Novel Investor • Page 3 of 13 • Compounding investing wisdom...

Seth Klarman: Opportunities from the Herd

November 28, 2018

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Jon

Studying investor behavior is a two-part process. The first, limiting the influence of biases and misbehavior improves your returns. The second step is to seize opportunities created by those who refuse to learn the same lessons you did.

The opportunities created by the short-term nature of the herd are why most strategies work. The heart of value investing revolves around this idea. Value exists because investors mistakenly discount current prices for an indefinitely bleak future.

But first, that means not getting swept up in the herd behavior you’re attempting to profit from. Optimism and pessimism, greed and fear, risk tolerance and risk-aversion are easier to latch onto when others do the same. Safety in numbers feels comforting until you find out, a little too late, that the numbers were acting irrationally.

Seth Klarman likes to point to the importance of discipline and patience in investing. Conveniently, discipline and patience are literally a contrarian stance as far as herd behavior is concerned. The independence it creates — to have a process you stick to no matter what — becomes the backbone to successful investing. Continue Reading…
Marty Whitman on Why Value Exists in Bull Markets

November 16, 2018

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Jon

I was browsing some of Marty Whitman’s old Third Avenue shareholder letters I had dug up a few years back. The nice thing about these old letters is the ability to go back to see someone’s thought process around bigger market events.

An excerpt (below) from one of those letters stood out for two reasons. First, Whitman wrote it in July 2000, a few months after the peak of the Dotcom Bubble, though nobody knew it was the peak at the time. The opening paragraph shows the juxtaposition of Dotcom enthusiasm versus the ignored value stocks Whitman was buying.

Those ignored stocks were trading at 10x earnings, while the market was going nuts over Nasdaq stocks at 141 times earnings. Even the P/Es of the Nasdaq versus the S&P 500 was hugely distorted.

The idea of paying $141 for $1 of earnings seems insane today, but that was typical back then. I remember friends asking about getting into eToys.com after the IPO. It practically tripled the first day, closing with a market cap 35% higher than Toys R Us despite only having $34 million in revenue and zero profits (Toys R Us had $11 billion in revenue at the time). Continue Reading…
Howard Marks: The Messy Cause and Effect of Cycles

November 14, 2018

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Jon

Howard Marks makes a point in his book, Mastering the Market Cycle, that cycles are messy. The repetition of cycles is not like a metronome — up and down, up and down — sounding off regular intervals. The repetition is only in a very general sense.

It’s not that B follows A and C follows B, but A leads to B because a multitude of factors influenced the how, why, when, and where of the next leg of the sequence causing B to happen. Then a multitude of factors causes C, and so on.

The point Marks is making is that cycles aren’t clean and uniform in the real world, but more of a jumbled messy interaction between human behavior, markets, businesses, economies…and so forth: Continue Reading…
Joel Greenblatt’s Version of Mr. Market

November 9, 2018

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Jon

Ben Graham’s Parable of Mr. Market is a simple story that gets to the heart of how the stock market works and how investors should work the stock market. Proof of its importance lies in just how often it gets retold. The thing about each retelling is that while the story is roughly the same, each storyteller adds their own spin, often focusing on a unique thing.

Joel Greenblatt’s version focuses on the one thing that is easily overlooked — the choice to do nothing. In every market situation, you have three options: buy, sell, or do nothing. A massive amount of digital ink is spilled on the first two. The market news and commentary revolve around it.

Yet, the last choice — the most important one — gets little attention. The ability to do nothing, to sit on your hands, and not react every time Mr. Market rattles off a crazy number for a piece of paper fits with the fortitude, patience, and discipline needed to succeed. Continue Reading…
Lessons on Risk From Peter Bernstein

November 7, 2018

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Jon

Being wrong, missing out, volatility, permanent loss…risk gets defined too many ways. It’s true, and yet, risk is a little more complex than a simple definition when uncertainty is involved.

After reading through a few dozen pieces from Peter Bernstein, I’m fairly sure he had risk figured out as best as anyone can figure it out. Though he doesn’t offer a simple definition for risk – the first highlight below is a great soundbite to add to the list — he does deliver a better way to think about it in a broader sense.

What follows are some of Bernstein’s thoughts on risk that stood out most in what I read. Continue Reading…
Happy Hour: The Spooky Month?

November 2, 2018

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Jon

October. This is one of the peculiarly dangerous months to speculate in stocks in. The others are July, January, September, April, November, May, March, June, December, August, and February. — Mark Twain

Octobers seem to be a spooky month and I’m not talking about Holloween. That’s because a few big market crashes give October a bad name — October 1929, 1987, and 2008. Those three Octobers were the three worst Octobers respectively.

So 2018’s October ends up being the 9th worst October for the S&P 500 at -6.9% for the month.

Yet historically, Octobers have been fairly tame, except for the outliers. The average S&P 500 return for the month of October is only 0.5%.

And when you compare October to all the other months, it looks less spooky. Continue Reading…

Seth Klarman: Opportunities from the Herd

Marty Whitman on Why Value Exists in Bull Markets

Howard Marks: The Messy Cause and Effect of Cycles

Joel Greenblatt’s Version of Mr. Market

Lessons on Risk From Peter Bernstein

Happy Hour: The Spooky Month?