Tag Archives: learning

For The Love Of The Game: How To Keep Learning In The Market

Summary This is a philosophical piece intended to help young aspiring analysts. I will share my mistakes and lessons learned on the buy side. I will briefly discuss Cheniere Energy. This is a philosophical piece with two goals in mind: To inspire young aspiring analysts, and to share the multitude of career mistakes that I made. With the benefit of hindsight and reflection, I know others can benefit from my self-inflicted missteps. Given the significant amount of time I spend engaged on the Seeking Alpha website, I am noticing more and more talented authors. For some of the folks more junior in their careers ascents or for aspiring analysts trying to make it into the research arena, I think my experience and unique observations may benefit them. So, in the spirit of trying to help others, I sincerely hope to pass the baton and impart some insights that may benefit them as they progress in their careers. The Power of Mentors For context, I will provide my brief background and relevant professional investment research experience. During my undergraduate days, I attended the Isenberg School of Management at the University of Massachusetts at Amherst. I was passionate about investing since middle school, as my dad sparked my intellectual curiosity. While at UMass, I gained access to an alumni list and then emailed as many people in the industry as possible. After getting a response, I would then call them, usually early in the morning, before their hectic day’s beginning. So here I was talking quietly in the dorm room hallways (trying not to wake up my floor at 7 am). As I had virtual no industry contacts, this was the best strategy. However, long on confidence, I was convinced that I was the next up-and-coming star analyst and I only needed to be discovered. From that point, I would land a junior analyst role. Not only I was incredibly naïve, but I had an exalted sense of self, which was unwarranted and unhelpful. However, nice alumni looked past this misplaced arrogance and focused on my passion. Through these calls, I was able to connect with many smart and talented UMass alumni who were actual market participants on the buy side. One individual was, and still is, a portfolio manager at prestigious Wellington Management. He is piercingly bright, very generous with his time, and passionate about helping UMass alumni learn about investing. Although I haven’t been in as close contact with him lately, he was extremely influential in my progress and evolution as an investor. I have one other mentor, whom I originally connected with on LinkedIn in 2004. This was a period between jobs, and I was still questing for that elusive foothold on the buy side. This individual is currently an equity portfolio manager at Alpine Funds. Yes, he has the shiny credentials of a top MBA and CFA, but more importantly, he is a great investor and extremely hardworking. He and I have been friends through email since 2004, and we constantly trade investment ideas via email. Over the course of thousands of email exchanges, my writing and thought process continued to improve. Specific investment lessons from these two mentors For context, my mentor at Wellington is a portfolio manager at Wellington, and manages international equity growth funds with approximately $4 billion in assets under management (AUM). Over the course of our friendship and multiple email exchanges, he explained (using the Socratic method) how growth stocks work. He said that the only thing that matters is consensus earnings estimates. In order to take a position in any equity, you need to qualitatively and quantitatively understand how the market arrived at current consensus estimates. If, and only if, you deeply study the company and build your high-level models that capture the major drivers of revenue and earnings can you have an opinion. Never, never, never have a strong opinion on a stock unless you have really done the work. The fastest way to get dinged during an interview on the buy side is to come across long on opinion and short on analysis. It is always better to say “Here is what I have read, and here is how I think about it, but perhaps I am missing certain angles.” It is much better to informed and humble than arrogant and overly confident, especially when speaking with actual market participants. He then taught me that many people fall into the trap that a stock is overvalued because it has a high P/E ratio compared to the market or its sector. With the supercomputers of today, crunching ratios is a waste of time, as it is fully reflected in the stock price, given that the market is very efficient at incorporating actual events. Again, you have to understand consensus estimates better than the Street. If your model and work are materially different from the consensus, only then should you make a bet. For a concrete example, over the course of a few emails, he walked me first-hand through why in mid-2003 Research in Motion, now BlackBerry (NASDAQ: BBRY ), was his largest holding. I think BBRY’s stock ultimately ended up increasing by 5,000% from 2003 to 2007. If any reader cares to do some searching on Google, they will find that the vast majority of then-leading experts thought BBRY was going to zero. They saw that they were losing money and also saw the company’s cash burn, and erroneously assumed that BlackBerry had nothing noteworthy in its pipeline. Now, my mentor will freely admit that he happened to have met with management (that is a major advantage of being a professional money manger – access to management teams to kick tires). During his visit to BBRY’s corporate HQ, he was able to work out first-hand how technologically advanced the company’s products were, and envisioned their appeal to chief technology officers in the Fortune 500. He also understood the huge addressable market, the potential margins on the handsets, the security features of its product, and that BBRY was really a great software company. Had I known then what I know now, I would be retired at age 35 if I had put on a concentrated long bet on BBRY and simply held it for four years. Clearly, I wasn’t wise enough to understand that I was handed a lottery ticket with winning numbers on it. (click to enlarge) My mentor from Alpine Funds has also taught me a great deal. Once a new investor gets up to speed on the core blocking and tackling, like being able to read financial statements and the basics of accounting, the best way to make money is to develop a great imagination. Stock prices will rise or fall past on their future cash flow and revenue growth relative to consensus estimates. For another vivid example, in 2004, this mentor of mine walked me through his largest holding in his personal account, Silver Wheaton (NYSE: SLW ). If I recall, SLW was then a $4 stock. He explain to me that he was very bullish on silver, and that this was the best vehicle to participate in silver’s ascent. He explained how silver was a by-product, and mining is extremely CAPEX-intensive, so producers who are targeting gold or copper are willing to sell their silver by-product production (or silver streams) for an upfront payment and then for a low price of $4 per ounce. The producers would then use the upfront payment to fund their CAPEX. Silver Wheaton eventually traded as high as $50 in May 2011, though it was a bumpy ride, with the stock dropping down to $2.50 during the 2009 equity crash. My mentor also emphasized the importance of being willing to take a contrarian stance if you have enough conviction in your idea. When he was traveling the hedge fund circuit, as he had two stints as a hedge fund analyst, he learned the importance of managing your downside risk, but also that betting big when the risk/reward was greatly in your favor. Although he was capable enough, he determined that the hedge fund world didn’t suit his personality and investment process. This is my long-winded way of stating that mentors are invaluable. They will encourage you, push you, and if you put in the effort, they will help you become a better investor. I am still in constant contact with my friend at Alpine Funds. I distinctly remember when he once told me, “My wish for you is that you greatly surpass my as an analyst.” That illustrated to me that he was invested in my success, and he was humble enough and had had the benefit of mentors while he was in his formative stages. Don’t get into fights with your boss My next piece of advice is that if you do make it to the buy side, know your role and keep your ego in check. Although the barriers to entry are very steep, just because you made the team doesn’t mean you can’t get cut. Despite an insatiable curiosity and undeniable passion for investing, my ego and poor semantics while expressing my investment ideas wrote proverbial checks that I couldn’t cash. The collective bill came due when I couldn’t meet the proverbial margin call. My five years of solid performance and exemplary annual reviews were marred by aggressive and arrogant interactions with senior analysts. No one want to be told they are wrong and that their thesis is wrong, especially from a 29-year old. You can’t tell your boss that you think you are a better investor than him. This is a career-limiting move, trust me. So the takeaway is that if you can surmount the incredibly high barriers to entry, take it slow, listen, observe and ask questions. Investing isn’t like the NFL, it isn’t a pure meritocracy. You have to work hard, learn, be likeable and keep your head down. If folks sense that you are not a team player (however misplaced this label may be), your career at that shop is effectively over. Know yourself Beside the fact that I didn’t have the right temperament for Liberty Mutual, you have to know yourself. Reflecting upon my five years at Liberty, I probably knew it wasn’t the right cultural fit in year three. However, don’t do the impulsive Jerry Maguire letter and then quit, as this is terrible career mistake that has to be explained away in future interviews. There are exceptions, but the buy side generally requires a CFA, Ivy League education (at least on the equity side), lots of networking, and even more luck to find your foothold. Although I made it into the industry, I only advanced to the bottom rungs of the ladder. There is an alternative pathway. There are excellent open source sites like Seeking Alpha, and different ways to make a living. However, this is the path less traveled, and it will invariably take years of building your brand, developing a portfolio of great research as evidence, and getting the marketing aspect right. There are members of the Seeking Alpha community who have successfully done this, so they would be a much better resources. I only write articles in my free time as a hobby. The Power of Redemption Moving along, let me power down my philosophical side of my brain, and let’s talk about one of my recent investment ideas written here on Seeking Alpha that seems to be playing out. I want to specifically highlight two investment pieces that I wrote recently on Cheniere Energy (NYSEMKT: LNG ). The point of bringing this up is that through the comments section of my first article, the Seeking Alpha community inspired me to improve upon my first article that some labeled incomplete. I viewed this as constructive criticism and an opportunity to dig deeper and write a follow-up article. Incidentally, my original thesis seems to be playing out, as Mr. Chanos disclosed a new short position in shares of Cheniere. However, I am not spiking the football on the one-yard line, as the stock has now become a battleground stock between the bulls, including investing greats like Seth Klarman and Carl Icahn, and the bears, like Jim Chanos. I have done a lot of research on the company and have shared my bearish view on the site. Again, I’m not writing to gloat, but simply suggesting that if we are passionate about our craft, we can make good investment calls. Of course, the buy side has its advantages of access to management team and access to many research publications. However, with the power of Google and some intellectual curiosity, you want produce compelling work. I can’t tell you the last time I read a sell side report. As a general rule, I completely ignore sell side research, as I like to do my own research. Moreover, when an idea finally works and it gets recognized by the market, it brings a great feeling of satisfaction and even redemption for hobbyists like me. To sum up Mr. Chanos’s bearish arguments: There will be massive global overcapacity in the LNG space. LNG is priced based on Brent prices, and Brent has collapsed from $110 to $50, so incremental new long-term supply agreements will be less lucrative. The industry is plagued by massive cost overruns (look at Chevron’s greenfield projects). Cheniere’s contracts aren’t sacrosanct. The company is way too promotional and has yet to sell any LNG. Its capital structure and executive compensation polices leave much to be desired. Concluding Thoughts Investing is more of an art than a science once you understand the fundamentals. For aspiring analysts: Find great mentors, don’t get in fights with your boss and know yourself. Investing is an extremely humbling pursuit; therefore, savor your victories, because they can be fleeting. Good luck, and thanks for reading. Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. (More…) I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.

The 7 Deadliest Words Of Investing And Why You Are Not Smarter Than The Average Bear

Summary Stay away from these 7 deadly words that we tell ourselves. See how investors can be classified into three types of lemmings. Discover a simple concept of what valuation really is to an investor. I’m a valuation nut. The methods I choose are not perfect because valuation involves art and science. But then again, what is the perfect valuation method? There’s no such thing. And that’s difficult for many people to grasp because we are taught to do things the “right” way, a “certain” way. One of the most difficult things with investing and any form of valuation is that there is no step by step guide. In any other industry there’s a clear process that you can follow from start to finish to accomplish a task Ikea furniture assembly instructions Photography tutorials How to tie a tie Learning to hang glide and so on But investing is like a choose your own adventure book that I loved to read growing up. A choose your own adventure book is one where you come to a section of the book and then get to choose which adventure you want to take. Depending on your choices, the ending is different. When it comes to investing, there is no clear single method of doing things and it can overwhelm, and frankly, freaks out some people. Instead of a straight path from A to B, the waves of decisions and new information you have to take in requires lots of work. And it’s too much for many people. That’s why you always see people asking strangers what their thoughts are on a stock they hold. But the truth is that people can invest successfully. People can value stocks properly. You’re just led to believe you can’t. It’s just that there are a ton of blogs, news and articles that discuss complex ideas, causing people to simply walk by obvious low risk ideas. I call these low hanging fruits. Bloggers, news reporters, financial analysts all want to write about the hard stuff to get recognized. The complex deals. Who wants to write about how a small, well run, industrial niche company in Nashville, with a 70 year long heritage that continues to gain business and generate cash when less than 400 people on the Internet will read it? Instead they could be writing about how Tesla (NASDAQ: TSLA ) is reinventing the auto industry and revolutionizing a new energy era, poring over PHD words and speculating about what the future could bring. It could go viral and look good on their writing stats. But… You’re led to believe that they must know something that you don’t. The 7 Most Deadly Words in Investing This is a video that I refer to now and then when I need to clear my head or when I start second guessing myself. I’ve marked the video to start from 1:57. Watch the next 2 minutes to around the 3:50 mark. Did you catch those 7 deadly words? They must know something that you don’t. If seasoned professionals fall into this trap, how much easier is it for regular investors to tell themselves the same thing? Especially when they read or hear people they regard as more intelligent as themselves disagreeing with their analysis and valuations. If you didn’t or can’t watch the video above, Prof Aswath Damodaran lays out a simple example that I certainly relate to. You value a company. Say you come up with a value of $50 per share. Let’s say the company is Amazon. Stock is trading at $278. One of the great stocks of the last decade. Your rational side is saying, “don’t buy that stock, it’s expensive”. But then you hear a voice at the back of your head. “They must know something that you don’t”. And when you hear that voice, magical things happen to your valuation. Your cash flows increase, your growth rates go up, your discount rates go down, $50 becomes $100, $100 becomes $150, and before you know it, guess what? You’re at $275, $300, justifying your need to buy. 3 Types of Lemmings Damodaran continues on to group investors into 3 groups of lemmings. After all, we are all lemmings to some degree. There is no such thing as a pure contrarian, because that just means you are a contrarian just for the sake of being a contrarian. Lemming #1: The Proud Lemming These are just momentum investors who are proud of following what’s hot. They don’t care what the company is or does. They look for a crowd and buy and sell whatever is being bought or sold. Lemming #2: The Yogi Bear Lemming Yogi Bear’s tagline is “smarter than the average bear” and it refers to the investors who like to think that they are able to pull out of a stock just before it crashes. The problem is that most people claim they are smarter than the average bear, but rarely are they able to jump ship of a momentum train before it crashes. If Isaac Newton, the father of advanced mathematics and mechanics couldn’t handle the charts, market and lemming fever, I have serious doubts about most of us. Isaac Newton Became a Lemming ( Photo Credit: Safal Niveshak ) Lemming #3: The Lemming with a Life Vest Valuation is simply a life vest. A compass. It’s something for you to hang onto when everyone else is doing something else. Buffett knew that dot com stocks were at stupid valuations in 2000 and held onto his life vest when Barron’s basically called him “old”. After more than 30 years of unrivaled investment success, Warren Buffett may be losing his magic touch. … To be blunt, Buffett, who turns 70 in 2000, is viewed by an increasing number of investors as too conservative, even passe. Buffett, Berkshire’s chairman and chief executive, may be the world’s greatest investor, but he hasn’t anticipated or capitalized on the boom in technology stocks in the past few years. Indeed, Buffett has even started taking flak on Internet message boards. One contributor called Berkshire a “middlebrow insurance company studded with a bizarre melange of assets, including candy stores, hamburger stands, jewelry shops, a shoemaker and a third-rate encyclopedia company [the World Book].” – Barrons I just love how Damodaran puts it because it’s exactly how I process it. Valuation slows the process down, gives your rational side a chance to mount an argument. Valuation is Simple. Don’t Complicate It. When you value stocks, you miss out on hundreds of opportunities. Most growth stocks go out the window. Forget about Tesla. Most investors don’t want to hear about valuation because it challenges their desire to hear what they want. But I love valuation and it’s the reason why the OSV Analyzer came to life in the first place. I love it and over 800 members have made great use of it because when facts and numbers over the past 5 years or 10 years are smack in front on your face, it’s difficult to trick yourself. Unless I can find a reason for why I have to increase my valuation from $50 to $300 without solid evidence, it’s easy to recognize I’m fooling myself. I could go into 101 reasons why everyone should use the analysis tool, but the more important thing is to start building a habit of valuing stocks. Investing is a game where you don’t win by making all the right calls. You can be right only 40% of the time. But if your conviction and position sizing is good, you can easily beat anyone out there. When I start chasing complicated stories, structures, deals, industries that I know nothing about, I’ve lost money every time. When I focus on valuation and follow it up with patiently waiting until the stock hits my margin of safety price, I’ve been rewarded more times than I’ve been wrong. You Can Win the Fight As a freebie, I have free valuation spreadsheets you can start with. It’s combined with an easy to digest mini valuation courses over email if you are a new subscriber. Just easy guides on how to value and analyze stocks using several different methods. Charlie Munger said that if he knew where he was going to die, he’d never go there. Well, you’ve just found the 7 deadliest words in investing. They must know something that you don’t. Let’s not go there. Disclosure: The author has no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. (More…) The author wrote this article themselves, and it expresses their own opinions. The author is not receiving compensation for it. The author has no business relationship with any company whose stock is mentioned in this article.

Learning From The Past

I wish I could tell you that it was easy for me to stop making macroeconomic forecasts, once I set out to become a value investor. It’s difficult to get rid of convictions, especially if they are simple ones, such as which way will interest rates go? In the early-to-mid ’90s, many were convinced that interest rates had no way to go but up. A few mortgage REITs designed themselves around that idea. Fortunately, I arrived at the party late, after their investments that implicitly required interest rates to rise soon, fell dramatically in price. I bought a basket of them for less than book value, excluding the value of taxes that could be sheltered in a reverse merger. For some time, the stocks continued to fall, though not rapidly. I became familiar with what it was like to go through coercive rights offerings from cash-hungry companies in trouble. Bankruptcy was not impossible… and I burned a lot of mental bandwidth on these. The rights offerings weren’t really good things in themselves, but they led me to buy in at a good time. Fortunately I had slack capital to deploy. That may have taught me the wrong lesson on averaging down, as we will see later. As it was, I ended up making money on these, though less than the market, and with a lot of Sturm und Drang. That leads me to my main topic of the era: Caldor. Caldor was a discount retailer that was active in the Northeast, but nationally was a poor third to Wal-Mart (NYSE: WMT ) and KMart. It came up with the bright idea of expanding the number of stores it had in the mid-90s without raising capital. It even turned down an opportunity to float junk bonds. I remember noting that the leverage seemed high. What I didn’t recognize that the cost of avoiding issuing equity or longer-term debt was greater reliance on short-term debt from factors – short-term lenders that had a priority claim on inventory. It would eventually prove to be a fatal error, and one that an asset-liability manager should have known well – never finance a long-term asset with short-term debt. It seems like a cost savings, but it raises the likelihood of insolvency significantly. Still, it seemed very cheap, and one of my favorite value investors, Michael Price, owned a little less than 10% of the common stock. So I bought some, and averaged down three times before the bankruptcy, and one time afterwards, until I learned Michael Price was selling his stake, and when he did so, he did it without any thought of what it would do to the stock price. Now for two counterfactuals: Caldor could have perhaps merged with Bradlee’s, closed their worst stores, refinanced their debt, issued equity, and tried to be a northeast regional retail player. It didn’t do that. The investor relations guy could have given a more understanding answer when he was asked whether Caldor was having any difficulties with credit lines from their factors. Instead, he was rude and dismissive to the questioning analyst. What was the result? The factors blinked and pulled their lines, and Caldor went into bankruptcy. What were my lessons from this episode? Don’t average down more than once, and only do so limitedly, without a significant analysis. This is where my portfolio rule seven came from. Don’t engage in hero worship, and have initial distrust for single large investors until they prove to be fair to all outside passive minority investors. Avoid overly indebted companies. Avoid asset liability mismatches. Portfolio rule three would have helped me here. Analyze whether management has a decent strategy, particularly when they are up against stronger competition. The broader understanding of portfolio rule six would have steered me clear. Impose a diversification limit. Even though I concentrate positions and industries in my investing, I still have limits. That’s another part of rule seven, which limits me from getting too certain. The result was my largest loss, and I would not lose more on any single investment again until 2008 – I’ll get to that one later. It was my largest loss as a fraction of my net worth ever – after taxes, it was about 4%. As a fraction of my liquid net worth at the time, more like 10%. Ouch. So, what did I do to memorialize this? Big losses should always be memorialized. I taught my (then small) kids to say “Caldor” to me when I talked too much about investing. They thought it was kind of fun, and I would thank them for it, while grimacing. But that helped. Remember, value investing is first about safety, and second about cheapness. Cheapness rarely makes something safe enough on its own, so analyze balance sheets, strategy, use of cash flow, etc. This is not to say that I did not make any more errors, but this one reduced the size and frequency. That said, there will be more “fun” chapters to share in this series, because we always learn more from errors than successes. Disclosure: None.