say, in the midst of a bear market), he should allocate toward 75% stocks and 25% bonds.

As Graham says on page 197,

the chief advantage, perhaps, is that such a formula will give him something to do

Remember, you are your biggest risk. Graham was concerned that without “something to do”, an investor might “to do” his portfolio to death with over activity, over-thought or over-worry.

This is a useful insight, but is Graham’s portfolio balancing technique still valid in today’s era of higher inflation risks?

Without stepping on the maestro’s toes too much in saying this, my thinking is that it is increasingly less valid. As Graham himself warns throughout the book, bonds provide no protection against inflation and, while inflation is not “good” for stocks in real terms, the ability to participate in increased earnings is at least better than having a fixed coupon payment in an inflationary environment.

In this sense, an allocation toward 100% stocks makes more sense, assuming we are entering a period of protracted inflationary pressures such as we are.

That being said, Graham’s warning about having something to do is still worth considering. Having kicked the legs out from under the “rebalancing act(ivity)”, perhaps a good substitute would be a continual turning over of rocks in the search for new investment ideas for the enterprising investor. For the defensive investor, the best course of action may be to enjoy the benefits of doing something through dollar-cost averaging, that is, making a little bit of his total intended investment each month or quarter rather than all at once. Another idea might be to allocate 10 or 15% of his portfolio into a MMF or equivalent when he feels the market is rising beyond prudent levels. But the thing that has never sat right with me about Graham’s reallocation technique is that, while in principle it makes sense, in practice it comes down to base attempts at market-timing that always end up generating unsatisfactory results.

Better to focus on Graham’s other major portfolio strategy tenet, which is diversification. Graham is a supporter of diversification for defensive and enterprising investors alike, mostly because it can serve to shield them from their own ignorance or over-enthusiasm. More specifically, many of Graham’s favored techniques (such as special situations, net-nets and bargain securities), while bearing overall pleasing risk/reward balances, nevertheless never bring certainty of either one and for this reason he believes developing a diversified portfolio of such opportunities is the best way for an investor to protect themselves from permanently losing a large part of their capital on one idea.

Saving the best for last: Mr. Market and the Margin of Safety concept

Mr. Market-mania

Markets are made up of people, and people are emotionally volatile. As a result, financial markets are volatile as well. While the vast majority of the time prices tend to move slightly above and slightly below an established trend line, at other times they can swing wildly off course in either direction:

the investor may as well resign himself in advance to the probability rather than the mere possibility that most of his holdings will advance, say, 50% or more from their low point and decline the equivalent one third [ X * 1.5 * .66 = ~X] or more from their high point at various periods in the next five years

Graham also warns against what might be termed the Paradox Of Market Goodwill:

The better a company’s record and prospects, the less relationship the price of its shares will have to their book value. But the greater the premium above book value, the less certain the basis of determining its intrinsic value–ie, the more this “value” will depend on the changing moods and measurements of the stock market

In Graham’s mind, the solution is to

concentrate on issues selling at a reasonably close approximation to their tangible-asset value– say, at not more than one-third above that figure [130% of TBV]

as a general principle of careful investing for the defensive investor. But there is more. Graham represents additional criteria based on the consideration of the firm’s earnings power, outlining what value-blogger Nate Tobik of Oddball Stocks likes to call the “two pillar” method:

A stock does not become a sound investment merely because it can be bought at close to its asset value. The investor should demand, in addition, a satisfactory ratio of earnings to price, a sufficiently strong financial position, and the prospect that its earnings will at least be maintained over the years

In terms of mastering an investor’s own psychology when facing the market, asset values reign supreme, however, because

the investor with a stock portfolio having such book values behind it can take a much more independent and detached view of stock-market fluctuations than those who have paid high multipliers of both earnings and tangible assets. As long as the earnings power of his holdings remains satisfactory, he can give as little attention as he pleases to the vagaries of the stock market. More than that, at times he can use these vagaries to play the master game of buying low and selling high

By Graham’s reasoning, buying a stock close to book value puts him in the same position as an individual offered an opportunity to buy into a private business’s book. Because he has paid a fair, businessman’s price, he doesn’t have to worry about what someone else thinks of his ownership stake, only the operating performance and financial strength of his chosen enterprise.

From a psychological standpoint, it is the high ground and much sought after.

But what is this “master game” of which Graham speaks? It is nothing more than the most masterly metaphor of the entire investing world, Mr. Market.

The idea of Mr. Market is that of a manic depressive business partner who on any given day may offer to buy your stake in the joint business for far more than you think it’s worth, or to sell you his stake for far less than you think it’s worth. The key to taking advantage of Mr. Market is to avoid trying to guess and anticipate why his mood ever suits him, instead relying on your own judgment and thinking about the value of the underlying enterprise regardless of Mr. Market’s various mood swings.

It’s worth quoting Graham at length on this subject:

The true investor scarcely ever is forced to sell his shares, and at all other times he is free to disregard the current price quotation. He need pay attention to it and act upon it only to the extent that it suits his book, and no more. Thus the investor who permits himself to be stampeded or unduly worried by unjustified market declines in his holdings is perversely transforming his basic advantage into a basic disadvantage. That man would be better off if his stocks had no market quotation at all, for he would then be spared the mental anguish caused him by other persons’ mistakes of judgement


the existence of a quoted market gives the investor certain options that he does not have if his security is unquoted. But it does not impose the current quotation on an investor who prefers to take his idea of value from some other source [such as his own study of the fundamentals]


price fluctuations have only one significant meaning for the true investor. They provide him with an opportunity to buy wisely when prices fall sharply and to sell wisely when they advance a great deal. At other times he will do better if he forgets about the stock market and pays attention to his dividend returns and to the operating results of his companies

In other words, once you have made your investment, the only value of further quotations is to be appraised of another opportunity to buy (if prices decline sharply from that point) or of an opportunity to sell at a profit (if prices rise sharply from that point).

The rest of the time, you can judge the soundness of your decision by studying whether the operating performance of the business plays out according to your expectations. If the underlying business performs as you anticipated over a long period of time, you only need wait for the market to recognize your good judgment. However, if the business steadily deteriorates in a surprising fashion, you may have a basis upon which to second-guess your original judgment. But a falling stock market price would not be the primary indicator in such a situation, nor would a rising one signal you have done well.

Margin of Safety, the central concept of investment

The intellectual principle of the margin of safety involves “inverting” a stock and thinking about it like a bond.

The margin of safety for bonds may be calculated, alternatively, by comparing the total value of the enterprise with the amount of debt

For example, if a business owes $X, but is valued at $3X, the business could shrink by 2/3rds before imperiling the position of the debt holders.


when a company has outstanding only common stock that under depression conditions is selling for less than the amount of bonds that could safely be issued against its property and earning power

the common stock can be considered to enjoy a margin of safety as large as that of a good bond.

Broadly, margin of safety can be thought of as the consistent earnings power of the equity, wherein

the margin of safety lies in an expected earning power considerably above the going rate for bonds

A proxy measure here would be to look at the earnings rate, or earnings yield (earnings/price) and compare this to the going rate on a similar bond.

Another, more general way to think about Margin of Safety is that it is the difference between how much you pay for something versus the calculated intrinsic value you determine that thing to have. In this sense, the Margin of Safety is always price dependent and will be higher at lower prices and lower at higher prices, relatively speaking.

And the Margin of Safety works in tandem with the principle of diversification:

Even with a margin in the investor’s favor, an individual security may work out badly. For the margin guarantees only that he has a better chance for a profit than for a loss– not that loss is impossible. But as the number of such commitments is increased the more certain does it become that the aggregate of the profits will exceed the aggregate of the losses. That is the simple basis of the insurance-underwriting business

The emphasis is always on finding an adequate margin of safety in order to protect your principal because if you do that, the returns will tend to take care of themselves:

To achieve satisfactory investment results is easier than most people realize; to achieve superior results is harder than it looks.

Special note on market-timing

There isn’t much more to it than this:

if he places his emphasis on timing, in the sense of forecasting, [the investor] will end up as a speculator and with a speculator’s financial results

In case you’re wondering, that’s a bad thing in Graham’s mind because he is convinced that all but the most talented and luckiest speculators lose out in the end because they do not pay attention to safety of principal.

The Free Capital Blog Digest

The following is a digest of posts from Guy Thomas’s Free Capital blog from Feb 2011 through Jan 2012.  Each post provides a link to the parent article with bullet-pointed lists of key-takeaways from each. For the complete discussion by the original author, please click the link to the parent article.

How important is analytical intelligence in investing?

  • Equity trading is not as reliant on raw mental strength (IQ, analytical ability) as fixed-income trading; instead, equity trading is more dependent upon mental characteristics such as:
    • Actively seeking information from dis-confirming sources
    • Adjusting for one’s biases
    • Accepting uncertainty for long periods
    • Deferring decisions for as long as possible
    • Calibrating your certainty to the weight of evidence
    • Responding unemotionally to new information
    • Indifference to group affiliation
  • The mental characteristics which are helpful in investing are not universal positives and may be useless or negative characteristics in other endeavors

Max, min and average payoffs

  • Most activities can be categorized as max payoff, min payoff or average payoff
  • Max payoff means the activity is “positive scoring”, your payoff is your highest or best result and failure carries no lasting consequences
  • Optimal traits for max payoff are:
    • high energy
    • irrational optimism
    • persistence
  • Examples of max payoff activities include:
    • selling
    • leadership
    • most sports
  • Min payoff means the activity is negative scoring, your payoff is your lowest result and even a single failure may have lasting consequences
  • Optimal traits for min payoff are:
    • meticulous care
    • good judgment
    • respecting your limitations
  • Examples of min payoff activities include:
    • flying a plane
    • driving a car
    • performing brain surgery
  • Average payoff activities combine elements of both max and min; investing is an average payoff activity, with particular emphasis on the min aspects
  • A lot of success in investing comes from simply avoiding mistakes (min payoff)

Discussion of diversification (posts 1, 2, 3 & 4)

  • Diamonds and flower bulbs
    • Diamonds are companies with exceptional economics and long-term competitive advantages that you’d be happy to hold if the stock exchange closed tomorrow for the next five years
    • Flower bulbs are companies which are cheap at the moment but which have no exceptional business qualities (they often make a good quantitative showing but not a strong qualitative one); they can usually be counted on to bloom but should be bought in modest size because they require liquidity to get back out of the position and realize the value
    • Which should you buy? Diamonds are exceptionally rare and require outstanding foresight of long-term durability; flower bulbs are more common, simpler to spot and merely require patience and a strong stomach
    • “Investing is a field where knowing your limitations is more important than stretching to surpass them”
  • How many shares should an investor hold? Some theory…
    • The optimal number of stocks to hold, N, is a function of…
      • quality of knowledge about return dispersions (decreasing)
      • $ size of portfolio (increasing)
      • volatility of shares (increasing)
      • capital gains tax rate (decreasing)
    • Exceptional investors with exceptional quality of knowledge should hold a concentrated portfolio; Buffett from 1977-2000 appears to have held approx. 1/3 of his portfolio in his best idea and changed it annually
    • With a small portfolio, liquidity is not a concern but as your portfolio scales a large number of holdings becomes optimal to maintain your liquidity which enhances your optionality by giving you the opportunity to change your mind without being trapped in a position
    • If the companies you target have highly volatile share prices, it becomes attractive to switch frequently so that you can “buy low and sell high”, thus you want to restrict your position sizing (higher number of positions) and maintain liquidity
    • If the capital gains rate is high you are penalized for turnover so you want to keep your total number of positions low and hold them for longer
  • How many shares should an investor hold? Some practicalities
    • There is clearly a trade-off between the number of positions you have and your quality of knowledge
    • A portfolio which is higher in diversification may hold many lower quality businesses (flower bulbs) but the certainty of the analysis of each might be significantly higher than a concentrated portfolio of several high quality businesses (diamonds) whose analysis is extremely sensitive to long-term forecasting accuracy
  • Concentrated investors often “come a cropper”
    • Many investors eventually disappoint because they have concentrated their bets on companies the world turns against
    • This has happened even to great investors like Warren Buffett (ex., WaPo, which now looks like a horse-and-buggy investment)
    • The danger of concentration is that nothing grows forever, and concentration + illiquidity often make it hard to escape mistakes

Meeting management

  • Opportunity cost of time: is it better spent speaking to management or investigating other ideas?
  • Getting an edge: sometimes speaking with management helps to understand the picture in a way that gives you an edge
  • Buffett: if you need to talk to management, you shouldn’t own the stock
  • Don’t be schmoozed

Analytics versus heuristics; why I don’t use DCF models

  • Time is precious and DCF models take too long
  • A good buying opportunity shouts at you from the market; if you need a calculator, let alone a spreadsheet, it’s probably too close
  • Robustness is more important than refinement; it’s easy to find apparent discrepancies in valuation, but most are false– it’s more important to seek out independent insights which confirm or deny the discrepancy than to calculate its size; when info quality is good, focus on quantifying and ranking options, but when it is poor, focus on raising it
  • Non-financial heuristics are often quicker and sufficiently accurate to lead to correct decisions; you may make more errors than the rigorous analyst but you can work much faster and evaluate many more opportunities which is usually a good trade-off

Thoughts On Diversification & Ideal Portfolio Management: Why Are You Diversified?

I’d like to talk today about diversification as a strategy within the theory of portfolio management.

What is portfolio management?

In portfolio management, you have two possible extremes between which most actual portfolios lie– own one thing, or own everything.

The classic example of a person who owns one thing is the owner of a small business, of which the proprietorship makes up his entire personal equity capital in relation to the total investment universe. Most people wouldn’t even consider this person to have a portfolio because he holds nothing else. His business is his portfolio.

Consequently, portfolios imply diversification, and vice versa. The moment you take equity in more than one venture, you have created a portfolio and you are simultaneously diversified. This is the mild hypocrisy of people who warn against diversification (calling it “deworsification”) and counsel investors to maintain a concentrated portfolio. A portfolio may be concentrated to a small number of holdings (let’s say, five or less to pick an arbitrary point of distinction), but this is not a non-diversified portfolio– the very fact that it is a portfolio implies it is diversified.

The standard argument for diversification

Proponents of diversification (or, what we might term “portfolioization” to come up with an even more complicated and hard to speak/spell nomenclature for the phenomenon) argue that diversification is a way to limit risk in equity ownership. It is the “multiple egg baskets” theory, the idea being that if you drop one basket you only lose the eggs inside of the dropped basket, whereas if you carry all your eggs in one basket and drop it, there goes dinner.

But it’s a bit of trickery, because risk can’t be eliminated, only exchanged. In effect, as you diversify (portfolioize), you exchange business risk for market, or economic, risk. The larger your portfolio becomes in terms of total positions, the more it comes to resemble the total universe of equity opportunities in its performance.

With diversification, you are not limiting risk, you are exchanging it. You’re determining how much of your equity will be exposed to each kind of risk in existence, not how much risk you will be exposed to in total (that question is settled by what particular risks you do put into your portfolio).

To summarize, two risk equations:

  • business risk vs. market risk
  • which business risk?

Standard counter-arguments to diversification (or, why it’s really deworsification)

The case for diversification isn’t complicated and neither is the case against it. There are two main points to consider:

  • diversification limits exposure to particular risks, but also limits potential rewards (no free lunch)
  • diversification may introduce an altogether separate risk– lack of focus

The first point is fairly self-explanatory. If you only invest X% of your portfolio in a particular risk, you ensure that your maximum loss is never greater than X%, but you also ensure that your maximum gain is never greater than X% * Y, Y being the return of the underlying investment.

So, if you invest 20% of your portfolio in ABC Company and the stock falls by half, thanks to the magic of diversification, you actually only lose 10% of your portfolio (-50% * 20% = -10%). On the other hand, if the stock rises by half, thanks to the magic of diversification you actually only make a return equal to 10% of your portfolio (50% * 20% = 10%).

There’s no free lunch. You only would get to capture the full 50% rise if you had the full 100% of your portfolio exposed. You essentially provide yourself downside insurance because, while your overall gain is capped, your overall loss is capped as well as it can never be higher than the 20% you exposed (provided you aren’t using leverage or shorting).

Perhaps more nefarious, some investment thinkers point out that by diversifying your portfolio, you spread your attention thin and could end up not understanding the individual risks your various positions hold as well as you might if you had one position (or two, or five…) and so, in a quest to limit business risk you actually enhance it because the quality of your analysis falls. Similarly, if you do poor analysis, you might be more prone to rationalize it because, “Oh well, ABC didn’t work out, but I’ve still got bets on DEF and XYZ, I’m sure they’ll turn out okay and make up for the loss– I’m diversified!”

The scarcest thing most investors have is attention they can devote to their investing, not capital.

Is one ever justified in diversifying?

Diversification by itself is not a terrible thing. As discussed above, it really doesn’t confer any advantages beyond the psychological– diversification by itself can’t improve the absolute returns of your portfolio, on net.

It also doesn’t have to be a purposeful strategy. Diversification can happen “by accident” in the following scenarios:

  • it would be inappropriate to invest 100% of your capital in a position due to market cap constraints
  • you have received new capital inflows following commitment of 100% of your previous capital
  • the market moves against you in the middle of taking a position

In the first case, imagine an investment opportunity in a company with a market cap of $100M, in which case the maximum appropriate position one could take without “bidding against oneself” is $5M, but one’s full capital represents the amount of $10M. In this situation, you would only invest half your capital in the idea because investing any more than this might destroy some of the value available. Diversification would be a natural consequence of a situation like this, whether diversification itself was desired or not.

In the second case, imagine you have $10M of total capital in period 0, which you fully invest in X. However, some time later, in period 1, you receive additional inflows of capital of $1M (perhaps you have earned a 10% dividend on your earlier investment in X). Unfortunately, the price of X has risen in the interim and no longer represents the value proposition it once did, although you’re still happy to have your earlier capital invested at the price available in period 0. In this case, you might invest the $1M in opportunity Y and, again, diversification would occur as a natural consequence of these developments whether it itself was desired or not.

In the final case, imagine you have total capital of $10M and have found an investment opportunity which could utilize your entire capital. However, you plan to accumulate in blocks because the investment is not liquid enough to take the $10M at once, and you do not want to make it obvious what you’re doing. You begin by investing $2M. Unfortunately, shortly after you do so a big-mouth blogger lets the whole world know about this great opportunity and the price of the investment opportunity rises to the stratosphere, pricing you out of any meaningful additional accumulation. You’re stuck with 80% of your capital uninvested and must look elsewhere. Again, diversification has occurred as a natural consequence even if it has not been actively sought after.

Ideal portfolio management implies no intended diversification

We’ve seen that diversification can result of two different catalysts– an investor can purposefully seek diversification in order to make a tradeoff between business risk and market risk (to self-insure his own decision-making process by giving up total return potential), or diversification can occur as the natural, unintended consequence of the general investment process.

Ideally speaking, the best situation for any investor to find themselves in is having one idea that has so much return potential relative to risk, that they are so confident about, that they are able to invest 100% of their capital in the idea, thereby avoiding diversification, or portfolioization, entirely. Ideally, one would have all their money at any given time in one idea and only one idea, and when that idea had either fruited, or a more profitable opportunity had arisen elsewhere, the investor would then sell the entire position and look to his next opportunity.

Outside of this ideal, portfolioization may occur inadvertently in pursuit of these very circumstances, in which case there is nothing to be upset over or critical about.

However, if diversification is pursued as a purposeful strategy outside the context of an individual contending with liquidity constraints (ie, perhaps investing 100% of capital in his best idea would put him in a bad position if outside demands for this capital, which are unpredictable, would require him to liquidate at an inopportune time), it stands to reason that an investor might ask himself, or be asked by another, “Why are you investing in something you’re not completely confident about in the first place?”

In other words, perfect confidence is unachievable (although it is the ideal), but it is hard to imagine why an investor would be justified in spreading his bets out across things he was less than as-confident-as-he-could-be about and consoling himself that he was doing well to mind risk thanks to diversification, when he could instead wait for an opportunity where his confidence about the risk-reward picture was as-confident-as-he-could-be and then invest all his capital in that one idea.

And of course, as almost always, I’d be wise to consider and hopefully even heed my own advice!

Review – Panic: The Betrayal Of Capitalism By Wall Street And Washington

Sadly, Panic: The Betrayal Of Capitalism By Wall Street And Washington does not appear to be in print any longer. Luckily, I found a good used copy on Amazon and will cherish its now-secret message all the more.

As I read through this book several months ago, instead of summarizing my thoughts I just want to record a few key ideas and quotes for later reference.

“The Anti-Entrepreneurs”

In any modern state the government will always be the banks’ biggest client and therefore will always make most of the rules, even if it pretends not to.

The ideologues of modern finance offered to make any fool rich if only he renounced the first obligation of the capitalist, the burden of judgment.

This process of confronting uncertainty and successfully resolving it usually by dint of hard work, diligent analysis, and sound judgment is the only source of what many economists have called “entrepreneurial profit” or sometimes “true profit”.

Underpinning the ideology of modern finance is the notion that the insight, judgment and even diligence of the entrepreneur are irrelevant for investing in public securities markets. These markets, we are told, are special, too powerful and too perfect to allow any entrepreneur’s judgment to matter.

If the ideology of modern finance had a motto, it might be “thinking doesn’t work.”

Capitalism demands free markets because it needs free minds.

The bureaucrat of capital dreams of a world in which failure is impossible.

Crony capitalists on the right and socialists on the left united as always behind their most fundamental belief, that wealth is to be captured by power and pull rather than created in the minds of men.

“New Risks in Old Bottles”

The great mission of modern investment theory is to replace all idiosyncratic risk with systemic risk.

The primary skill for finance, under this theory, becomes diversification, which becomes an advanced statistical methodology for making sure a relatively small number of securities accurately represents a much larger class of securities.

If I know nothing, my need for diversification is infinite.

All investment is reduced to insurance.

Ignorance is the father of panic.

“The Misinformation Economy”

One way to think about panic is as a general, nonspecific response to a poorly understood particular and specific problem.

“To build a perfect model of the universe would require all the matter and energy in the universe, because the only perfect model, the only model that shed no information and made no compromises in order to achieve its object, would be the universe itself.”

The mortgage meltdown can be understood as an instance of model failure.

information is differentiation; information is what comes as a surprise against the background of knowledge already possessed.

If uncertainty and risk are nearly synonyms. then information and risk are nearly opposites.

It is not particularly unusual for all thirty stocks in the Dow to go up and down at the same time; that rarely happened when market participants were interested in the value of individual companies.

“The Reign of Risk”

Modern portfolio theory was a late bloom of the great eighteenth and nineteenth century impulse to explain human society by mechanical or “scientific” principles as regular as those of classical physics.

If economics were about entrepreneurship, it would not look like physics. It would look a little like philosophy. Mostly it would look like literature. [The Lion’s note: if you ascribe to the Austrian school, it does!]

To treat investment as a quantitative exercise relying on the efficiency of markets and advanced mathematics to eliminate the hazards of human judgment. [the ambition of investors under Modern Portfolio Theory]

MPT created a field for which PhDs could be granted and journal articles published. Before MPT, investment theory had been mere reflection upon experience, a wisdom literature dominated by amateurs like Benjamin Graham.

[MPT…] can be deeply attractive to those trying to support capitalist lifestyles with only bureaucratic talents.

The most important question any investor can ask: For what are investors paid? MPT’s answer: For accepting risk.

risk is not the foundation of profit but its most dreaded enemy.

The modern theory conceptually severed financial markets from the rest of the economy. [My note, ” Macro is to Micro as Financial is to Real”]

“The Romance of Risk”

Men and societies become richer precisely as they employ insight, skill and experience, effort and discipline to reduce risk.

Investors are paid for being right, not for the possibility of being wrong.

In life, men who make one good judgment tend to make more good judgments; men who make one bad judgment tend to make more bad ones.

the most important but the most difficult-to-identify ability in business management (or investment) is the ability to judge other men’s ability to judge. [meta-judgment]

“Zoom, Zoom, Zoom”

What modern capital markets do very well is raise large amounts of capital from a broad base of investors who are persuaded to give their money to perfect strangers with precious little idea of what those fortunate recipients are going to do with it. [And, I’d add, little control or legal right to have any say in such decisions; “crowd-sourcing”]

different markets make different trade-offs between liquidity and price discovery one one hand and confidence about value on the other.

Public equity investors demand liquidity in large part because they are unsure about value.

Humor is surprise

It is reasonable to call markets better or worse depending on how much surprise they can absorb before convulsing in dramatic disequilibrium

Lacking a more substantial basis on which to make decisions, financial markets set prices to an astonishing extent by watching– prices!

The most dramatic resolution of this conflict is to eliminate most of the shareholders altogether by taking public companies private

public companies have no owners

Companies, like most assets, do better with strong owners than weak owners.

“Strategic Ambiguity”

When New Dealers tried to set up a banking system immune to panic, their top priority was to remove Mom-and-Pop from their role as bank police.

“Insolvent Immunity”

Here is the quickest way to determine whether you are operating in an honest capitalist system or a corrupt imitation thereof: check the bankruptcy rates.

“Black September”

“Things are somewhat amiss when a country’s finance minister plays bond salesman for a supposedly privately owned company.”

By this time the government had: (a) intimated that deficits in the financial sector were so large and widespread that “anyone could be next” (b) terrified private investors from making investments that might preserve the solvency of deteriorating institutions (c) assumed unprecedented responsibility for investment banks outside the Federal Reserve system and then abandoned that responsibility and (d) made clear that its policy would change on an ad hoc basis. [on the US federal government’s initial response to the financial panic of 2008]

To assume that the buying and selling of shares amounts to managing the firm is the most extreme form of efficient market worship.

“Capitalism Without Capitalists”

The term for someone who rests his economic fate on unknowable future events is not “owner” or even “investor,” but “speculator.”

the government, the biggest player and the weakest owner of all. [criticizing the present ownership of major banks]

Another great review of this book was posted by “CP” at

And after reading this book, I was inspired to purchase Frank Knight’s Risk, Uncertainty and Profit for my library for further study.


Does Net-Net Investing Work In Japan?

If you took a look at the companies I purchased off my Japanese net-net (“JNet”) worksheet about six months ago, you’d probably conclude net-net investing doesn’t “work” in Japan, at least not over a six month period. The cheap, crappy companies I bought then are cheaper, still crappy companies today.

However, if you took a look at all the companies I didn’t buy from my list, you might get a different impression altogether. While there are a few companies of this group whose fundamentals worsened and/or whose stock price fell, most are up anywhere from 10-15% with several up substantially more, 30-50%. About 10% of the total list seems to have gone private as you can’t find financial info nor trade the symbol any longer, which in my experience in JNet-land typically means they received an MBO.

And if you look at an entirely different list of JNets I generated about two months ago (because all my original picks were no longer JNets), which I finished researching one month ago and which I failed to do anything about until yesterday, the story is even better (or worse, if you’re me). How would you like to see the top pick on your list closed up 25% the day prior and about 40% total since you composed your list? How would you like to see the average company on your list priced 15% or more higher from where you first researched it, meaning you could’ve locked in your 15% annual return for the year in a few months time?!

Once again, this list also had several symbols which no longer trade, presumably because they received buyouts or other going private transactions.

So, in the last few days I learned a few things about JNets:

  1. They “work”
  2. The “M&A activity in Japan, particularly in the small cap space, is a non-starter” claim, is a myth
  3. Even crappy businesses with cash-rich balance sheets are moving like hotcakes in Abenomic Japan
  4. The strengthening of the dollar against the Yen does impact your $ returns, but so far Yen prices on JNets have outpaced the move of the Yen against the dollar
  5. Contrary to my belief that I could take my time allocating idle capital in Japan, it now appears that time is of the essence

My old motto for JNets was, “Steady as she goes.” My new motto is, “Churn and burn” or “Turn and earn.” I’m going to be watching things much more closely than I had before.

To be clear, my experience so far has been frustrating, but it hasn’t been catastrophic as I suggested in my introduction. I have captured some of the windfall moves myself although I continue to have laggards in the portfolio, at least in dollar terms. Very few of the original companies I picked are trading lower than when I bought them, though some have not moved up enough yet to make up for the exchange rate loss. My first portfolio of JNets was bought when the Yen/$ rate was 79. It’s now almost 99 Yen to the dollar and I made my second portfolio purchase around 94 Yen to the dollar.

Overall, in dollar terms my first portfolio is up 5%, with one MBO and apparently another just recently as I found out the stock is up 43% with no ask but I haven’t found a news item explaining why yet. Several others traded above NCAV so I am culling them and putting them into new opportunities. I have not yet determined what the “secret formula” is for picking the JNets that will really take off– oddly, it was mostly the companies whose prospects seemed least fortunate that I neglected to purchase and was in shock to see their stock prices 35% higher or more. As a result, I plan on wider diversification and a more random strategy in choosing between “best” companies and cheapest stocks.

I’m sure many investors have done much better than 5% in Japan in the last half year, and many more have done better still in the US and elsewhere. This isn’t a contest of relative or absolute performance. This is simply an opportunity to settle the score and point out that yeah, Benjamin Graham’s philosophy is alive and well in Japan.

Video – Toby Carlisle, Q&A Notes at UC Davis Talk on Quantitative Value

Click here to watch the video (wear earphones and bring a magnifying glass)

UC Davis/Farnam Street Investments presents Toby Carlisle, founder and managing partner of Eyquem Investment Management and author of Quantitative Value, with Wes Gray.

Normally I’d embed a video but I can’t seem to do that with the UC Davis feed. Also, these are PARAPHRASED notes to the Q&A portion of Toby’s talk only. I ignored the “lecture” portion which preceded because I already think I get the gist of it from the book. I was mostly interested in covering his responses to the Q&A section.

The video is extremely poor quality, which is a shame because this is a great talk on a not-so-widely publicized idea. I wish there was a copy on YouTube with better audio and zoom, but no one put such a thing up, if it exists. I hope Toby does more interviews and talks in the future… hell, I’d help him put something together if it resulted in a better recording!

I had trouble hearing it and only thought to plug in some earbuds near the end. Prior to that I was contending with airplanes going overhead, refrigerator suddenly cycling into a loud cooling mode as well as my laptop’s maxed out tinny speakers contending with the cooling fans which randomly decided to cycle on and off at often the most critical moments. I often didn’t catch the question being asked, even when it wasn’t muffled, and chose to just focus on Toby’s response, assuming that the question would be obvious from that. That being said, I often conjoined questions and responses when there was overlap or similarity, or when it was easier for me to edit. This is NOT a verbatim transcript.

Finally, Toby recently created a beta forum for his book/website, at the Greenbackd Forum and I realize now in reviewing this talk that a lot of the questions I asked there, were covered here in my notes. I think he’s probably already given up on it, likely due to blockheads like me showing up and spamming him with simpleton questions he’s answered a million times for the Rubed Masses.

Major take-aways from the interview:

Q: Could we be in a “New Era” where the current market level is the “New Mean” and therefore there is nothing to revert to?

A: Well that’s really like saying stocks will revert down, not up. But how could you know? You could only look at historical data and go off of that, we have no way to predict ahead of time whether this “New Mean” is the case. I think this is why value investing continues to work, because at every juncture, people choose to believe that the old rules don’t apply. But the better bet has been that the world changes but the old rules continue to apply.

Q: So because the world is unknowable, do you compensate by fishing in the deep value ponds?

A: I like investing in really cheap stocks because when you get surprises, they’re good surprises. I find Buffett stocks terrifying because they have a big growth component in the valuation and any misstep and they get cut to pieces; whereas these cheap stocks are moribund for the most part so if you buy them and something good happens, they go up a lot.

Q: (muffled)

A: If you look at large cap stocks, the value effect is not as prevalent and the value premia is smaller. That’s because they’re a lot more efficient. There’s still only about 5% of AUM invested in value. But the big value guys portfolios look very similar; the value you have as a small investor is you don’t have to hold those stocks. So you can buy the smaller stuff where the value premia is larger. The institutional imperative is also very real. The idea of I’d like to buy 20 stocks, but I have to hold 45. That pushes you away from the optimal holdings for outperformance.

Q: (muffled)

A: The easiest way to stand out is to not run a lot of money. But no one wants to do that, everyone wants to run a lot of money.

Q: (muffled)

A: The model I follow is a bit more complicated than the Magic Formula. But there are two broad differences. I only buy value stocks, I only buy the cheapest decile and I don’t go outside of it, and then I buy quality within that decile. ROIC will work as a quality metric but only within the cheapest decile. ROIC is something Buffett talks about from a marketing perspective but I think in terms of raw performance it doesn’t make much sense. There’s definitely some persistence in ROIC, companies that have generated high returns on invested capital over long periods of time, tend to continue to do that.  If you have Warren Buffett’s genius and can avoid stepping on landmines, that can work. But if you don’t, you need to come up with another strategy.

Q: (muffled)

A: Intuition is important and it’s important when you’re deciding which strategy to use, but it’s not important when you’re selecting individual stocks. We can be overconfident in our assessment of a stock. I wonder whether all the information investors gather adds to their accuracy or to their confidence about their accuracy.

Q: (muffled)

A: All strategies have those periods when they don’t work. If you imagined you ran 4 different strategies in your portfolio, one is MF, one is cheap stocks, one of them is Buffett growth and one is special situations, and you just put a fixed amount of capital into each one [fixed proportion?] so that when one is performing well, you take the [excess?] capital out of it and put it into the one that is performing poorly, then you always have this natural rebalancing and it works the same way as equal-weighted stocks. And I think it’d lead to outperformance. It makes sense to have different strategies in the fund.

Q: (muffled)

A: QV says you are better off following an indexing strategy, but which market you index to is important. The S&P500 is one index you can follow, and there are simple steps you can follow to randomize the errors and outperform. But if you’re going to take those simple steps why not follow them to their logical conclusion and use value investing, which will allow you to outperform over a long period of time.

Q: (muffled)

A: Not everyone can beat the market. Mutual funds/big investors ARE the market, so their returns will be the market minus their fees. Value guys are 5% of AUM, can 5% outperform? Probably, by employing unusual strategies. Wes Gray has this thought experiment where he says if we return 20% a year, how long before we own the entire market? And it’s not that long. So there are constraints and all the big value investors find that once they get out there they all have the same portfolios so their outperformance isn’t so great. There’s a natural cap on value and it probably gets exceeded right before a bust. After a bust is then fertile ground for investment and that’s why you see all the good returns come right after the bust and then it trickles up for a period of time before there’s another collapse.

Q: (muffled)

A: I think the market is not going to generate great returns in the US, and I am not sure how value will do within that. That’s why my strategy is global. There are cheaper markets in other parts of the world. The US is actually one of the most expensive markets. The cheapest market in the developed world is Greece.

Q: Did you guys ever try to add a timing component to the formula? That might help you decide how to weight cash?

A: Yes, it doesn’t work. Well, we couldn’t get it to work. However, if you look at the yield, the yield of the strategy is always really fat, especially compared to the other instruments you could invest the cash in, so logically, you’d want to capture that yield and be fully invested. I think you should be close to fully invested.

Q: What about position sizing?

A: I equal weight. An argument can be made for sizing your cheaper positions bigger. I run 50 positions in the portfolio. In the backtest I found that was the best risk-adjusted risk-reward. That’s using Sortino and Sharpe ratios, which I don’t really believe in, but what else are you going to use? If you sized to 10 positions, you get better performance but it’s not better risk-adjusted performance. If you sized to 20 positions, you get slightly worse performance but better risk-adjusted performance. So you could make an argument for making a portfolio where your 5 best ideas were slightly bigger than your next 10 best, and so on, but I think it’s a nightmare for rebalancing. The stocks I look at act a little bit like options. They’re dead money until something happens and then they pop; so I want as much exposure to those as I can. I invest globally so the accounting regimes locally are a nightmare. IFRS, GAAP to me is foreign. You have to adjust the inputs to your screen for each country as a result of different accounting standards.

Q: digression

A: Japan is an interesting market. Everyone looks at Japan and sees the slump and says it’s terrifying investing in Japan but if you look at value in Japan, value has been performing really well for a really long time. So, if the US is in this position where it’s got a lot of govt debt and it’s going to follow a similar trajectory, you could look at Japan as a proxy and feel pretty good about value.

Q: (muffled)

A: I’ll take hot money, I am not in a position to turn down anyone right now. It’s a hard strategy [QV] to sell.

Q: (muffled)

A: Special situation investing is often a situation where you can’t find it in a screen, something is being spun out, you have to read a 10-K or 10-Q and understand what’s going to happen and then take a position that you wouldn’t be able to figure out from following a simple price ratio. It’s a good place to start out because it’s something you can understand and you can get an advantage by doing more work than everyone else. It’s not really correlated to the market. I don’t know whether it outperforms over a full cycle, but people don’t care because it performs well in a bad market like this.

Q: What kind of data do you use for your backtests?

A: Compustat, CRISP (Center for Research Into Securities Prices), Excel spreadsheets. You need expensive databases that have adjusted for when earnings announcements are made, that include adjustments that are made, that include companies that went bankrupt. Those kinds are expensive. They’re all filled with errors, that’s the toughest thing.

Notes – Buffett Partnership Letters, 1957-1970

Recently I sank into my overstuffed armchair (in this situation, “sank” is used derisively to connote frustration and discomfort with regards to ideal reading conditions) with a copy of Buffett’s partnership letters from the 1957-1970 period in my hands. I found them on and had never taken the time to read them before, but figured it was about time as I was curious to consult a primary source on this period of Buffett’s investment career, having already read a 3rd-party recounting in The Snowball.

My interest was to read critically. Buffett’s letters have been read and analyzed and mulled over by thousands of investors and business people and have been discussed ad nauseum. But everyone seems to come away with the same lessons and the same pithy quotes that they throw up on their blogs when appropriate. I wanted to see if I could find anything original. From my own set of knowledge and understanding of Buffett and “how he did it”, I achieved my goal, but I can not guarantee creativity to anyone else who may be reading this. Somehow, somewhere in some overlooked nook of this vast interweb, I may have missed the discussion where someone went over these exact points.

Market timing, or the “value climate”

Amongst value investors, the sin of attempting to time the market is considered to be one of the greatest (for example, see the special note at the end of my recent review of The Intelligent Investor). Luminaries like Graham warn us that attempting to jump in and out of the markets according to their perceived price level being high or low is a speculative activity that will be rewarded as such, which is to say, it’ll eventually end in disaster.

However, while value gurus like Graham warned against market timing as a primary tool of analysis in an investment program, it’s also true that both Graham and Buffett were nonetheless intimately aware of market valuations and sentiment and both of them discussed the way their perception of market valuation influenced their portfolio orientation at any given time. For Graham and his intelligent investors, the response was to weight the portfolio toward bonds and away from stocks when the market was high and the opposite when the market was low. Similarly, Buffett advised in his 1957 letter:

If the general market were to return to an undervalued status our capital might be employed exclusively in general issues… if the market should go considerably higher our policy will be to reduce our general issues as profits present themselves and increase the work-out portfolio

This quote alone, along with many others just like it throughout the partnership letters, makes it clear the Buffett did not ignore broad market valuations. And not only did he not ignore them, he actively manipulated his portfolio in response to them. However, there are a few key things to note in terms of the heavily nuanced differences between what Buffett did and what the average market timer does:

  • Market timers are forecasters, they act on a perceived market level because of their anticipation about future market levels; Buffett refused to speculate about what the future of the market level might be and instead accepted it for what it was, changing what he owned and in what proportions, not whether he was invested or uninvested
  • Market timers are binary, choosing between “risk on” or “risk off”; Buffett responded to higher market levels by seeking to gain greater exposure to market neutral opportunities (special situations revolving around corporate action) while still continuing to make investments in individual undervalued businesses as he found them
  • Market timers always maintain the illusion of “full control” knowing they can always sell out or buy in any time they like in response to market valuations; Buffett acknowledged that many times he might desire to have greater market neutral exposure but that such opportunities might dry up in the late stages of a bull market, dashing his plans

The importance of relative performance

Another concept of Buffett’s money management style that stood out was his obsession with relative performance. I found this interesting again because the orthodox value investment wisdom is that it is not relative, but absolute, performance which matters– if you permanently lose a portion of your capital in a period, but your loss is smaller than your benchmark, you’ve still lost your capital and this is a bad thing.

Again, from the 1957 letter, Buffett turned this idea on its head:

I will be quite satisfied with a performance that is 10% per year better than the [Dow Jones Industrial] Averages

Because Buffett calculated that over the long-term the DJIA would return 5-7% to shareholders including dividends, Buffett was aiming for a 15-17% per annum performance target, or about 3x the performance of the Dow. But, as always, there was an important twist to this quest for relative out performance. In his 1962 letter, Buffett stated in no uncertain terms:

I feel the most objective test as to just how conservative our manner of investing is arises through evaluation of performance in down markets. Preferably these should involve a substantial decline in the Dow. Our performance in the rather mild declines of 1957 and 1960 would confirm my hypothesis that we invest in an extremely conservative manner

He went on to say:

Our job is to pile up yearly advantages over the performance of the Dow without worrying too much about whether the absolute results in a given year are a plus or a minus. I would consider a year in which we were down 15% and the Dow declined 25% to be much superior to a year when both the partnership and the Dow advanced 20%

And he concluded by noting:

Our best years relative to the Dow are likely to be in declining or static markets. Therefore, the advantage we seek will probably come in sharply varying amounts. There are bound to be years when we are surpassed by the Dow, but if over a long period we can average ten percentage points per year better than it, I will feel the results have been satisfactory.

Specifically, if the market should be down 35% or 40% in a year (and I feel this has a high probability of occurring in one year in the next ten– no one knows which one), we should be down only 15% or 20%. If it is more or less unchanged during the year, we would hope to be up about ten percentage points. If it is up 20% or more, we would struggle to be up as much

In his 1962 letter, he added further detailing, sharing:

Our target is an approximately 1/2% decline for each 1% decline in the Dow and if achieved, means we have a considerably more conservative vehicle for investment in stocks than practically any alternative

Why did Buffett focus so much on relative out performance in down years? Because, as a value investor, he was obsessed with permanent loss of capital. In a broad sense, making money in the market is somewhat easy as over long periods of time as the market has historically tended to rise higher and higher. Every now and then, however, it corrects sharply to the downside and it is in these moments when the average investor panics and sells out at a loss, thereby permanently impairing his capital.

Buffett believed that by buying at a discount and taking a more conservative approach to the investment problem from the outset, he would limit any losses he might sustain in the inevitable downturns in the market. This by itself would put him ahead of other market participants because he’d have more of his capital intact. The real power behind this strategy is what comes afterward, as then the just-as-inevitable recovery would continue the compounding process again– with more of his original capital than the other guy, Buffett would enjoy greater pure gain over time as he would have a relatively shallower hole to climb out of each time.

True Margin of Safety: two pillars of value

Fellow value investor Nate Tobik over at has talked repeatedly about one of Ben Graham’s concepts which he refers to as the “two pillars of value”, namely, that a company which represents a bargain both on the basis of a discount to net assets and a discount earnings is the most solid Margin of Safety one can possess because you’re not only protected two ways but you also have two ways to “win.”

Reading the Buffett partnership letters, it’s clear that the reason Buffett was knocking it out of the park in his early years was because he relied upon the same methodology. Buffett later was critical of his own early practices and many others have derided the investment style as akin to picking up soggy cigar butts and taking the last puff before discarding them, but there is no denying in studying several of the investments Buffett disclosed that Buffett was buying things which were “smack you over the head” cheap.

For example, in the 1958 letter, Buffett disclosed the partnerships’ investment in Commonwealth Trust Company of New Jersey, a small bank. Buffett claimed the company had a computed per share intrinsic value of $125, which was earning $10/share and trading for $50. This meant that Buffett bought the company for 40% of book value, or at a 60% margin of safety to indicated value. And, in two pillar tradition, he was also buying at a 5x multiple of net earnings– by any standards, an incredibly cheap value. If one were to look at the company as a bond and study it’s earnings yield, this company was offering a 20% coupon!

Making good buys, not good sales

In the example of Commonwealth Trust Co. discussed earlier, though Buffett calculated an intrinsic value of $125/share, he ultimately sold for only $80/share. He did not sell out near intrinsic value but rather far below it. Still, because he had originally bought at $50/share, he nonetheless earned a 60% return despite the company trading at a still-substantial discount to intrinsic value.

As Buffett chirped in his 1964 letter:

Our business is making excellent purchases– not making extraordinary sales

Why does Buffett harp on this idea so frequently? There are a few reasons.

One, an excellent purchase price implies a substantial discount to intrinsic value and earnings power, therefore there is a built-in margin of safety and the downside is covered, a principle of central importance to sound investing.

Two, an individual has 100% control over when they buy a security but relatively little control over when and in what conditions they sell, particularly if they use margin. You may not always get the price you want when you are ready to sell but you will always get the price you want when you buy because that decision is made entirely by you and doesn’t require the cooperation of anyone else. Buying at a discount ensures you “lock in” a profit up front.

Three, buying at a discount gives one optionality. If a better deal comes along, it is more likely you can get back out of your original investment at cost or better when you buy it cheap. When your original purchase price represents a substantial discount you have a better chance of finding a buyer for your shares because even at higher prices such a sale would probably still represent a bargain to another buyer meaning both parties can feel good about the exchange.

This last point was critical in Buffett’s Commonwealth situation. He was happy to sell at only $80/share despite a $125/share intrinsic value because he had found another opportunity that was even more compelling and because his original purchase price was so low, he still generated a 60% return. Meanwhile, the other party who took this large block off his hands was happy to provide the liquidity because they still had a 56% upside to look forward to at that $80/share price.

Early activism, the value of control

Another lesson from Buffett’s partnership letters is the importance and value of activism and control. From an activism standpoint, the examples of Sanborn Maps and Dempster Mills are well-known and don’t require further elaboration in this post (follow the links for extensive case study analysis at, or even read Buffett’s partnership letters yourself to see his explanation of how these operations worked).

But activism is something that is best accomplished with control, and often is its by-product. On the topic of control, Buffett said in his 1958 letter with regards to Commonwealth:

we became the second largest stockholder with sufficient voting power to warrant consultation on any merger proposal

By gaining a large ownership share in an undervalued company, an investor can play a more active role in ensuring that potential catalysts which might emerge serve to adequately reward shareholders. Similarly, time is money and when one has control,

this has substantial advantages many times in determining the length of time required to correct the undervaluation

An investment situation offering, say, a 30% return, offers a 30% annualized return if captured within a year, a 15% annualized return if gained after two years and only a 10% annualized return if it takes 3 years to realize value. Having control can often be the difference between a 30% and a 10% annualized return by allowing an investor to accelerate the pace at which they turn over their capital.

It is a myth, therefore, that Buffett only became a wholesale/control buyer as he employed greater amounts of capital in his later years. While many of his investments were passive, minority positions in the partnership years, Buffett never shied away from control and activism, even saying in his 1961 letter:

Sometimes, of course, we buy into a general with the thought that it might develop into a control situation. If the price remains low enough for a long period, this might very well happen

In this sense, “value is its own catalyst” and something which is cheap and remains cheap for an extended period of time can actually be a unique opportunity to accumulate enough shares to acquire control, at which point the value can be unlocked through asset conversion, a sale or merger of the company or through a commandeering of the company’s earnings power.

Portfolio buckets: generals, work-outs and control

In his 1961 letter, as well as later letters, Buffett outlined the three primary types of investments that could be found in the partners’ portfolios, the approximate proportion of the portfolio to be involved with each and the basis upon which such investments should be chosen.

The “bread and butter” according to Buffett was his “generals”, businesses trading at substantial discounts to their intrinsic value which were purchased with the intent of eventually being resold at a price closer to the intrinsic value:

our largest category of investment… more money has been made here than in either of the other categories… We usually have fairly large positions (5% to 10% of our total assets) in each of five or six generals, with smaller positions in another ten or fifteen… Sometimes these work out very fast; many times they take years. It is difficult at the time of purchase to know any specific reason why they should appreciate in price… individual margin of safety coupled with a diversity of commitments creates a most attractive package of safety and appreciation potential… [we] are usually quite content selling out at some intermediate level between our purchase price and what we regard as fair value to a private owner

While admitting that the particular and eventual catalyst was often not known with the average investment in a general security, Buffett also admitted in his 1963 “Ground Rules” letter section:

Many times generals represent a form of “coattail riding” where we feel the dominating stockholder group has plans for the conversion of unprofitable or under-utilized assets to a better use

The next category was workouts:

our second largest category… ten or fifteen of these [at various stages of development]… I believe in using borrowed money to offset a portion of our work-out portfolio since there is a high degree of safety in this category in terms of both eventual results and intermediate market behavior

The beauty of work-outs is that they relied on corporate action, not market action, to realize value. In this sense, they could provide a meaningful buffer to share price declines in generals during bear markets as their performance was largely “market neutral.” For example, in his 1963 (1962 being a bear market) letter Buffett said:

This performance is mainly the result of having a large portion of our money in controlled assets and workout situations rather than general market situations at a time when the Dow declined substantially

The final category was control, which started out as something of an after-thought or an accidental consequence of investing in certain generals which remained cheap, but later turned into an active category Buffett would search for opportunities in.

Buffett also mentioned the idea of the “two-way stretch” in control situations– if bought at a significant discount, there were generally two ways to profit from a control investment. Either the stock price remained low for a long period of time and control was acquired, in which case “the value of our investment is determined by the value of the enterprise,” or else the stock would move up in the process of consolidating a position in which case it could be sold at a higher level in the way one would normally “complete a successful general operation.”

Time horizons for performance

This particular point is more well-known but it bears repeating here. Buffett was obsessed with long-term performance and constantly advised his partners about appropriate timelines for judging investment performance, especially based-upon the particular type of investment being considered. For example, in his 1960 letter he said:

My own thinking is more geared to five year performance, preferably with tests of relative results in both strong and weak markets

In the 1961 letter, Buffett discussed “establishing yardsticks prior to the act” and again emphasized:

It is my feeling that three years is a very minimal test of performance, and the best test consists of a period at least that long where the terminal level of the Dow is reasonably close to the initial level

In other words, what did your performance look like after a three year period where the broad market index made no progress, or even reversed?

With control situations specifically, Buffett advised:

Such operations should definitely be measured on the basis of several years. In a given year, they may produce nothing as it is usually to our advantage to have the stock be stagnant market-wise for a long period while we are acquiring it


It’s clear that Buffett had 15-21 “generals” or about 50-60% of his portfolio, with another 10-15 positions in workouts or another 15-30%, with the remainder in control situations. However, control situations could scale up to as much as 40% of the portfolio in an individual investment if the situation called for it in Buffett’s mind.

And while Buffett mentioned in an earlier letter of having approximately 40 positions in the portfolio in total, he later (around the time he started being influenced by Charlie Munger and other “quality over quantity” investment practitioners) became more critical of the idea of diversification. In the 1966 letter, Buffett lamented:

if anything, I should have concentrated slightly more than I have in the past

He also castigated “extreme diversification”:

The addition of the one hundredth stock simply can’t reduce the potential variance in portfolio performance sufficiently to compensate for the negative effect its inclusion has in the overall portfolio expectation

Buffett was learning the merits of “concentration” in areas outside the portfolio, as well. In discussing slight additions to the office space at Kiewit Plaza and the hiring of additional support personnel, Buffett added:

I think our present setup unquestionably lets me devote a higher percentage of my time to thinking about the investment process than virtually anyone else in the money management business

Of course, the results of this focus were obvious to all in time.

Sizing things up

Buffett dwelled on “the question of size” at length in his letters to partners. He made it clear that portfolio size and investment opportunity looked something like a continuum with small size on the left of the spectrum and large size on the right, with “generals” hanging near the left pole (size is a disadvantage), workouts inhabiting some kind of middle ground where they were neither benefitted nor impaired by size and control situations distinctly on the right where size was an enormous advantage.

Generals and control situations are, in this sense, almost opposites because Buffett warned that some generals were too small to buy meaningful stakes in for a large portfolio, whereas a small portfolio might never be able to acquire enough shares to gain control of certain investments.

Inflation-adjusting Buffett’s portfolio positions and capital at various points in time also gives important clues to the role size played in his operations. For example, Sanborn Maps was apparently around a $4.5M market cap when he mentioned the company in his letters. This would be about $35M or so in today’s dollars (this is not an endorsement of BLS/CPI measurement techniques, just a convenient rule-of-thumb), so clearly Buffett was hunting in a small/micro-cap space at least at this time.

In a similar vein, Buffett started with $105,000 in capital in 1956, which is about $893,000 in 2012. In his 1966 letter, he complained that the amount of capital being managed at the time, $43,645,000, was beginning to be burdensome in terms of size versus opportunities. This would be about $312,000,000 in 2012, to put it into perspective.

Apparently, the value investment framework Buffett created could work quite well even at a scale that we might consider to be decently large.

Serendipity: the reason for Buffett’s rise, and retirement

Few ever think to mention the incredible role serendipity played in Buffett’s early fortunes, but Buffett himself was well-aware. Not only did he begin his career at the outset of an astounding decade-long-plus bull market, but in 1952,

and for some years subsequently, there were substantial numbers of securities selling at well below the “value to a private owner” criterion we utilized for selection of general market investments

As the bull market started to grow gray hairs in the late 1960s and Buffett began contemplating an exit from the business, he similarly remarked in his 1967 letter:

Such statistical bargains have tended to disappear over the years. This may be due to the constant combing and recombing of investments that has occurred during the past twenty years, without an economic convulsion such as that of the ’30s to create a negative bias toward equities and spawn hundreds of new bargain securities

The comment on the aftermath of the 1930s bears repeating. The primary reason for the prevalence of bargain issues in the market around the time Buffett started investing was due to a massive psychological paradigm shift in attitudes about the stock market following the crash of 1929 and subsequent depression of the 1930s. By the late 1960s, a new inflationary thrust had managed to erase this psychology and great gains were actually made in sending it in the reverse direction. Buffett was convinced of

the virtual disappearance of the bargain issues determined quantitatively

the kind whose figures “should hit you over the head with a baseball bat”, which were being replaced by

speculation on an increasing scale

So how did Buffett respond to these new market conditions where his toolkit didn’t seem to work as well? Did he compromise his standards, or try to shape-shift his style into the “New Era” of investors and keep going? Well, anyone who has studied Buffett already knows the answer. Buffett knew his circle of competence and he knew what worked. When what he knew worked stopped working (because the opportunities weren’t available), he quit.

Despite writing in his 1968 letter that the answer to a potential phase out of the partnerships was “Definitely, no.” Buffett nonetheless in his 1969 letter suggested that “the quality and quantity of ideas is presently at an all time low” and that “opportunities for investment that are open to the analyst who stresses quantitative factors have virtually disappeared” and for this reason, he decided to close up shop.

There’s a lesson for all of us here. As Joel Greenblatt has argued, value investing doesn’t work all the time, which is why it works. We should respect this, just as Buffett did– when the deals dry up, we should go fishing (or at the very least, look for bargains in other markets that are in a different stage of psychology/sentiment/valuation). Trying to make great long-term returns when valuations won’t support it is a fools game and more likely to end in failure.

A few miscellaneous notes

In the 1968 letter, Buffett referred to 10-12% as “worthwhile overall returns on capital employed”.

With regards to dividends, although Buffett always described the return of the Dow for each annual period inclusive of dividends earned, and although when describing his investment in Commonwealth he specifically mentioned that the company was not paying dividends, and although we know from an anecdote in The Snowball that Buffett was receiving substantial dividend checks from his partnership portfolios because his wife Susie accidentally through a few away one time, I noticed that Buffett makes no specific mention in any of the letters of the importance of dividends nor that dividends impacted his investment decisions or philosophy.