Novel Investor

Compounding investing wisdom...

Reminiscences on Human Nature

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Edwin Lefevre tells an entertaining story of a fictionalized account of Jesse Livermore in Reminiscences of a Stock Operator. The draw of Livermore is an interesting one because he failed to learn the biggest lesson, summed up by Levefre:

In addition to trying to determine how to make money one must also try to keep from losing. It is almost as important to know what not to do as to know what should be done.

Even after he made and lost multiple fortunes in his life, Livermore never figured it out. In the end, he died broke. But this is less about Livermore and more about highlights from the book.

Despite the book being fiction, it offers some great lessons on history, human nature, and what not to do: Continue Reading…

Investing Lessons from the Banana Business

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The first real banana business began in the 1860s. It was literally a race against time. Profits were dependent on getting from port to port as quickly as possible, so as to avoid spoilage. Sail too long and they’d lose everything.

But once that first company sprung up, other’s soon followed. By the late 1890s, the market for bananas was booming.

Then just before the turn of the century, it stopped.

Like most booms, it could not last. Not because there was anything wrong with the product: the banana is perfect. Not because there was any scarcity in demand: people loved bananas from the start — the average American now consumes seventy a year. But because supply was uncertain… Most firms got their fruit from a single farm or valley, greatly increasing this vulnerability. The entire supply of many early traders could be wiped out by one bad storm.

This became painfully clear in 1899, the Year Without Bananas. There had been a heat wave, a flood, a drought, a hurricane. The market sheds were shuttered, the pushcarts stood empty. Dozens of firms went under. It was like the natural disaster that wipes out all but a few impossible-to-kill species.

The lessons from 1899 became obvious to the few surviving businesses. Since investing is very business-like, those same lessons transfer over. Continue Reading…

7 Moats of Great Investors

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A moat is a competitive advantage one company has over the competition. It can’t be easily copied either. Otherwise, it wouldn’t be a moat, it’d be a temporary edge.

The moat comes in several forms — economies of scale, network effects, intellectual property, switching costs, and cost advantage — that produce phenomenal performance over extended periods. Buffett’s focus on moats created a craze around finding these “wonderful companies.”

But before you run off to do the same, consider this. Buffett is unique in that he has his own moat. All great investors do. They have a competitive advantage over everyone else that produces phenomenal performance over extended periods. Without their moat, they’d be like everyone else.

You might think their moat is IQ, the right college degree, or experience. It’s not. Those things are important because they keep you in the game but all those things can be copied to some degree. It’s a temporary edge until a similarly smart, experienced person comes along. Besides, up to a certain point, an extra IQ point or one more experience brings less to the table. Continue Reading…

Joel Greenblatt on the Opportunity in Misbehavior

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Joel Greenblatt is one of the rare few who can claim 40% returns over two decades. He also has a knack for explaining things simply.

He did that in his first book, You Can Be a Stock Market Genius, which explained how he earned some of that 40% return. And it showed again in his second book, The Little Book that Beats the Market.

And he did it again in his third book, The Big Secret for the Small Investor, though it’s a little different than the first two. It’s written for people new to the game, but there’s something in it for everyone.

His message is simple: the small investor has built-in advantages over the pros and there is more than one right way to invest. You can try to value stocks, evaluate fund managers, or settle for index funds. And if the typical index fund is too average for you, maybe spice things up with equal- or value-weighted funds instead. Continue Reading…

The Behavior of a Successful “Gambler”

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Finishing How to Take a Chance (notes) led me to chase down the source of a few quotes from the book. The last post was a result of that distraction. Today’s post is another — and the last of that odyssey.

In 1902, a guy named Clemens J. France wrote a study called The Gambling Impulse. It’s interesting only in the sense that he took a biological and historical perspective of gambling and chance.

The summarized version is this. Gambling has been around forever, literally since the first utterance of “Wanna bet?” It can be traced back several thousand years — Ancient Egypt, Greece, Rome, and to 2100 B.C. China. Biologically, its a battle of hope and fear, to provide a level of certainty in life. If you plan to glance through the 44 pages, the section on luck, with examples of superstitious beliefs, offered a good laugh. This seemed relevant:

In London about Throgmorton Street (the paradise of stock brokers), there used to sit a man with a bag of nuts into which passers by thrust a hand, and if they guessed correctly the number, they would be paid a penny for each, if wrong, the guesser paid a penny. Many a speculator regulated his ‘bulling’ and ‘bearing’ by his successful or unsuccessful dip into the bag.”

To think that a trader’s (in)ability to guess the number of nuts determined their feeling explains a lot about irrational markets. Continue Reading…

A Study in the Psychology of Gambling

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Why is that some people treat the dumbest bet in the world as genius when it hits? It’s not genius, obviously, but confusing skill and luck is a common mistake made by gamblers and investors alike. It’s one of many that arise when human nature and gambling collide.

When the House has the advantage, like in most games of chance, winning has nothing to do with brilliance. It’s almost always a bad decision saved by dumb luck. Yet, hindsight bias spares us from being honest with ourselves.

Picture the person who hits on 17 at blackjack and catches a 4. Or another who goes on an amazing run picking numbers playing roulette. It’s not some uncanny ability. It’s not infinite wisdom. It’s not foresight. It’s dumb luck. But the story is sold as skill.

The mistake is not only denying luck after hitting the improbable 4 on a 17 but embracing bad luck after busting from a hit on 17. The failure to account for stupidity is probably worse than being falsely endowed with unnatural gifts. Who learns from bad luck?

Of course, this problem is as old as gambling itself. Case in point is a letter to the editor of The Spectator in 1873. An insightful English gentleman shared a scathing assessment, of himself and his fellow gamblers, after his first experience in a casino. Continue Reading…

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