Thomas Macpherson is one of my all-time favorite writers on Gurufocus. I have learned so much from his articles and his great presentation at the 2016 Gurufocus’s conference. It is thus with great pleasure that I found out about Tom’s book “Seeking Wisdom: Thoughts on Value Investing” on Amazon. Without hesitation I bought it and read it from cover to cover. Although I’ve read most of Tom’s articles already, it’s still refreshing to revisit them as reinforcement. Tom’s book is very unique because it is a combination of deep thinking and practicality using real life examples from his professionally managed and market-beating Nintai portfolio. I highly recommend it to everybody. The rest of this article is a compilation of my biggest 10 takeaways from the book.
- The most important point of the book in my opinion, as Tom puts it – “how you think about investing is as equally important – if not more important – than what you invest in your portfolio. Thinking about investing as a process – with many different inputs and components – can greatly improve your results.
- On the importance of constantly improving the decision making process and designing a right system:”Investors should look at some of their larger decisions that can impact their decision-making. Designing a system that can remove your emotions during times of market disruption can save you from making horrible mistakes.”
- Taleb shows us how an event that happened can be labeled as a black swan. Tom brilliantly applied Charlie Munger (Trades, Portfolio)’s inversion thinking and pointed out that “a black swan event can be something that doesn’t happen against all our expectations – a non-occurrence of an event that is perceived as highly probable. This non-occurring black swan event could have a huge impact on your investment thesis.” Tom calls this “breaking the case.” An example of this non-occurring black swan event would be a company’s failure to win a government contract after having won the same government contract each time it has been put out to bid since 1952. This reminds me of IBM (IBM, Financial), who’s won the CIA contract for who knows how many years consecutively, lost it to Amazon(AMZN, Financial) a few years ago.
- Risk and uncertainty are two different things. As Michael Mauboussin describes it: “Risk has an unknown outcome, but we know what the underlying outcome distribution looks like. Uncertainty also implies an unknown outcome, but we don’t know what the underlying distribution looks like.” Tom suggests that first of all, we have to think about risk and uncertainty. But that’s not enough, we have to “place them in the context of value and price.” Nintai has a proprietary Risk/Uncertainty score system in which both the risks and uncertainties a company face are quantified to the extent they can. While not perfect, as most of the time, assessing risks and uncertainties is half science half “, the Risk/Uncertainty score is a good way to put risk, uncertainty, price and value into perspective.
- Focus on how much, not how many. As Tom shrewdly observed, “not many investors think of investing as probabilistic exercise where the frequency of correctness does not matter; but rather the magnitude of correctiveness is vital. What really throws many investors is that you can be correct more frequently than not and still underperform the markets. It’s critical to understand that the percentage of stocks that go up in a portfolio does not determine its performance – it is the dollar change.”
- How to prevent losses due to emotional biases? Here Tom provides a simple and practical answer – by limiting data intake, creating models with intellect focus on value, and building systems to minimize emotional responses. “Be ruthless in your evaluations, invert your estimates, and build in truly horrific assumptions.” This advice is truly relevant now as euphoria in the U.S market has been unabated.
- “Go back and check your fundamentals.” This is another very practical advice. Whenever a company’s stock drops significantly, the first thing we should do is to check the fundamentals of the business and review our assumptions. Doing so will help us shut off the noise around us, especially during a down market.
- The dual circle of competence and comfort. Again, this concept is very practical. If a company falls into your circle of competence but management is doing something that makes you uneasy, or if the balance sheet has deteriorated, move on. A great quote Tom uses is from Scott Simmons – “Being able to sleep at night is one prerequisite for an investment manager.”
- Improving our thinking process means not only “proactively changing in a positive manner (adopt new thinking) but also changing in a negative manner (rejecting certain thinking) as well. Positive adoptions include thinking like a business owner and preferring quality companies. Negative rejections include “short term thinking” and “value doesn’t matter.”
- Getting to Zero. A key component in Tom’s investment selection process is creating models that get his investment to exactly that place – broken, impaired, and bankrupt. Tom will test each model, estimate, and assumptions and find a way to reach zero valuation. He would generally deconstruct his business case and pressure test it in five ways: revenue, credit/debt, management, competition, and regulatory.
I want to thank Tom again for all his teachings over the past 2-3 years. It’s been a great learning journey for me and I look forward to more of Tom’s articles. For the readers, go get Tom’s book if you haven’t done so. It’s a gem.
