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10 Insights I Learned from Benjamin Graham

Benjamin Graham doesn’t need an introduction. His sober look at the stock market has built an enormous following and for a good reason.

Here are some of his brilliant quotes and my comments on them:

1. “If you are shopping for common stocks, choose them the way you would buy groceries, not the way you would buy perfume.”   –  It is true that perfumes come and go out of popularity, but no trend lasts forever. There are trends that last 3 months; there are trends that last 3 years.

2. “Obvious prospects for physical growth in a business do not translate into obvious profits for investors.” – it depends on to what level has the expected growth been already discounted. The truth is that it is really hard to forecast growth in quickly developing businesses. The market always overdiscounts at some point, but in the meantime trend followers could make a killing. You never know how long or how fast a trend could go.

3. The only constants in the markets are change and uncertainty. Not only business environment changes, but also people’s perceptions of stocks change. Look at $GMCR for example. It went from making a new all-time high at $10 back in March 2009 to $115 in September 2011 to $25 today.

Most businesses change in character and quality over the years, sometimes for the better, perhaps more often for the worse. The investor need not watch his companies’ performance like a hawk; but he should give it a good, hard look from time to time.

4. Different catalysts matter for the different time frames:

Basically, price fluctuations have only one significant meaning for the true investor. They provide him with an opportunity to buy wisely when prices fall sharply and to sell wisely when they advance a great deal. At other times he will do better if he forgets about the stock market and pays attention to his dividend returns and to the operating results of his companies.

5. The difference between a trader and investor

The most realistic distinction between the investor and the speculator is found in their attitude toward stock-market movements. The speculator’s primary interest lies in anticipating and profiting from market fluctuations. The investor’s primary interest lies in acquiring and holding suitable securities at suitable prices. Market movements are important to him in a practical sense, because they alternately create low price levels at which he would be wise to buy and high price levels at which he certainly should refrain from buying and probably would be wise to sell.

6. How to think about risk

The risk of paying too high a price for good-quality stocks – while a real one – is not the chief hazard confronting the average buyer of securities. Observation over many years has taught us that the chief losses to investors come from the purchase of low-quality securities at times of favorable business conditions. The purchasers view the current good earnings as equivalent to “earning power” and assume that prosperity is synonymous with safety.

7. There is nothing guaranteed. The market doesn’t owe you anything. There are no sure things. Equity selection process is important, but risk management discipline should always trump conviction:

Even with a margin [of safety] in the investor’s favor, an individual security may work out badly. For the margin guarantees only that he has a better chance for profit than for loss – not that loss is impossible.

8. “To achieve satisfactory investment results is easier than most people realize; to achieve superior results is harder than it looks.”

9. “Wall Street people learn nothing and forget everything.”

10. “Most of the time stocks are subject to irrational and excessive price fluctuations in both directions as the consequence of the ingrained tendency of most people to speculate or gamble … to give way to hope, fear and greed.”

House of Mirrors

 

There is a saying that the market reflects the price of everything and the value of nothing. Wall Street is such a house of mirrors. There are very few original thinkers. If you have a good track record (read you were right at least once big time) and you sound and act confident, not only no one is going to question you, but also you are likely to have tremendous impact on the market.

Are there way too many “second level” thinkers in this market, who prefer to take the short cuts and let’s say look only at charts and follow established names? Everyone is taking the path of least resistance, not only because it takes less efforts, but because it has worked most of the time. Who is left to do the real homework? I am certainly guilty of charge.

I am sure that even David Einhorn was pleasantly surprised by the reaction his comments caused during Herbal Life’s conference call. Here is what one of the StockTwits’s users rightfully pointed out earlier today:

ronbo811: $HLF stock went from $6 in 2009 to $73 and today everyone just realized the comp is a scam after a couple questions at a meeting?…Really?    May. 1 at 11:18 AM

He makes a really good point. Benjamin Graham liked to say that “Price is what you pay. Value is what you get”. The reality is that value is what you think you get. Price is what the market is willing to pay for it. Value could be very subjective, even in the stock market. What is worth zero to you, is worth $1 billion to Facebook, for example.

 
And another comment:
 

KidDynamiteBlog: $HLF funny thing is that if I hadn’t come to the conclusion that I was wrong I would have bought even more stock and made a killing!  May. 1 at 1:07 PM

Everything looks so clear and easy in hindsight, but it is never so in real time.

The market has become so short-sighted, impulsive and reflective. Or maybe it has always been like that.

Prices change when expectations change and the latter change under the influence of outside factors. In short-term perspective, price could go anywhere and the major catalyst that impacts expectations is price action itself.

Disclosure: I traded $HLF during the day. I didn’t mention it on my StockTwits stream, because it was a short-term trade that was hard to follow.

10 Insights from Abnormal Returns – The Book

When two amateurs play tennis, the one that makes the least amount of mistakes usually wins. The same rule often applies to investing except that what matters more is not the number of mistakes, but their size. While Tadas Vishkanta doesn’t necessarily teach his readers what to do in his first book – Abnormal Returns; he does an even more important job by highlighting what not to do.

Tadas looks at investing from all perspectives imaginable and paints a rich portrait of the market reality, without saving the uncomfortable truth. While Abnormal Returns reads like a textbook at times, it provides deep market understanding of the common hurdles each market participant faces in this enormously challenging field. Unbiased, with no issue that could blind his objectiveness, Vishkanta summarizes and explains a ton of practical investment wisdom from some of the best financial minds of our time.

Abnormal Returns is really informative reading that will enrich your understanding of financial markets. Certainly a worthwhile addition to your investing library.

Here are ten insights I was reminded of by reading the book:

1. Opportunity cost is often overlooked, not only in terms of return, but also in terms of time:

The time and effort spent in trying to become an accomplished trader, by definition, come at the expense of other activities. The biggest cost to the 90% or so of traders who fail is not necessarily the financial costs, but rather the time lost to other opportunities. Money can be made in a number ways, trading only being one of them. However, time is not something any of us can get back.

2. Know your limits:

Great investors recognize that once they make an investment decision, the results are largely out of their control. They can have a plan about when to sell, but the market will ultimately dictate how that investment works out over time.

3. The worst forecasters are often the most confident. Once in a while, they hit the jackpot like a blind squirrel finds an acorn sometimes.

Analysts who correctly called the market crash of 1987 have been living off that call ever since then. The irony is that research shows that those forecasters who get these “big calls” correct turn out to have the worst overall track records.

4. Finding skilled money managers is one of the hardest endeavors on earth

First, we should recognize that investing is a field in which both skill and luck do play a role. Investing is often compared to gambling and most often to poker, and for good reason. Recent research also shows, contrary to what the authorities say, that poker on the whole is a game of skill. Unfortunately for investors, our ability to identify skilled investment managers is much more difficult than identifying skilled poker players.

5. Distinguish between skill and chance

Fama and French examine the performance of mutual fund managers and find that before expenses the top 5% or so of managers demonstrate some skill compared with chance.9 The performance picture worsens dramatically once you take into account expenses, which largely wipe out the benefit of skill in the best managers. You can guess what it does for the rest of the mutual fund manager crowd. Anyone looking for skilled managers needs to recognize that identifying skill isn’t enough. The challenge is identifying managers whose skill outweighs whatever fees they charge investors.

6. Different catalysts rule the market in the short-term vs the long-term

Howard Marks says it well: “In the long run, there’s no reasonable alternative to believing that good decisions will lead to investment profits. In the short run, however, we must be stoic when they don’t.” We live in a world filled with randomness, and recognizing this is an important step in dealing with our investments in a more measured and mature fashion.

7. Confirmation bias hurts us more than we could imagine. “On a subconscious level, we simply never perceive information that may not fit with our worldview.”

8. “You may think you’re able to filter the noise. You cannot; it overwhelms you. So don’t fight the noise—block it.”

9. Momentum investing works because it is psychologically hard to apply

Momentum works because it calls on investors to do things that do not come naturally. Momentum strategies require investors to buy things that have already increased in value and are trading near their highs, not their lows. Successful momentum strategies also have strict and well-defined selling, or switching, strategies. Both these pieces of the momentum puzzle are difficult for investors to master.

10. Value investing works because it is also psychologically uncomfortable to practice:

This is a more challenging task than simply buying stocks that are statistically cheap. Swensen writes, “In many instances, value investing proves fundamentally uncomfortable, as the most attractive opportunities frequently lurk in unattractive or even frightening areas.”

Howard Marks writes: “To boil it all down to just one sentence, I’d say the necessary condition for the existence of bargains is that perception has to be considerably worse than reality. That means the best opportunities are usually found among things most others won’t do.”

Source: Viskanta, Tadas (2012-03-30). Abnormal Returns: Winning Strategies from the Frontlines of the Investment Blogosphere,  McGraw-Hill. Kindle Edition.