The Manual of Ideas: A Highly Personal Endeavor
Excerpt from the great book on value investing, The Manual of Ideas: The Proven Framework for Finding the Best Value Investments from the first chapter, followed by a link to the first full chapter and then a short description of the book.
Man the living creature, the creating individual, is always more important than any established style or system.
The stock market is a curious place because everyone participat-ing in it is loosely interested in the same thing—making money.
Still, there is no uniform path to achieving this rather uniform goal. You may be only a few mouse clicks away from purchasing the popular book The Warren Buffett Way,1 but only one man has ever truly followed the path of Warren Buffett. In investing, it is hard enough to succeed as an original; as a copycat, it is virtually impos-sible. Each of us must carve out a personal way to investment suc-cess, even if you are a professional investor.
That said, great investors like Ben Graham, Seth Klarman, and Warren Buffett have much to teach us, and we have much to gain by learning from them. One of the masters’ key teachings is as important as it is simple: A share of stock represents a share in the ownership of a business. A stock exchange simply provides a convenient means of exchanging your ownership for cash. Without an exchange, your ownership of a business would not change. The ability to sell your stake would be negatively affected, but you
would still be able to do it, just as you can sell your car or house if you decide to do so.
Unfortunately, when we actually start investing, we are inevi-tably bombarded with distractions that make it easy to forget the essence of stock ownership. These titillations include the fast-moving ticker tape on CNBC, the seemingly omniscient talking heads, the polished corporate press releases, stock price charts that are con-solidating or breaking out, analyst estimates being beaten, and stock prices hitting new highs. It feels a little like living in the world of Curious George, the lovable monkey for whom it is “easy to for-get” the well-intentioned advice of his friend. My son loves Curious George stories, because as surely as George gets into trouble, he finds a way out of trouble. The latter doesn ’t always hold true for investors in the stock market.
Give Your Money to Warren Buffett, or Invest It Yourself?
I still remember the day I had saved the princely sum of $100,000. I had worked as a research analyst for San Francisco investment bank Thomas Weisel Partners for a couple of years and in 2003 had man-aged to put aside what I considered to be an amount that made me a free man. Freedom, I reasoned, was only possible if one did not have to work to survive; otherwise, one was forced into a form of servitude that involved trading time for food and shelter. With the money saved, I could quit my job, move to a place like Thailand, and live on interest income. While I wisely chose not to exercise my freedom option, I still had to find something to do with the money.
I dismissed an investment in mutual funds quite quickly because I was familiar with findings that the vast majority of mutual funds underperformed the market indices on an after-fee basis.2 I also became aware of the oft-neglected but crucial fact that inves-tors tended to add capital to funds after a period of good perfor-mance and withdraw capital after a period of bad performance. This caused investors’ actual results to lag significantly behind the funds’ reported results. Fund prospectuses show time-weighted returns, but investors in those funds reap the typically lower capital-weighted returns. A classic example of this phenomenon is the Munder NetNet Fund, an Internet fund that lost investors billions
of dollars from 1997 through 2002. Despite the losses, the fund reported a positive compounded annual return of 2.15 percent for the period. The reason? The fund managed little money when it was doing well in the late 1990s. Then, just as billions in new capi-tal poured in, the fund embarked on a debilitating three-year losing streak.3 Although I had felt immune to the temptation to buy after a strong run in the market and to sell after a sharp decline, I thought this temptation would be easier to resist if I knew exactly what I owned and why I owned it. Owning shares in a mutual fund meant trusting the fund manager to pick the right investments. Trust tends to erode after a period of losses.
Mutual funds and lower-cost index funds should not be entirely dismissed, however, as they offer an acceptable alternative for those wishing to delegate investment decision making to someone else. Value mutual funds such as Bruce Berkowitz’s Fairholme Fund or Mason Hawkins’s Longleaf Funds are legitimate choices