Let’s Start with Safal Niveshak
Here are some useful posts from Safal Niveshak archive which you might want to read again…
- To index or not to index – that is the question. Here’s why we don’t invest in index funds.
- When it comes to investing, Surfing is an important mental model that every investor should be thinking about for picking stocks.
- Network effect is an important attribute to look for while evaluating the presence of economic moat.
- We do things for people we like, because it’s a natural reciprocation to being liked. A mental model from psychology – Liking Bias.
Mohnish Pabrai’s The Dhandho Investor is one of the simplest books I have read on value investing. Pabrai has a knack for simplifying complex sounding ideas. If there is anybody else, other than Warren Buffett, who can simplify things down to the level of a layman, it’s Mohnish Pabrai.
Warren Buffett says, “I don’t look to jump over 7-foot bars: I look around for 1-foot bars that I can step over.” So the way Buffett deals with difficult problems is to avoid them altogether. That’s a very simple approach. But it’s easier said than done.
And here’s what Pabrai writes in his book –
Every business has an intrinsic value, and it is determined by the same simple formula. John Burr Williams was the first to define it in his The Theory of Investment Value published in 1938.1 Per Williams, the intrinsic value of any business is determined by the cash inflows and outflows—discounted at an appropriate interest rate—that can be expected to occur during the remaining life of the business. The definition is painfully simple.
…while John Burr Williams’s definition of intrinsic value is painfully simple, calculating it for a given business may not be so simple.
The Dhandho way to deal with this dilemma is painfully simple: Only invest in businesses that are simple—ones where conservative assumptions about future cash flows are easy to figure out. What businesses are simple? Well, simplicity lies in the eye of the beholder.
Simplicity is a very powerful construct. Henry Thoreau recognized this when he said, “Our life is frittered away by detail . . . simplify, simplify.” Einstein also recognized the power of simplicity, and it was the key to his breakthroughs in physics. He noted that the five ascending levels of intellect were, “Smart, Intelligent, Brilliant, Genius, Simple.” For Einstein, simplicity was simply the highest level of intellect. Everything about Warren Buffett’s investment style is simple. It is the thinkers like Einstein and Buffett, who fixate on simplicity, who triumph. The genius behind E=mc2 is its simplicity and elegance.
Everything about Dhandho is simple, and therein lies its power…the psychological warfare with our brains really gets heated after we buy a stock. The most potent weapon in your arsenal to fight these powerful forces is to buy painfully simple businesses with painfully simple theses for why you’re likely to make a great deal of money and unlikely to lose much. I always write the thesis down. If it takes more than a short paragraph, there is a fundamental problem. If it requires me to fire up Excel, it is a big red flag that strongly suggests that I ought to take a pass.
￼￼￼￼￼￼￼￼￼￼￼￼￼￼￼￼￼￼￼￼￼￼￼￼￼￼￼￼￼￼￼￼Before looking for such simple businesses, one should first check his or her own portfolio. If you find a stock in your current portfolio which can’t be explained in a short paragraph, it’s a warning signal.
May be you don’t understand your stocks well. If you don’t, why are you holding them?
Stimulate Your Mind
Here’s some amazing content we read in recent times…
- The behaviour you see is usually the result of incentives you don’t see. With ‘agency problem’ you need to take your thinking to second and third level. The distorting power of incentives.
- Second level thinking is essential for effective decision making process. Here’s an interesting example – why it’s a very bad idea to wipe mosquitoes off the face of the Earth.
- The Kingfisher chief may have fled India but he offers some valuable lessons for small investors. Anti-lessons from Vijay Mallya.
- An old but very useful article by Prof. Sanjay Bakshi. A primer on PE ratios.
This is the very first question you must answer before you get down to investing in the stock markets.
I am not asking whether you own stocks or bonds. The question here is – Are ‘YOU’ a stock or a bond?
Now before you answer that, let’s make sure we’re on the same page as far as the definitions of a ‘stock’ and a ‘bond’ are concerned.
What’s a bond? A bond guarantees a regular income (in the form of interest) and a confirmed payout at the end of a predefined time. Whereas a stock’s future performance is unpredictable. This is because a stock is backed by a company that has inconsistent earnings (in most cases) and subsequently inconsistent performance.
If we extend the same definition to evaluate ourselves, here’s how one should think.
You are a bond if you have a stable job that is unaffected by the volatility of the stock markets. And you have many years left to work. Which means you’re young and/or work as a banker, doctor, government employee, teacher, or a professor.
On the other hand, you are a stock if you don’t have many years of work ahead of you, or if you work in a volatile and unpredictable field that could decline quickly with little notice (like the stock markets itself!). In other words either you are close to retirement or work as investment bankers, economists, stock market analysts, fund managers, derivatives trader, financial advisors, or small businessmen.
So your age and your nature of primary profession/work defines whether you’re a stock or a bond.
Once you’ve answered this question for yourself, you can then decide whether you should invest in safe instruments like bank deposits (liquid or debt funds) or in stocks.
If you are a stock, make sure your savings and investments are tilted toward bonds.
On the other hand, if you discover that you’re a bond, make sure your savings and investments tilt towards stocks.
Simplify, simplify, simplify!
Stay happy and stay blessed.
Be kind to others, and to yourself.
Vishal & Anshul
simple and a useful.