Quote for the Week

Real investment risk is measured not by the percent that a stock may decline in price in relation to the general market in a given period, but by the danger of a loss of quality and earning power through economic changes or deterioration of management. In the five editions of The Intelligent Investor I have used the example of A&P shares in 1936-1939 to illustrate the basic difference between fluctuations in price and changes in value. By contrast, in the last decade the price decline of A&P shares from 43 to 8 paralleled pretty well a corresponding loss of trade position, profitability, and intrinsic value. The idea of measuring investment risk by price fluctuations is repugnant to me, for the very reason that it confuses what the stock market says with what actually happens to the owners’ stake in the business. — Benjamin Graham (source)

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Quote for the Week

I’ve been an advisor to a couple of endowment funds. I was on a finance committee on one of them for quite a while. We had an outside advisor who set up benchmarks and suggested managers and hedge funds that would supposedly outperform, and so forth. The committee would work on this very seriously. These were smart, successful people, about a dozen, with a range of expertise. They would debate long and hard about how to allocate the assets — how much to emerging markets, how much to bonds, and so forth. And they’d fine-tune it from time to time, but mostly it didn’t make much difference. I found it difficult to persuade them that all this cerebration was a waste of our time. — Ed Thorp (source)

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Here’s what I’ve been reading for the past three months:

• Value Investing Makes Sense – Jean Marie Eveillard is a French-born value investor who had a successful career that began running a mutual fund at SocGen, which became First Eagle. He describes his journey from the discovery of value investing, why he transitioned from Graham-style to a Buffett-style strategy, and the experiences that led to his long-term success. The book is only available in print, as far as I know, and is not the easiest to find.  (notes)
• American Business History – Walter Friedman explains why the U.S. is so unique compared to the rest of the world when it comes to businesses. He covers the factors that drove business dynamism since before the early colonies. If you like history and business, this is a good book for you. (notes)
• Men and Rubber: The Story of Harvey Firestone – Harvey Firestone’s autobiography recalls the story of how he turned a small tire company into an industry leader. The book includes a detailed perspective of the early automobile industry and insights into the problems new businesses continue to run into today. (notes)
• Immoderate Greatness: Why Civilizations Fail – Major civilizations throughout history, much like markets, cycle from rise to peak, to collapse. The book focuses on the primary drivers of the decline and fall of civilizations. It’s not the most optimistic book, nor unbiased, and for a short book, the author over-relies on analogies that could have been cut out. Notes to come.
• The Buffett Essays Symposium – The book is an annotated transcript of an event held in 1996 to discuss topics covered in Warren Buffett’s essays. You get a mix of different views from Buffett, Munger, and others on corporate governance, investing, M&A, accounting, and more. If you’ve read The Essays of Warren Buffett, you might find this interesting. Notes will be published once I’ve finished it.

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Quote for the Week

When you want to understand the perversity of risk, it’s important to recognize that the riskiness of investing comes only partly from the things you invest in. A lot of the risk comes from the behavior of the participants. Almost any asset can be risky or safe, depending on how other investors treat it.

You asked earlier about the formative influences on me. Entering the equity business in 1968 at an institution that practiced nifty-fifty investing was a formative influence because over the next five years or so, we lost 80 or 90 percent of our clients’ money while investing in the best companies in America. That was a pretty good object lesson that the safety or risk in investing doesn’t come from the securities you buy or the companies whose securities they are. Safety and risk come from how the investments are priced. We lost that money because we bought those stocks at price/earnings ratios of 80 and 90, as I recall.

I said in my book that there’s no asset so good that it can’t be overpriced and become a bad investment, and very few assets are so bad that they can’t be underpriced and be a good investment. People just don’t understand this. They say things like, “This is a great company, and you should buy the stock.” If it’s a great company, maybe you should buy the stock — but only at a good price. — Howard Marks (source)

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Stocks can be crushed in bear markets with no guarantee of recovery. But markets, more broadly, tend to move in cycles. The worst can become first and vice versa.

The S&P 500 is the perfect example of this cyclicality where last year’s worst performers are this year’s darlings. The sector returns, specifically, show that the worst-performing sectors last year — Info Tech, Consumer Discretionary, and Communications — are the three best performers year to date.

With cycles, it’s relatively simple to guess what might qualify for some reversion to the mean. Just look to the most extreme market performers. Except, it’s difficult to guess when it happens.

Hindsight, of course, makes it easy to explain why two of those three sectors performed so well thanks to the bump from AI. Yet, how many predicted they would have such a phenomenal start to the year?

Market history is filled with examples of worst-performing asset classes over one or more years that find their way to the top of the list once (almost) everyone least expects it. Put simply, bear markets in asset classes and sectors turn into bull markets eventually.

The lesson is not about timing but rather staying put. Being invested throughout the cycle brings the upside of surprising bounces, without the need to know when to get back in. Continue Reading…