Sanity for your investing bookshelf
In times like these, consulting calmer experts can keep you focused. Here are some you should spend some time with.
By Vitaliy N. Katsenelson
In crazy times like these, all one can and actually should ask for sanity. Yes, sanity -- a clear mind free of noise to deal with the insanity that is thrust upon us by that volatile noise-making machine also known as the stock market.
We find ourselves glued to computer screens or CNBC waiting to find out what the Dow’s next tick is going to be. Unfortunately, we're often left with only a headache and wasted time.
Here is my advice: read. Read books that will bring you sanity, ones that will snap you back into the shell of investor and out of the sorry shell of nervous observer of daily stock market melodrama, ones that come with plenty of sanity and sage advice.
I wrote a list of recommended books for investors last year; recently I updated it and added a few more. I hope to add to it every year. It contains six sections: Selling, Think Like an Investor, Behavioral Investing, Economics, Stock Market History and Books for the Soul.
I’ll start with "It's When You Sell That Counts," by Donald Cassidy. Selling is usually as popular as candy the day after Halloween. During secular bull markets, selling is frowned upon as buy and hold turns into an investing religion. Since sell violates the “hold” covenant of that religion, the investor who buys and sells is labeled as a nonbeliever, or even worse, a trader (say “trader” fast enough it sounds like “traitor.”)
In secular bull markets, on average, sell decisions are not as rewarding as hold decisions, as market valuations are expanding and even second-rate dogs (stocks) start looking like pedigreed cocker spaniels. Every investor is a “long-term” investor, and sell becomes a four-letter word. But being a long-term investor is not about the longevity of your hold decisions; rather, it is an attitude. Holding a stock just because you bought it is a fallacy; you should only hold a stock if future risk-adjusted return warrants it.
Warren Buffett has been mistakenly promoted (or, I’d argue, demoted) into deity status in this buy-and-hold temple. But let’s correct this mistake. Warren Buffett became a buy-and-hold investor when his portfolio and positions got big enough, pushing $60 billion, that selling became a difficult undertaking. In his early career, before “Oracle of Omaha” was his moniker, he was a buy-and-sell investor. Being on the boards of some of his biggest holdings (like Coke and Washington Post) made selling even more difficult.
One doesn’t need the benefit of hindsight to know that, at 55 times earnings, Coke was tremendously overvalued in 1999. Coke, like the majority of Buffett’s top public holdings, did not go anywhere for a decade. I dare you to take a look at his top public holdings and tell me whether he would have done a lot better if he had sold them when they became fully valued (or slightly overvalued). In most cases, that would have been a decade ago.
Emotions assault us from different directions when we face a sell decision: If it is a losing investment, we want to wait to break even. This is the wrong attitude. Our purchase price and sell decision should not be related (the only exception I can think of is tax selling). Or when it comes to selling a winner, we want to sell only at the top. Again this is the wrong attitude: the top is only apparent in hindsight, when it is usually too late.
We should sell a stock when it reaches our price or valuation target, determined at the time of purchase. We (our emotions and false goals to be exact) are our biggest enemy when it comes to investing, and especially selling. Cassidy’s wonderful book can help us fix this. Its objective is to recalibrate your mind and free you from the imprisonment of past decisions, to break you free from the buy-and-hold state of mind and turn you into a buy-and-sell investor.
OK, this is a bit of a long introduction to a book, but it’s a terrific and a very important work. A proper sell discipline can be the difference between great or mediocre returns for even the best-crafted buy decisions. Pros may want to skip a few chapters, but it is an important read for everyone, especially in today’s environment.
Think and behave like an investor
The following books should help you to think like an investor, forcing you to think beyond ticker symbols and focus on what is under the hood: real businesses and the people who run them.
The first one is "The Essays of Warren Buffett." It’s a compilation of Buffett’s letters to shareholders from annual reports dating back to the 1970s. Before this book came out (or at least, before I was aware of its existence), I had my graduate students at University of Colorado read Buffett’s annual reports, which as you may expect were very repetitious. His wisdom doesn’t vary that much from year to year. This book organizes main concepts and removes annoying redundancy.
Another good book is "The Entrepreneurial Investor," written by my friends at West Coast Asset Management. It accomplishes many objectives of Buffett’s essays, plus has plenty of cultural references, humor and common sense. All of these things make it a fun and enjoyable read. I made this book suggested reading in my graduate investment class.
"The Super Analysts" by Andrew Leeming is a book I think few people have heard of. The author interviews successful investors (not academics), and they discuss their approach to investing and analysis of common stocks and some specific industries.
"You Can Be a Stock Market Genius" by Joel Greenblatt is one of those books that should be read more than once. Joel shares very unique approaches about how to find undervalued stocks. On top of being a very good investor, he has a healthy sense of humor. Joel also has written "The Little Book That Beats the Market." I plan to read this book with my son when he gets older, as it is a great introduction to investing. At the end of the book, Joel offers a “magic formula,” a screen that has beaten the market over a long period of time.
The magic screen is very simple: buy low price-to-earnings stocks that have a high return on capital. Low P/E is an indication of cheapness, while high return on capital is an indication of competitive advantage (at least in the past) and the possibility to grow earnings at high rates. Here is the book’s Web site, which provides a weekly list of stocks that score high on both measures.
"The Business of Value Investing" by Sham Gad. Wiley sent me the manuscript to review, and it happened to arrive on my birthday in June. I opened the manuscript when guests showed up at the door; I set it on the kitchen table. My niece, a recent graduate from business school who has little interest in investing, picked it up and I did not see her for the whole evening. She loved it! It is hard to make value investing interesting, but Sham did. I’ve read it too, and thought it was an excellent introductory book to value investing.
"Pilgrimage to Warren Buffett's Omaha" by Jeff Matthews. This is not another biography of Warren Buffett, but rather the most insightful and critical (fair and balanced) analysis of Buffett and Berkshire I’ve ever read. I also encourage you to read Jeff’s musings on his blog; I’ve been reading it for years.
"The Little Book That Builds Wealth" by Pat Dorsey. Michael Porter wrote "Competitive Strategy" a few decades ago; quite deservedly it turned into a bible of industry analysis at all business schools and taught in all management programs. Pat Dorsey took Michael Porter’s concepts and in this very little book applied them directly to investing. To be honest, if this book had been out when I was teaching my investment class, I’d have used it instead Porter’s (sorry Michael), as it is written for investors.
"More Mortgage Meltdown: 6 Ways to Profit in These Bad Times." This book was written by Whitney Tilson and Glen Tongue, who are excellent investors. I’ve seen the presentation that is the core of this book, presented by Whitney and Glen, several times; in fact you can download the latest version here. Investment ideas of how to profit from today’s crisis have already played out for the most part, so this book will not give you fish, but understanding the analytical process will teach you how to fish.
Vitaliy N. Katsenelson, CFA, is a portfolio manager/director of research at Investment Management Associates in Denver, Colo. He is the author of "Active Value Investing: Making Money in Range-Bound Markets" (Wiley 2007). To receive Vitaliy's future articles by e-mail, click here.
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