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Forrest Reads The Intelligent Investor


Passively investing in Equities is a great strategy for most people. However, Forrest wants to see if he can get better return by learning from the legends.

Imagine market as a person: Mr. Market - an emotional short sighted person who occasionally buys/sells businesses at prices lower or higher than their value.

Benjamin Graham says all you need is 1) Framework, and 2) An ability to keep emotions from corroding that framework. Simple.

As we discussed in our last post, keeping 100% of Forrest's savings in Equities is a great starting point. And if Forrest didn't have free time in his hand to study businesses and understand how to value a business, he would have just bought low cost S&P 500 ETF every month from his savings and keep building his wealth.

Students meet the Master

It's a great book with a lot of takeaways but Forrest limited himself to lessons which he can actually apply. Forrest notes his understanding/conclusions in italics.

  1. Price and Value. "We understand only two  things, current stock price and Value of the business. We don't concern our self with Beta, CAPM, Covariance etc etc. We don't understand these things honestly." - Yeah, the simpler the better. Forrest thinks there is only one type of investing, buying something at a price less than its "Value". And "Value" is the price which a rational buyer would pay for the whole business.

    • There are so many academic studies on irrelevant things because academics feel the need to do something with the knowledge they have acquired. 
    • A great company is not a great investment if you pay too much for the stock.
    • Courage To Bet Big. In the world of securities, courage becomes the supreme virtue after adequate knowledge and a tested judgment are at hand. - It is extremely important to make big bets when the opportunity presents. Example: Buffett buying Wells Fargo when analysts predicted the bank is about to default, has the most exposure to falling housing in California. Even fellow investors from School of Graham and Dodd felt Buffett is doing a mistake.

      • Having the courage to act on your analysis, and not be dissuaded by crowd/sentiment, is utmost important. Courage comes from doing thorough analysis. But it's important to have a well-calibrated confidence. Ask yourself, What is the counter party selling/buying thinking ? How much can I lose? How will I react if my thesis is wrong ?

      • Either people understand "buying a dollar for 40 cents" or they don't. Either it just clicks, or it takes decades and they still don't get it. - This is simple, Forrest understands this.

      • 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. - more volatility means more opportunities for Forrest.
    • Focus On Long Term. Do not take yearly results too seriously. Instead, focus on four or five-year averages. - Forrest understood that yearly results have to look bad for an opportunity to arise, for investors to flee the market, and that is the time to analyze vigiltantly. 
      • Without a saving faith in the future, no one would ever invest at all. To be an investor, you must be a believer in a better tomorrow.
      • The real risk is not overpaying for a good quality company. The real risk is paying too much for a low quality company when economy is doing well. - When taking 5 year average, ensure they are not the merriest of times.
    • Protect The Downside. One very important rule is to "not lose money". 

      • It takes a looong time to recover money lost; that's the way compound interest works. Example: After losing 50% on one's portfolio, you will need to gain 100% to break even; getting that 100% cumulative return can take years.

      • You WILL make bad investments, all you can control is price you pay for it, percentage you allocate to the stock and  how you react after the investment fails.

    • Aligned Management Incentives.You have to consider that you are not buying the whole business, hence you should ensure that people running the business are running it for shareholders. 
      • Serial acquirers usually end up meeting a bad end on wall street. Soon they start taking restructuring charges.
      • Forrest will ensure that the management has skin in the business. Forrest doesn't like management which have stock options because management gets the upside but doesn't share the downside. Forrest would like to invest in companies where the CEO and other senior management has significant stock ownership. This is the only way to ensure alignment of interest.

    Observation: All great investors from the "School of Graham & Dodd" have a record of 20ish% per year. Forrest noted that translates to an alpha of 10% approx. They never complained about "value traps", "value investing being out of favour" etc which are usual reasons given now a days by so called Value Investors who have not generated alpha for years.

    Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.