Novel Investor

Compounding investing wisdom...

Peter Lynch on Portfolio Construction

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Peter Lynch is known for his versatility. He deployed a wide range of strategies during his career to earn market-beating returns.

As described in his book, One Up on Wall Street, he’d invest in anything — slow growers, stalwarts, fast growers, cyclicals, turnarounds, and asset plays. He even borrowed Ben Graham’s net-net strategy to invest in Dot-com stocks after the bubble burst.

But how did he put that skill to use regarding portfolio construction?

In a 1985 interview, he described how he constructed the Magellan Fund. Lynch divided the fund into three buckets — conservative stocks, growth stocks, and special situations: Continue Reading…

Seth Klarman: Consistency in a Bubble

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Imagine writing out your investment strategy every year. What would it be? Would it be consistent? Or would it change every few years?

Now, imagine writing it down during the longest bull market in history. Would it change then?

Fund managers do this almost annually to remind clients, partners, or shareholders about the underlying goals of the fund. On some level, it probably acts as a self-reminder, offering reassurance that their strategy does work, just not right now. And looking back, it becomes a telling sign of whether they stayed consistent, especially during the rough years.

Seth Klarman’s letters are a good example of consistency. His letters not only show what it takes to stick to your knitting but to do it in the face of a massive bubble that makes your strategy look foolish. Continue Reading…

Too Good To Be True

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For as long as there have been markets, there have been charlatans, con-artists, and fraudsters getting rich selling hope to the uninformed. In every case, the returns turned out to be “too good to be true.”

Charles Ponzi is probably the most infamous. He wasn’t the first to do it, but they named the scam after him anyway. He defrauded clients with promises of 50% returns in a month and a half or 100% in three months investing in postal stamps.

Of course, there was no investing going on. The only strategy Ponzi followed was to rob Peter to pay Paul. He used money from new clients to pay old clients. As long as he maintained a big enough supply of new clients, he could keep the fraud running. Ponzi’s scheme latest about three years before it finally fell apart.

So right away, there are things to watch out for from Ponzi’s scheme. The returns are unbelievably high and the claimed method of earning them is complex.

Now, Ponzi pails in comparison to Bernie Madoff. Historic market crashes tend to expose fraud going on right under our noses. The 2008 financial crisis was no exception. Multiple cases came to light but Madoff’s was the biggest. Continue Reading…

The 1960s Franchise Mania

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The 1960s saw a wave of tiny bubbles that pulled investors back into the stock market. But the over-indulgence in the franchise mania brought the decade and the stock market to a crashing end.

A franchise is a license that grants you the right to run a business under the name of a recognizable brand. In exchange, you agree to sell their products or services while following their operating procedures. In return, the company collects an upfront licensing fee and a percentage of your sales.

It’s a mutually beneficial way for franchise companies to expand. Outside money funds expansion, allowing the company to focus on training, advertising, and improving its products.

Fast food restaurants like McDonald’s, Taco Bell, and Kentucky Fried Chicken are a perfect example. In fact, each of those companies was started in the 1950s and contributed to the boom in the next decade (the interstate highway system, the migration to the suburbs, and baby boomers hitting their teenage years helped). Continue Reading…

T. Rowe Price’s Recipe for Growth Stocks

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“Growth stock” investing was a new idea that arose in the 1930s. Thomas Rowe Price was one of the founders of the theory. He publicly make the case for it in 1939.

Price recognized early in his career that a few companies had an advantage of stable long-term growth. They could plow earnings back into the company and grow for decades. Those were the companies he wanted to own.

He explained in a series of articles appropriately called “Picking ‘Growth’ Stocks.” He defined it like this:

“Growth stocks” can be defined as shares in business enterprises which have demonstrated favorable underlying long-term growth in earnings and which, after careful research study, give indications of continued secular growth in the future.

A decade later he refined his definition in a follow-up article: Continue Reading…

The Follies of Speculation in 1875

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Misbehavior often gets in the way of investing profits. To say it’s been a longstanding problem is an understatement. Arthur Crump pointed it out in 1875 and little has changed since.

Crump is an Englishman who wrote about speculating in stock markets based on his observations of London markets. His book, The Theory of Stock Exchange Speculation, warned about the common mistakes “haphazard operators” made, and lost money on, almost 150 years ago.

And he doesn’t hold back. You may even recognize a few: Continue Reading…

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