— Warren Buffett, 1996 Letter to Shareholders
"To invest successfully, you need not understand beta, efficient markets, modern portfolio theory, option pricing or emerging markets. You may, in fact, be better off knowing nothing of these. That, of course, is not the prevailing view at most business schools, whose finance curriculum tends to be dominated by such subjects. In our view, though, investment students need only two well-taught courses - How to Value a Business, and How to Think About Market Prices."
Buffett has mentioned these "two courses" numerous times since this letter. He later mentioned that in the How to Value a Business course, he would simply "do one case study after another."
What Are Case Studies?My short definition: A case study is reading about a specific investment result and then attempting to reverse engineer the thesis and the thought process that the investor had when he or she made the decision to buy the stock, and then taking note of how that thesis played out during the course of the investment.
In other words, find a particularly good or bad investment result and ask, "Why?"
- What was the outcome? (note: you can learn from both good and bad results, but often times more from the ones that resulted in losses). This can be your own investments (the best case studies), or another investor's investments.
- Why did the investor decide to buy the stock?
- Why did the result turn out the way it did?
For starters, reading and studying Buffett's letters are probably the greatest things you can do to improve as an investor. I've read through them a few times, but I continue to review them and probably will do so throughout my career. I still learn something new each time. The great thing about reading Buffett's (and other fund managers') letters is that they often lay out their logic for us in a very clear and concise manner. They basically say "Here's why I did this, and here's why it worked (or didn't work)". So sometimes case studies are simply listening when other great investors are doing their own post-analysis.
Other times it's more complicated. I often read through old letters from various funds I follow and come across an investment that did extraordinarily well or extraordinarily poorly, but without further commentary. In this case, I might be inclined to dive deeper and read some old annual reports and try to really reverse engineer the investor's thought process.
All Knowledge Is CumulativeOur investment decisions are partly based on the framework of our experience and each time I read Buffett's letters, I learn something or see something in a different way because over time my thought process and learning experience evolve. It's a latticework of various bits and pieces of experience and knowledge all coming together, and building on itself overtime.
Buffett likens this learning process to compound interest. And as Pabrai says, "All knowledge is cumulative." So these case studies compound on themselves over time, improving our investment skill set and streamlining our ability to make decisions. Our filters get stronger, our risk management process becomes more robust.. As Buffett did, we get faster at saying no. It becomes easier to identify problems that might harm the investment, etc.
A Blueprint for SuccessAnd it's not just filtering negatives. Studying past successful investments provide us with blueprints for what to look for in future ideas. Studying what Henry Singleton did at Teledyne gives us a blueprint for successful capital allocation strategies. Eddie Lampert gave us a similar blueprint at AutoZone (AZO). Studying Schloss' investment in the Penn Central bonds gives us a blueprint for all the great things that can happen by simply buying things cheap: A "dollar for 40 cents." Buffett's investment in See's Candy (or his most famous investment of all: Coke) give us blueprints for what can happen when you buy great businesses that have pricing power and durable competitive advantages (moats).
LeBron James Game-Winning Layup: A Great Case StudyIt's just like procedural memory in sports. I thought the 2013 NBA playoffs were the most exciting NBA playoffs since the Jordan days... Other than game 6 of the finals, I thought the most exciting game was Game 1 of the Eastern Conference Finals. Lebron James won the game for the Heat with a game winning layup as time expired.
I found the sequence of events that transpired during that play interesting. There were only two seconds left. The play was clearly designed for James to receive the inbound pass and take a jumpshot. If he didn't have a clear jump shot, his likely alternative would have been a quick head fake, maybe a dribble, and then a jumpshot. Either way, the likely outcome would be a James jumpshot as time expires.
However, the play developed in such a way that James' defender Paul George got caught low as James' received the inbound pass. This meant George had to hustle out to the top of the key to try and defend an open James' jumpshot. LeBron saw this developing and as George sprinted toward him, James took the opportunity to blow by him toward the basket. George couldn't stop his momentum and James breezed by for an easy game-winning layup.
I thought about this afterward and how if this same situation was played out 20 more times, this result (a James layup) might occur one out of 20 (maybe not even that often).
So How Did James Pull This Off?It wasn't planned.. He didn't have time to think consciously about it. It was just procedural memory. Over the course of James' life (on the playground courts, high school, the NBA, etc.) he's seen countless situations [size=11pt; line-height: 115%; font-family: Calibri, sans-serif]— [/size]case studies, if you will.). The more situations like this he's in, the more natural and fluid the decision-making process becomes.
James can instantly assess probability on the basketball court. Within milliseconds he can quickly evaluate a circumstance and decide to take action that will result in the highest probability of success. This ability is often referred to as "basketball IQ," but it's really just the procedural memory that comes from seeing thousands of similar situations and understanding the proper course of action to take.
Procedural memory is what athletes, concert pianists, ballet dancers, doctors and many other professionals rely on to successfully execute their respective activities, often without the time to consciously consider what they are doing.
Luckily, as investors, we don't have to act in seconds. We don't even have to act in hours, or in most cases days. We usually have a lot of time to evaluate a situation as it develops and begins to unfold. And like LeBron on the basketball court, these skills get developed through experience. Part of this is just making investments and learning over time, and part is by studying the results of our own and other investors' past investments. Case studies.
Buffett himself even referenced this type of benefit derived from studying past investment cases in a 1996 interview with Outstanding Investor Digest when he said:
"You do see repetition of certain business patterns and business behavior. And Wall Street tends to ignore those, incidentally."
Case studies help you identify potential profitable and/or harmful situations, and Wall Street doesn't care, thus allowing you to take advantage of those insights!
How to Do Case Studies?So if you're all fired up after watching LeBron's incredible display of procedural memory and can't wait to begin improving your own skills, I'd recommend doing the same thing I do: Read, read and read some more. The best thing to do is just read investment letters.
I've already mentioned the Berkshire letters above. You could spend a year just studying Buffett. Eddie Lampert did that, and he ended up achieving one of the greatest track records of all time, close to 30% annual returns for a couple decades. A Bloomberg article from 2004 references the foundation Lampert built by studying Buffett's investments:
In fact, in the shareholder letter I referenced above, the very next paragraphs lay out Buffett's basic thought process for taking a stake in US Air. This did not turn out to be a successful investment, but with Buffett's clearly laid out thought process, along with his mentioning of the key things that went wrong, it becomes a great learning lesson for the rest of us.
"Lampert has carefully studied Buffett for years. He started reading and rereading Buffett's writings while working at Goldman after college. He would analyze Buffett's investments, he says, by "reverse engineering" deals, such as his purchase of insurance company GEICO. Lampert went back and read GEICO's annual reports in the couple of years preceding Buffett's initial investment in the 1970s. "Putting myself in his shoes at that time, could I understand why he made the investments?" says Lampert. "That was part of my learning process." In 1989 he flew out to Omaha and met Buffett for 90 minutes, peppering him with questions about his investing philosophy."
In addition to reading old shareholder letters, there are some books with great case studies to read about. Alice Schroeder's "Snowball" has some of the best case studies complete with great detail into how Buffett thought, including some of his lesser known investments. Maybe the best book of all for case studies is Joel Greenblatt's "You Can Be a Stock Market Genius." This book has case studies of some of Greenblatt's greatest investments laid out in simple, concise form.
There are many other books ("Market Wizards," "Buffettology," etc.) that lay out case studies often at a cursory (but still valuable) level. These are great to read because they often take just a few minutes, but reinforce some valuable concepts.
In addition to reading letters and books, I have a number of blogs that I read, and some of them are worth going through the archives to find examples of their own past investments, and sometimes their commentary on other investors' past investments. CSInvesting, Brooklyn Investor, Geoff Gannon, Above Average Odds and Greg Speicher among others are great places to read old case studies.
My System for Tracking Case Studies
There is a lot out there to read. Sometimes it's overwhelming. The key is to just read, and let "compound knowledge" work in your favor over time. Don't get too rigid about any of this. Just read. I think if you consistently go through Buffett's letters and Greenblatt's book, along with a few others, that you just happen across (which happens often when you read a lot), you'll develop a great foundation for understanding what some of the greatest investors of all time were thinking when they made some of their greatest (and worst) investments.
You may adopt something similar to what I do. I have a three step filter for when I come across case studies. First off, most of the time I just read them and let it sink in over time. This way, I can read, move on to the next thing, read it, move on to the next, etc., but over time, you'll come across some things that you may want to notate for future reference.
What I do here is this:
- Keep a Binder: Print the article or letter that has the case study and file it in a binder I have. This is like a scrapbook of case studies in no particular order with scribbled notes and ideas for me to review later.
- Keep a Word Doc: I then take some brief bullet point notes of the case study and record them on a word doc, that is getting massive at this point. I can also review these over time. I have a section on this doc for "key learnings," which are takeaways from the case studies.
- Build a Checklist that contains certain aspects of things I've learned.
To Sum It UpSo, hopefully this lays out a case for why I think it's important to do these case studies. Again, this is part of the process. Much of learning and improving as an investor has to do with reading, and often times this will come in the form of studying and reading about current ideas (current 10-Ks, reports, etc.). But reading about past investments and occasionally taking down some notes of important points will help you improve over time.
The more situations you can identify with, the more accurately you'll be at gauging risk and being able to estimate the probability of success on any given investment.
What I plan to do over time on this blog is put up some brief points on some of the case studies I've done. The key is to keep the big picture in mind. Usually the investment success/failure can be traced back to just a couple main points. That's what we want to find out. What are those points, and how can we use them to our advantage the next time we see that "play" develop.
We'll go over some of these over time, along with continuing to discuss certain ideas I find interesting.
Have a great weekend!
Also check out:
- Joel Greenblatt Undervalued Stocks
- Joel Greenblatt Top Growth Companies
- Joel Greenblatt High Yield stocks, and
- Stocks that Joel Greenblatt keeps buying
- Mohnish Pabrai Undervalued Stocks
- Mohnish Pabrai Top Growth Companies
- Mohnish Pabrai High Yield stocks, and
- Stocks that Mohnish Pabrai keeps buying