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Charlie Munger’s 10 Rules for Investment Success

Charlie Munger's 10 Rules for Investment Success When Charlie Munger talks, people listen— particularly if they want to know how to invest their money.

Munger, who is the vice-chairman of Berkshire Hathaway, has delivered instrumental guidance to Berkshire’s renowned founder, Warren Buffett, and many others. By means of what Munger identifies as “elementary world wisdom,” Munger’s technique weighs risk and reward, make the most of fact-based data and abating emotion.

Keeping it simple, Munger declares, “I observe what works and what doesn’t and why.” Like Buffett, Munger pulls much of his motivation from post-Great Depression era investor Benjamin Graham, a “value investor.” Graham sought “mispriced assets” with values greater than people think.

Charlie Munger has some advice for investors.

  1. Measure risk: All investment evaluations should begin by measuring risk, especially reputational.
  2. Be independent: Only in fairy tales are emperors told they’re naked.
  3. Prepare ahead: The only way to win is to work, work, work, and hope to have a few insights.
  4. Have intellectual humility: Acknowledging what you don’t know is the dawning of wisdom.
  5. Analyze rigorously: Use effective checklists to minimize errors and omissions.
  6. Allocate assets wisely: Proper allocation of capital is an investor’s No. 1 job.
  7. Have patience: Resist the natural human bias to act.
  8. Be decisive: When proper circumstances present themselves, act with decisiveness and conviction.
  9. Be ready for change: Accept unremovable complexity.
  10. Stay focused: Keep it simple and remember what you set out to do.

Munger has argued that if “you’re investing for 40 years in some pension fund, what difference does it make if the path from start to finish is a little more bumpy or a little different than everybody else’s so long as it’s all going to work out well in the end? So what if there’s a little extra volatility.”

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Read to Find Investment Ideas

Read to find investment ideas The secret of finding investment ideas can be summarized in one word: READ.

Of course, in order to spend a lot of time on business news, you must be interested in economic and financial affairs. But as you become more accustomed to accumulating and storing financial information, you will find the subject increasingly interesting, particularly if your interpretation of events leads to profits.

Nothing can motivate you more than your own success. The turbulence in the financial markets underscores the importance of becoming your own analyst. This will insulate you from other people’s opinions and will give you the confidence to pursue your own ideas and goals by checking out the facts.

The way to do this is with a disciplined system of reading and information gathering. Over time, you should acquire a financial file or library of companies, ideas and trends that warrant investment attention. To sniff out opportunities from the financial news requires an understanding of what to look for.

Two people might read the same article, one of whom may spot a nuance that suggests an important opportunity, while the other person sees nothing of significance.

What we aim to provide in this chapter are some hints and clues on what to look for in the financial news, what to read and how to accomplish all this in the least amount of time.

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Lessons from Edgar de Picciotto

Edgar de Picciotto of Union Bancaire Privee

Edgar de Picciotto, an early promoter of hedge fund investing, passed away on Sunday 13 March 2016 after a long sickness. On November 12, 1969, de Picciotto opened his own asset-management bank in a city dominated by such well-known private banking names as Pictet Group, Lombard Odier, Darier and Hentsch.

Edgar de Picciotto founded Union Bancaire Privee (UBP) in 1969. UBP is one of the most favorably capitalized private banks in the world, and a leading player in the field of wealth management in Switzerland with $110 billion in assets under management at the end of December 2015. Edgar de Picciotto, who was born of Syrian-Lebanese parentage, moved to Switzerland in the 1950s and worked as a financier before founding UBP’s predecessor in 1969. From the bank’s inconspicuous headquarters on one of Geneva’s chief luxury-shopping drags, he built a customer base of affluent individuals and institutions all over Europe, the U.S., and the Middle East.

De Picciotto was born in Beirut and hailed from a lineage of businesspersons, which lived from the 14th to the 17th century in Portugal, moving in later centuries via Italy and Syria to the Lebanon. He afterward lived with his parents and brothers in Milan, ultimately deciding to study mechanical engineering in France. However, it was financial engineering, which took his perpetual fancy. He earned his spurs and made financial contacts, working in his previous father-in-law’s bank in Geneva. In its 2015 annual report, UBP recalled,

As our 2015 Annual Report was going to print, we learnt with deep sorrow that Edgar de Picciotto, the Chairman and founder of Union Bancaire Privee, had passed away at 86 years of age.

Edgar de Picciotto was a recognized creative visionary and pioneer in a wide variety of fields in the banking industry. He quickly rose to become a leading figure of the Geneva financial hub, and one of the most respected authorities on investments around the world.

In just a few decades, Edgar de Picciotto turned UBP into one of the world’s biggest family-owned banks. Very early on, he also set up a governance structure designed to ensure the Group’s longevity by integrating the second generation of his family into the business.

UBP is his life’s work. UBP is his legacy to us. It now falls to us to grow UBP with the same entrepreneurial spirit that he used to create the Bank, by perpetuating the values that Edgar de Picciotto would wish to see upheld every day and in everything we do.

Edgar de Picciotto’s children and all the members of UBP’s management are determined to carry on the spirit that its founder instilled in it, and they know that they can rely on the professionalism and dedication of all UBP’s staff members to continue to grow the Bank’s business, while also maintaining its independence.

In 2002, news of merger talks between two family-controlled private banks, Union Bancaire Privee (UBP) and Discount Bank & Trust Company (DTBT) over forming one of Geneva’s biggest private banks became newest sign of the altering attitude among the country’s private banks. Withdrawing from UBP’s operational management 20 years ago, de Picciotto set up a governance structure designed to guarantee the bank’s durability. His son Guy de Picciotto has been chief executive officer since 1998, while his daughter, Anne Rotman de Picciotto, and his eldest son, Daniel de Picciotto, are on the board of directors.

Byron Wien, vice chairperson of Blackstone Advisory Partners, had the pleasure of calling Edgar de Picciotto his mentor.

My purpose in reviewing Edgar’s thinking over the past 15 years is to show how he consistently tried to integrate his world view into the investment environment. That was his imperative. He wasn’t always right, but he was always questioning himself and he remained flexible. When he lost money, it tended to cause minimal pain in relation to his overall assets, and when one of his maverick ideas worked, he made what he called “serious money.”

Lessons from Edgar de Picciotto of Union Bancaire Privee

Edgar de Picciotto as a Mentor

Mentors fall into two categories: there are those you work with every day who are incessantly guiding you to enhanced performance. The ability to serve as a great mentor is one of the most undervalued and underappreciated skills in finance. Perhaps better branded as a “role model,” an outstanding mentor can provide not only a wide-ranging knowledge base and technical skills, but also the sagacious financial judgment that implies the high-class investor. Perhaps of even larger importance, a mentor can express a “philosophy of practice,” including the optimal interaction with clients and economists, a procedure for remaining current with advances in the field, and a thorough concept of how the practice of finance fits into a full life. A sympathetic mentor can also provide counselling in selecting the best practice opportunity and can maintain a close relationship for many years.

Mentors are significant to all of us, as they teach us what can’t be learned from books or in the classroom. They set aside a concrete example of “how to get it done,” and, sometimes more importantly, what to be done, when to do it, and whom to engage in the effort. Their inspiration often carries us through when nothing else does.

  • Understand the consequence of understanding the macro environment. “Many people describe themselves as stock pickers … but you have to consider the economic, social, and political context in which the stocks are being picked.” De Picciotto indubitably showed he had a good nose for trends.
  • Meet as many people of authority as you can. “For him, networking never stopped.” De Picciotto took great pleasure from knowing smart people and exchanging ideas with them.
  • “Nobody owns the truth.” De Picciotto would test his ideas on those he cherished and, and if he ran into a convincing conflicting opinion, he would contemplate on it seriously and sometimes change his position. While he never lacked principle about his ideas, he was unprejudiced and malleable.
  • Value the trust and the delight of friendship and the vainness of resentment. De Picciotto was gratified of his own success but also an enthusiast of the success of others who were his friends.
  • Never talk about overlooked opportunities except when you are disapproving yourself. Be your own harshest critic. Even if you are an intellectual risk taker, you will make many mistakes. Diagnose them early, but never stop taking risks, because that is where the tangible opportunities are and your life will be more invigorating as a result.
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Value Investing: Philip Fisher on When to Sell a Stock

Common Stocks and Uncommon Profits, by Philip Fisher

Philip Fisher (1907–2004) is widely considered the pioneer and thought process leader in long-term value investing. Years after his death, Fisher

is widely respected and admired as one of the most influential investors of all time. Fisher developed his long-term investing philosophy decades ago

and discussed them in his seminal book, Common Stocks and Uncommon Profits. Common Stocks and Uncommon Profits was first published in 1958

and continues to be a must-read today for investors and finance professionals around the world.

Philip Fisher, Investor, Author of Common Stocks And Uncommon Profits Today, we will dig deeper into his selling discipline. For many investors, buying a stock is much easier than deciding when to sell it. Selling securities is much more difficult than buying them. The average investor often lacks emotional self-control and is unable to be honest with himself. Since most investors hate being wrong, their egos prevent taking losses on positions, even if it is the proper, rational decision. Often the end result is an inability to sell deteriorating stocks until capitulating near price bottoms.

Selling may be more difficult for most, but Fisher actually has a simpler and crisper number of sell rules as compared to his buy rules (3 vs. 15). Here are Fisher’s three rules for selling a stock:

  • Wrong Facts: There are times after a security is purchased that the investor realizes the facts do not support the supposed rosy reasons of the original purchase. If the purchase thesis was initially built on a shaky foundation, then the shares should be sold.
  • Changing Facts: The facts of the original purchase may have been deemed correct, but facts can change negatively over the passage of time. Management deterioration and/or the exhaustion of growth opportunities are a few reasons why a security should be sold according to Fisher.
  • Scarcity of Cash: If there is a shortage of cash available, and if a unique opportunity presents itself, then Fisher advises the sale of other securities to fund the purchase.

Many investors are reactive and sell at the same time everyone else does—when they’re fearful. But your emotions aren’t the best guide for making critical financial decisions. Long-term investors should not fear occasional swings in the market. When the market dips or takes an unusual turn, that is the perfect time to review your portfolio and re-evaluate your investing strategy.

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Conspicuous Consumption

Conspicuous Consumption

Conspicuous consumption is the purchase of goods and services for the sake of publicly exhibiting wealth or status

The overt display of luxury goods and services by the ruling classes in the late nineteenth century led Thorstein Veblen to formulate his economic theory of conspicuous consumption. He wrote, “Conspicuous consumption of valuable goods is a means of reputability to the gentleman of leisure.”

In his influential book The Theory of the Leisure Class: An Economic Study in the Evolution of Institutions published in 1899, Thorstein Veblen (1857-1929) identified a distinctive feature of the newly established upper class of the late nineteenth century and the rising middle class of the twentieth century: their accumulation of luxury goods and services for the expressed purpose of displaying prestige, wealth, and social status. Veblen, a U.S. economist and social scientist, viewed this phenomenon as a negative symptom of the new rich that would inhibit social adaptation to the necessities of the industrial age.

The intention for exhibition embodied in the idea of conspicuous consumption is in contrast to the securing of goods and services for their intrinsic value or their originally established purpose. Focusing on the “conspicuous” aspect of the term, conspicuous consumption can conceivably occur among members of any socio-economic class, from the richest to the poorest. Acquiring status indicators can happen in any social setting. Focusing on the “consumption” aspect of the term, conspicuous consumption relates to the purchase and display of goods beyond what is necessary, and applies primarily to the middle and upper classes, who then set patterns of social behavior and consumption that are imitated by others. In this respect, it is closely tied to consumerism.

One ramification of Veblen’s insights into conspicuous consumption relates to the idea of a “luxury tax.” Such a tax increases costs on goods and services that primarily serve as declarations of affluence, in order to raise revenue and redistribute wealth with little loss to consumers who purchase for the sake of status and not utility. It may also gradually reduce conspicuous consumption of such “positional goods,” or “Veblen goods,” which bear the namesake because demand for them increases as price increases.

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Warren Buffett’s Tips for Long-Term Investing

Warren Buffett's Tips for Long-Term Investing WSJ extracts four tips for long-term investing from Warren Buffett’s 2014 annual letter to Berkshire Hathaway’s shareholders. Here are excerpts.

  1. Own low-cost S&P 500 index funds: “Don’t try to pick winning stocks. Instead “own a cross section of businesses that in aggregate are bound to do well.” A low-cost S&P 500 index fund helps any investor do this well.”
  2. Ignore your or anyone else’s predictions about long or short-term price changes. “Focus instead on productivity of assets.”
  3. Ignore the macro environment and political environment: “Buffett notes that when he and his partner Charlie Munger buy stocks, they think of them as “small portion of businesses” and try to see the earnings power of these businesses over the next five years or more. “In the 54 years we have worked together, we have never forgone an attractive purchase because of the macro or political environment.””
  4. Make as few investments as possible: “Investors these days are pushed to be active and to buy low, sell high. Frequent buying and selling only cuts into long-term returns. Mr. Buffett continues: “Ignore the chatter, keep your costs minimal, and invest in stocks as you would a farm.””
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Ben Graham and Warren Buffett on Temperament in Investing

  • “We have seen much more money made and kept by “ordinary people” who were temperamentally well suited for the investment process than by those who lacked this quality, even though they had an extensive knowledge of finance, accounting, and stock-market lore.”
    Ben Graham, Father of Value Investing and mentor of Warren Buffett
  • “Success in investing doesn’t correlate with I.Q… Once you have ordinary intelligence, what you need is the temperament to control the urges that get other people into trouble in investing.”
    Warren Buffett
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To Allocate Capital, You Need a Good Search Strategy

'Keeping America Great' at Columbia with Warren Buffett and Bill Gates

At the 2009 CNBC Town Hall Event called “Keeping America Great” at Columbia University with Warren Buffett and Bill Gates (video here), Buffett said that to allocate capital, you need a good search strategy. Developing this strategy requires a lot of hard work, “turning pages” as Buffett calls it:

If you are going to spend a lot of time on investment, you know I just advise looking at as many things as possible and you will find some bargains. And when you find them, you have to act. … And you have to find them yourself. The world isn’t going to tell you about great deals. You have to find them yourself. And that takes a fair amount of time. So if you are not going to do that, if you are just going to be a passive investor, then I just advise an index fund more consistently over a long period of time. … Good businesses are going to become worth more over time. And you don’t want to pay too much for them so you have to have some discipline about what you pay. But the thing to do is find a good business and stick with it.

It is not possible to pick the bottom. Learn how to value companies, practice until you get good, and buy when you find a good business that you understand, with good management, available at an attractive price.

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Buyback Binge and Financial Engineering

Boston-based asset management firm Grantham Mayo van Otterloo’s Jeremy Grantham scrutinizes the buyback binge and the financial engineering it entails:

Jeremy Grantham of Grantham Mayo van Otterloo Grantham argues that capitalism is failing for now. He blames the rise of “stock option culture” and a complicit U.S. fed for the problem. Up to 80% of executive compensation now flows from stock options, which are tied to short-term performance of a company’s stock rather than long-term performance of the company. People respond to the incentives they’re given, so managers tend toward those actions which increase the value of their stock options. Investing in the company is slow, uncertain and risky, and so capital expenditures (“capex”) by publicly-traded firms is falling. Buying back stock (overpriced or not) and issuing dividends is quick, clean and safe, and so that sort of financial engineering expands. Interest rates at or near zero even encourage the issuance of debt to fund buybacks (“Peter, meet Paul”). It would be possible to constrain the exercise of options, but we choose not to. And so firms are not moving capital into new ventures or into improving existing capabilities which, in the short run, continues to underwrite record profit margins.

Source: The Mutual Fund Observer’s report after Morningstar’s Annual Investor Conference in Chicago.

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Charlie Munger’s Sit-on-Your-Ass Investing Concept

Charlie Munger presented the model of “Sit on your ass investing” at the 2000 Berkshire Hathaway Annual meeting. Description courtesy of Losch Management Company, an Orlando, Florida-based investment advisor.

'Charlie Munger: The Complete Investor' by Tren Griffin (ISBN 023117098X) You have value investing, and growth investing, but now we also have “sit on your ass investing”, which is better.

The problem with value investing is it requires too much work.

First you have to find an undervalued stock and buy it cheap. Then you have to sell it when it the price reaches or exceeds your calculated figure for its intrinsic value.

Because this requires many decisions over a long period of time, Charlie Munger prefers his own method in which all you have to do is pick a really great company when it is attractively priced, and then just sit on your ass. The great advantage being that it only requires one decision.

Charlie said: “If you buy a business just because it’s undervalued then you have to worry about selling it when it reaches its intrinsic value. That’s hard. But if you can buy a few great companies then you can sit on your ass … that’s a good thing.”

The whole idea of not having to do something extraordinary is one all investors should heed, yet it is easy to forget, particularly in stressful situations.

Recommended Reading: ‘Charlie Munger: The Complete Investor’ by Tren Griffin

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