How to think like an investor
This year's recommended books offer sage advice for turbulent times. Part 2 focuses on the wisdom of some of the best investors.
By Vitaliy N. Katsenelson
I originally wrote this list in 2008 and again last year. I intend to keep adding to and revising it every year. This is the second of seven parts in this year's list. Read Part 1 here. Part 3 will be out on Monday.
The following books should help you to think like an investor, forcing you to think beyond stock tickers and focus on what is under the hood: the businesses and the people who run them.
The first book is "The Essays of Warren Buffett," a compilation of Warren Buffett’s annual letters to shareholders dating back to the 1970s. As you might expect, Buffet’s annual reports themselves, are fairly repetitious. His wisdom doesn’t vary that much from year to year. This book organizes main concepts and removes annoying redundancy.
"You Can Be a Stock Market Genius" by Joel Greenblatt is one of those books that should be read more than once. Greenblatt shares unique approaches to finding undervalued stocks. On top of being a very good investor, Joel has a healthy sense of humor. Joel also has written "The Little Book That Beats the Market." 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 and the possibility to grow earnings quickly. Here is the book’s Web site, which provides a weekly list of stocks that score high on both measures.
"Margin of Safety" by Seth Klarman is another gem.
Unfortunately, you won’t find this book in book stores. It is out of print, and it occasionally sells on eBay for thousands of dollars. This book lacks Greenblatt’s humor, but it is full of Buffett-like lucidity, and it is a must-read for anyone who is serious about value investing. In fact, even though Joel Greenblatt receives the credit for identifying and popularizing spinoffs as an often-mispriced subset of stocks, Klarman dedicated a good portion of a chapter to spinoffs in his book, which was published eight years earlier than Greenblatt’s.
Klarman talks about how investors’ time horizon has shrunk over the years:
"Like dogs chasing their own tails, most institutional investors have become locked into a short- term, relative-performance derby. … The short-term orientation of money managers may be exacerbated by the increasing popularity of pension fund consultants. These consultants evaluate numerous money managers, compare their performances, contrast their investment styles, and then make recommendations to their clients. Because their recommendations can have a significant influence on the health of a money management business, the need to impress pension fund consultants may add to the short-term performance pressures on money managers."
Since Klarman wrote his book in 1991, the investment industry has gotten even worse. The precipitous cost decline of micro processing and color printers’ ink has elevated the influence of consultants over the investment industry to absurd levels. Armed with Modern Portfolio Theory – a Nobel Prize-winning framework, consultants now port alphas and deport betas. Unfortunately, in the process of quantifying the unquantifiable to the precision of a basis point, common sense was lost.
Though they hide behind Greek symbols and fancy, colorful presentations, these are the same folks that persuaded their gullible pension fund clients to allocate a greater portion of their assets to “growth” stocks in late 90s, real estate and alphabet soup investments in mid 2000s, and long-term treasuries today. These people are always chasing the latest fad.
In this consultant-infested environment, a long time horizon is a competitive advantage.
"The Super Analysts" by Andrew Leeming is a book few people may have heard of. The author interviews successful investors (not academics), and they discuss their approach to investing and their analyses of common stocks and of some specific industries.
"Pilgrimage to Warren Buffett’s Omaha" by Jeff Matthews is not another biography of Warren Buffett, but rather the most insightful, critical, 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.
Finally, I also recommend "The Little Book That Builds Wealth" by Pat Dorsey. Michael Porter wrote "Competitive Strategy" a few decades ago, and it quite deservingly it turned into a bible of industry analysis that is taught in all business schools and management programs.
Pat Dorsey adopted Michael Porter’s concepts into this little book and applied them directly to investing. To be honest, if this book had been out when I was teaching my investment class, I’d be using it instead Porter’s – sorry, Michael!
Vitaliy N. Katsenelson, CFA, is Chief Investment Officer at Investment Management Associates in Denver, Colo. He is the author of Active Value Investing (Wiley, 2007) and the upcoming The Little Book of Sideways Markets (Wiley, December 2010). To receive Vitaliy’s future articles by email, click here or you can read them on ContrarianEdge.com.
Copyright Vitaliy N. Katsenelson 2010. This article may be republished only in its entirety and without modifications.
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