Journeys of a Bumbling Investor

Which is better?

It seems that everyday we are bombarded with news of so-and-so company's stock that went up 20-40% in one day. And so many times you feel like kicking yourself saying "Why did I miss that?" Hence the question: Is there really an opportunity in short-term trading? or is it just statistics playing with us? If there are 10,000 companies and 365 days a year, its not that surprising if there's a 'wonder' every day right?

My reasoning is this: If such short-term opportunities are really out there, someone would have done it already (yes i know the story about the dollar on the ground). The fact that a 30% annual return is still considered an excellent return shows that people have not made it consistently with short-term trading. Coupled with the fact that long-term investing has proven its capability to achieve the 30% returns, hence the obvious choice is to do long-term investing.

(with respect to the dollar on the ground, I believe that there are many more people who are much more opportunistic than me, who are playing the stock market as we speak. Hence if they can't do it consistently, I'm assuming that the opportunity does not exist)

Another point about long-term investing. Does that mean that we should park all our money into long-term investments? I believe that eventually, it should be a hybrid of long-term and short-term investments. A portion of the net worth should be in liquid, short-term investments (less than a year). This short-term pool will 1) act as some backup incase the market is down for an extended period of time, and 2) help to generate more money for other long-term investment opportunities that would come along. Regular cash inflows from your wage should go into this short-term pool of funds.

Rating: Below Average

Background:
3rd book in my attempt to devour all books Buffett. In case you're wondering, 4th book will be "Trade Like Warren Buffet", followed by "The Warren Buffett Way" and the final finale is "Essays of Warren Buffett"

Detail:
Not much real substance as to how to pick stocks, but still some noteworthy points:

Thought-provoking items:

1. There is a tax advantage in doing your own investing as opposed to using a mutual fund. When you make a capital loss, you get a tax deduction for the loss. However, if the mutual fund makes a loss, you don't get the tax benefit and you are still slapped with the management fee.
2. There is a pretty interesting parable of an old man trying to sell his apple tree. The bids go like this: 1) salvage value, 2) one year's earnings, 3) 10 years earnings without discounting, 4) last guy's bid, 5) capitalising earnings including discount rate + expenses + depreciation. The book makes that point that two methods are reasonable. 1) capitalising earnings such as 5) above. or 2) using real cash flow + discounting. On the one hand, the first method monkeys around with depreciation assumptions, and on the other hand, the 2nd method has to predict future lump sum cash outflows. But this gives me more assurance of my initial inkling to use cashflow.
3. Quote from Goizueta of Coke, who quoted German poet and playwright Goethe: "Whatever you can do or dream you can, begin it. Boldness has genius, power and magic in it. Begin it now"

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Rating: Average

Background:
2nd book in my recent attempt to devour all books on Buffett.

Detail:
Few new ideas, but some noteworthy points below.

Though-provoking items:

1. Made a distinction between Market value, Intrinsic value, Book value, Liquidation value
2. Made a good argument for value-based, long-term investing. Had tables which showed that if you buy/sell at each precise low/high, you will end up earning alot more. However, if you miss the precise low/high points by 2.5%, returns drop significantly. And if you miss by 5%, you are better off doing the long-term investing.
3. An interesting point on DRIPs. If you subscribe to a DRIP program administered directly by the firm, then its ridiculous. This is because the firm will give out dividends because they are unable to use the funds effectively, and if you the investor gives the money back to the firm in exchange for more stock, then 1) the shares are diluted, 2) the firm still doesn’t have a good use for the extra cash.
4. In the long-run, the less mistakes you make, the better off you are. “If you just take care of the downside, the upside will take care of itself”.
5. Had a table on adjusting the balance sheet assets for liquidation value. Cash 100%. Receivables 80%. Inventory 40%. Plant/Equipment 5%. (rough values)
6. Made a good point on calculating operating leverage to gauge how fast earnings will grow as sales grows.

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Rating: Excellent

Background:
I’ve had this copy of Buffettology by Mary Buffett and David Clark for what must have been 5 years. Its one of those books that you tell yourself that its a good book to read someday but never ever got around to reading it. I had been thinking about the problem of stock picking for some time, from learning about DCF, all the ratios, and finally getting down to picking some stocks. It was at that time that I felt it was opportune to finally start reading Buffettology.

Detail:
And I must say, its been an excellent journey. Many of the conclusions that I had arrived to literally mirror what was written in the book, and the best thing is, the book went further and developed a whole neat model of how to pick stock based on the underlying principles. Many of what was presented in the book is so logically and beautifully thought-out, I am sure that Warren Buffett did originate them.

Thought-provoking items:

1. To convert from earnings to price, initially it was suggested using earnings/risk-free rate. Later it was suggested to use the average historical P/E ratio. I’m thinking that that some adjustments need to be made: 1) adjustment for the stock risk taken (total risk, not just systematic), 2) adjustment to include all future earnings not just one year of earnings. This would include projection of growth of earnings. 1) will reduce the price. 2) will increase the price.
2. What kind of earnings should be used? FCFF? FCFE? NI? CF? should depreciation be included? I am inclined more and more towards using real cash flow available to stockholders. Amortization will not be done, so that the initial spending will make a larger dent. Also, is there some kind of reconciliation that can be done with our original method of estimating FCFF (estimating 3 params on working capital rate, dep rate, etc.)
3. With respect to the kind of companies to invest in, I agree wholeheartedly with the commodity vs consumer monopoly (toll bridge) analogy. However, with all the outsourcing in recent times, things may not be as clear cut. Many things being sold now are produced in China/India. That brings about volatility. The Chinese production facilities can easily defect to other companies. There would also be manageability problems. Hence even current “consumer monopoly” companies might not be that “safe”. What then is the solution? The obvious solution is to choose consumer monopolies that thrive on intangibles – intellectual capital, intellectual property etc. Not drug companies though, too risky with the drug approval process. Apart from firms such as market research and consulting firms, software firms deserve more attention.
4. The book gives the impression that Buffett does long term investing and only participates in short-term investing when there’s no better opportunities around. More on that later
5. When calculating ROE, should we use Avg Equity (beg eq + end eq / 2) as the denominator? it complicates calculations as we would need to use the solver, but it seems to reflect the reality more accurately.

 [Note: There is a good summary here.]

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