The Importance of Stories

My Take-Aways:

I recently did a course on Corporate Valuation at Columbia University. In my view, it is very easy to get drawn into the intricate details of the numbers when you learn how to do D.C.F. models. However, this is something to guard against. Constructing any financial model requires you to make several assumptions, which can have significant effects on your expected share price. As a result, it is very important that there is a reasoning behind each assumption. This reasoning is your story.

Coming at it another way:
Investing is about buying a part of a (good) company for less than it is worth. The market price represents the views of the entire market put together. Things can only seem 'cheap' when your view about the future is brighter than others' view about the future. Hence, you must have either, fantastic insight, or fantastic foresight, to arrive at a valuation different to that of the market. Thus, the value you see in a company is determined by your opinion of the company's future. Hence, there must be a story driving the numbers.

So what?
Let this serve as a reminder about the importance of the story. Remember, that the numbers are never really precise, and a story is the foundation upon which every valuation is built. Indeed, stories will also give you conviction in your investment. Conviction is the most important tool, if you are intending on waiting - patiently - for the market's acknowledgement of this 'value' you noticed. It is worth noting, that your story may change over time: When the facts change, you must change.

The blurb on Youtube:

The world of investing/finance is divided into two camps. In one, you have the number-crunchers, who believe that the only things that matter are the numbers and that imagination/creativity are dangerous distractions. In the other, you have the storytellers, who build on the stories they tell about companies and how these stories will bring untold wealth. Each side believes it has a monopoly on the truth and looks with contempt at the other. Prof. Damodaran contends that stories matter, but only if they are connected with numbers. And numbers are empty, unless they are connected with narratives. In this talk, he looks at the process by which one might build narratives, check them against reality and convert them into valuations. Uber and Ferrari examples are used to illustrate the process.

Other resources to look at:

• Slides for the talk: https://goo.gl/zKVaQL
• Check out the book on Google Play: https://goo.gl/tnGlDe

Stocktrak Learnings: Problems With Stock Market Simulators.

During the three week course on Corporate Valuation at Columbia University, we used Stocktrak, which is a stock market simulator. Whilst using this simulator, I realised how a pressure to perform in the short-term can cause you to make mistakes. On the Monday afternoon of the third week, the professor urged us to 'shuffle our portfolios' and look at the ranking. Being roughly tenth or twelfth out of fifteen, I was overcome by the urgency instinct, and proceeded to make decisions poor decisions; they were so bad that I immediately reversed some of them!

This experience reaffirmed my belief that stock market simulators are useless in terms of teaching people how to make money in the real world. They encourage you to be speculative and short-term oriented and make decisions based upon superficial analysis. This is all because without the fear of losing real money, there is an inclination to ignore the downside and focus on the upside. That being said, they are arguably a useful way of reminding yourself about the common errors made by asset managers.

Principle 5

A continuation of the series of posts relating to 'Factfulness'.

The fear instinct and panic-selling.

Investing is often driven by emotion; in particular, greed and fear are often said to drive investors - and ruin their financial returns. In this post I will mention and discuss some of the interesting things Hans Rosling had to say about fear, and how they connect with investing. 

• "When we are afraid we do not see clearly."
• "Critical thinking is always difficult, but its almost impossible when we are scared. Theres no room for facts when our minds are occupied by fear."
• "Get calm before you carry on. When you are afraid, you see the world differently. Make as few decisions as possible until the panic has subsided."

Basically fear is equal to factlessness. If you are scared, you act without analysing facts. In investing, you want to always analyse facts. Letting fear grip you is like taking your wallet and throwing its contents around you. This is why it is better to not act when you are feeling fearful; in investing it is more important to know when not to act than when to act. If you sell out of fear, you are probably losing an opportunity and giving others money. 

• " 'Frightening' and 'dangerous' are two different things. Something frightening poses a perceived risk. Something dangerous poses a real risk. Paying too much attention to what is frightening rather than what is dangerous - that is, paying too much attention to fear - creates a tragic drainage of energy in the wrong directions."
• "Risk = danger x exposure. How dangerous is it? And how much are you exposed to it?"

Risk and fear must be distinguished between. One is real, and the other is imaginary, and investing is about what is real. Mixing these up will lead you to behave irrationally and may result in you selling after a correction offers a golden opportunity. As Howard Marks said, in uncertain times - when you are likely to be more afraid - is the time when the best bargains are available.

'Great' Investors

I'm doing a 3 week summer program at Columbia University. We have watched a few videos which provide an insight into the investment principles of some of the world's most respected investors. I am attaching the videos of the first two, and my thoughts...

1. Warren Buffett - The Oracle of Omaha.

Have a concentrated portfolio, and only invest in businesses you understand. Buffett says that investing is a very advantageous game, because you don’t need to hit each ball; instead you can wait for a ball to come into your sweet spot.

2. George Soros.

I agree with his thought process that when you think you are right, you should bet big. Overall, however, I disagree with Soros’ philosophy as presented by this video, because he was willing to take on a large amount of leverage, and essentially ‘bet the ranch’. This seems to ignore the fact that leverage magnifies both upside and downside. Soros’ risk-tolerance appears to be bigger than mine! 

3. Ray Dalio. (Unable to find exact video)
In order to make money you have to have a different view to that of the consensus AND be right. When you take on such a contrarian point of view, there is a high risk of being wrong. In order to reduce this risk, you have to stress-test your investment thesis. At Bridgewater this is achieved through discussion. In Dalio's opinion, you learn more this way. Overall, I agree with Dalio that it is important to engage in debates with smart people, who a different point of view, and that we have to learn to love mistakes.

4. Paul Tudor Jones. (Unable to find exact video)

• FOCUS ON THE DOWNSIDE: If you spend 90% of your time figuring out how much you can lose, and how you might come to lose it, you are unlikely to lose a lot of money in the long run. In investing, though, you still have to be willing to catch a falling knife.
• It's good to have some hard boundaries at which you will almost certainly exit a position.
• A CONFIRMATION for me: As traders you are trying to predict what’s going to happen on the market in the next five minutes. I do not think anyone is good enough to do that.

5. Guest Speaker: 

• "There are no good or bad assets, only good or bad prices." This statement is true. However, if you want to invest in companies which you will never sell, you also have to focus on the fundamentals of the business. That being said, anything is a good investment at a low enough price.
• "Spend 99% of the time thinking about what you don't know, and other risks." This statement essentially tells you to be humble and risk-aware. However, to invest, one must be an optimist.
• "When the facts change, you must change; new information may well change your thesis, or significantly impact a business' fundamentals." This essentially is something to be aware of, so that you change your thesis when there is a significant change. On the flip-side, however, letting one insignificant thing completely change your view would also be a bad thing.

6. Howard Marks.

• We pay a high price for certainty. At a time of certainty and confidence, a value investor should be uncomfortable; you will find better bargains in uncertain times.
• It takes an insight to feel better when the share price of a company goes down temporarily.
• Companies which will endure, but most importantly, which are selling below their worth.
• Look for things people think are improper(e.g. Junk bonds); you are likely to make more money here.
• Emotional Control; be cautious, conservative, risk-averse and stick to your strategy even when you are tempted to deviate from it.

7. Peter Lynch.

• Invest in an industry which you know a lot about; Buy ONLY what you know and understand.
• Buying just because it has fallen is stupid; you can’t call the bottom. Relatively low [prices] doesn’t mean low [prices]. So, you do NOT have to react just because there has been a correction.
• When things look high - and there is too much confidence - that’s when it MAY turn.
• You must be patient and take a long-term view, to make money in this business.

8. Stanley Drucken Miller.

• Put your eggs in a few baskets and monitor it carefully; don’t diversify.
• Think out of the box; the present is already priced into the market valuation.
• The obvious is obviously wrong.
• Think about status quo. Why is this going to change? What will this mean?

10 Things I Learned At First State

I spent two weeks at the Singapore office of First State Investments this summer. During this period, I attended meetings/calls with eight companies, and two team meetings. These meetings have allowed me to gain exposure to the banking sector in India, to a few Chinese, Philippine, Indonesian, and Japanese companies, and to understand the importance of good governance. At First State, I noticed that a significant amount of time and effort is spent on deciding whether one can trust the management. I am confident that this will – and has already begun to – strongly influence the way I will think about companies too.

In the second week, I began to understand how profit and loss statements link with balance sheets. This introduction to numerical analysis will serve as a useful base from which I can further my understanding of accounting, and will also allow me to do some more numerical analysis before I make an investment. 


I am very grateful to the entire team at First State, and look forward to more experiences like this in the future. Here are 10 Important Things I Learned:

1. You have to be able to trust the management, and feel that their interests are aligned with those of minority shareholders. Also look to see if there are enough checks and balances in place.
2. A good quality management is risk-aware, honest, open to new suggestions, and willing to acknowledge mistakes.
3. A culture of accountability, which can be created through employee-ownership of the company, is important. Growth opportunities within a company also create a more competitive work-environment. 
4. Questioning an investment thesis is very important. Being surrounded by a group of people who think differently and are willing to ask difficult questions allows people to see things from different perspectives, and reduces the effects of confirmation bias.
5. Investing is an art; there will always be positives and negatives, and the key is to decide whether you think the positives outweigh the negatives or not.
6. Look for companies with a moat, and see how the moat is evolving.
7. Look for a company with a solid long-term track record.
8. High ROCE, good governance and growth are 3 key factors to look at.
9.  Look for structural shifts and changes in consumer behavior and secular trends.
10.  It is difficult to differentiate between what the management wants you to see and what is real.