I highly recommend this interview with Howard Marks.
Reflections on the Ten Attributes of Great Investors [notes]
Yesterday I read the report published by Michael Mauboussin called as this post title. Michael is Head of Global Strategy at Credit Suisse. I am fascinated with this report, all the common sense Michael share in it. Also, I would like to recommend the Alphaville podcast with the author.
About teaching:
Teaching imposes a discipline of understanding and communication that few other activities can—save perhaps writing. Inspirational teachers are also diligent students. So a commitment to teaching at a high level demands constant learning and consolidation of knowledge. There is the additional benefit of being around young people who are bright and challenging.
Actual time to be an investor:
As I like to tell my students, this is an exciting time to be an investor because much of what we teach in business schools is a work-in-progress.
Values:
I believe in economic value, the importance of constant learning and teaching, and that diverse input combined with rigor can lead to insight. This is all very consistent with what Charlie Munger, the vice chairman of Berkshire Hathaway, calls the “mental models” approach.
Michael divided his work into 10 attributes that great investors have.
- Be numerate (and understand accounting), Michael comments his favourites books:
Financial Shenanigans: How to Detect Accounting Gimmicks & Fraud in Financial Reports, Creative Cash Flow Reporting: Uncovering Sustainable Financial Performance, The Financial Numbers Game: Detecting Creative Accounting Practices, The Art of Short Selling. Financial statements have two goals: 1) translate financial statements into free cash flow and 2) find the link between company’s strategy and how it creates value.
- Understand value (the present value of free cash flow). Try to understand the magnitude and sustainability of free cash flow.
- Properly assess strategy (or how a business makes money). Two dimensions:
- How the company makes money.
- The competitive advantage when it earns a return on investment above the opportunity cost of capital and earns a higher return than its competitors.
- Compare effectively (expectations versus fundamentals). Human are quick to compare but not very good at it. Here Michael explains the “variant perception” concept, I first here about this concept in a well-know twitter account called @PlanMaestro. Variant perception definition: “He develops perceptions (intellectually sound investment thesis) which are at variance with the general market view. In other words, a view that is at odds with the prevailing Wall Street view. He will play those variant perceptions until he feels they are no longer so.”. Fundamentals are how fast the horse will run, and expectations are the odds.
- Think probabilistically (there are few sure things). Here the point is that you need to earn more when you are right versus when you are wrong, even if you are wrong more times than right.
- Update your views effectively (beliefs are hypotheses to be tested, not treasures to be protected). Open-minded, period.
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Beware of behavioural biases (minimizing constraints to good thinking). Here, Michael, presents Keith Stanovich’s idea between IQ (intelligence quotient) and RQ (rationality quotient). I save the name of the last book called The Rationality Quotient. IQ = “mental skills that are real and helpful in cognitive tasks” and RQ = “the ability to make good decisions”.
- Know the difference between information and influence.
- Position sizing (maximizing the payoff from edge).
- Read (and keep and open mind). Albert Einstein’s quote:”success comes from curiosity, concentration, perseverance and self-criticism”.
Multiples are not valuation but a shorthand for the valuation process. No thoughtful investor ever forgets that. Shorthands are useful because they save you time.
What I found more useful in this report is the following part. To peak performance as an investor, you need some factors. From left to right you can find it.
Selection.
Both Keith Stanovich’s work on IQ and RQ and Phil Tetlock’s work on superforecasting strongly suggest that there’s more to good decision making than traditional smarts measured through IQ. Qualities such as active-open mindedness, thinking probabilistically, an ability to update views frequently and accurately, and persistence are not well captured in tests. Even proxies for intelligence, such as graduating from an elite university, do not do the job.
Deliberate practice.
Done properly, deliberate practice is designed with a specific objective, requires timely and accurate feedback from a coach or teacher, entails substantial repetition, and is only viable for students who are motivated. Deliberate practice is not fun, but it is gratifying because the performance improvements are tangible.
Seth Klarman 2016 year-end letter
I have access to the 2016 year-end letter that Seth Klarman has shared with Limited Partners and stuff.
How important is Trump’s presidency that Seth divided the year between “Before” (44 weeks) and “After” Trump to share his view of the year. The first one was dominated by tepid economic growth, low-interest rate, rich valuations and relatively low volatility. Also, quantitative easing, QE-infinity and negative rate (quite nonrational IMHO).
The election was an inflexion point, “after“, post-election rally, winners and losers (of course, those in most influence Trump’s point of view will win more that the others).
Seth quote the last summer article called “It’s Getting Scarily Quiet in the Stock Market”, this article warned the complacency about the central banking, Seth’s point of view is that the central banks, with their policies, have increased the financial assets. Examples such as The market and Methuselah, Saudis bonds and Austria. The debt expansion was huge in 2016, IMF said last October that world debt is a real thread for 2017. A really good point is that last 35 years the modern world has been living in a bull market, low-interest rates and right now inflation is going up and interest will raise and not much of active managers have experience in this type of market. Seth is critical with this topic:
- Whenever interest rates return to more normal levels, these bonds will trade below price
- Inflation, if this comeback, these instruments will sell off further.
After
Animal spirits drove US stocks, election benefited infrastructure companies. News highs, especially shares of those companies expected to benefit most from lower taxes, expanded infrastructure spending, and deregulation. Post-election, interest rates jumped and bonds slumped in anticipation of policy changes and an acceleration in economic growth. As Trump promised, tax cuts and fiscal stimulus will cause higher corporate profits. Also, a relaxation of regulations is expected to boost the banking industry.
“Goldman Sachs notes that the S&P 500, in aggregate, recently traded at 85th percentile of its historical valuation over the last 40 years, while the median company in the S&P 500 had reached the 98th percentile of valuation”
The main point about Trump economy is that “may be able to temporarily hold off the sweep of automation and globalization, keeping jobs at home, bolstering inefficient and uncompetitive enterprises is likely to only temporarily stave off market forces[…] the U.S long ago abandoned protectionist trade policies is because they not only don’t work, they actually leave society worse off”.
For businesses and investors predictability it really importance to make assumptions, model performance and finds decisions. Elections matter, Trump will create investment opportunities and high uncertainty.
“A value investing approach is defensive by nature, emphasising preservation of capital through the purchase of investments with a margin of safety”.
In my opinion, the best part of the letter is the last one, when Seth explain that the key approach is to maintain conservative in weak markets. In top-down approach, you need to be right in the magnitude, path and timing.
The market is in bull market mode as we can see below.
Becoming Warren Buffet 2017 | HBO
Becoming Warren Buffett
I just watch it! It is a great documentary film about his life, most of the time he is talking about his family. I though the whole documentary will be about life/business related but it was a huge surprise that most of the time it was about his life.
This week Charlie Rose interviewed Warren and Bill Gates. Also a great talk.
2017: a value year?
Great interview by Estrategias de Inversión. If you understand Spanish you must watch this interview to María Dolores Solana, Fund Manager at Santander Asset Management. She has been managing the fund Santander Small Caps for more than 10 years. See below the performance (source).
A few comments and quotes:
“I am starting to change the sectoral weight of the portfolio.”.
She is looking for value companies and not growth, most of them in Spain because the economy is right now at the bottom of the recovery that started two years ago. One example she says is the Banking sector. Most of the value investors in Spain have been out of these companies for too long. After last summer, for example, Bestinver started to invest in banks (Bankinter, Bankia and ING). Inflation is rising, economic improvement and banks will be back to his operational business soon.
I’m looking for cheap banks, below 1 book value, more with domestic exposure and potential for recovery or M&A.
Also, she is long on average in Media, why? In her opinion, companies need to gain market share and investing in advertising is a good way to do it.
“Investing in their own brand through advertising”.
“Another sector that has lagged but I see value and is in an initial phase of recovery is that of energy. The oil went from 80 to 50, it will not reach 80, but it can recover something. Therefore, I am increasing exposure to values linked to energy and oil.” (underline mine).
To sum up, she is looking for re-rating, companies that have been in the bottom of the recovery and now are going up in terms of profitability and operating incomes.
The Memo: Expert Opinion by Howard Marks
New memo is out. For those who follow Howard Marks this insight is a must-read.
The Memo: Expert Opinion | Link
16 Questions About Self Driving Cars + links
Every day I need to drive my car around 30 minutes. I do not have a good public transport commute to go to work, so, drive my own car is the best way. But it is quite boring and unproductive. Maybe in 2023 or before I will have the opportunity to read or watch Youtube videos during my commute.
In this fantastic video, Frank Chen, partner, at Andreessen Horowitz explain us the main questions about self-driving cars. It is not a 101 guide, but I provide a few more links to really understand the current situation of this amazing industry.
16 Questions about Self Driving Cars from Andreessen Horowitz on Vimeo.
Everything that moves, says a16z partner Frank Chen, will go autonomous. But what does that really mean? In this presentation from our a16z Summit, Chen goes over the 16 most commonly asked questions about autonomous cars, and what their answers might be: Will we progress level by level, or go straight to Level 5, i.e. full automation? Will they use LIDAR or not? What blend of software techniques will be used? What rules of the road (traffic lights!) will become a thing of the past, and how will insurance be affected? You can’t understand autonomous vehicles without understanding these 16 basic and essential questions — and the issues at stake tied to them — in this concise overview that covers everything you’re wondering about autonomous vehicles in a nutshell.
Slide 1. Frank Chen.
Slide 2.
Slide 3.
Talking about cars only, this is Goldman Sachs‘s opinion:
In the next ten years, the auto industry will undergo a profound transformation: the cars it builds, the companies that build them and the consumers who buy them will look significantly different. Technology will be leading this change, but it will be shaped by four key themes.
Slide 4. Cars market is a huge one, as we can see in the following graph. Big industry around the globe.
Questions about technology, business and social implications in the self-driving industry.
1.-Technnology
Question 1: automated driving. There are 6 levels, from zero to five,
Level one: assisted.
Level two: complex drive assistance.
Level three: semi-autonomous driving.
Level four: fully autonomous car.
Nowadays different companies are doing opposite things. More of them are going level by level. Mercedes, VW, BMW or GM are learning the curve step by step. On the opposite side is Google, with fully autonomous driving car prototype. So, the key question here is: level by level or straight to level five? I am sure car manufactured companies will go level by level. Google, instead, will reach level five as soon as possible and when achieve enough test hours and all the Government paperwork done will try to monetize all this.
Question 2: LIDAR or not? First of all, what is LIDAR? Below you can find good examples of what is LIDAR (in general) and a great car visualization of LIDAR technology.
LIDAR – a surveying technology that measures distance by illuminating a target with a laser light. LIDAR is an acronym of Light Detection And Ranging, (sometimes Light Imaging, Detection, And Ranging) and was originally created as a portmanteau of “light” and “radar.”
Not all car companies are using/investing in LIDAR technology. Tesla, instead is equiping cars with 8 cameras, 360 ultrasonics, GPS and radar.
Question 3: pre-computed “HD Maps”, or built on the fly?
Beyond GPS and Google Maps is for people. So, we need a different type of maps for cars or we need a car with the technology to calculate everything on the fly, just by driving by. This a good post by NVIDIA, “Beyond GPS: How HD Maps Will Show Self-Driving Cars the Way”.
Question 4: What blend of software techniques? Deep learning, path planning, cloud or data. Deep learning is winning all surveys. More about this topic.
A few good introductions to deep learning/machine learning.
Question 5: how much real world vs machine world?
Question 6: Will V2X radios play an important role? V2X, X is a variable, vehicle-to-vehicle conversation. Mercedes will use it in 2019. How does it work?
Question 7: Can we get rid of traffic lights and four-way stops? Will autonomous cars need traffic lights? MIT visualization, who wanna be the first driver?
Question 8: How will automakers “localize” their cars?
2.- Business:
Question 12: Who will win? Silicon Valley vs China vs Incumbents?
Traditional car makers, service providers, technology companies…a lot of competition.
Question 13: will we buy cars or transportation as a service? Service (UBER, Hailo or Lyft) or Buy ( Toyota, VW). Fly industry, Airbus vs Boing. Loyalty to the carrier, not the manufacturer.
IMHO I believe big cities like London, NYC, Ciudad de Mexico or Paris, service providers will win the battle. Fewer people will buy a car and they will use public and private transport more often. 
Question 11: How will insurance change? All new questions will come up. Repair costs up or down?
The motor insurance market may shrink by 60% by 2040, according to KPMG. The insurance aspects of this gradual transformation are at present unclear. More about this topic, “Self-driving and insurance”.
Question 9: How will accident rates trend? Rapid decline in the number of fatalities over time. Self-driving cars? What will happen? Human error related, driver error. Learning curve: better in a 16 boy or a machine? That the question! I truly believe more in machines than in myself ith 18 years driving my first car. Follow before chart:
Question 14: How will commute change?
In my opinion, the gap between renters and owners will decrease heavily in the next 5 years.
Question 15: How will cities change?
Question 16: When ill this start, and then ho quickly will we switch to autonomous cars?
The future will be better for customers, still, a lot of questions to solve and asked.
Source | a16z
The little book of valuation: some notes.
To Buy, sell or hold is at heart of any valution process. Trying to find the diferrent between market price and intrinsic value at the end of the research process is the aim of any investment process. At the end, numbers and the story need to make the securitie a buy, sell or hold. I will try to sumarize the well-know book “The Little Book of Valuation: How to Value a Company, Pick a Stock and Profit” by Aswath Damodaran. Notes: chapter 1, 2 and 3.
Notes Chapter 1:
- You buy a financial assets for the cash flows that you expect to receive in the future (dividends).
- Two approaches to valuation: intrinsic and relative.
- Intrinsic: is determined by the cash flows you expect that asset to generate over its life and how uncertantain (sometimes called RISK) you feel about these cash flows.
- Relative: assets are valued by looking at how the market prices similar aassets (“peer group”). Quite useful for real state purposes.
- Relative’s example: Exxon Mobil will be viewed as a stock to buy if it is trading at 8 times earning while other oil companies trade at 12 earning.
- There is a role for valuation at every stage of a firm’s life cycle.
- Some truths about valuation:
- All valuations are biased
- Most valuations (even good ones) are wrong. Reasons:
- Raw information into forecasts–> estimation error.
- Uncertainty.
- Simpler can be better.
Notes Chapter 2:
- Time is money. Finance 101, present value vs future value. Do you prefer a dollar today or next year? Three reasons why a cash flow in the future is worth less than a similar cash flow today:
- People prefer consuming today instead of consume in the future.
- Inflation decreases the purchasing power of cash over time.
- A promised cash flow in the future may not be delivered. RISK!
- Discounting future value, discounting rate, real return, expected inflation and premium interest.
- Simple cash flow: CF in the future / (1+ discount rate) ^ time period.
- Annuity : constant casf flow that occurs at regular intervals for a fixed period of time. Annual cash flow ((1 – 1/(1+discount rate) ^numbers of periods)/ discount rate)
- Example: You can buy a car, $10,000, cash down or paying installments of $3,000 a year, for 5 years. Discount rate: 12%. $3,000((1-1/(1.12)^5/12%) = $10,814. The economical option is to pay the car today instead of paying installments.
- Growing annuity: cash flow that grows that grows at a constant rate for a specified period of time.
- Example: You have the rights to a gold mine that generated $1.5 million in cash flos last year. For the next 20 years, 3% a year and a discount rate of 10% to reflect your uncertainty. Cash flow*(1+g)[1- (1+g)^n/(1+r)^n / (r-g)]
- Perpetuity: is a constant cash flo at regular intervals forever. Cash flow / discount rate.
- Growing perpetuity: is a cash flow that is expected to grow at a constrant rate forever. Expected cash flow next year / (discount rate – Expected growth rate)
- Risk: diversification, CAPM…the risk of any asset then becomes the risk added to this “market portfolio”, which is measured with a beta. Beta is a relative risk measure and it is standardized around one. Beta > 1 = more exposed to market risk than the average stock (market). Expected return on the investment = Risk Free rate + Beta.
- CAPM is based on unrealistic assumptions.
- Alternatives: multi-beta models and proxy models.
- All these models are flawed:
- risk matters:
- some investments are riskier than others:
- the price of risk affects value
- Accounting 101:
- Balance sheet
- Income Statement
- Cash flow statement
- Fixed and LT assets: value = originally paid for the asset (historical cost) and reduce that value for the aging of the asset (depreciation or amortization).
- ST assets: amenable to the use of an updated or market value.
- To principles underlie the measurement of accounting earnings and profitablity.
- 1st, accrual accounting: the revenue from selling a good or service is recognized in the period in which the good is sold or the service is performed, same for expenses.
- 2nd, is the categorization of expenses into operating, financing, and capital expenses.
- Operating margin = operating income / sales
- Net marging = Net income / sales
- Capital invested in the firm = Book value ( debt and equity, net of cash, and marketable securities.
- After- tax ROC = (operating income (1-tax rate) / BV of debt + BV of equity – Cash
- ROE = Net Income / BV of common equity
- Financial BS vs Accounting BS
Notes Chapter 3:
- Determining intrinsic value. DCF: discount expected cash flow at a risk-adjusted rate.
- Valuing a company: value the entire BUSINESS or just the EQUITY.
- Assets in place + growth assets = value of business–> to value the entire business, discount the casf flows before debt payments (cash flow to the firm) by overall cost of financing, including both debt and equity (cost of capital).
- Assets in place + growth assets = value of business – Debt = VALUE OF EQUITY.
- Inputs to intrinsic valuation:
- cash flow from existing assets
- expected growth in these cash flows for a forecast period
- cost of financing the assets
- estimate of what the firm will be worth at the end of the forecast period
- Cash flows: dividends paid or stock buybacks. Augmented dividends = dividends + stock buybacks.
- Free Cash Flow to Equity = the cash left over after taxes, reinvestment needs, and debt cash flows have been met.
- Free Cash Flow to Firm = After-tax operating income – (Net Capital expenditures + Change in non-cash orking capital).
- Reinvestment rate = (Net Capital expenditure + Change in non-cash WC) / after-tax operating income
- FCFF = After-tax operating income (1- Reinvestment rate).
- Risk:
- Business: risk in firm’s operations
- Equity: at the risk in the equity investment in this business
- Risk captured in the cost of capital.
- Cost of equity: a risk-free and a price for risk to use across all investments, as well as a measure of relative risk:
- Risk-free rate.
- Equity risk remium.
- Relative risk or beta.
- Cost of equity = RFR + Beta * ERP
- Interest coverage ratio = Operating income / Interest expenses
- Terminal value: to ays of estimating terminal value are to estimate a liquidation value for the assets of the firm or to estimate a going concern value.
- Terminal value in year n = Cash Flow in year (n + 1) / Discount rate – perpetual growth rate
- Three constraints that shold be imosed on its estimation:
- No firm can grow forever at a rate higher than the growth rate of the economy in which it operates.
- Firms move from high growth to stable growth,
- Discounted dividends or free cash flows to equity on a per-share bassi at the cost of equity:
- add back the cash balance of the firm
- adjust for cross holding
- subtract other potential liabilities
- subtract the value of management options
- Market price vs value:
- You have made erroneous or unrealistic assumptions about a company’s future groth potential or riskiness
- That you have made incorrect assessments of risk premiums for the entire market
- The market price is rong and that you are right in your value assessment.
Investing thought
“So how do you really understand and gain that great insight? Pick one business. Any business. And truly understand it. I tell my interns to work through this exercise – imagine a distant relative passes away and you find out that you have inherited 100% of a business they owned. What are you going to do about it? That is the mentality to take when looking at any business. I strongly encourage you to start and understand one business, inside out. That is better than any training possible. It does not have to be a great business, it could be any business. You need to be able to get a feel for how you would do as a 100% owner. If you can do that, you will have a tremendous leg up against the competition. Most people don’t take that first concept correctly and it is quite sad. People view it as a piece of paper and just trade because it is easy to trade. But if it was a business you inherited, you would not be trading. You would really seek out knowledge on how it should be run, how it works. If you start with that, you will eventually know how much that business is worth.” -Li Lu (from back in 2010)
SAETA CAPITAL 