Novel Investor

Compounding investing wisdom...

Howard Marks: The “Negative Art” of Investing

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Howard Marks once describes his investment philosophy like this:

My philosophy of investing was built primarily on experiences but also on things I read: John Kenneth Galbraith’s ideas about cycles, the importance of contrarianism and being a countercyclical, and the importance of not being a forecaster, and Charlie Ellis’s article on “The Loser’s Game” — the desirability of just keeping the ball in play rather than trying to hit home runs.

Strategies that swing for the fences can experience random catastrophic strikeouts that ruin a game. Marks wants to stay in the game as long as possible, so he’ll forgo home runs for singles, doubles, and even walks. It’s like a small ball approach to investing, to continue the baseball analogy.

The point is, Marks wants to avoid as many mistakes as possible and not lose. To do that, he follows a process he learned from Ben Graham called the negative art. Here’s how he described it: Continue Reading…

How to Stop Being Your Own Worst Enemy (in Investing)

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The most overlooked aspect of investing is behavior. Instead, we focus on intelligence, timing, forecasting, and a host of other things we believe carry more weight in the returns we earn. Some of it matters, but not nearly as much as we hope.

Of course, Ben Graham tried getting the importance of behavior across decades ago. He plainly explains it in the introduction to The Intelligent Investor: “For indeed, the investor’s chief problem — and even his worst enemy — is likely to be himself.” If you can overcome yourself, you’ll be better off than most investors.

Here’s the thing.

Humans have been hardwired over the centuries with quick natural responses that enhanced our survivability. Thousands of years ago, survival required focusing on what’s around the corner instead of what’s far off in the distance. So we became great at leaping to the first conclusion rather than thinking things through.

That works great if we want to avoid being mauled by an animal, but works terribly if we want to survive in the stock market. Simply, human nature hasn’t kept pace with our changing environment. Continue Reading…

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…

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