What questions to ask before buying a stock.

“Good thinkers are good questionnaires.” — Alison King

Mistakes will be made when investing, that’s how you learn and become a better investor. One mistake I have made, one of the many, was that of following other investors stock picks, cloning respected value investors and losing the vast majority of the investment.
Why did it happen? I didn’t do my homework, I didn’t ask the right questions, all I did was looking for confirmation bias on why it would make a great investment.
Do not blindly clone other investors. If they promote a particular stock, put it on your ‘radar’, and do the thorough analysis you would have done otherwise.
The part you can clone and learn from is their methodology. Try to understand what system/process they have and how they arrive to the conclusion to make or not make an investment.

Two well known investors I like to learn most from are Charlie Munger and Warren Buffett, their investment methodology is simple and effective:

Understanding the business

Warren Buffett uses the following questions as filters before committing time and money1) Seeking WIsdom – From Darwin to Munger – Peter Bevelin Page 220:

  •  Can I understand it? If it passes this filter.
  • Does it look like it had some kind of competitiveness advantage? If it passes this filter.
  • Is the management composed of able and honest people? If it passes this filter.I
  • Is the price right? If it passes this filter we write a check.

What does Warren Buffett mean by “understanding” a business? Predictability: “Our definition of understanding is thinking that we have a reasonable probability of being able to assess where the business will be in 10 years.

Asking the right questions

Warren Buffett learned a great deal from his mentor Benjamin Graham, the ‘father’ of value investing. In the book that Benjamin Graham wrote with David Dodd, Security Analysis, they outlined their analysis process into two parts, Quantitative and Qualitative analysis:

Quantitative:

  1.       Capitalization
  2.       Earnings and dividends
  3.       Assets and liabilities
  4.       Operating statistics

Qualitative:

  1.       Nature of the business
  2.       The relative position of the individual company in the industry
  3.       It’s physical, geographical, and operating characteristics
  4.       The character of the management
  5.       The outlook for the unit, industry and business in general

Each point of the analysis has questions that need to be answered, for instance the second point of Quantitative analysis, Earnings and dividends:

  • What are the true earnings for the period studied? 2)Accounting, Business and Investing leading questions
  • What indication does the earnings record carry as to the future earnings power of the company?
  • What elements in the earnings exhibit must be taken into account, and what standards followed, in endeavoring to arrive at a reasonable valuation of the shares?

Not any company is the same, therefore the questions shouldn’t be the same for every situation and company, alter each set of questions to the company and industry.

Create a narrative

Warren Buffett combines questions and answers on a multitude of topics with a capability most of us can only dream of, he does this to create a narrative in his head that will help him make a decision. Most importantly, he has a partner, Charlie Munger, for discussing ideas and thought processes. From a 1988 Carol Loomis article in Forbes3)https://www.fool.com/investing/general/2015/01/31/charlie-munger-5-quotes-show-why-warren-buffetts-2.aspx:

So in conversations with Buffett over the years he preached the virtues of good businesses, and in time Buffett totally accepted the logic of the case … ”I have been shaped tremendously by Charlie,” says Buffett. ”Boy, if I had listened only to Ben (Benjamin Graham), would I ever be a lot poorer.’

Other famous partnerships are those between Mohnish Pabrai (Pabrai Funds/ Dhando Funds) and Guy Spier (Aquamarine Capital). If you have no immediate person to discuss your analysis with, you can use websites like cornerofberkshireandfairfax.ca , The Motley Fool, Seeking Alpha, etc.

Keep it simple

When doing an analysis try to keep it simple. There is no point in getting lost in the process, you will only be more likely to miss something and make a mistake. In Seeking Wisdom From Darwin to Munger, Peter Bevelin quotes Warren Buffett and Charlie Munger on the importance of keeping things simple:

Warren Buffett: “We try to stick to business we believe we understand. That means they must be relatively simple and stable in character.”

Charlie Munger: “We never sit down, run the numbers out and discount them back to net present value. The decision should be obvious.

Charlie Munger: Some of the worst business decisions I’ve seen came with detailed analysis. The higher math was false precision. They do that in business schools, because they’ve got to do something.

Making good predictions in general is something that you should try to stay away from as it almost impossible to do it correctly. Just look back at the predictions that professional analysts and Economists have made..they are almost always all wrong.4)https://www.oaktreecapital.com/docs/default-source/memos/go-figure.pdf?sfvrsn=7

Margin of Safety

What is the risk of losing 100%? Maintaining a margin of safety will protect you against miscalculations/ mistakes made in your analysis and unforeseen events. Be patient and wait until the stock reaches your target price that includes a margin of safety.

Seth Klarman – founder of Baupost and investing legend, wrote a book: Margin of Safety (out of print), in there he states the importance of maintaining a Margin of Safety:

“It would be a serious mistake to think that all the facts that describe a particular investment are or could be known. Not only may questions remain unanswered; all the right questions may not even have been asked. Even if the present could somehow be perfectly understood, most investments are dependent on outcomes that cannot be accurately foreseen. Even if everything could be known about an investment, the complicating reality is that business values are not carved in stone. Investing would be much simpler if business values did remain constant while stock prices revolved predictably around them like the planets around the sun. If you cannot be certain of value, after all, then how can you be certain that are you buying at a discount? The truth is you cannot.”5)https://www.fool.com/investing/general/2010/05/18/10-quotes-from-one-of-the-greatest-investment-book.aspx

The more things that can go wrong, i.e. with the business you analyse, the higher the margin of safety, thus, the higher the risk of something going wrong the more margin of safety you should apply.

Keep learning

Analysing companies is an evolving, never ending process. Adapt and improve when you learn new things. Keep reading/ learning, applying new techniques and learn from your mistakes. Stay curious and have a desire to learn.

…Munger later wrote, “If Warren Buffett had never learned anything new after graduating from the Columbia Business School, Berkshire would be a pale shadow of its present self. Warren would have gotten rich — because what he learned from Ben Graham at Columbia was enough to make anybody rich. But he wouldn’t have the kind of enterprise Berkshire Hathaway is if he hadn’t kept learning.”6)http://www.omaha.com/money/buffett/warren-buffett-and-charlie-munger-billion-dollar-partnership/article_2819b16e-1933-51a7-b14b-002d9bb918de.html

Reading is key to gaining knowledge,besides books there are other sources to expand your knowledge, such as Podcasts, Youtube Channels, Magazines like the Economist, articles, hedge fund letters, and of course other Blogs.

Alice Schroeder on Buffett and Munger:

…The lessons that they had which is learning yourself, making yourself as smart as you can, is extremely valid, and not just relying on a library where you can look something up all the time. Because a lot of the times when you need to make a decision and need 50 pieces of information, you need to know it then and that’s been Warren Buffett greatest secret of success.”

In summary:

  • Ask the right questions (use a checklist)
  • Create a Narrative (bull and bear case)
  • Keep it Simple
  • Maintain a Margin of Safety
  • Be patient and never stop learning

Links:

Seeking Wisdom From Darwin to Munger

Security Analysis

The Snowball: Warren Buffett and the Business of Life

Alice Schroeder on How Buffett Values a Business and Invests

Keynote: Alice Schroeder, author of “The Snowball: Warren Buffett and the Business of Life”

http://buffettfaq.com/

 

 

 

References   [ + ]

Shortness of Life

“It’s not that we have little time, but more that we waste a good deal of it.”

Seneca

Do you get anxious about time and goal setting? I think most of us do…I do, I am not someone who easily gets stressed or anxious. However, now and then I get it, anxiety about time and working towards goals that I have set up for myself.

When I have experienced bereavement, as I have recently, it makes me reflect on my own life and how I am spending my time. It ignites my anxiety about time and goal setting. After having read passages in the past, I thought this was the right time to read Seneca’s Shortness of Life completely. Although I wish I had read this 5 years ago, it will definitely be something I will re-read on a regular basis. It is one of the best works that I have read on life and how to deal with time. People always complain how little time they have and how fast life is passing be. Is that so? Or are we just not making the best use of our time?

This is what Seneca, a Stoic philosopher, wrote in ‘On the Shortness of Life’ a letter to his friend, Paulinus, about time:

“It is not that we have a short time to live, but that we waste a lot of it. Life is long enough, and a sufficiently generous amount has been given to us for the highest achievements if it were all well invested. But when it is wasted in heedless luxury and spent on no good activity, we are forced at last by death’s final constraint to realize that it has passed away before we knew it was passing. So it is: we are not given a short life but we make it short, and we are not ill-supplied but wasteful of it.”
Seneca. On the Shortness of Life (Penguin Great Ideas) (pp. 1-2). Penguin Books Ltd. Kindle Edition.

Printing press

Seneca wrote this almost 2000 years, before the industrial revolution and invention of the printing press. In today’s society we have more distractions than ever before. Technology firms use algorithms to give their users personal recommendations, which in return leads them to spend more time on their platform. To quote from The Economist special report on mass entertainment:”Technology has turned human distraction into its metrics of profit”*.

With the ease of use of online services like Netflix, binge watching has become a normal activity…Nobody really looks confused when you mention that you spent the weekend binge watching the new season of House of Cards. Just think about that for a second.. we complain about not having enough time, that we are too busy, and here we are spending 1 hour a day on Facebook and watching Netflix** for 2 hours a day, that accounts for 21(!) hours a week.

How much time do you spend on Netflix or Youtube? Try to track for a week how you spend your time, from commuting to work/school, exercise, social media, video games, internet, Netflix, etc.

Once you gain insight into how you spend your time, you can limit the time wasted. You will be surprised how much time you actually have.

“But among the worst offenders I count those who spend all their time in drinking and lust, for these are the worst preoccupations of all.”
Seneca. On the Shortness of Life (Penguin Great Ideas) (p. 9). Penguin Books Ltd. Kindle Edition.

Traces of alcohol have been found on a drinking cup from China that could be traced back 9,000 years.(National Geographic February 2017 issue cover story is about ’The birth of Booze, Our 9,000-year love affair with alcohol’) Alcohol has become part of our social life, whether you have glass of wine during dinner with family or go out for drinks with friends. There is not much wrong with drinking a glass or two of wine during dinner. Unfortunately most people don’t stick to just that. They can be in a situation where they feel pressure from friends/ colleagues to go out and drink alcohol  because it’s simply what is expected of them.. which then leads to drinking more than necessary. Who ever really sticks to just one or two drinks a night, or none at all? More than likely we drink more than planned and regret it the morning or day after. The negative health effects  of alcohol (over) consumption are well known, from sleep deprivation  to lack of energy, poor coordination, inability to focus etc. Still want that drink?

Recently I heard somebody reporting which Roman general first did this or that: Duilius first won a naval battle; Curius Dentatus first included elephants in a triumph. So far these facts, even if they do not contribute to real glory, at least are concerned with exemplary services to the state: such knowledge will not do us any good, but it interests us because of the appeal of these pointless facts. We can also excuse those who investigate who first persuaded the Romans to embark on a ship. That was Claudius, who for this reason was called Caudex because a structure linking several wooden planks was called in antiquity a caudex. Hence too the Law Tables are called codices, and even today the boats which carry provisions up the Tiber are called by the old-fashioned name codicariae. Doubtless too it is of some importance to know that Valerius Corvinus first conquered Messana, and was the first of the family of the Valerii to be surnamed Messana from the name of the captured city – the spelling of which was gradually corrupted in everyday speech to Messalla. Perhaps you will also allow someone to take seriously the fact that Lucius Sulla first exhibited lions loose in the Circus, though at other times they were shown in fetters, and that javelin-throwers were sent by King Bocchus to kill them. This too may be excused – but does it serve any good purpose? – to know that Pompey first exhibited in the Circus a fight involving eighteen elephants, pitting innocent men against them in a staged battle.
Seneca. On the Shortness of Life (Penguin Great Ideas) (pp. 20-21). Penguin Books Ltd. Kindle Edition.

Have you ever scrolled through your facebook news feed and clicked on articles with intriguing headers? Looking up useless facts, reading articles on news websites that are pure speculation, recycling old articles and rephrasing new ones from other sources with some added facts to get more clicks/readers. Websites like Buzzfeed and Business Insider get millions of visitors a month. If you look at the content you notice that most articles are just clickbait, even news sources such as Bloomberg have recommended articles at the end of their news articles:

You are intrigued by the headers, friends on facebook are sharing it, liking it, you get triggered, the source is questionable and you have your doubts about the articles reliability, however you curiosity wins over and you click on the link.

After reading the previous passage from Seneca it really struck me, I spend too much accumulating useless facts. I won’t be able to remember or recall what was in this article, it’s not important. Being able to distinguishing between reading to accumulate knowledge or useless facts is key.

Knowing how to read a book is important to get the most out of your books or articles that you read.
Before reading/buying a book: Glance over the title, go through the content page/index, read the introduction, scan through the chapters and read some passages.
What is the author trying to say?
What of it?
This is not only applicable for books, use it for video, audio (podcasts), magazines, etc. Ask yourself: Is this worth my valuable time?

The greatest obstacle to living is expectancy, which hangs upon tomorrow and loses today. You are arranging what lies in Fortune’s control, and abandoning what lies in yours. What are you looking at? To what goal are you straining? The whole future lies in uncertainty: live immediately.
Seneca. On the Shortness of Life (Penguin Great Ideas) (p. 13). Penguin Books Ltd. Kindle Edition.

Life is divided into three periods, past, present and future. Of these, the present is short, the future is doubtful, the past is certain.
Seneca. On the Shortness of Life (Penguin Great Ideas) (p. 15). Penguin Books Ltd. Kindle Edition.

Still curious?

How do you avoid wasting time? Below are some  tricks to make better use of your time:

  • Set a reminder if you fall into the trap of distraction. For example: Trick yourself into remembering to focus on your goals when you’re about to get into your old habit, put the item that is important for you to get closer to your goals next to the TV (or on a prominent spot in your house), my ‘to read books’ are next to my TV, just in case…
  • Wake up earlier to get something done without having to worry about being disturbed. Keep in mind that if you get up earlier you should go to bed earlier as well.
  • Keep a daily journal on the most important tasks you want to accomplish that day and review them before going to bed, Benjamin Franklin used to ask himself two questions:
    • The morning question: “What good shall I do this day?”
    • The evening question: “What good have I done today?”

Here are some more links:  

Stoicism:

Shortness of life book
Seneca  The Younger Literature – Free
How to be a Stoic – New Yorker
Tim Ferriss
Brainpickings
Daily Stoic
Farnam Street – Seneca on The Shortness of Life
STOICISM – ON THE SHORTNESS OF LIFE BY SENECA | ANIMATED BOOK REVIEW

Time:
Time hacks: Wait But Why? 100 Blocks a day
Farnam Street – Seneca on saving time

Don’t Say ‘Maybe’ If You Want To Say ‘No’
The importance of saying NO:
https://sivers.org/hellyeah

Other:

Brain Pickings – Daniel Gilbert Happiness Future Self

Ted Talks – Dan Gilbert you are always changing

Farnam Street – On Shallowness

Manuel Domínguez Sánchez, The suicide of Seneca (1871), Museo del Prado

*The Economist Feb 11-17 2017 The Attention Economy – Mass Entertainment special report

**The Economist Feb 11-17 2017 TV and Video – Mass Entertainment special report.

Purpose of this blog

What is the purpose of this blog?

Initially, the intention was to share content related to investing.There is no shortage of content and topics to share and post; from value investors, investing websites, videos, podcasts, investing tools, etc. While collecting the material and preparing it to post online I realized that it wasn’t going to add any value to the blog, not for myself nor the visitors. If someone wanted for instance to find out more information regarding a value investor they could go to other websites such as Valuewalk, Investopedia, Wikipedia and dozens of other websites/blogs…or simply Google the investor’s name.

The same goes for sharing content; video’s, articles, podcasts and posting it as ‘Weekly Kaizen’, what good does it do when it’s just a collection of links? So I decided to go back to the basics: writing.

The blog post writings will be on my thoughts/ views on a wide variety of topics related to investing or gaining wisdom. This could be on philosophy (Stoicism), summaries of books/articles or analysis on companies/sectors.

What makes writing so important? Writing helps to validate your thinking process to make sure you understand the related topic/ experiences.
Quoting Dr. Paul Kalanithi from ‘When Breath becomes air’ on the reason to write:

‘I felt that to understand my own direct experiences, I would have to translate them back into language. Hemingway described this process in similar terms: acquiring rich experiences, then retreating to cogitate and write about them. I needed words to go forward.’

Furthermore, it is one of the most overlooked traits of great investors in that they are excellent communicators:

Look around at some of the best investors of all time and you’ll see a common denominator: They are excellent communicators.

Warren Buffett – amazing writer.
Charlie Munger – amazing writer.
Ben Graham – amazing writer.
Seth Klarman – amazing writer.
John Bogle – amazing writer.
Joel Greenblatt – amazing writer.
Howard Marks – amazing writer.
Jim O’Shaughnessy – amazing writer.
(source: http://www.collaborativefund.com/blog/the-most-overlooked-trait-of-investing-success/?__s=mhnosisgskbqpa42mnzs)
Consistency in writing (posting blog posts) will be key. Yes I will make mistakes, in grammar, thinking processes, analysis, and more. I will read back articles that I wrote and disagree with myself or be embarrassed that I wrote something like that down. That’s ok, as long as it will make me a better writer and investor. There is nothing wrong with making mistakes and sharing them, it will help me not to repeat those mistakes. Warren Buffett is famous for openly sharing his thoughts and mistakes, and he is one of the greatest investors of all time.

Consistency by a great love of the work.