Investing Notes to Myself

Investing Notes to Myself

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1) Wager Value

Money is made in the dark, not the light.

Stephen Goddard, The London Company

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Back in the eighties I use to go to the racetrack to bet on Thoroughbred Racehorses. It was a good training ground for investing in the stock market. I came across a term by handicapping author,  James Cramer. He called it Wager Value.  Essentially it meant focusing on information that other handicappers weren’t using. Whereas most people who went to the track used speed ratings and the horse’s current form shown in the past performance tables, Cramer like Stephen Davidowitz before him, focused on trainer patterns, track bias and result charts. He reasoned that if he based his handicapping (estimating probabilities) on underused information, the horses he would come up with would help provide him with more attractive odds. So he might estimate a horse’s chances of winning to be 3-1 while the tote board (based on everybody else opinion) would have the same horse going off at 8-1. This is the very heart of handicapping a horse race, betting on the horse who has the best chance of winning relative to his odds.

Applying the concept of ‘Wager Value’ to the stock market you would want to focus on the inefficient areas of the market. Small and Mid capitalization stocks tend to be a major source of inefficiency in the stock market. Most mutual funds and institutions want to increase their assets under management so they can grow their businesses and get bigger. Most of them get so big that they price themselves out of the smaller cap world. The small and mid caps end up being too illiquid for the giant institutions to bother with so they are forced to move up the food chain to the large caps. This means there are less people buying the small/mid caps and fewer analysts following them. This makes them prone to being mispriced. The small/mid cap world is an ideal environment for the small do-it-yourself investor who is far more nimble and quick than his huge institutional counterparts. Of course small/mid caps can introduce additional risks as well. They tend to more unstable then the large caps. Small caps often have just one or two products lines and a smaller customer base. They can be overly dependent on a few key individuals in the executive suite. So you have to be careful. These risks can be mitigated by concentrating on companies that are serving a potentially big market and that actually have growing revenues, cash flow and earnings. You also like to see management own a good portion of their own stock. If it's run by a founder CEO, even better. It’s an attractive area to explore and their financial statements can be easier to read as well, and its great fun and after all that’s all part of the game.

In my own portfolio I hold some large and mid cap names, while holding some small caps as well. I run sort of a barbell approach in my own investment portfolio. It’s all a matter of taste. You might want to have just a few of the smaller cap names in your portfolio or hold many and maybe have a larger cash position, it’s up to you.

Great patience is often needed as small caps especially, can be out of favor for long periods of time and in this day of the internet can be the subject of bear raids so it’s important to be familiar with the underlying fundamentals of the company. You don't want to be shook out of your position. There are some great small cap mutual funds out there where you can get some unique investing ideas in this area. 

The small do-it-yourself investor gives up a huge advantage to the financial establishment in ignoring this area. Remember when investing you have to have some sort of edge over your competition and the small to mid cap area is a great place to exercise it. And Canada is basically a small to mid cap market and an ideal place to go hunting for under followed names.

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2) Margin of Safety 

What is it that makes outcomes tolerable even when the future doesn't live up to your expectations? The answer is margin of safety.

Howard Marks, The Most Important thing

The Margin of Safety (MOS) is the difference between a stock's intrinsic value (what the company is truly worth) and its current market price.

In simple terms, it's a principle of buying a stock at a price significantly below your estimate of its true value.

Here's a breakdown of what it means and why it's so important:

Core Concept: The Protective Cushion

The Margin of Safety acts as a protective cushion or buffer for the investor. This idea was popularized by Benjamin Graham, the father of value investing and mentor to Warren Buffett.

• Protection against Errors: No valuation model is perfect, and human judgment can be flawed. The MOS provides room for error in your intrinsic value calculation. If you were wrong and the company is only worth 15% less than your estimate, a 40% MOS ensures you still bought at a discount.

• Protection against Market Volatility: It minimizes your risk of capital loss during market downturns, bad luck, or unforeseen corporate challenges. When the market price drops, you are protected because you bought the stock for a price that already had a significant discount built-in.

• Maximizing Returns: When the market eventually recognizes the stock's true value, the price is expected to rise from the discounted purchase price to the intrinsic value, providing a higher potential return.

A wide Margin of Safety is the central principle for value investors. It means:

Never pay full price. Always buy assets for significantly less than their worth. (As Warren Buffett famously said, "You leave yourself an enormous margin. When you build a bridge, you insist it can carry 30,000 pounds, but you only drive 10,000-pound trucks across it.")

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3) Buy and Hold

Investment is a process in time.

Hyman Minsky

'Buy and hold' is a long-term, passive investment strategy where an investor:

1. Buys a financial asset (like stocks, bonds, or mutual funds) based on the belief in its long-term growth potential.

2. Holds that asset for an extended period—often many years or even decades—regardless of short-term market fluctuations or volatility.

Key Principles of Buy and Hold:

• Long-Term Focus: The strategy relies on the historical tendency of the overall market (or a fundamentally sound company) to grow over long periods.

• Ignoring Short-Term Noise: The investor deliberately ignores daily or monthly price swings, resisting the urge to sell during market downturns (panic selling) or buy into temporary speculative bubbles (chasing returns).

• Time in the Market, Not Timing the Market: It emphasizes that consistently staying invested over a long time is more effective than trying to predict when the market will peak or bottom.

• Benefits of Compounding: The strategy maximizes the effect of compounding, where the returns on your investment are reinvested to generate their own returns over many years, creating exponential growth.

• Lower Costs and Taxes: Fewer trades mean lower transaction costs (brokerage fees/commissions). In many jurisdictions, holding an asset for over a year qualifies for lower long-term capital gains tax rates, which is a significant advantage.

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4) Concentrated Portfolio

The strategy we've adopted precludes our following the standard diversification dogma. Many pundits would therefore say the strategy must be riskier than that employed by conventional investors. We disagree. We believe that a policy of concentration may well decrease risk if it raises, as it should, both the intensity with which an investor thinks about a business and the comfort level he must feel with its economic characteristics before buying it.

Warren buffet

Since we're familiar with the underlying fundamentals of the company we've invested in, and are judgements are based on hidden or neglected information, it only makes sense to concentrate your holdings on your best ideas. Why diversify your edge away? As Marty Whitman and Charlie Munger both said, "diversification is a hedge for ignorance."

Joel Greenblatt too observed, as the number of stocks in the portfolio increases, the benefits of diversification drop quickly. In other words know what you own and pick your spots. Put your money into your best ideas and learn to think for yourself. Ten stocks in your investment portfolio are enough if you have good well-thought reasons for investing in them and you spread them out between different industries. Yes, it may be volatile, but volatility is not risk, it's noise. The longer you hold your positions the more the risk will go out of them. A better way to approach diversification is by putting money into low-risk investing instruments (cash, T-bills). Sort of a barbell approach. 

In my own investing, I run an unbalanced as well as a concentrated portfolio. I put most of my money into my best ideas. It's all a matter of taste. The longer you are in the market, your investing style will gradually emerge over time. The market not only teaches you how to invest in stocks, but it will teach you about yourself as well.

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5) Be a Contrarian

If everyone's doing them, there must be something wrong with them.

Henry Singleton

Don't do the obvious thing. Because if it's obvious, it's already a crowded trade. A crowd yields to instincts that an individual, acting alone, represses. The crowd instinctively  follow the impulses of the herd. An individual who becomes involved in a group becomes less capable of thinking for himself. In a crowd every sentiment and act is contagious, and contagious to such a degree that an individual readily sacrifices his ability to think for himself and to stay dispassionate about his investments. He gets emotionally swept away with the crowd and soon finds himself lost and out to sea.

Market extremes represent inflection points. These occur when bullishness or bearishness reaches a maximum. Figuratively speaking, a top occurs when the last person who will become a buyer does so. Since every buyer has joined the bullish herd by the time the top is reached, bullishness can go no further and the market is as high as it can go.

There’s only one way to describe most investors: trend followers. Superior investors are the exact opposite. Superior investing, as I hope I’ve convinced you by now, requires second-level thinking—a way of thinking that’s different from that of others, more complex and more insightful. By definition, most of the crowd can’t share it. Thus, the judgments of the crowd can’t hold the key to success. Rather, the trend, the consensus view, is something to game against, and the consensus portfolio is one to diverge from. As the pendulum swings or the market goes through its cycles, the key to ultimate success lies in doing the opposite.

Howard Marks, The Most Important Thing

And above all, at times of extreme emotion in the market...Be Contrary.

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