Archive for the ‘Value investing’ Category

Moneyball: Why money can definitely help out when you run after under-valued players

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Posted 25 Dec 2011 — by Charles Martineau
Category Movie, Value investing

Story of Moneyball

I always wanted to read the book Mon­ey­ball by Michael Lewis but I never had the chance. In exchange, I just saw the movie on Lewis’ book (nonethe­less, I still intend to read the book). For those who don’t have a clue what Mon­ey­ball is all about just read the wiki page but roughly the story behind Mon­ey­ball is how a man, a base­ball team gen­eral man­ager, with lit­tle finan­cial resources can com­pete against big pow­er­ful teams with a lot of cash (i.e. Yan­kees and the Red Sox). The “poor” team in ques­tion was the Oak­land A’s and their Gen­eral Man­ager used some sim­i­lar con­cepts of value invest­ing to find play­ers that will give him the best bang for the bucks invested and remain com­pet­i­tive against teams that spend three times more on payroll.

Is it only about stats?

To get the best bang for your bucks invested in play­ers, the Gen­eral Man­ager heav­ily relied on stats (more than just RBI, hit­ting %, etc.) – in part, stats develop by Bill James. One of the goals of the GM was to line-up play­ers with sim­i­lar stats and pick the cheap­est one. Hence, you get the biggest bang for your bucks. More impor­tantly, if the player does not live up to its poten­tial, you will limit the finan­cial cost (sim­i­lar to the mar­gin of safety).

Here’s why money mat­ters and why it is not only about stats

Imag­ine you have two or more play­ers where the stats are almost iden­ti­cal. You will look for the cheap­est play­ers since you have a low salary cap. Here’s why money mat­ters — by that I mean why spend­ing more for some­one with sim­i­lar stats mat­ters. Stats don’t incor­po­rate all aspects of a player such as team lead­er­ship and sports­man­ship. These qual­i­ta­tive skills tend to be incor­po­rated into the salary some GM is will­ing to give to player – which are sig­nif­i­cant to win base­ball play­offs games. So, if a GM selects the cheap­est player among those with the iden­ti­cal stats, he is neglect­ing the qual­i­ta­tive aspect of a player and its unpre­dictable con­se­quences (i.e. there are some play­ers that carry with them a trouble-maker reputation).

Bot­tom line

The bot­tom line is that the more money you have, greater the pos­si­bil­ity to invest more on a player with qual­i­ta­tive or even tacit skills that is hard to quan­tify but how cru­cial in order to win cham­pi­onships. Don’t get me wrong, the stats of a player is fun­da­men­tal and I think what the GM in Mon­ey­ball did was bril­liant but if he had more money to shop around he would have been able to pay extra for play­ers with more qual­i­ta­tive skill. Nonethe­less, the stats deter­mine the price floor (i.e. the player that cost the less given the iden­ti­cal stats with other play­ers is the price floor).

Great line from Warren Buffett in “The Superinvestors of Graham-and-Doddsville”

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Posted 19 May 2011 — by Charles Martineau
Category Finance, Value investing

For the first time today (and some may say: it’s about time!) I read the clas­sic arti­cle “the Super­in­vestors of Gra­ham –and-Doddsville” written by War­ren Buf­fett in the 80’s for the 50th anniver­sary of Secu­rity Analy­sis by Ben­jamin Gra­ham and David Dodd. In this arti­cle, there is one of the best writ­ten lines on risk/reward. I always hated to learn in school that greater risk should legit­i­mately lead to greater rewards. Really? Here’s what Buf­fett has to say on risk/reward:

I would like to say one impor­tant thing about risk and reward. Some­times risk and reward are cor­re­lated in a pos­i­tive fash­ion. If some­one were to say to me, “I have here a six-shooter and I have slipped one car­tridge into it. Why don’t you just spin it and pull it once? If you sur­vive, I will give you $1 mil­lion.” I would decline — per­haps stat­ing that $1 mil­lion is not enough. Then he might offer me $5 mil­lion to pull the trig­ger twice — now that would be a pos­i­tive cor­re­la­tion between risk and reward!

The exact oppo­site is true with value invest­ing. If you buy a dol­lar bill for 60 cents, it’s riskier than if you buy a dol­lar bill for 40 cents, but the expec­ta­tion of reward is greater in the lat­ter case. The greater the poten­tial for reward in the value port­fo­lio, the less risk there is.

One quick exam­ple: The Wash­ing­ton Post Com­pany in 1973 was sell­ing for $80 mil­lion in the mar­ket. At the time, that day, you could have sold the assets to any one of ten buy­ers for not less than $400 mil­lion, prob­a­bly appre­cia­bly more. The com­pany owned thePost, Newsweek, plus sev­eral tele­vi­sion sta­tions in major mar­kets. Those same prop­er­ties are worth $2 bil­lion now, so the per­son who would have paid $400 mil­lion would not have been crazy.

Now, if the stock had declined even fur­ther to a price that made the val­u­a­tion $40 mil­lion instead of $80 mil­lion, its beta would have been greater. And to peo­ple that think beta mea­sures risk, the cheaper price would have made it look riskier. This is truly Alice in Won­der­land. I have never been able to fig­ure out why it’s riskier to buy $400 mil­lion worth of prop­er­ties for $40 mil­lion than $80 mil­lion. And, as a mat­ter of fact, if you buy a group of such secu­ri­ties and you know any­thing at all about busi­ness val­u­a­tion, there is essen­tially no risk in buy­ing $400 mil­lion for $80 mil­lion, par­tic­u­larly if you do it by buy­ing ten $40 mil­lion piles of $8 mil­lion each. Since you don’t have your hands on the $400 mil­lion, you want to be sure you are in with hon­est and rea­son­ably com­pe­tent peo­ple, but that’s not a dif­fi­cult job.

Why value investing is a great investment philosophy

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Posted 27 Apr 2011 — by Charles Martineau
Category Finance, Value investing

So why value invest­ing is a great invest­ment philosophy? Security analysis.jpg

Not because War­ren Buf­fett became rich thanks to value invest­ing. Its because the premise behind value invest­ing is this: Us, humans, are not so smart as we might think. Hence, we must come up with some tools and phi­los­o­phy to pro­tect us from our igno­rance (and emo­tions) when we invest money.

In Secu­rity Analy­sis by Ben­jamin Gra­ham and David Dodd (sixth edi­tion, p.703) there is a great line on what makes secu­rity analy­sis (value invest­ing) a great approach to investment:

In secu­rity analy­sis, the prime stress is laid upon pro­tec­tion against unto­ward events. We obtain this pro­tec­tion by insist­ing upon mar­gins of safety, or val­ues well in excess of the price paid. the under­ly­ing idea is that even if the secu­rity turns out to be less attrac­tive than it appeared, the com­mit­ment might still prove a sat­is­fac­tory one.

Its a phi­los­o­phy that shares the same thoughts of the great philoso­pher Karl R. Pop­per — “Our knowl­edge can only be finite while our igno­rance must nec­es­sar­ily be infinite.”

I may also add that value invest­ing offers the chance for investors to increase their odds to find com­pany with a “black swan*” future success.

* A black Swan event does not nec­es­sar­ily leads to a neg­a­tive consequence.

That is why value invest­ing is great — not per­fect — just great.

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