As I mentioned yesterday, I’ve recently been reading Moonwalking with Einstein (and I highly recommend you do too). Part of the book (a piece right in the middle) talks about how people often reach the “ok” plateau and then stop improving:
Walking with Einstein even suggests an example of this. Mammographers only find out the accuracy of their diagnosis weeks or months after the case, at which point they’ve completely forgotten the details and can no longer learn anything from it, while surgeons get immediate feedback (a patient either improves or doesn’t), and thus are almost forced to constantly improve. And this plays out in the stats: mammographers tend to get less accurate with diagnosis over time, while surgeons see their performance improve with age.
So how can you be a surgeon, not a mammographer, in your quest to be a great investor? In other words, how can you practice with immediate feedback?
The way I see it, there are three ways.
The first is actually not related to immediate feedback, but it’s important nonetheless. It is to avoid forgetting your investing thesis! Mammographers don’t improve because by the time they get feedback, they’ve already forgotten the case. You can break this cycle simply by writing your thesis down when you make an investment, and then doing post-mortems as the investment plays out and you eventually exit. This is why I’ve been encouraging you so strongly to start writing a blog!
The second tip (and first for getting immediate feedback) is one that Gannon and distressed debt investing have been promoting recently: blind stock valuation. In this, you’re given several years of financials without being told the company’s name or stock price, and your job is to guess the stock price.
I think it’s an excellent practice, but it does have its limitations. Without more information (like reading the company’s footnotes, accounting policies, etc), the valuation is necessarily limited. Remember, part of the process is challenging yourself: if you’re constantly staring at numbers in a vacuum and then guessing a multiple for them, are you truly challenging yourself to be a better investor, or are you becoming a better calculator? And if you try this process with businesses in flux (for example, Radioshack, Research in Motion, or Best Buy), you’ll always be dead, dead wrong because the financials alone won’t tell you that the future is likely to be much, much bleaker the past.
That said, I know Buffett has stated that he engaged in a similar practice when he was getting started, though I think he took it one step further. Buffett would read several years’ worth of financials and then try to guess the stock price of a company. I think the difference here is Buffett allowed himself to read the footnotes, MD&A, etc. Doing so allowed Buffett to get a general feel for the company, industry, management, etc, as well as add value in for any “hidden assets” that a simple glance at the financials may miss (for example, a quick glance at Gramercy’s (GKK, Financial) financials would reveal a complete mess on the verge of bankruptcy; missing that all of the losses and debt are within non-recourse subs and investments).
So that’s one method: do blind stock valuations company by company.
I personally think this would be most effective if done within one industry. For example, you could do the restaurant industry by doing a blind stock valuation on every publicly traded restaurant. Doing so would allow you to develop industry expertise while developing valuation skills.
The second method would be to recreate successful investments from famous investors in the past. This would be similar to chess players studying the grand masters’ games. You would read the financials that were most recent when the famous investor was making his investment and try to construct the logic behind the investment: what was the investor seeing? What was the market missing? Where was his margin of safety? What was the price of the company at the time, and what would you value the company at? You could then read through the investors’ letters and presentations to confirm that you had reconstructed his logic (or see if you had missed anything), and then read the future financials to see how the investment played out.
For example, you could recreate Ackman’s successful investment in Wendy’s by reading all of Wendy’s 10-ks from the 2005-2007 time frame (before Ackman made his investment) and trying to value the company. You could then look through Ackman’s presentations to see how accurate you were in assessing his thesis, and see if you had missed anything. Finally, you would read the future financials to see how the investment played out.
Why do I mention Ackman here, and not Buffett or Klarman? Ackman and some of the other “new” generation of value investors (Einhorn’s another great example) are perfect breeding grounds: they clearly lay out an investment thesis quite publicly, and their investments have been recent enough (and in large enough companies!) that the filings are on Edgar. Buffett’s old investments would be nice to recreate, but many of his investments are so old that their filings aren’t available, and he’s so close-lipped about his investments that it is more difficult to reconstruct / confirm his logic.
So, here’s my challenge to you, the reader. Every Sunday I’m going to post a company to value, and then the following weekend I will post my valuation and the reasoning behind it. I’m going to challenge you to take a few hours at of your week to value the company as well, and then compare your valuation to mine, and our valuations to the current market price. Let’s use our valuations to challenge the strengths and weaknesses of each other’s thesis and force each other to become better investors.
To keep this post from becoming a novel of epic proportions, and to provide a page that will serve as a quick link back for instructions in each of the weekly challenges, I will post more details to “the challenge” in a follow up post tomorrow.
When you want to get good at something, how you spend your time practicing is far more important than the amount of time you spend. In fact, in every domain of expertise that’s been rigorously examined, from chess to violin to basketball, studies have found that the number of years one has been doing something correlates only weakly with level of performance. My dad may consider putting into a tin cup in his basement a good form of practice, but unless he’s consciously challenging himself and monitoring his performance – reviewing, responding, rethinking, rejiggering – it’s never going to make him appreciably better. Regular practice simply isn’t enough. To improve, we must watch ourselves fail, and learn from our mistakes.Now, one of the problems with becoming an expert in investing is the lack of immediate feedback. Unless you are engaging in merger arbitrage or distressed investing, it can take years for investment thesis to play out (note that I have purposefully ignored things like day trading or momentum / technical investing, because while those do provide for immediate feedback I do not consider them investing). Even in merger arbitrage or distressed investing, the “noise” from any one investment or even several investments can reward bad processes over the short run and make true feedback difficult.
The best way to get out of the autonomous stage and off the OK plateau … is to practice failing yourself. One way to do that is to put yourself in the mind of someone far more competent at the task you’re trying to master, and try to figure out how that person works through problems…. The best chess players… will often spend several hours a day replaying the games of grand masters one move at a time, trying to understand the expert’s thinking at each step. Indeed, the single best predictor of an individual’s chess skill is not the amount of chess he’s played against opponents, but rather the amount of time he’s spent sitting alone working through old games.”
Walking with Einstein even suggests an example of this. Mammographers only find out the accuracy of their diagnosis weeks or months after the case, at which point they’ve completely forgotten the details and can no longer learn anything from it, while surgeons get immediate feedback (a patient either improves or doesn’t), and thus are almost forced to constantly improve. And this plays out in the stats: mammographers tend to get less accurate with diagnosis over time, while surgeons see their performance improve with age.
So how can you be a surgeon, not a mammographer, in your quest to be a great investor? In other words, how can you practice with immediate feedback?
The way I see it, there are three ways.
The first is actually not related to immediate feedback, but it’s important nonetheless. It is to avoid forgetting your investing thesis! Mammographers don’t improve because by the time they get feedback, they’ve already forgotten the case. You can break this cycle simply by writing your thesis down when you make an investment, and then doing post-mortems as the investment plays out and you eventually exit. This is why I’ve been encouraging you so strongly to start writing a blog!
The second tip (and first for getting immediate feedback) is one that Gannon and distressed debt investing have been promoting recently: blind stock valuation. In this, you’re given several years of financials without being told the company’s name or stock price, and your job is to guess the stock price.
I think it’s an excellent practice, but it does have its limitations. Without more information (like reading the company’s footnotes, accounting policies, etc), the valuation is necessarily limited. Remember, part of the process is challenging yourself: if you’re constantly staring at numbers in a vacuum and then guessing a multiple for them, are you truly challenging yourself to be a better investor, or are you becoming a better calculator? And if you try this process with businesses in flux (for example, Radioshack, Research in Motion, or Best Buy), you’ll always be dead, dead wrong because the financials alone won’t tell you that the future is likely to be much, much bleaker the past.
That said, I know Buffett has stated that he engaged in a similar practice when he was getting started, though I think he took it one step further. Buffett would read several years’ worth of financials and then try to guess the stock price of a company. I think the difference here is Buffett allowed himself to read the footnotes, MD&A, etc. Doing so allowed Buffett to get a general feel for the company, industry, management, etc, as well as add value in for any “hidden assets” that a simple glance at the financials may miss (for example, a quick glance at Gramercy’s (GKK, Financial) financials would reveal a complete mess on the verge of bankruptcy; missing that all of the losses and debt are within non-recourse subs and investments).
So that’s one method: do blind stock valuations company by company.
I personally think this would be most effective if done within one industry. For example, you could do the restaurant industry by doing a blind stock valuation on every publicly traded restaurant. Doing so would allow you to develop industry expertise while developing valuation skills.
The second method would be to recreate successful investments from famous investors in the past. This would be similar to chess players studying the grand masters’ games. You would read the financials that were most recent when the famous investor was making his investment and try to construct the logic behind the investment: what was the investor seeing? What was the market missing? Where was his margin of safety? What was the price of the company at the time, and what would you value the company at? You could then read through the investors’ letters and presentations to confirm that you had reconstructed his logic (or see if you had missed anything), and then read the future financials to see how the investment played out.
For example, you could recreate Ackman’s successful investment in Wendy’s by reading all of Wendy’s 10-ks from the 2005-2007 time frame (before Ackman made his investment) and trying to value the company. You could then look through Ackman’s presentations to see how accurate you were in assessing his thesis, and see if you had missed anything. Finally, you would read the future financials to see how the investment played out.
Why do I mention Ackman here, and not Buffett or Klarman? Ackman and some of the other “new” generation of value investors (Einhorn’s another great example) are perfect breeding grounds: they clearly lay out an investment thesis quite publicly, and their investments have been recent enough (and in large enough companies!) that the filings are on Edgar. Buffett’s old investments would be nice to recreate, but many of his investments are so old that their filings aren’t available, and he’s so close-lipped about his investments that it is more difficult to reconstruct / confirm his logic.
So, here’s my challenge to you, the reader. Every Sunday I’m going to post a company to value, and then the following weekend I will post my valuation and the reasoning behind it. I’m going to challenge you to take a few hours at of your week to value the company as well, and then compare your valuation to mine, and our valuations to the current market price. Let’s use our valuations to challenge the strengths and weaknesses of each other’s thesis and force each other to become better investors.
To keep this post from becoming a novel of epic proportions, and to provide a page that will serve as a quick link back for instructions in each of the weekly challenges, I will post more details to “the challenge” in a follow up post tomorrow.
