Book Reviews, Value Investing

Book Review of The Entrepreneurial Investor: The Art, Science, and Business of Value Investing

This book “The Entrepreneurial Investor: The Art, Science, and Business of Value Investing” is written by Paul Orfalea, Lance Helfert, Atticus Lowe, and Dean Zatkowsky of West Coast Asset Management (WCAM). They are the co-founder, co-founder and President, Chief Investment Officer, and former Vice-President of Marketing at WCAM respsectively. In particular, Paul Orfalea is the founder of Kinko’s.

The book goes through a lot of the basics of value investing, quoting from many famous people such as Ben Graham. Overall I felt that the book covers value investing at a pretty high level, and does not go into the guts of the details needed to actually manage a portfolio (e.g. position sizing, how to buy into a position, how to determine the discount rate, etc.).

Two sections I particular like are the section on Traps (see below) and on managing the elasticity of demand, the fact that even if your product is highly elastic,  you can still be consistently profitable.  The two chapters on Bernard Baruch and Howard Hughes are also interesting to read.

Competitive Advantage

  • Long-term commitments create competitive advantage. Four Seasons Hotel contracts to manage existing properties for other owners, and its average management contract term is over 50 years. This also allows the company to focus on managing the property and not negotiating the next contract.
  • Anheuser Busch (BUD) has a dramatic advantage in distribution efficiency over its rivals.
  • Wal-Mart has competitive advantage in supply-chain management which allows them to dictate terms to suppliers and provide low prices.
  • Home Depot makes high inventory their competitive advantage so that it does not run out of items, which would cause customers to visit its competitors (e.g. Lowe’s) to get it and everything else at the same time.

Company Culture

  • ATP Oil & Gas Corp (ATPG) had an incentive plan for 2005 where upon attainment of company goals, every employee in the company would receive a brand new 2006 Volvo S60. That worked out well for shareholders interests as the company met or exceeded every goal.

Elasticity of Demand

  • Some products are highly inelastic (e.g. oil – changes in price do not significantly affect the quantity demanded), while some are elastic (e.g. oranges can be substituted with bananas).
  • Look for companies that understand and manage the elasticity of demand for their products. E.g.
    • Wrigley manages its inventory, shelf space, and branding to maintain its profitability despite selling products with highly elastic demand.
    • Pharmaceuticals create inelastic demand for a time with patents. They need to manage their product life cycles to introduce a new high-margin product just as an old product’s margin starts to decline.

Red Flags

  • Resist the urge to jump onto new and exciting trends and ignore business fundamentals. Real trends create multiple opportunities over time. You can always get in later in a company that has proven its worth.
  • There is no such thing as just one cockroach. Pat McHugh, then manager of the $120M Global Strategy Canadian Companies mutual fund sells at the first negative surprise. He notes that a company with one earnings surprise will be followed by a series of subsequent negative surprises.
  • Companies with multiple sources of revenue must be examined carefully. E.g. GE derives much of its profits from GE Capital, so is very susceptible to economic volatility.
  • Read the auditor’s report to see if the auditor has any “qualified” opinion on the company.
  • Misstated asset valuations account for nearly half of all financial statement fraud, and overvalued inventory makes up nearly all of the exaggerated asset valuations.


  • Home Depot makes high inventory their competitive advantage so that it does not run out of items, which would cause customers to visit its competitors (e.g. Lowe’s) to get it and everything else at the same time.
  • Technology companies need to keep inventory levels as low as possible.
  • Manufacturers need to keep their inventory low (i.e. supply low) so as to keep their margins high, yet cannot be too low to frustrate prospective customers.
  • Discontinuing sales of items with lower profit margins may not always be wise, as they might be contributing to the sales of the higher margin items.
  • Inventory-intensive businesses should be obsessed with maximizing turnover of their inventory.
  • The value of inventory can be time-dependent. High toy inventory just before Christmas is good, but after Christmas the inventory value can plummet.
  • Companies using LIFO inventory system might have hidden assets in terms of real estate bought a long time ago, or antiques that have become more valuable as time passes.

10 Signs of a Strong Company

  1. Simple business model (to understand)
  2. “Wide-Moat” competitive advantage
  3. Recurring revenue
  4. Low inventory risk
  5. Alignment of interests
  6. A healthy culture
  7. A flat organizational structure (should show through as high profit per worker)
  8. Low reinvention risk
  9. Low capital requirements
  10. Favorable demographics

ABCs of Investing

  • Assets
  • Bargain
  • Catalyst

Seek companies that boast real, measurable assets, which can be acquired at a bargain price, the value of which may be increased by a catalytic event, such as a merger or new business development. If one can buy assets at a deep enough discount, one can profit even if a catalyst does not materialize.

Potential catalysts

  • New drug or medical device approval
  • New oil or natural gas discovery
  • Evaluation of strategic alternatives
  • Divestment of non-strategic assets
  • Sale of the entire company
  • Share repurchase
  • Special dividend
  • Spin-off of non-synergistic business
  • Share structure unification
  • Activist shareholder

Studying trends help to narrow the field of companies to research into. E.g.

  • Aging populations need more health care.
  • Tensions for supplies of commodities mean that defense-related stocks will still be growing for some time.

Quotes from Bernard Baruch

Baruch was one of the great investors in history and an economic adviser to politicians and presidents. He specialized in mining because he believes that nobody could know all investments thoroughly so it was best to stick to what one knew best. Baruch believed in hands-on research and traveled all over the world to meet with mine owners, smelter operators, and others with firsthand knowledge of companies.

  • If you get all the facts, your judgment can be right; if you don’t get all the facts, it can’t be right.
  • Know your own failings, passions, and prejudices so you can separate them from what you see.
  • Two things are bad for the heart — running up stairs and running down people.
  • Don’t try to buy at the bottom and sell at the top. If can’t be done except by liars.
  • I made my money by selling too soon. I never lost money by turning a profit.
  • If a speculator is correct half of the time, he is hitting a good average. Even  being right 3 or 4 times out of 10 should yield a person a fortune if he has the sense to cut his losses quickly on the ventures where he is wrong.


  • Many people sell their winners and keep their losers, hoping to recoup their losses over time. Research shows that it rarely happens, and that the winning stocks often perform even better after they are sold, while the losers continue to languish. [Perhaps it is better to sell the losers, and after the winners have hit your price target, sell them and re-look at the losers to see if there is still an opportunity there.]
  • For WCAM, if a poor-performing stock in their portfolio is undervalued, they might sell it and buy it back 31 days later to comply with the wash sale rule, or to take their losses and move on to better opportunities. While there is a risk that the stock could realize its intrinsic value during the 31-day period, the benefit of taking a loss on losers usually outweighs the consequences of desperately hanging onto them.
  • Investors are reluctant to buy a stock that has gone up in the recent past, and would rather blame themselves with 20/20 hindsight (‘if only’). Instead investors should take that as a signal to re-evaluate the intrinsic value of the company and see what, if anything, has changed and how the latest price compares with the intrinsic value.



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