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Gerald Loeb takes the contrary view that preservation capital requires some level of speculation to earn a return high enough to overcome the inevitable “losses” investors will experience in their lifetime.
The Notes
- “Any earner who earns more than he can spend is automatically an investor. It doesn’t matter in the slightest whether he wants to be or not, or even whether he realizes that he is investing.”
- Too often investors expect “too much and aim too little” and rarely consider their return in relation to loss of purchasing power.
- On the new investor: “Into this field the outsider turns for quick and easy profit, or a high income, or a haven of safety. On the average, he gives it less thought than most of his activities, and he is usually careless as to whom he consults or through whom he deals. Frequently he fails to distinguish between results obtained by chance and those secured through knowledge. Often he is “sold” something instead of buying it on his own decision, and often he is the victim of sharp practice.”
- Experience and knowledge are needed to understand and interpret information and filter out the noise. And yet, even that won’t help if one is not cut out for investing.
- “There is no such thing as a final answer to security values… Market values are fixed only in part by balance sheets and income statements; much more by the hopes and fears of humanity; by greed, ambition, acts of God, invention, financial stress and strain, weather, discovery, fashion and numberless other causes impossible to be listed without omission.”
- The stock’s price influences investor decisions. For example, depending on the investors, a low price may cause selling, deter buying, or attract bargain hunters.
- Often new investors equate their making money with intelligence and/or investing is easy.
- “Any way one looks at it, nothing is more difficult than succeeding in Wall Street, yet nothing is attempted by such poorly equipped people or is considered as easy.”
- Realizing how far you are from perfection and the dangers involved is the measure of investing success.
- “‘Fools rush in,’ and in Wall Street that is fatal.”
- Preservation of capital has an often overlooked hidden cost of loss of purchasing power.
- Investment returns must be high enough to offset investing losses, mistakes, inflation, taxes, and unexpected events that lead to forced premature selling. In other words, some amount of speculation is needed to continue “growing the pie,” so to speak, in order to increase your purchasing power, even if you’re only trying to preserve it.
- The author believes a concentrated portfolio is the best way to achieve “high enough” returns, but with stipulations: requires the right temperament, willingness to learn everything about holdings, and the ability to sit in cash. In other words, put all your eggs in one basket and watch the basket.
- No permanently safe, ideal investments exist.
- “Any investment policy followed by all naturally defeats itself. Thus the first step for the individual really trying to secure or preserve capital is to detach himself from the crowd.”
- Early pitfalls: trade too broadly, trade too often, trade too illiquid or complex securities, trade too emotionally, trade on tips.
- The only return that matters is total return (dividend, interest, and capital gains) after taxes and fees.
- “It is far better to let cash lie idle than to buy just to “keep invested” or for “income.””
- “Here lies the greatest handicap of most investors. They have had no experience.”
- For new investors who want to learn — without the market charging a high cost of tuition — the author suggests investing only in one stock at a time, never more than 100 shares. It forces you to make decisions — keep the stock, take a loss or profit — since you must sell the stock before you can buy another.
- “…one must devote some time every day to the subject of investment. Nothing is more logical, yet nothing more surprising to most people.”
- Before buying any investment, know why you’re buying, what you expect to make, how long you might own it, and how much you’re willing to risk. Selling becomes harder without that information. Write it all down to track your thought process on each investment. Following this basic guideline should lead to a fewer number of holdings, as you weigh opportunity with risk, versus “holding cash.”
- “Over-diversification acts as a poor protection against lack of knowledge.”
- Concentrated portfolios work best with knowledgable, less emotional investors willing to learn every detail about their holdings.
- “The bargains which must be sought to raise investment performance out of the average class, in which net losses occur, into the exclusive class of those who make and keep profits are not available except occasionally. It should be recognized also that such opportunities will inevitably be available principally when the majority of buyers of securities refuses, because of fear, to take advantage of low prices. Just as inevitably, the opportunities will not be available when securities are generally popular and eagerly bought. It should be axiomatic that the successful investor will keep his capital idle in times of popular over-investment and over-confidence. He will be sorely tried at times when profits and income are seemingly easy to procure. Any program which involves complete investment of all capital at all times is not apt to be the most successful one.”
- Knowledge about a typical company begins and ends at the headlines. Few people bother to read annual reports and financial statements. This is a requirement if you want to know what and why you’re buying.
- The author likes to look at cash flow: is there enough to cover working capital, feed growth/expansion, pay dividends, etc.
- Understanding financial statements and skeptical/curious/independent mindset is the best way to separate facts from rumors and misinformation.
- “The factors that make an ideal investment are never all present at the same time. Even if such an opportunity actually did exist, it would be almost impossible for anyone to recognize its existence.”
- Still, here are a few things to watch for:
- Sentiment on the stock is bearish, the market is liquid, selling at a “low price.”
- Business conditions/expectations are poor. Maybe earnings have fallen, dividends cut, etc. and expected to worsen.
- The average opinion is a lack of faith in the company and it’s reflected in the stock price.
- The buyer must have the contrary opinion — things are better than expected — backed by sound judgment and reliable information.
- “The objective is always buy that which the majority thinks is speculative and sell it when the majority believes the quality has reached investment grade. It is in this policy that both safety and profits exist. As price is the all-important consideration, the type of corporation and its characteristics are of relatively minor consequences.”
- A stock’s price can move significantly in a few months. The ability to sit in cash, waiting for these opportunities is the key to success.
- “As soon as a security is purchased, the buyer loses the power to avoid a decision. It becomes necessary for him to decide whether to hold or sell. As an inexorable consequence, the percentage of correct conclusions must be lowered. Therefore, intelligent investors expect to make a great many more errors in closing transactions than in opening them.”
- You must stay emotionally detached to investments. It makes it easier to cut losses and let profits run.
- “People like to take profits and don’t like to take losses. They also hate to repurchase something at a price higher than they sold it. Human likes and dislikes will wreck any investment program. Only logic, reason, information and experience can be listened to if failure is to be avoided.”
- “The most important single factor in shaping security markets is public psychology.”
- Trying to pick the bottom and top of markets is a losing battle. It’s better to understand where the general market psychology stands at any given time. Like, the psychology that drives someone to pay 40x earnings for a stock under one condition but refuses to pay 10x earnings for the same stock under another.
- Security analysis done correctly considers past earning power under various conditions to estimate future earnings.
- “Full consideration must be given to what investors think something is worth and not only to what its theoretical value might seem to be.”
- Understanding that prices are driven by psychology in the short term presents opportunities (trend) when the crowd is enthusiastically buying (or selling) stocks. Even though the crowd might be doing something that is eventually costly — like buying near the top or selling near the bottom — it’s still an opportunity if you can assess the trend.
- Investing is an art precisely because psychology affects prices. That makes it difficult.
- “Uninformed buying, per se, is not always a sign of the top. It is in fact frequently the sign of a wild advance.”
- Investing for the short term accepts the difficulty in consistently picking the few big stocks that outperform over decades. The author defines short term as 6-18 months.
- Think about profits in terms of percentages, not points (dollars).
- “Accepting losses is the most important single investment device to insure safety of capital. It is also the action that most people know the least about and that they are least liable to execute… The most important single thing I learned is that accepting losses promptly is the first key to success.”
- It’s a mistake to think that falling stocks are certain to rise.
- It’s a mistake to not sell an investment because of the tax hit.
- The difference between consistently successful investors and everyone else is their ability to seize opportunities and limit costly mistakes.
- “Experience teaches you how little you know, even under the best circumstances.”
- Forecasting is hard. Making money off forecasts is damn near impossible.
- “Dwight W. Morrow once said, when asked when he would know that the deflation of the “thirties” was over: “I will tell you six months after it has happened.””
- “In my practical experience, the way to successful investment lies much more in learning how to utilize your best thoughts and minimize your worst rather than in being better at selection or better at timing than the average.”
- Flexibility offers safety against changing markets.
- “There is no guarantee that what happened in the past will happen again in the future or that what happened in one place will happen in another…”
- “The desire for gold is the most universal and deeply rooted commercial instinct of the human race.”
- Diversifying positions across different sectors or business cycles is worth considering.
- “The most important things any reader of these chapters can learn are likewise that investment and speculation are difficult, not easy; uncertain, not clearcut; treacherous, not logical. Here, more than anywhere in the world, is the land of illusion. Things are not what they seem. Two and two don’t always make four. “Stocks were made to sell.” Caveat emptor —”Let the buyer beware.””
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