Big Money Thinks Small

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Big Money Thinks Small

Joel Tillinghast, one of the best mutual fund managers, runs the money in Fidelity’s Low-Priced Stock Fund.  It has one of the best long-term records among stock funds over the 28 years that he has managed it.

The author gives you a recipe for how to pick good stocks, but he doesn’t give you a machine that produces them.  In a style that is clever and discursive, he summarizes his main ideas at the beginning and end of the book, and explains the ideas in the middle of the book.  The ideas are simple, but learning to apply them will take a lifetime.

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Here are the five ideas as written in the beginning (page 3):

  1. Make decisions rationally

  2. Invest in what we know (did I mention Peter Lynch wrote the foreword to the book?)

  3. Worth with honest and trustworthy managers

  4. Avoid businesses prone to obsolescence and financial ruin, and 

  5. Value stocks properly

At this point, some will say “You haven’t really given us anything!  These ideas are too big to be useful!”  I was surprised, though, to see that the same five points at the end of the book said more (page 276).  Ready?

  1. Be clear about your motives, and don’t allow emotions to guide your financial decisions

  2. Recognize that some things can’t be understood and that you don’t understand others.  Focus on those that you understand best.

  3. Invest with people who are honest and trustworthy, and are doing something unique and valuable.

  4. Favor businesses that will not be destroyed by changing times, commoditization, or excessive debt.

  5. Above all, always look for investments that are worth a great deal more than you are paying for them.

That says more, and I think the reason they are different is that when you read through the five sections of the book, he unpacks his initial statements and becomes more definite.

Much of the book can be summarized under the idea of “margin of safety.”  This is a type of value investing.  When he analyzes value, it is like a simplified version of reverse discounted cash flows.  He tries to figure out in a broad way what an investment might return in terms price paid for the investment and what “owner earnings,” that is, free cash flow, it will generate on a conservative basis.

One aspect of the conservatism that I found insightful is that he assumes that the terminal value of an investment is zero. (page 150)  In my opinion, that is very smart, because that is the area where most discounted cash flow analyses go wrong.  When the difference between the weighted average growth rate of free cash flow and the discount rate is small, the terminal value gets really big relative to the value of the cash lows prior to the terminal value.  In short, assumptions like that say that the distant future is all that matters.  That’s a tough assumption in a world where companies and industries can become obsolete.

Even though I described aspects of a mathematical calculation here, what I did was very much like the book.  There are no equations; everything is described verbally, even the math.  Note: that is a good exercise to see whether you understand what the math really means.  (If more people on Wall Street did that, we might not have had the financial crisis.  Just sayin’.)

One more fun thing about the book is that he goes trough his own experiences with a wide variety of controversial stocks from the past and his experiences with them.  His conservatism kept him a great number of errors that tripped up other celebrated managers.

I learned a lot from this book, and I enjoyed the writing style as well.  He clearly put a lot of effort into it; many people will benefit from his insights.

Quibbles

His methods are a lot like mine, and he clearly put a lot of thought into this book.  That said, he doesn’t understand insurance companies as well as he thinks (I’m an actuary by training).  There are a number of small errors there, but not enough to ruin a really good book.

Summary / Who Would Benefit from this Book

I highly recommend this book.  This is a book that will benefit investors with moderate to high experience most. For those with less experience, it may help you, but some of the concepts require background knowledge.  If you want to buy it, you can buy it here: Big Money Thinks Small: Biases, Blind Spots, and Smarter Investing.

Full disclosure: The publisher asked me if I wanted a free copy and I assented.

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David J. Merkel, CFA, FSA — 2010-present, I am working on setting up my own equity asset management shop, tentatively called Aleph Investments. It is possible that I might do a joint venture with someone else if we can do more together than separately. From 2008-2010, I was the Chief Economist and Director of Research of Finacorp Securities. I did a many things for Finacorp, mainly research and analysis on a wide variety of fixed income and equity securities, and trading strategies. Until 2007, I was a senior investment analyst at Hovde Capital, responsible for analysis and valuation of investment opportunities for the FIP funds, particularly of companies in the insurance industry. I also managed the internal profit sharing and charitable endowment monies of the firm. From 2003-2007, I was a leading commentator at the investment website RealMoney.com. Back in 2003, after several years of correspondence, James Cramer invited me to write for the site, and I wrote for RealMoney on equity and bond portfolio management, macroeconomics, derivatives, quantitative strategies, insurance issues, corporate governance, etc. My specialty is looking at the interlinkages in the markets in order to understand individual markets better. I no longer contribute to RealMoney; I scaled it back because my work duties have gotten larger, and I began this blog to develop a distinct voice with a wider distribution. After three-plus year of operation, I believe I have achieved that. Prior to joining Hovde in 2003, I managed corporate bonds for Dwight Asset Management. In 1998, I joined the Mount Washington Investment Group as the Mortgage Bond and Asset Liability manager after working with Provident Mutual, AIG and Pacific Standard Life. My background as a life actuary has given me a different perspective on investing. How do you earn money without taking undue risk? How do you convey ideas about investing while showing a proper level of uncertainty on the likelihood of success? How do the various markets fit together, telling us us a broader story than any single piece? These are the themes that I will deal with in this blog. I hold bachelor’s and master’s degrees from Johns Hopkins University. In my spare time, I take care of our eight children with my wonderful wife Ruth.
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