Scaling Laws in Biology and Other Complex Systems & the Read-through for Investing

It seems the whole universe is designed based on the principle of economy of scale, from metabolic rates, to vascular systems, cancer growth, aging, mortality, etc. Those are log (x) correlated (<1.00) - metabolic rates, for instance, stand at 0.75. When it comes to cities, economies of scale still apply. Examples are less paved roads and gas stations per capita. Those are super-linear correlated (e(x) or >1.00) at 1.15 on average.

The question which pops out thus is "Is our system sustainable?!". Society and companies have to innovate in a regular, but accelerated, fashion. Clearly this isn't sustainable, at least not in the required pace for the long term. This is straightforwardly applied to the technology sector and that's why disruptive innovation exists. The curious part is that the below speech took place at Google!

But what about Coca-Cola company? What make those companies "moats", as Buffett would put it, large enough for generations to see? In hindsight it would be an easier call, but what can we look for when trying to identify ex ante such a great 100-year business? Food for thought.

Warren Buffett’s Meeting with University of Maryland MBA Students Nov '13

This is likely to be the last post of the year and it couldn't end any better. I have highlighted what got my attention from Buffett's latest talk to MBA students. I'd also like to thank those who indicated this to me.

• On "quality investing":

It’s better to buy wonderful businesses at fair prices than so-so businesses at low prices.

After exposure to Fisher and Charlie, I started looking for better companies.

• On candor: After reading many annual letters, it's hard to find one more clear and candid than Berkshire's. After all Rittenhouse is right indeed.

I try to think of my shareholders as my partners. I try to think of the information I would want them to send me if they were running the place, and I was the shareholder. What would I want to know? This is what I tell them.  In my first draft, I address it to my sisters who don’t know a lot about finance. “Dear sisters”- I explain to them what they would want to know in their position. I also like to write one section that is a general teaching lesson that doesn’t directly apply to Berkshire.

This is what I can do, this is what I can’t do, this is how I intend to go about it, and this is how I measure my success.

• On cash and human behavior: 

BRK always has $20 billion or more in cash. It sounds crazy, never need anything like it, but some day in the next 100 years when the world stops again, we will be ready. There will be some incident, it could be tomorrow.  At that time, you need cash. Cash at that time is like oxygen. When you don’t need it, you don’t notice it. When you do need it, it’s the only thing you need.

Fear spreads fast, it is contagious. Doesn’t have anything to do with IQ. Confidence only comes back one at a time, not en masse. There are periods when fear paralyzes the investment world. You don’t want to owe money at that time, and if you have money then you want to buy at those times.

• On assessing executives:

But will they behave the same after they get the money and I get the stock certificate? Will they work just as hard when they’re putting money in their own pocket? 3/4 of our managers are independently wealthy. These people don’t need to go to work, but they are putting the work in. If I give him 4 billion dollars, will it be the same results next month? Next year? I don’t deal with contracts; I have to size up whether management is going to continue working that same way. Generally, I’ve been right in my assessments and I’ve gotten better. They don’t need me, I need them. Why do I come to work? I can do anything I want to do, and yet I come out every morning and can’t wait to get into work. I enjoy working Saturdays, talking to students. Why do I do it? I get to paint my own painting. Berkshire Hathaway is my painting. People love creating things. I think I’m Michelangelo, painting the Sistine Chapel but it could look like a blob to someone else. Second thing – I want applause. I like it when people appreciate my painting. If others have their own paintings, then who am I to tell them how to paint it? (Just like management) I appreciate what they do. I know the game, so when I praise them, they know they’re getting approval from a critic they like. I have their stock certificate, but it’s still their business. It’s a good culture when managers really care about the business.

• On investing:

I like running businesses better than investing.  It is more fun building businesses than moving money around.

• On moats:

You need 2 things – a moat around the castle, and you need a knight in the castle who is trying to widen the moat around the castle. How did Coca-Cola build their moat? They deepened the thought in people’s minds that Coca-Cola is where happiness is. The moat is what’s in your mind. Railroad moats are barriers to entry. Geico’s moat is low prices. Every day we try to widen the moat.  See’s Candies creates a moat in the minds of consumers.  It is a more effective gift on Valentine’s Day than Russell Stover.  See’s Candies has raised its price every year on December 26 for 41 years.  BRK bought See’s Candies for $25 million in 1972.  Today it earns $80 million.

• On balancing your life:

The most important decision you’re going make is who you’re going to marry. What’s important is that what your thoughts are on big things, must make sure that your spouse has the same thoughts on the same big things. Don’t marry someone to change them. Marry someone who is a better person than you are. Always associate yourself with people who are better than you.

• On negotiation:

Bargaining with people you love is a terrible mistake. It’s destructive. The most powerful force in the world is unconditional love.

• On mistakes:

It is better to learn from other people’s mistakes rather than your own. Look at all kinds of business failures. I don’t believe in beating yourself over it, you’re going to make mistakes. My biggest mistake was buying Berkshire Hathaway and trying to make it better. 

• On his risk profile:

I try to operate in a way where I can’t lose significant sums over time. I might not make the most money this way, but I will minimize the risk of permanent loss. If there’s 1 in 1000 chance that an investment decision can threaten permanent loss to other people, I just won’t do it.

Full credit to Dr. David Kass, who has taken notes on the entire interview. You may find the entire piece by clicking here. 

Broad Run: Repetitive Advantage

Broad Run's suggestive name says (almost) it all: looking for long term compounders, i.e., for companies which can allocate capital at attractive rates of return over the long term (10 year test). These managers focuses on buying U$0.80 cents on at least U$3.00 instead of U$0.50 on U$1.00. Since they can't find many names, they are a concentrated fund and, thus, have more than one analyst looking into a company in order to mitigate untapped risks and ignorance. Other tidbits are (i) preference for conservative leverage and consequently high ROA instead of high ROIC on top of a mountain of cheap debt and (ii) executives' skin in the game. You shall allocate your time well by reading the article below.

Broad Run VII Profile Nov 2013 by Igor Chalhub

Munger's Quotes

“Three rules for a career: 1) Don’t sell anything you wouldn’t buy yourself; 2) Don’t work for anyone you don’t respect and admire; and 3) Work only with people you enjoy.”

“In my whole life, I have known no wise people (over a broad subject matter area) who didn’t read all the time – none, zero. You’d be amazed at how much Warren reads – and at how much I read. My children laugh at me. They think I’m a book with a couple of legs sticking out.”

“It never ceases to amaze me to see how much territory can be grasped if one merely masters and consistently uses all the obvious and easily learned principles.”

“I'm not entitled to have an opinion unless I can state the arguments against my position better than the people who are in opposition. I think that I am qualified to speak only when I've reached that state.”

“We don’t claim to have perfect morals, but at least we have a huge area of things that, while legal, are beneath us. We won’t do them. Currently, there’s a culture in America that says that anything that won’t send you to prison is okay. We believe there should be a huge area between everything you should do and everything you can do without getting into legal trouble. I don’t think you should come anywhere near that line. We don’t deserve much credit for this. It helps us make more money. I’d like to believe that we’d behave well even if it didn’t work. But more often, we’ve made extra money from doing the right thing.”

Feynman on Curiosity

"But it is not complicated. It is just a lot of it. And if you start at the beginning, which nobody wants to do – I mean, you come in to me now for an interview, and you ask me about the latest discoveries that are made. Nobody ever asks about a simple, ordinary phenomenon in the street."

"It has to do with curiosity. It has to do with people wondering what makes something do something. And then to discover, if you try to get answers, that they are related to each other(...)"

Be skeptical.

Mauboussin on Three Steps to Effective Decision Making

Baupost's Klarman on Holding Cash - 2004 Letter Excerpt

Seth Klarman on the Painful Decision to Hold Cash by Igor Chalhub

Mauboussin on Complex Adaptive Systems

Mauboussin was recently invited to seat at the Santa Fe Institute board, a research and education center which praises diversity to solve complex problems (by the way, there are tons of top notch materials and events to be checked out there). I found this interview with Mauboussin via compoundingmyinterests. Below, I highlighted and commented on some quotes:

#1. "The problem is that modeling complex adaptive systems is a lot messier than those other approaches." 

Although, financial analysts focus on modelling EPS and finding out if it's going to be . I'd argue the best research practice is understand capital allocators incentives & agenda.

#2. "This work showed that under some conditions returns actually move sharply away from the mean. This is counter to classic microeconomic thinking that assumes returns are mean-reverting."

This reinforces the previous post on quality investing. 54% of companies tend to remain in the 1st quartile after a long period of time, assuring their moat is wide and deep enough to bear multiple attacks.

#3. "Diversity is essential, both in nature and in markets, and the system has to be able to take advantage of that diversity. On the flip side, when you lose diversity the system can become very inefficient. And that’s also what we see in markets—diversity loss leads to booms and crashes."

Now let's frame the diversity in investment teams. Or even in Santa Fe Institute, which is exactly how it's done by the way. Different backgrounds working on the same problem is the knowledge leap.

#4. "Many businesses are being defined less by their specific market segment and more by the ecosystem they create. And it is often the case that in a battle of ecosystems, one will come out on top. So this set of steps provides a mental model to understand the process of increasing returns and, as important, how to identify them in real time."

The concept is beautiful, but applying it is tough. When it comes to the environment/value chain businesses are in, the spectrum is too wide for a quick research project. Actually, it can be the work of a lifetime. The "knowable" facts are scattered in open field and the “unknown unknowns” are also out there. For those interested, critical thinking might be an useful vertical for you to dive in.

#5. "First, it’s essential to provide your mind with good raw material. That means exposing yourself to a lot of disciplines and learning the key tenets. It also means spending time with people who think differently than you do. Second, you have to be willing and able to make connections."

I liked this quote because it uses plain language. Nothing better than that.

Capital Stewardship: from Clients to Portfolio Managers to Executives

No matter the position within the value chain, we are always outsourcing capital allocation in some instance. In this way, looking for outstanding capital stewards is of top priority for funds' clients (looking for great funds), portfolio managers (looking for great companies) and executives (looking for great projects).

In this paper, it's argued that no matter the insider ownership, one must analyze and trace the profile of key people. Stating the obvious: no matter if the key executive has 90% ownership in a company if he's a gambler who loves leverage willing to bet his entire fortune in one eccentric new segment. Right?

Analyzing people, their behaviors and habits, their principles and goals, their formal and informal incentives, is of main importance. We must remember businesses are run by people, so let's put "number crushing" a little aside.

Is the corporate culture appropriate? Is a repeatable mechanism entrenched in employees routine? Are leaders' personal goals aligned with the company's formal strategy? Which are the perverse incentives in place? What are the executives/board members' personal agenda main items? Do they conflict with the company's path? How?

Can you think of more questions?

Food for thought.

Quality Investing: Quantitative Endorsement

We likely share the qualitative view of what I call quality investing, but the below article helps us have some quantitative info. The top quartile companies ranked by profitability tend to remain in the first quartile 54% of the time.  28% of the time they slip to the second quartile, but very rarely those companies go to the laggards division. Thus mean reversion is likely to be against-the-odds investing. Try to search for "boring" companies: those are the best investments or what some call "compounders". Read the full article.

Baupost Q2 Letter Quote

"We are deliberate and consistent in what we do. We are methodical but never ponderous, responsive but never reactive." 

On Knowledge, Ignorance and Misperception

Many times we, research analysts, think we have completed the puzzle. Actually we NEVER do. What we actually do is think we have completed it. At the end of the day we are just tricking ourselves. If you think twice, our job is like playing the Jigsaw game - do you remember the movie? Things are getting scary, right? So, don't freak out and let me explain it.

Analysts are flood with information from companies, sell-side analysts and stockholders - to name a few. This is just like playing Jigsaw's game. The game is set up, someone controls your attention. You have to figure out  by yourself, just like a CIA agent, what the actual facts are. Distraction is across the corner, but the facts are buried down there. You will have to triangulate information across different sources in order to reach somewhere. Well, "somewhere" is a place where there are a lot more questions to be answered and that's what knowledge means: knowing what you DON'T know. In other words, knowledge is ignorance acknowledgement. And so the game goes on. It's an infinite game. Thus when you get home at night I suggest you to upgrade Munger's lesson "Make sure you learn something new every single day" to "Make sure you end your day with more questions than when you woke up."

Want to dig further?

Ignorance: How it drives science by Stuart Firestein

Finite and Infinite Games by James Carse

Holmes on the Brain - "A Study in Scarlet"

"I consider that a man's brain originally is like a little empty attic, and you have to stock it with such furniture as you choose. A fool takes in all the lumber of every sort that he comes across, so that the knowledge which might be useful to him gets crowded out, or at best is jumbled up with a lot of other things so that he has a difficulty in laying his hands upon it. Now the skillful workman is very careful indeed as to what he takes into his brain-attic. He will have nothing but the tools which may help him in doing his work, but of these he has a large assortment, and all in the most perfect order. It is a mistake to think that that little room has elastic walls and can distend to any extent. Depend upon it there comes a time when for every addition of knowledge you forget something that you knew before. It is of the highest importance, therefore, not to have useless facts elbowing out the useful ones."

- Sherlock Holmes

Sherlock Holmes & Thought Improvement

I just came across Peter Bevelin's new book "A Few Lessons From Sherlock Holmes" and Farnam Street post on the book. I'd rather point out these links than trying to outsmart incredibly intelligent people. Though I shall recommend you Sherlock Holmes complete collection for 88 cents.

How can David defeat Goliath? Gladwell Proposes an Answer

Malcolm Gladwell has just released his new book "David and Goliath: Underdogs, Misfits, and the Art of Battling Giants". The book is all about winning asymmetrical wars, defeating giants, you name it. By using the "anchor & twist" strategy, making the unexpected move (pressing Goliath for example), using the advantage of being an outsider who doesn't have anchored references or, simplifying, using the art of what I call "wise effort" one can win tough wars. For those who don't have the time to read the entire book, below you can find an '09 article published in the New Yorker by Malcolm himself on the same topic.

Malcolm Gladwell - How David Beats Goliath by Igor Chalhub

Yvon Chouinard - Patagonia Founder- Speech at UCSB

Financial analysts usually use sophisticated terms - almost another dialect - to describe and analyze businesses. The thing is: in the real world stuff is simpler. The world is made by givers, doers and shakers, not takers.  

Besides, when analyzing a business it's important to consider the open-ended story with "infinite duration" (using financial wizards' terms). Sustainability is a key word, not on the environmental aspect solely, but one should understand if the company's culture is sustainable and what are its drivers - to mention one aspect only. Another buzz-wordy question would be: Is the moat widening or at least maintaining its original width?

His speech is easy to watch due to his sense of humor and amazing story. Main takeaways were: (i) despite his amazing trajectory, most things happened naturally or by accident; (ii) common values among people is key; (iii) sustainability concept came from a financial crisis, not from environmental causes - later on they made the term widespread in different spectrums; (iv) let people free to create and express themselves; (v) do not grow just for getting bigger - grow if it's the best option for all your stakeholders.


Below follows his two published books:

• The Responsible Company: What we've Learned in Patagonia's First 40 years

http://www.amazon.com/The-Responsible-Company-Learned-Patagonias/dp/0980122783/ref=reg_hu-rd_add_1_dp

• Let My People Go Surfing: The Education of A Reluctant Businessman

http://www.amazon.com/Let-People-Surfing-Education-Businessman/dp/0143037838/ref=reg_hu-rd_dp_img

Market Price versus Value

Why should the human brain suffer from market price oscillations? 

Mind Expanding Books (from Quora)

Since one of the main ways to develop our brains is to have perspective, reading about different topics grasping various point of views is a great way for us to be less dumb.I found out this suggested reading list which was assembled by Quora's members. Don't miss it. (if you want the direct link, click here)

History

• From Dawn to Decadence: 500 Years of Western Cultural Life 1500 to the Present: Jacques Barzun. 
• The Master Switch: The Rise and Fall of Information Empires: Tim Wu. 
• The Ghost Map: The Story of London's Most Terrifying Epidemic--and How It Changed Science, Cities, and the Modern World: Steven Johnson. 
• Guns, Germs, and Steel: The Fates of Human Societies by Jared Diamond 
• Why the West Rules--for Now: The Patterns of History, and What They Reveal About the Future by Ian Morris (thanks to Kaiser Kuo for recommendation) 
• A Farewell to Alms by Gregory Clark 

Design

• A Pattern Language: Towns, Buildings, Construction: Christopher Alexander. 

Politics 

• The Righteous Mind: Why Good People Are Divided by Politics and Religion: Jonathan Haidt 

Evolution

• Evolution for Everyone: How Darwin's Theory Can Change the Way We Think About Our Lives: David Sloan Wilson. 

Philosophy and Psychology

• The Beginning of Infinity by David Deutsch 
• Thinking, Fast and Slow by Daniel Kahneman 
• Ecological Rationality by Gerd Gigerenzer 
• The Stuff of Thought by Steven Pinker 
• This Will Make You Smarter by John Brockman 
• Intuition Pumps And Other Tools for Thinking by Daniel Dennett 
• Just the Arguments by Michael Bruce and Steven Barbone 
• How to Win Every Argument by Madsen Pirie 
• History of Western Philosophy by Bertrand Russell 
• The Truth About Everything by Matthew Stewart 
• Everything Must Goby James Ladyman and Don Ross 
• Antifragile by Nassim Taleb 
• Metamagical Themas by Douglas Hofstadter. 
• Games People Play: The Basic Handbook of Transactional Analysis: Eric Berne. 
• Metaphors We Live By: George Lakoff, Mark Johnson. 
• The Hero with a Thousand Faces: Joseph Campbell. 
• Influence - The Psychology of Persuasion by Robert B. Cialdini 

Problem Solving

• How to Solve It: G. Polya. 

Puzzle Books 

• What Is the Name of This Book?: The Riddle of Dracula and Other Logical Puzzles: Raymond M. Smullyan. 

Sexuality

• Sex at Dawn: How We Mate, Why We Stray, and What It Means for Modern Relationships: Christopher Ryan, Cacilda Jetha. 

Education

• How Children Fail: John Holt. 
• Wounded by School: Recapturing the Joy in Learning and Standing Up to Old School Culture: Kirsten Olson. 
• Summerhill School: A New View of Childhood: A. S. Neill, Albert Lamb. 
• Mindstorms: Children, Computers, And Powerful Ideas: Seymour A. Papert. 
• Writing Hat Box: The Collected Lyrics of Stephen Sondheim: Stephen Sondheim. 
• Clear and Simple as the Truth: Francis-Noël Thomas, Mark Turner. 

Theatre

• A Practical Handbook for the Actor: Melissa Bruder, Lee Michael Cohn, Madeleine Olnek, Nathaniel Pollack, Robert Previtio, Scott Zigler, David Mamet. 
• The Actor and the Target: Declan Donnellan. 
• How to Stop Acting: Harold Guskin. 
• Different Every Night: Putting the play on stage and keeping it fresh: Mike Alfreds. 
• Notes on Directing: 130 Lessons in Leadership from the Director's Chair: Frank Hauser, Russell Reich. 
• Impro: Improvisation and the Theatre: Keith Johnstone. 

Shakespeare

• Thinking Shakespeare: A How-to Guide for Student Actors, Directors, and Anyone Else Who Wants to Feel More Comfortable With the Bard: Barry Edelstein. 
• Hamlet in Purgatory: Stephen Greenblatt. 
• Hamlet and Revenge: Eleanor Prosser. 
• Shakespeare's Metrical Art: George T. Wright. 

Fiction

• If on a winter's night, a traveller by Italo Calvino 
• Sense and Sensibility 
• Pride and Prejudice 
• Emma 
• Wuthering Heights 
• House of Mirth 
• One Hundred Years of Solitude 
• Watership Down 
• Cat's Eye 
• Bleak House 
• Lonesome Dove 
• Catcher in the Rye 
• The Queen's Gambit 
• 1Q84: Haruki Murakami, Jay Rubin, Philip ­Gabriel. 
• War and Peace: Leo Tolstoy. 
• The Great Gatsby: F. Scott Fitzgerald. 

Technical

• How to Find a Habitable Planet by James Kasting (more technical) 
• Scientific Genius by Dean Simonton (more technical) 
• The Extended Phenotype by Richard Dawkins (more technical) 

Other / Not Yet Categorized 

• Mind Children: The Future of Robot and Human Intelligence: Hans Moravec. 
• In the Blink of an Eye Revised 2nd Edition: Walter Murch. 
• The Age of Insight: The Quest to Understand the Unconscious in Art, Mind, and Brain, from Vienna 1900 to the Present: Eric Kandel. Gödel, Escher, Bach; 
• Predictably Irrational, Dan Ariely 
• Darwin's Dangerous Idea Intuition Pumps And Other Tools for Thinking 
• The Selfish Gene 
• The Black Swan 
• The Symbolic Species 
• The User Illusion. 
• You Just Don't Understand: Women and Men in Conversation: Deborah Tannen. 
• The Little Schemer - 4th Edition: Daniel P. Friedman, Matthias Felleisen, Duane Bibby, Gerald J. Sussman. 
• Steppenwolf, and The Glass Bead Game by Hermann Hesse 
• The Wall, by Jean-Paul Sartre 
• The Bone People, by Keri Hulme 
• A Brief History of Time, by Stephen Hawking 
• Godel, Escher, Bach, by Douglas Hofstadter 
• Confessions of a Mask, by Yukio Mishima 
• The City and The City, by China Mieville 
• Out of Control: The New Biology of Machines, 
• Social Systems and the Economic World by Kevin Kelly 
• The Symbolic Species: The Co-Evolution of Language and the Brain by Terrence W. Deacon 
• At Home in the Universe: The Search for Laws of Self-Organization and Complexity by Stuart Kauffman 
• The Discoverers by Daniel J. Boorstin 
• Letters from the Earth: Uncensored Writings by Mark Twain 
• Irrational Man : A Study in Existential Philosophy by William Barrett 
• Gödel, Escher, Bach: An Eternal Golden Braid by Douglas R. Hofstadter 
• The Social Contract by Jean-Jacques Rousseau 
• Personal favorite: Born to Run - Christopher McDougall 
• Best quick read: E-Myth Michael Gerber 
• Best core idea: The Black Swan - Nassim Taleb 
• Best fiction story: Deception Point Dan Brown 
• Most inspiring (entrepreneurial): Losing My Virginity - Richard Branson; 
• Zappos Delivering Happiness - Tony Hsieh 
• Most interesting (behavioral): Why We Make Mistakes - Joseph Hallinan 
• Most interesting (business): Founders at work - Jess Livingston 
• Most interesting (psychological): Mindstorms - Seymour Papert 
• Most dense with information: Economic Facts and Fallacies - Thomas Sowell; 
• Short History of Nearly Everything Bill Bryson 
• Most valuable (entrepreneurial): Rework Jason Fried; 
• Four Steps to Epiphany Steve Blank; 
• Most valuable (growth stage business): Good To Great - Jim Collins 
• Most empowering: 48 laws of Power Robert Greene; 
• The art of war Tsu Most 
• sexual: I Hope They Serve Beer in Hell - Tucker Max 
• Most disappointing: Eight Weeks to Optimum Health Andrew Weil 
• Most useless: How I Made My First Million on the Internet EWEN CHIA 
• Most overrated: Super Freakanomics Levitt & Dubner; The Knack Norm Brodsky 
• The Power of Full Engagement Jim Loehr and Tony Schwartz 
• The Strategy and Tactics of Pricing (5th Edition) Thomas Nagle 
• Leaving Microsoft to Change the World John Wood 
• Zen Mind, Beginner's Mind Shunryu Suzuki 
• 22 Immutable Laws of Marketing Al Ries & Jack Trout 
• Strategy for Sustainability Adam Werbach 
• Why We Make Mistakes Joseph Hallinan 
• Deception Point Dan Brown 
• Audacity of Hope Barack Obama 
• Vagabonding Rolf Potts 
• A Whole New Mind Daniel Pink 
• Economic Facts and Fallacies Thomas Sowell 
• Game Change, James Heilemann 
• Getting Things Done, David Allen 
• How to Win Friends and Influence People, Dale Carnegie 
• Linchpin, Seth Godin 
• Born to Run - Christopher McDougall 
• Outliers Malcolm Gladwell 
• Rework Jason Fried 
• 4 hour work week Tim Ferriss 
• The Knack Norm Brodsky 
• Success Principles Jack Canfield 
• The Talent Code Daniel Coyle 
• 10 Faces of Innovation Tom Kelly 
• The Tipping Point Malcolm Gladwell 
• Too Big To Fail Andrew Sorkin 
• What the Dog Saw Malcolm Gladwell 
• 4 steps to epiphany Steve Blank 
• Innovators Dilemma 
• Paypal wars Eric Jackson 
• Who Says elephants can't dance Louis Gerstener 
• The Big Short (2010 Book) by Michael Lewis
• Cognitive Surplus: Creativity & Generosity in a Connected Age - Clay Shirky 
• The Score Takes Care of Itself by Bill Walsh 
• The Upside of Irrationality by Dan Ariely 
• The Checklist Manifesto by Atul Gawande 
• The Curse of the Mogul by Jonathan Knee, et. al. 
• 100 Startup Chris Guillebeau 
• The Thank You Economy Gary Vaynerchuk 
• Outsmarting IQ: The Emerging Science of Learnable Intelligence by David Perkins 
• Consilience: The Unity of Knowledge by Edward O. Wilson 
• The Selfish Gene: 30th Anniversary Edition--with a new Introduction by the Author by Richard Dawkins Heaven in a Chip: Fuzzy Visions of Society and Science in the Digital Age by Bart Kosko T
• he Blank Slate: The Modern Denial of Human Nature by Steven Pinker 
• The Wealth of Networks: How Social Production Transforms Markets and Freedom by Yochai Benkler 
• DARWIN'S DANGEROUS IDEA: EVOLUTION AND THE MEANINGS OF LIFE by Daniel C. Dennett 
• The Executive Brain: Frontal Lobes and the Civilized Mind by Elkhonon Goldberg 
• Curious Minds: How a Child Becomes a Scientist by John Brockman 
• Why Smart People Can Be So Stupid by Robert J. Sternberg 
• The Quark and the Jaguar: Adventures in the Simple and the Complex by Murray Gell-Man 
• Origin of Wealth: Evolution, Complexity, and the Radical Remaking of Economics by Eric D. Beinhocker 
• The Myth of the Rational Voter: Why Democracies Choose Bad Policies by Bryan Douglas Caplan 
• The Stuff of Thought: Language as a Window into Human Nature by Steven Pinker 
• Catching Fire: How Cooking Made Us Human by Richard W. Wrangham 
• Create Your Own Economy: The Path to Prosperity in a Disordered World by Tyler Cowen 
• Rare Earth: Why Complex Life Is Uncommon in the Universe by Peter Douglas Ward 
• Crowdsourcing: Why the Power of the Crowd Is Driving the Future of Business by Jeff Howe 
• Super Crunchers: Why Thinking-by-Numbers Is the New Way to Be Smart by Ian Ayres 
• The Upside of Irrationality: The Unexpected Benefits of Defying Logic by Dan Ariely 
• Teaching As a Subversive Activity by Neil Postman 
• Origins of Genius by Dean Simonton 
• Mind wars: brain research and national defense‎ by Jonathan Moreno 
• Spent: Sex, Evolution, and Consumer Behavior‎ by Geoffrey Miller 
• Rapt: Attention and the Focused Life‎ by Winifred Gallagher Snoop: 
• What Your Stuff Says About You‎ by Sam Gosling 
• Figments of reality: the evolution of the curious mind‎ by Ian Stewart 
• The Structure of Scientific Revolutions by Thomas Kuhn 
• The 10,000 Year Explosion by Gregory Cochran 
• The World is Flat by Thomas Friedman

David Einhorn Q2 2013 Letter

Here is the most recent letter from David Einhorn. According to him, as the game has changed from Beat and Raise to Beat and Lower guidance, the street keeps on the P/E expansion mode.

I'd also like to apologize for being much more of a curator of material I like (ok, I see some value added doing that) than trying to share my own thoughts - great part of this is due to my intense routine. 

Mauboussin - Measuring the Moat

Do you remember Mauboussin's classic "Measuring the Moat"article? So he is back at Credit Suisse (skill or luck?!) and republished the updated article. You may find it here.

Seth Klarman - Permanently "Risk-off"

I suppose a little bit more of Klarman is never enough. So here is an excerpt of his 2012 year end letter. The first part is composed by macroeconomic bearish tidbits. In my view, the best part is the last one, in which he rapidly mention what to focus on. Easy to say, hard to do - that's why we need processes.

Seth Klarman Recent Quote

“Investing today may well be harder than it has been at any time in our three decades of existence, not because markets are falling but because they are rising; not because governments have failed to act but because they chronically overreact; not because we lack acumen or analytical tools, but because the range of possible outcomes remains enormously wide; and not because there are no opportunities, but because the underpinnings of our economy and financial system are so precarious that the unabating risks of collapse dwarf all other factors.”

Source

Quality Investing

What if we make the link that people drive good business and then we got the (in)famous bottom line "E" so we finally have our estimated multiple? Then, value investing is all about people and corporate culture after all! Have you thought of that?

Henry Singleton, Outstanding Capital Allocator

I first heard of Henry Singleton, CEO of Teledyne by reading The Outsiders: Eight Unconventional CEOs and Their Radically Rational  Blueprint for Success, which shares the stories of great capital allocators of all times. Then, I received this presentation about him presented by Leon Cooperman from Omega Advisors in the Value Investing Congress of 2007.

Singleton was able to buy over 100 companies in the "Conglomerate Era" and then, in the '80s, reaped the benefit of shrinking the total share count from 40 million to 12 million shares, without using debt, at low multiples.

His entire strategy used very little debt, with return on assets being very close to return on equity (ten-year ROA of  18,1% versus ten-year ROE of 19,3%). Despite not being a MBA student, he taught us a outstanding class on financial engineering.

Seth Karman - Margin of Safety

For those who haven't read the book from Seth Klarman which is still being sold from US$ 999 to US$ 2.000 at Amazon, here is a short list of the main ideas from the book. Hope it helps!

Seth Klarman - Don't be a Yield Pig

In 1992, Seth Klarman worte an article to Forbes called "Don't be a yield pig". As current market participants complacency has risen to amazing levels, it seems this 21-year old article is from last week. Definitely it's worth to dedicate 5 minutes to read it.

Richard Feynman - No Ordinary Genius

As the title says, Feynman was no ordinary genius. His endless curiosity, questions and imagination enabled him to never stop. He also confessed he has never frozen because he didn't know something, on the contrary, that motivated him.

With all his humbleness and tremendous willpower, he was able to think independently, using the art of storytelling, simple examples and qualitative/conceptual thinking in order to explain complex problems. Also,  geometric visualization skills helped him a lot.

Pieces of advice are "use your brain"and "read everything you can". Quoting Li Lu's interview in the last Graham & Doddsville newsletter, "know what know, know what you don't know, know what you don't have to know and there are always unknow unkowns."

Don't miss the opportunity to check out this documentary on Feynman's life.

Graham & Doddsville Spring 2013

In this latest issue, I highlight Li Lu's interview, whom is also personal friend of Charlie Munger - I'd rather spare the details so you're forced to read the full content. Besides, Preston Athey from T. Rowe's Value Fund mentions his edge over his peers is that he managed a growth strategy before, so he was more prone to letting winners keep winning. Instead of setting a price target, he would rather compare relative valuations in order to mitigate selling too soon. A highlight is his low portfolio turnover (less than 10% in the last 10 years) mostly caused by forced selling, like takeovers.

Detective Skills

As already said in a prior post, Kahneman's framework of our brains, working in an intuitive system one and a reflexive system two, is key to understand how our minds trick us. In order to be/act reflexively, we must enforce ourselves to de-bias. This painful effort is clearly cited by Beveridge in his book, "The art of Scientific Investigation". Montier argued the same in his 2002 paper.

Being skeptic may be one of the paths to wordily wisdom. FOCUS, ATTENTION, MOTIVATION, AWARENESS are key words.

“Powers of observation can be developed by cultivating the habit of watching things with an active, enquiring mind. It is no exaggeration to say that well developed habits of observation are more important in research than large accumulations of academic learning.” — W. I. B. Beveridge in The Art of Scientific Investigation

Baupost's Culture/Principles - Seth Klarman Interview (2008)

After years of compounding at a great rate of return, Klarman definitely and deservedly is considered one of the best investors of all times. In spite of Baupost's historical return, the main subject one would need to understand/study before judging a firm's performance, is the company's culture/principles. That's how one may achieve long term success.

Bottom line: do what you love in the first place, not for money, cultivate a strong culture, value long-tenured people you can trust and pay them well, so you hang out with them the longest time possible, be willing to delegate tasks, investing is more of an art than anything so be curious and open since we never know everything. Below, I have highlighted a couple quotes from this interview with him, by TIFF.

On needed skills:

"We want people who want to be part of a team. We also place huge empashis on values and ethics."

"We try to identify people with broad ideational fluency. Just plain common sense is also important."

"I think to take the next step and be a portfolio manager you need both a sense of history and a vivid sense of risk.(...) A broad curiosity blended with some contrarianism and a sense of what makes you money is the right combination of traits. Also, understanding the value of optionality is important." 

On turnover:

"I hate turnover; I really hate value long-tenured people. So I'd rather pay up for the people that I might be able to attract to make their entire careers at our firm rather than try to be cheap about it and hire bargains but ultimately pay the price for that in turnover or other things." 

"I think turnover is terrible not just because you've taken the time to train people and not necessarily gotten a lot of value out of them. It's really bad because there's something about the facility of communication with longstanding partners."

"When that knowledge walks out the door, and even more dangerously, when new knowledge that you're not familiar with walks in the door, it's very hard to think about where the trust is. Trust has to be earned, not just given." 

On investing:

"I would say (it is) art first and foremost, craft second, science third. (...) the nuances I was talking about - the ability to distill two or three major themes out of an investment and get right to the heart of the matter - is truly an art."

"(...)we think more value is added by being generalists and seeing opportunities from  a broader perspective. If you have silos, you're going to own things only within those silos."

On compensation/meritocracy:

"(...)we have evolved to a system where the partners would strive for equality with each other. (...) let's do this together, let's make it work. There are huge advantages to not keeping track of each person's individual contribution in terms of letting capital slosh back and forth so that no one person hogs the capital. (...) The problem is, if over time the contributions aren't equal, equal compensation will adversely select the people who are contributing less."

"What's great about our team is that I think most people feel like the firm is bigger than themselves. (...) Also, I think by bending over backwards to be fair and to not hog the money myself, I think everybody feels pretty good about a system that gives them a lot of compensation, even if it's not exactly the right amount."

On time allocation, an scarce item:

"We don't spend a lot of time in client meetings - I think, historically, that's probably 1% or 2% of our time, at most. That let me focus the great majority of my time on investing. I think that I do a good job of delegating, so that as we've grown, I've been able to bring other people into the loop and to give them serious responsibility." 

On explaining the firm's investment philosophy:

"The truth is, some of our clients don't understand, but we've worked really hard over time to explain it and to educate them to our way of thinking. It isn't the only way of thinking, but it;s how we approach it." 

On the best job ever:

"You know, I've said over and over, I have the best job in the world. I get to do something that is interesting and ever-changing and therefore ever-interesting, working with great people in a great culture. I get to do things like this from time to time. I get to teach from time to time. I get to write a book and communicate frequently to my clients. So I have the best deal possible." 

Darwin's Mind: The Evolutionary Foundations of Heuristics and Biases (James Montier)

In this old (2002) article, Montier discusses our minds' tricks. It suggests mistakes we make have four common causes, namely:

(i) Self-deception: makes us believe we are better than average. The thing is that we lie to ourselves! It's common to ask to a group "Do you guys think yourselves are a better than average investor?" and get 80% of positive answers. Naturally this number isn't feasible. Framing is also important. Quoting Montier, "We find it incredibly hard to see through the way in which information is presented to us. The brain is effectively modular, if a problem is presented to us in a family fashion we can solve it, but in another guise we fall flat on our faces."

(ii) Simplification: our brain is composed by system one (intuitive, emotional, dreamier, right side of the brain) and system two (reflective, analytical, logical, left side of the brain). Tasks may perhaps start out as the subject of system two but when they become familiar, they are processed in system one. The trick here is try to be more analytical, i.e., use our system two way more than system one.

(iii) Emotion/Affect: emotions are important to our survival. Sentiments like fear are key to living longer, i.e., taking less risks. Hence we have become evolutionarily tuned to listen to our system one (intuitive) responses. Naturally this leads to a couple errors in day to day analytical tasks. Watch out so you do not deceive yourself.

(iv) Social Interaction: information serves to transmit information vertically and horizontally in the social group. Also, social learning is much faster than natural selection. Once we have speech and imitation skills, the possible role of a second replicator emerges as a major evolutionary force. Remember group think is something to avoid.

Think critically and debias yourself!

Reiterating Simplicity: stop deceiving yourself

Is there any easier way to say something intelligent than by quoting Buffet & Munger? So let them speak:

I have no use whatsover for projections or forecasts. They create an illusion of apparent precision. The more meticulous they are, the more concerned you should be. We never look at projections (Warren Buffett)

Projections are put together by people who have an interest in a particular outcome, have a subconscious bias, and its apparent precision makes it fallacious. They remind me of Mark Twain`s saying "A mine is a hole in the ground owned by a liar". Projections in America are often a lie, although not an intentional one, but the worst kind because the forecaster often believes them himself. (Charlie Munger)

Evoking the storytelling discipline, there`s a little story that says a CIO was presenting a M&A proposal to the key management and the board of directors. He made a very detailed slideshow, full of premises and sensitivity analysis. Being harshly questioned by his audience, he gave up by saying: "Ok, fellas! The deal doesn`t make any sense! I just need to beat the street`s growth estimates and earn my bonus!"

Remember, the more simpler, the more fairer. If you can`t explain it in plain straightforward language, there`s a chance you are deceiving even yourself.

Mental Fitness

"The brain can be developed just the same way as the muscles can be developed, if one will only take the pains to train the mind to think."
- Thomas Alva Edison

Sequoia Annual Letter to Shareholders

I'd rather just quote this outstanding team than say the words by myself. For the full letter, click here.

Investment philosophy in their words:

Rather than try to guess what might happen next, we think it more prudent to own a portfolio of market leading companies that earn high returns on capital, boast strong balance sheets and self-fund their growth. We try to invest alongside motivated and ethical management teams and to identify businesses with many years of growth ahead of them. We try to buy these businesses carefully, taking advantage of occasional periods when their stocks seem to be mispriced. Though it contradicts academic theory, we believe a concentrated portfolio of businesses that has been intensively researched and carefully purchased will generate higher returns with less risk over time than a diverse basket of stocks chosen with less care. However, a concentrated portfolio may deliver results in an individual year that do not correspond closely to the returns generated by the broader market.

Declining holding periods, for who?!

          We have now owned TJX for 12 years and Mohawk for 10 years.

Signs of an expensive market:

In the fourth quarter of 2012, we were modest net sellers of equities for the first time since 2008, in response to specific situations at several of our portfolio holdings. In particular, we exited Target Corp., the discount retailer we’d owned since 2006, as we became increasingly concerned by its lackluster sales growth and vulnerability to competition from online retailers.

Given the huge run up in equities since early 2009, we are no longer finding compelling valuations, either for our existing holdings or for new ideas we are researching. Our current portfolio seems fairly valued today. That said, anyone who has paid attention over the past 15 years knows equities can trade at extreme levels, both of overvaluation and undervaluation.

Top down thoughts:

Valuations for stocks are heavily influenced by interest rates, and particularly by the risk-free rate of return on 10-year and 30-year United States Treasury bonds. Relative to the current return on Treasury Bonds, stocks continue to be quite attractive. However, the current risk-free rate of return is not a product of market forces. Rather, it is an instrument of Federal Reserve policy. As long as these policies remain in place, and stocks trade at higher levels of valuation, it will be more difficult for us to find individual stocks that meet our criteria for returns on a risk basis that incorporates substantially higher interest rates than exist currently. Just as we think it would be a mistake for investors to buy bonds at current levels, we believe it would be a mistake for us to buy stocks on the assumption that interest rates remain anywhere near current levels.

A Junior's Thoughts on Investing

One thing I have come to realize by myself is that investing is much more of an art than what I thought before while trying to figure out exact calcs to reach a conclusion. Thus developing your framework - as Munger would say, wordily wisdom or mental models - is key to becoming a great investor. Perspective and curiosity are another two relevant characteristics. Naturally, perseverance must reign in your life so you can develop your mind.

Having read a book of the greatest CEOs of all time - if you are interested, just contact me, it made it easier for me to contemplate how they allocated capital: back of the envelope calculations, having a great knowledge of the specific market/segment they were investing in and knowing the two or three key issues on that topic. Therefore one reaches the conclusion that no complex DCF model is sharp enough predicting the future. Deep knowledge is the path to clarity and wise decision making.

Moreover elaborating on the above topic, portfolio turnover should be really low or none since your knowledge is so thorough you wouldn't change your mind frequently.By the way, if you have any good books to recommend, please do not hesitate to share.

Howard Marks - The outlook for equities

Thinking of the big picture forces me to read Marks' comments. In his last memo, he goes on generalization issues; extrapolation risks which we oftentimes incur but shouldn't; the role of PRICE as a proxy of risk, despite the asset class - for example, bonds today seem way riskier than equities; the concept of ERP - the one he likes the most is "the margin by which equity returns will exceed the risk-free rate in the future" and that can't be read anyplace; three psychology-descriptive stages of bull and bear markets and so on.

Bottom line he is constructive on equities, since "A move upward can be powered by a switch from the fear of losing money to the fear of missing opportunity. When attitudes are moderate & allocations are low, it doesn't take much."

Howard Marks makes his point about what puzzles him the most in investing saying "Many of the important things in investing are counter intuitive." and as Einstein has said once: "Not everything that counts can be counted, and not everything that can be counted counts."

Berkshire 2012 Letter

Another insightful thoughts from Warren Buffett in his last letter to Berkshire`s shareholders:

(i) he analyzes Berkshire performance in a rolling 5 year window against the S&P;
(ii) highlights the importance of brilliant people at management/board level;
(iii) little lesson on accounting of intangibles;
(iv) recent newspapers acquisitions rationale;
(v) the role of capital allocator and its options: reinvest, distribute dividends & share repurchases.

Charlie Munger on The Daily Journal Meeting

It`s proved that we only learn when we are able to make connections between things. Moreover, metaphors can help us out in order to understand what we could not comprehend at first sight. That said, Buffett`s partner is a intriguing mind. Charlie Munger has thought us how to be a fox, learning the basic principles from many relevant areas of study and developing our own mental models.

So here is the last speech available from Charlie Munger. Hope you learn from this brilliant mind.

Graham & Doddsville Newsletter

Columbia Business School recently released the new G&D Investment newsletter. Hope if you find good use with the interviews with JANA Partners & other relevant investors.

FPA`s Steve Romick & Bob Rodriguez 4Q 2012 Letters

Both letters have nice macro insights - speacially for those daily focused on bottom up analysis - and a cautious tone towards the investing environment. Even with equity risk premium at or near all time high, investors have a good amount of cash. But one may notice some portfolio managers are being pressured to be fully invested. I don`t want to sound like a perma-bear but we know this story ends.

We may find good business models with nice returns but the missing part of the mosaic is the right price - and we know that without the right price, one underperfoms and may lose capital permanently.

I will leave it up to you reading these two insightful letters.

FPA Capital - Bob Rodriguez

FPA Crescent - Steve Romick

Howard Marks - Ditto

In Howard Marks last piece he goes through cycles rationale, how history rhymes as time goes by and the propensity of humans toward risk taking. The latter naturally has to do with behaviorism and how it affects returns. Behaviorism and being a contrarian at right time is a path to success. Below follows some quotes from the document:

"It's not asset quality that determines investment risk. (...) But, all other things being equal, the price of an asset is the principal determinant of its riskiness.(...) Bottom line: No asset is so good that it can't be bid up to the point where it's overpriced and thus dangerous. And few assets are so bad that they can't become underpriced and thus safe (not to mention potentially lucrative). Since participants set security prices, it's their behavior that creates most of the risk in investing."

"Becoming more and less risk averse at the right time is a great way  to enhance nivestment performance."

"To be a successful contrarian, you have to be able to:

• see what most people are doing, 
• understand what's wrong about most people's behavior,
• possess a strong sense for intrinsic value, which most people ignore at the extremes,
• resist the psychological pressures that make most people err, and thus
• buy when most people are selling and sell when most people are buying."

""There are times for aggressiveness. I think this is a time for caution." Here as 2013 begins, I have only one word to add: ditto."