Novel Investor

Compounding investing wisdom...

Wise Words on Risk Management

by Jon

The art of long term investing is about surviving the short run. It’s risk management 101.

This is a friendly reminder that every investment brings the possibility of gain or loss. But when the market’s rising, and everything is going well, it’s easy to become complacent and focus less on the downside.

Every investment has a downside, even if you can’t see it. Random things happen. Being wrong is possible. Markets are always changing, and with it, the riskiness of your portfolio.

Prudent risk management starts with the obvious question: What’s the downside? Now is a good time as any to reacquaint yourself with it.

Because when the market’s rising, and things are going well, it’s the perfect time to test the survivability of your portfolio and make any needed adjustments. It only works if you prepare in advance.

Don’t just take it from me: Continue Reading…

What Has and Hasn’t Changed in Investing

by Jon

Ben Graham spent a lifetime teaching about the errors of our ways. He started his career in 1914. 33 years later he would find himself lecturing students on the problems in security analysis.

In his final lecture, he looked back at the entirety of his career, up to that point, to highlight the many improvements.

I would like to make some final observations, relating to a long period of time, as to what has happened to the conduct of business in Wall Street.

If you can throw your mind, as I can, as far back as 1914, you would be struck by some extraordinary differences in Wall Street then and today. In a great number of things, the improvement has been tremendous. The ethics of Wall Street are very much better. The sources of information are much greater, and the information itself is much more dependable. There have been many advances in the art of security analysis. In all those respects we are very far ahead of the past.

All of these things have continued to improve since the mid-1940s. And a couple of things can be added to Graham’s list as well, like lower trading costs and easier access to markets. Continue Reading…

Enduring Drawdowns in Wonderful Companies

by Jon

The stocks of great companies are not immune to deep drawdowns. In fact, it’s practically guaranteed to happen more than once.

Hendrik Bessembinder followed up on previous research with a deep dive into the greatest companies ever. His first conclusion shouldn’t be too surprising.

The most successful company investments in terms of wealth created for shareholders at the decade horizon also involved very substantial peak-to-trough drawdowns. Even those investments that are the most successful at long horizons typically involve painful losses over shorter horizons.

Bessembinder looked at the top 100 companies based on shareholder wealth creation by decade since 1950. He then measured the largest drawdown shareholders faced in that decade.

Investors in the greatest companies faced a drawdown of 32.5%, on average, despite being one of the greatest decades of performance ever. That was just the largest drawdown, on average. It says nothing of the second, third, and so on drawdowns during the same decade. Continue Reading…

The Downside of Chasing Huge Wins

by Jon

Most people know John Maynard Keynes the economist. Not many know Keynes the investor. The track record of his personal accounts and the King’s College Chest Fund show he was a decent, though risk-averse, investor.

One thing stands out when you compare the two records. He consistently used margin loans in his personal accounts. I wanted to take a deeper dive into the impact margin loans had on his results.

For those not aware, a margin loan is borrowed money used to buy securities in an attempt to juice returns. The results can be exceptional if things go right or horrendous when things go wrong.

When you borrow money against an asset, and the value of the asset falls, bad things can happen. The main reason is due to minimum margin requirements. Lenders don’t like to lose money any more than we do, so minimum margin requirements help safeguard lenders from losses.

But it doesn’t protect you from losses. In fact, the minimums do the opposite whenever it’s triggered. Because you’re hit with a margin call. Continue Reading…

A 90-Year-Old’s Tale of Compounding

by Jon

Warren Buffett turned 90 last weekend and many tributes have come out since highlighting his track record. Why wouldn’t they? It’s the best long term track record ever.

It starts with the 31.6% annual return during his partnership days from 1957 to an almost perfectly timed closure in 1968.

He followed that up with a stint at Berkshire Hathaway. Since he took control in 1965, its stock has achieved a 20% annual return…so far.

The chart below shows what a $10,000 investment in Berkshire in 1965 looks like. Continue Reading…

Follow the Earnings

by Jon

Growth stocks were in vogue by the end of 1972. The five most popular companies had a market cap of $100 billion on earnings of $2.2 billion.

$100 billion is nothing by today’s standards, but those five companies — IBM, Minnesota Mining (3M), American Home Products, Xerox, and Eastman Kodak — accounted for 15% of the total market cap of every company listed on the NYSE. They had an average P/E of around 40. The general view was their growth made them “safe.”

Therein lies a problem. Equating high multiples with “growth” is a common mistake made by investors. But making the leap from “growth” to safety compounds the error.

The skill is in separating growing companies from high multiple stocks that are rising in price. Because one meets certain characteristics that drive earnings growth over time. The other has only to do with price action. Continue Reading…

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