Pembridgecap

A Wealth Creation Journal

Tag: investing

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

Should you invest in franchises or managements? It depends.

Note we wrote this post last year.

Many investors categorize themselves and either say

  • they make judgment call on management or
  • rather focus on the franchise or business (it’s rather cool for some in the value investing church to say not getting to know management is a good thing)

Should we focus on the horse or the jockey?

Investor Robert Vinall is known to focus a lot on management. He believes it’s a hard but important question. Important, because it is difficult to quantify, and therefore there’s less competition from conventional investors and quant funds.

Guy Spier, on the other hand, likes to think of himself as a merely good investor, with lots of limitations, such as judging management. He therefore avoids talking to management. Getting to know managements opens us up to get manipulated by their – often perfect – act.

On bad business turnarounds Warren Buffett has said this:

When a management with a reputation for brilliance tackles a business with a reputation for bad economics, it is the reputation of the business that remains intact.

While we definitely think there’s great arguments for both point of views, we think the relative importance of analyzing franchises versus managements changes a lot with one critical variable: growth.

Focus on the racehorse and on the show jumping jockey

As the entrepreneurial HBS author of the book Buying a small business often repeats

With revenue growth comes new customers, and with new customers come new (types of) problems

In other words, growth brings change. While changing companies are not necessarily growing (e.g. turnarounds in the above Buffett quote), growing companies are always changing.

Another recent observation I had redrafting this post one year later is that venture capitalists tend to focus much more on the founder or team.

From the above, we make a case for focusing on the franchise in mature companies in markets with stable competitive dynamics.

In fast-growing companies, management becomes much more important as they need to make a lot of judgment calls in execution and capital allocation of growth investments.

In show jumping, the horse needs the jockey.

Lastly, the only competitive differentiator in commodity companies is management (companies with fast-changing circumstances).

We believe there is an opportunity in looking at jockeys in commodity industries as 

  1. investors hate commodity/capital intensive industries
  2. investors are focusing on “great franchises” right now (peak quality?) while growing more sceptical of looking at management 
  3. we believe management can be the (non-durable) competitive advantage for these businesses

While media attention tends to go to the folklore of billionaire jockeys of once-fast-growing start-ups, some examples of great commodity Jockeys: 

  1. Philip Meeson in Dart Group plc
  2. Belgian owner-operator Luc Tack in Picanol and Tessenderlo
  3. Buffett overseeing (mostly incentives) in (re-)insurance operations

We’d love to hear your under-the-radar commodity jockeys and thoughts!

MC & TC

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