Pembridgecap

A Wealth Creation Journal

Tag: Book Summary

Book review: Free Capital

I have never felt that investing is like working. It is more like playing ten parallel games of poker.

Peter Gyllenhammar

I recently read Guy Thomas’ excellent book “Free Capital: How 12 Private Investors made millions in the Stock Market” and learned a few things.

The book profiles 12 UK private investors who left their career to invest. I found the book an enjoyable and easy read.

The depth of the interviews is quite good. It’s easy to see the author is very knowledgeable in stock market investing (i.e. he’s an independent investor himself).

The book is agnostic on investment philosophy and there’s no larger narrative. Rather, the book is similar to the all-time classics Market Wizards or Inside the House of Money or John Train’s The Money Masters. The main difference is it profiles succesful non-“professionals”.

As the book does not have a big narrative, I’ll share some interesting concepts and quotes I picked up. The book is also full of “concept boxes” that explain certain touched-upon concepts. Even for seasoned investors, you will learn a few things. I will not share these.

Interesting thoughts, resource and quotes. Unsurprisingly, as an electrical engineer myself, the “hard science” investors’ thoughts resonated most:

  • most investors used the bulletin boards to share info with others ADVFN (which I find useful as well for our Dart Group plc position), Fool, iii.co.uk, stockopedia.co.uk

Investing is not like Olympic diving: there are no marks for degree of difficulty

Sushil
  • optimal betting size (i.e. Kelly Betting) is more cautious to downside risks than simply going by “expected returns” (i.e. probability-weighted return). Optimal betting uses logarithmic returns: while an investment with 50% chance of +25% return and 50% change of -20% has a 5% “expected return”, it has a 0% expected logarithmic return. Another way to see how an investor “gets” 0% and not the expected return is by continuously investing in the above 50/50 +25%/-20%-type of investments: +25%’s that are equally followed by -20% return 0% over time
  • Path-indendepent thinking: occupational identity can be a mental constraint. Don’t let your thinking be constrained by your identity.

I don’t seem to have very much influence on Walter. That’s one of his strengths: nobody seems to have much influence on him.

Warren Buffett on walter schloss
  • look for motivated sellers
  • better be right than consistent

The best decisions in the stock market attract no applause

Vernon
  • structuring your investments by writing down a brief 1) thesis 2) secondary factors 3) “hygiene factors” (absence of red flags)
  • investing is a game with negative scoring: avoid mistakes, learn from other people’s mistakes
  • optimal rate of error: it is not worth knowing everything about a company, because every point investigated has a time-opportunity cost. Your aim in checking “hygiene factors” is not to find out everything, but to reduce your error rate to an acceptable level

On talking to insiders and activism:

  • strategic naïvety: it can help to appear less sophisicated than you are. It helps persuade insiders to open up.
  • manage company meetings: at AGM’s, set expectations at the start of the meeting by informing insiders you have several questions to ask. Take note of who answers which questions and how they interact.
  • create a paper trail: putting your communication on paper makes it harder for directors to evade their fiduciary duties and ignore you

Another interesting – and complimentary – review can be found here.

TC

Book Summary: The Energy World is Flat by Parilla

I read this book because its author proved to be correct on oil.  This is a non-exhaustive book summary I made last year. In the meantime, other events prove another call in the book: the book predicts convergence of global energy prices: oil has come down and the cheapest natural gas in the world (American) is rising.

The Energy World is Flat offers a refreshing view on the oil market. I found it through one of the better Real Vision interviews with Diego Parilla two years ago. The title is a variation to Tom Friedman’s best-selling book on globalization The World is Flat. Lastly, Diego Parilla and I are alumni from the same oil & gas business school.

I only read the book now as I realized that the author’s first call on the flattening of oil call has already proven profitable. These are the main calls the book makes:

  1. the term curve of oil will flatten
  2. geographic spreads will flatten
  3. spreads between energy equivalent prices of fossil fuels will flatten
  4. oil price volatility will lessen

If we compare the oil term curve between the publishing date (1/1/15) and now, we find that it has flattened considerably.

Chapter 1: the Flattening and Globalization of the Energy World

In the oil shock of the ’70s, oil was displaced for power generation and industrial uses in favour of coal, natural gas, nuclear and others because the primary consideration is price in these industries.

Today, oil still reigns over other fossil fuels for transport purposes despite its higher price (e.g. oil was 10X more expensive per energy equivalent than natural gas in the US in 2012). The main is reason is that oil is exceptionally compact both in terms of volume and weight per energy equivalent. Over the short-term, transport is very price inelastic.

Geopolitical events that created volatility sowed the seeds for more buffers ‘flatteners’: storage, demand destruction, new technologies and discoveries. A result can be found in 2014 when the exceptional combination of the below supply disruptions failed to make the oil price spike (the move was limited to 10$/barrel from bottom to peak).

  1. the arab spring (e.g. disruptions in Libya)
  2. oil sanctions in Iran,
  3. conflicts and disruptions in Sudan, Syria and Iraq

Chapter 2: Lessons from the Dotcom bubble

The tech revolution (and bust) created huge capital inflows that led to miserable investor returns over the cycle. The big winners were consumers that benefited from stranded assets such as fiber-optic broadband.

The revolution of fracking and horizontal drilling is similar. Although there is still a lot of skepticism towards shale for environmental reasons, Parilla draws a parallel with ultra-deep-water drilling that faced critics in the early ’90s but developed into a very safe technology. Peak oil sentiment similarities to the tech revolution includes huge capital investment into:

  1. LNG terminals (requires huge upfront capex)
  2. pipelines (see European and Asian projects)
  3. E&P
  4. demand efficiency

One trap for energy investors is to follow consensus according to Parilla. The sector is driven by extremely optimistic assumptions of demand growth. Every year, demand growth estimates are revised down an average of 15-20% from the January estimates (IEA, OPEC). Since 1998, only one year, 2012, has seen meaningful upward revisions. Main reasons are

  1. optimistic GDP growth estimates
  2. using the rear-view mirror correlation between GDP and energy demand that has been breaking down since 1998

Another parallel with the dotcom boom is the diversified ‘venture capital’ approach. In the energy world a lot of capex is being made in new technologies, with a lot of losers. The mentality for

  • big integrated O&G company boards is to ‘be’ invested in new areas as it looks better on paper
  • investors to be invested in all new areas as “you only need one winner”

Examples in the transportation world are:

  1. compressed natural gas (CNG)
  2. LNG for trucks, trains and ships
  3. electric and hybrid vehicles (EV’s and HV’s)

Note: according to Parilla, governments have delayed EV’s by subsidizing combustion-engine car sales (and bailing out the companies) post-recession by a 6-to-1 investment factor to EV subsidies.

Last parallel: the bubble accelerates the impact of the revolution. The runaway oil price in 2007 set in motion a huge supply response by oil producing and oil consuming countries alike.

Diego warns that a sum-of-the-parts valuation for companies that invest in many fashionable new technologies can be very dangerous with bad capital allocators, as the good parts might subsidize loss-making ones, and that focused companies should be welcomed.

Chapter 3: The 10 Flatteners of the Energy World

Interesting excerpt:

During the super-cyclical run up in corn prices in the 2000s, most commodities were making historical highs, from crude oil, to coal and natural gas, to copper and corn. Correlations had notably increased, which was often used as an argument to justify that speculators were driving prices. And of course, high fuel and food prices were generating inflation and increasing the risk of financial stability. One again, politicians and regulators were quick to blame the speculators. “Food inflation, how dare they?” Corn was considered too expensive and would impact the poor the most and increase inequality. How cynical.

The main reason why corn prices were going up was the surge in demand for corn-based ethanol in response to both high energy prices and the regulated mandates. Corn, which had traditionally been “food and feed”, had become “food,feed, and fuel”. [..] In 2012, following an acute drought in North America, the prices of corn reached historical highs, 400% of 2005 prices. “The speculators are taking advantage of the situation.” Yet, that year over 40% of the physical harvest went to ethanol to “feed” the car. The quantities were mandated by the government as “fuel” forced the demand destruction of “food and feed” via high prices. It was the cattle and hogs who had to change their diet, not the car. By mandate.

Do spot prices converge to futures prices, or is it the other way around? A causality study by Merill Lynch, and Parilla, say futures converge toward the physical fundamentals of the spot market. Speculators will discount future fundamentals in the price. If they improperly discount future risk factors into prices, they will lose money as the future prices converge toward the in-the-future-prevailing spot fundamentals.

TC

© 2019 Pembridgecap

Theme by Anders NorenUp ↑