A Very Long Hill

Excited to announce my new eBook on getting kids started investing, its called A Very Long Hill. And it is available in the Kindle store now.

This book’s goal is to help parents and kids learn more about an incredibly important topic – how to invest for the long run, and take advantage of two of the most powerful forces in the world: time and compounding.

Hopefully this work generates some good discussions on these critically underserved areas - investment education and long term thinking. 

Book Review: Tren Griffin's "Charlie Munger - the Complete Investor"

A key question I had going into reading Tren Griffin's new book "Charlie Munger - The Complete Investor" was - what would the work add to the previous books on Munger? I am happy to report that the book is an excellent addition to the family of Munger books.

"Poor Charlie's Almanack" by Peter Kaufman is one of my favorite all time books, its a compendium and includes lengthy speeches from Munger. It is unique.

"Damn Right" by Janet Lowe is not nearly as well known, but it covers some useful biographical material on Munger's life. It also explains a key component as to why Munger is worth studying. Buffett is a prodigy and became a millionaire very early on. Its hard for most people to relate to whiz kids who have astonishing success from very early ages. We can all admire Buffett, Gates, and Mozart. We can draw many lessons, but its not always as relatable. Damn Right shows in a lot of detail how Munger worked his way through some tough personal periods including a divorce and did not achieve great financial wealth until much later in life. Overcoming these challenges is something that everyone can comprehend.

"Seeking Wisdom" by Peter Bevelin puts Munger's thought processes into a historical context of thinkers from Charles Darwin to Michel de Montaigne. It shows you certain habits that you can improve your thinking and avoid common errors of judgement.

I had many takeaways from all of these books and the numerous transcripts available on line, so I had a bit trepidation picking up Griffin's effort. What would Griffin add on a life that is well covered from many perspectives? Like Poor Charlie's Almanack, The Complete Investor contains a diverse array of Munger's wit and wisdom. Like Seeking Wisdom, The Complete Investor shows how Munger's analytical process fits into a larger context.

The Complete Investor goes on to tackle a couple of areas that are fundamentally new. Note, as I am reading I fold pages so that I can revisit, the middle part of the book is chock full of things worth revisiting.

The two areas that I see where Griffin broke new ground were first in assembling Munger's ideas into an investing context. It sounds a bit crazy, but Munger is such an original thinker that the previous books focused mainly on his thought process. Griffin's book deftly brings together incisive quotes from Munger, decades apart, into a tossed salad where each idea slots into a business and investing context.

The other area is my favorite chapter, "The Seven Variables in the Graham Value Investing System." I spent a fair bit of the early part of the book a bit perplexed by how Griffin continually referred to Munger in the context of a Graham value investor. One key insight I have learned from Munger is how he helped move Buffett away from the strict bargain basement Graham school of cheap stocks and towards wonderful businesses at fair prices. So it was initially disconcerting for the early stage of the book to look at Munger mainly in a Graham context.

But that made the Seven Variables work all the more enjoyable because Griffin brings that evolution into clear focus. To summarize the seven variables that Griffin distilled from Munger's work I have chosen one of my favorite quotes. Again, what is interesting to me here is that Griffin's work is the first attempt that I have seen by someone attempting to pull together an investing framework based on Munger's thinking. That alone makes the book very useful.

To give you an idea on this important chapter, I have copied the variables that Griffin distilled below along with my favorite Munger quote (of the several that Griffin includes and comments on in the section). Notice the progression. The first two variable are old testament Graham, and then Griffin shows how Munger builds upon that foundation to a new, quality at a reasonable price style.

First Variable - Determining the Appropriate Intrinsic Value of a Business
"There are two kinds of businesses: The first earns 12 percent and you can take it out at the end of the year. The second earns 12 percent, but all the excess cash must be reinvested - there's never any cash. It reminds me of the guy who looks at all of his equipment and says, "There's all of my profit." We hate that kind of business." - Charlie Munger, Berkshire Annual Meeting, 2003

Second Variable - Determining the Appropriate Margin of Safety
"Ben Graham had this concept of value to a private owner – what the whole enterprise would sell for if it were available. And that was calculable in many cases. Then, if you could take the stock price and multiply it by the number of shares and get something that was one third or less of sellout value, he would say that you’ve got a lot of edge going for you. Even with an elderly alcoholic running a stodgy business, this significant excess of real value per share working for you means that all kinds of good things can happen to you. You had a huge margin of safety – as he put it – by having this big excess value going for you." - Charlie Munger, USC Business School, 1994

Third Variable - Determine the Scope of an Investor's Circle of Competence
"Warren and I have skills that could easily be taught to other people. One skill is knowing the edge of your own competency. It’s not a competency if you don’t know the edge of it. And Warren and I are better at tuning out the standard stupidities. We’ve left a lot of more talented and diligent people in the dust, just by working hard at eliminating standard error." - Charlie Munger, Stanford Lawyer, 2009

Fourth Variable - Determining How Much of Each Security to Buy
"I always like it when someone attractive to me agrees with me, so I have fond memories of Phil Fisher.  The idea that it was hard to find good investments, so concentrate in a few, seems to me to be an obviously good idea.  But 98% of the investment world doesn’t think this way." - Charlie Munger Berkshire Annual Meeting, 2004

Fifth Variable  - Determining When to Sell a Security

"There are huge advantages for an individual to get into a position where you make a few great investments and just sit back and wait: You’re paying less to brokers. You’re listening to less nonsense. And if it works, the governmental tax system gives you an extra 1, 2 or 3 percentage points per annum compounded." - Charlie Munger, Damn Right, 2000

Sixth Variable - Determining How Much To Bet When You Find a Mispriced Asset

"We came to this notion of finding a mispriced bet and loading up when we were very confident that we were right." - Charlie Munger, USB Business School, 1994

Seventh Variable - Determining Whether the Quality of a Business Should be Considered

“Grahamites ...realized that some company that was selling at 2 or 3 times book value could still be a hell of a bargain because of momentum implicit in its position, sometimes combined with an unusual managerial skill plainly present in some individual or other, or some system or other. And once we’d gotten over the hurdle of recognizing that a thing could be a bargain based on quantitative measures that would have horrified Graham, we started thinking about better businesses. We’ve really made the money out of high quality businesses. In some cases, we bought the whole business. And in some cases, we just bought a big block of stock. But when you analyze what happened, the big money’s been made in the high quality businesses. And most of the other people who’ve made a lot of money have done so in high quality businesses.” -Charlie Munger, USC Business School, 1994

(Interestingly enough the chapter called "The Seven Variables in the Graham Value Investing System has an eighth variable)

Eighth Variable - Determining What Businesses to Own (in Whole or in Part)

“The difference between a good business and a bad business it is that good businesses throw up one easy decision after another. The bad businesses throw up painful decisions time after time.” - Charlie Munger, Berkshire Annual Meeting, 1997

In the spirit of Munger I have nothing to add to these variables. 

As to the book, the above example shows exactly how Tren Griffin takes a broad range of Munger's ideas and assembles them to compose a set of the key insights on the investor's decision tree.

Sonho Grande (Dream Big)

Two years back, Buffett recommended the book "Dream Big", the story of 3G Capital, which I finally got around to reading. When Buffett recommended it he was referring to 3G's involvement in the Heinz deal and how much he liked doing business over the years with Jorge Paulo Lemann. Since then, 3G spearheaded deals with Tim Horton's and the Kraft Heinz merger. I figured it was finally time to read the book.

Its not an investing book, more of a business history and all the of the history leading up to 3G is covered in detail. Since they started in Brazil there was a lot I did not know about the founders, and I suspect it will be new to most US investors. 3G has a much bigger name now controlling so many well known North American and global brands, its a fair question to ask, how did a few people from Brazil with no particular advantage pull of this feat?

Its easy to see why Buffett appreciates doing business with 3G. They are at the same time quite successful and very focused on discipline and results. They are also modest. My favorite quote in the book is at the end. When the author approached Lemann with the idea to write a book, he did not think they were worthy. Lemann said "All we did was copy a little from Goldman Sachs and a bit from Walmart. Nothing more than that." That's a pretty big understatement from a firm that controls beer across Latin America, Anheuser-Busch, Kraft Heinz, Tim Horton's, Burger King, and a lot more besides.

One key to success is a major focus on costs and zero based budgeting, managers have to fight every year to justify budget items. The mantra is that costs are like fingernails, they have to be trimmed regularly. This mantra is playing itself out at Kraft Heinz right now, the cuts go way beyond jobs - no free cheese sticks for employees, employees can't bring competitors food for lunch, printing on both sides of the paper, and so on. The goal for Kraft Heinz is to take out $1.7B in costs by 2017.  The book does a good job showing that this is not new to 3G, this playbook is their DNA and it has evolved for decades.

They have a strong culture where they look to find and empower PSDs - Poor, Smart, and Deep Desire to get rich. 3G's process has identified many of these folks over the years, such as Carlos Brito, and once they are able to find them, the recipe basically is to give them the playbook,  keep costs way down, latitude to operate, and big incentives to deliver. Brito came from nothing, worked his way up to CEO of Anheuser-Busch and ended up with 0.18% of the company's shares after delivering on the aggressive performance metrics set for him.

The culture is high on meritocracy and low on formality. Beto Sicupira comes to the office in scruffy jeans and a backpack. "the simplest guy in the whole world." Like Berkshire and Walmart, results matter, puffery doesn't. People matter, Oscar Telles still is involved in the new employee orientation, to ensure the culture stays consistent.

Selecting the right kinds of businesses to invest in matters with this approach. 3G buys low cyclicality, low capital businesses like consumer staples firms. These companies are ideal for the 3G approach, if you tried the same playbook at another firm, it might not work nearly as well.

One criticism is that 3G does not do a lot of traditional innovation with product launches and such. I am not sure if that is that big a deal. Look at P&G, GE and other firms that spent the last decade acquiring, now they are shrinking brands as fast as they can. 3G has run this focused playbook for a long time. In reading the book I was left with the distinct impression that it would be no fun at all to compete against these guys. When your competition can sustain a cost advantage it probably means they also have an advantage in focus and in customer service. That's what Sam Walton and Hunter Harrison figured out.

Like Berkshire, 3G does not do grand strategic plans.  When 3G originally started in the beer business they looked around Latin America. The richest guy in Venezuela was a brewer. Same with Colombia, same with Argentina. They thought - they can't all be geniuses, it must be the business model that is good.  That is where the genius of 3G lies, finding simple, scalable businesses and focus on them. Then get the right people, give them room to operate, excellent incentives and give them room to run. Its a  recipe that has delivered and should continue for years to come.

How to Lie with Statistics

This is a book that two of my favorite people report that they give as their holiday gift of choice. Bill Gates recommends it on his summer reading list. After finishing How to Lie with Statistics, I can see why.

Just on the craft part of writing, the book is a great example for how to communicate important but dry concepts in an engaging, entertaining way.

"Permitting statistical treatment and the hypnotic presence of numbers and decimal points to befog casual relationships is little better than superstition. And it is often more seriously misleading. It is rather like the conviction among the people of the New Hebrides that body lice produce good health. Observation over the centuries taught them that people in good health usually had lice and sick people very often did not. The observation itself was accurate and sound, as observations made informally over the years surprisingly often are. Not so much can be said for the conclusion to which these primitive people came to from their evidence: Lice makes a man healthy. Everybody should have them"

Huff's book is written in a tongue in cheek way as if the reader wants to use stats for a tool to fool other people, of course plenty of people do do this. It can be hard to tell the difference. The current age has so much data, but far less quality analysis and consequently we have very little information relative to data we are awash in.

"It's all a little like the tale of the roadside merchant who was asked to explain how he could sell rabbit sandwiches so cheap. 'Well' he said 'I have to put in some horse meat too. But I mix 'em fifty-fifty: one horse, one rabbit.'"

Anyone who has tried, say, Kona coffee and Kona coffee blend can relate to this. Statistical models are often wielded to distract from important points. As Sherlock Holmes said "there is nothing more deceptive than an obvious fact."

As to investing, we need look no further than dividend yield to see a great example of misleading stats. Once a yield gets too high, say triple the current S&P yield, you are generally in "sucker yield" territory. The company that says its going to payout 8% dividends today should not be taken at face value, and in fact it should be looked at as a negative, because once you look at the quality metrics you are likely to find the company will have a hard time delivering on that number.

The last chapter should be required reading for any citizen, frankly, as a self-defense mechanism in the so-called information age. Its a set of rules for how to talk back to a statistic, always ask:

• Who says so?
• How does he know?
• Did somebody change the subject?
• Does it make sense?

I might add to this list - how can you test this to see if the trend holds or not? The reason I see this book as required reading is that people with agendas are wont to throw out stats to prove their point, if you do not ask these questions you miss important points. 

I will give Mr. Huff the last word:

"Encephalitis cases reported in the central valley of California in 1952 were triple the figure for the worst previous year. Many alarmed residents shipped their children away. But when the reckoning was in, there had been no great increase in deaths from sleeping sickness. What had happened was that state and federal health people had come in in great numbers to tackle a long-time problem: as a result of their efforts a great many low-grade cases were recorded that in other years would have been overlooked, possibly not even recognized."

The Detective and the Investor

One of the first books I read when I started learning about investing was Robert Hastrom's "The Warren Buffett Way." Hagstrom is a writer who excels at seeing connections and finding patterns.

As a fan of detective stories in general and Holmes in particular, I was happy to uncover a Hagstrom book from 2002, called "The Detective and The Investor." Its out of print now, but easy to find copies on Amazon. If you like investing and detective novels then you will enjoy it, because Hagstrom finds a lot of common thought processes from great detectives  and investors.

There is a chapter dedicated to the specific techniques of the three main subjects that Hagstrom covers: Poe/Dupin, Conan Doyle/Holmes, and Chesterton/Father Brown. Each chapter then links what the investor can learn from the methods of the detective.

Hagstrom draws out the Habits of Mind from the great detectives:

• Auguste Dupin
• Develop a skeptic's mindset; don't automatically accept conventional wisdom
• Conduct a thorough investigation
• Sherlock Holmes
• Begin an investigation with an objective and unemotional viewpoint
• Pay attention to the tiniest of details
• Remain open minded to new, even contrary information
• Apply a process of logical reasoning to all you learn
• Father Brown
• Become a student of psychology
• Have faith in your intuition
• Seek alternative explanations and re-descriptions

Hagstom skillfully traces the evolution of the detective novel, which he says begins with Poe's Dupin. The book shows how each of the three detectives refined the craft of the detective and brings new methods to the table. Each of these prove useful to investors as well.

Dupin shows the value of plodding detective thorough investigation (Hagstrom calls this the document state of mind) when combined with the tenacity to dig out as many facts as possible. This is done both by confirming and disconfirming observations. The most talented, productive people that I have worked with are the ones who work the hardest at beating up their own ideas.

Holmes has many qualities of successful investors. To cite one example, Holmes works at determining the underlying factors of what appears as self-evident. Holmes says "There is nothing more deceptive than obvious fact." That quote immediately brings to mind Charlie Munger's - "every time you see the word EBITDA, you should substitute the word ‘bullshit’ earnings.”

In the Father Brown chapter, Hagstrom shows how Buffett's famous Coca Cola purchase occurred at a time in 1988 when Coke was selling at five times book value, a below average dividend yield and an above average P/E. Where was the buy signal? Yet Buffett found it, put in $1 Billion and it led to one of the best investments of his career. Though the raw numbers did not show it, Buffett, like Father Brown, saw that things are not always as they seem.

Its a unique book on two of my favorite topics, so its hard to have too many quibbles. Some of the analogies and linkages are a bit of a stretch, but that is unavoidable in this type of writing, and the main points that connect the analytical toolboxes are expertly linked. Chesterton's work went well beyond detective novels and it may have been interesting to hear more about his other work as a logician. But these are minor points, like licorice this book is not for everyone, but the people who like it will like it a lot. If this is the kind of book that you will like, you already know it by now. I think its a hidden gem.

Book Review - Education of a Value Investor

We live in a categorized, check box kind of world, so Guy Spier's "Education of a Value Investor" is bound to be sitting on a shelf in the Business/Investment category at Barnes & Noble right next to the numerous How To investing guides. But this is not a How To book, its a personal journey of discovery and value investing as conducted by Buffett, Munger, and Pabrai is a North star on this journey.

I received the book today and read it in one go, I suspect others will have a similar experience; find a quiet place and a comfortable chair - Guy Spier's story, told warts and all, pulls you in. Its hard to imagine rooting for a  self admitted Gordon Gekko type, but when he eventually starts to get it and figure out the bigger picture, and helps the reader learn from his own travails its easy to get behind Guy Spier's journey.

The book plainly isn't about the mechanics of investing, there are lots of books that covers these. The main theme is much more fundamental - make sure you spend as much of your time as possible with high quality people. One of my mentors in my own career advised you should always take at least one job in your career simply because of the people you would work with at that company. Guy Spier has sort of adopted this and expanded so its not about one job but a core operating philosophy. He cites a numerous second and third order powerful obliquities that arose out of this mode of operating.

There is another unexpected theme along this journey - gratitude. One of the most compelling parts of the book to me is the description of Guy Spier's devotion to the small, thoughtful kindness of writing thank you notes. To many people. This has the effect of both touching other people and ensuring that you are accounting for what you have received. These are important lessons not to lose sight of in today's world.

Friendships, people, gratitude - there are large parts of the book that are more like a self improvement book, and Guy Spier points to Tony Robbins' and others influences. Lots of people have benefitted from their work to improve their own productivity, health and personally develop, but Guy Spier shows exactly how this plays out in financial markets and in investor psychology which is a unique contribution, especially due to his transparent writing. Its a brave effort to put his mistakes on display and to share the journey at this level.

Value investing is almost like its own character in the book, and in the beginning of his career, Spier is as far from that concept as you could be, but by the end he has fully embraced and internalized the concepts.

Practically speaking there are number of good lessons, too. Spier's discussion of moving his practice from New York to Zurich goes into some detail about his thought process on designing the new space. There is a hard separation between the computer, Bloomberg busy room and a quiet library for reading with no computers. It struck me that Kahneman might call them System 1 room and System 2 room.

Spier stresses the importance of checklists and shares the key insight that checklists are not to tell you what to do, checklists are critical as a mistake avoidance tool. He includes a helpful way to think about processing investment ideas - do your own research first and then read news and other things about companies. Don't be led in by news or analyst reports because your susceptible to seeing things through their lens.

The overall theme is personal growth and connecting on a deeper level with great people (living and dead(through books)) they will help you discover vital things you can't on your own. The personal theme is to be true to yourself, do your research first, or as I say - outsource execution if you want, but never outsource strategy. Guy Spier writes that the "path to true success is through authenticity"and on this measure the book is a Peter Lynch ten bagger.

The real gem is the insight that value investing principles can go well beyond making money in the stock market; Guy Spier shows how value investing principles can be applied to enrich your personal life.

Why Moats Matter

I read Why Moats Matter while on Martha's Vineyard. This felt especially appropriate. The moat concept that Morningstar pioneered is all about different kinds of structural competitive advantages. When you are on an island like Martha's Vineyard, there is no bridge to the mainland, only a ferry or a plane. If you need anything you better hope you brought it with you or prepare to pay a rich price to acquire it on the island. The only thing better than a moat is an ocean.

Heather Brilliant, Elizabeth Collins, and an all star cast of Morningstar analysts provide a detailed analysis of the Morningstar analysis framework. The book opens with the five kinds of moats that Morningstar uses - Intangible Assets, Cost Advantage, Switching Cost, Network Effect, and Efficient Scale. The rest of the book could just as easily be called How Moats Matter since it really focuses more on how to analyze moats and use them in your investing analysis.

The chapter on moats trends breaks down the competitive landscape by sector. That's interesting because looking at the positive and negative moat trends shows which spaces are more hotly contested

Todd Wenning's chapter is on How Stewardship affects economic moats. Morningstar's view is that its more about the horse than the jockey. Todd writes "Management itself can't make a moat, but a company can enhance or establish a moat resulting from its management's skillful effort to allocate capital toward moat-widening projects. On the other hand, poor stewards of shareholder capital that consistently invest in competitively disadvantaged projects for the sake of short-term growth and destroy long-term shareholder value in the process would likely see moats erode over time."

One of my favorite parts of the book is the many real world examples. The stewardship chapter lists detailed examples for each sector of exemplary standouts (like consistently shareholder friendly IBM) and poor standouts (like Dean Foods).

Josh Peters' chapter on using moats with dividend investing has several useful nuggets, several of which are gleaned from the real money portfolio that he runs. The first is on the importance of avoiding dividend cuts. In the real money dividend portfolio, that Josh Peters runs at Morningstar, they have experienced negative total returns in 81% of the companies where the dividend was cut. For companies that held the dividend flat, they earned a positive return 67% of the time, and for the dividend growers it was 89% positive. Simply avoiding dividend cutters makes a huge difference in total returns, So how can moat analysis help? The business' moat is an important safety measure.

Moat	Frequency of Cuts	Avg Cut Size
No moat	7.4%	69.8%
Narrow Moat	5.3%	66.8%
Wide Moat	3.0%	66.0%

Wide moat companies are more than half as likely to undergo a dividend cut. That's a factor that should be considered right alongside traditional dividend safety metrics like dividend coverage, payout ratios and so on.

Long run total returns and wide moats work well together, Josh Peters writes "An attractive and sustainable dividend policy can create a "clientele effect" in which shareholders, amply rewarded through dividends, are less likely to dump their shares and hurt the stock price on the basis of short-run fluctuations in profits. This in turn may give management a freer hand to concentrate on long-term initiatives, even at the expense of near-term profits or cash flow." The ability to think longer term than your competition is a very rare thing, this strikes me as a huge advantage when an investor can find wide moat, dividend paying companies.

The first half of the book is on the conceptual, analytical framework. Just as useful is the second half which shows how the analytical tools are put to use in each sector. Like Pat Dorsey's book, this sector by sector view is very helpful because it shows how to apply moat analysis in different segments. What you look for in energy is quite different than technology or industrials. Further, the authors describe their view as to what kind of moats you are likely to find in each of the major industry sectors.

The book works well on two levels - as a guide for how moat analysis helps investors, and how these apply in sectors. For me, the most fruitful insight is the intersection of wide moats and dividends, which can result in, as Josh Peters writes "a sound provider of income and total returns."

Why We Write - Anecdote from Davis Dynasty Book

There is a great anecdote in The Davis Dynasty that I think resonates well with anyone who writes. As I mentioned in my full review of The Davis Dynasty book, this is a different kind of investing book. There are tons of business books about how one person or another climbed the ladder, found a way to make a fortune. Those are great, but the Davis Dynasty shows more of the effects on the personal side through three generations, which is pretty unique.

Towards the end of the book, the third generation Andrew Davis and Chris Davis are establishing themselves in the investment world. Chris Davis is working for Shelby Davis the patriarch, then in his 80s, who is at the tail end of his career. Shelby Davis specialized in investing in insurance companies, and he had published a weekly insurance newsletter. One of Chris (his grandson's) jobs was to help with publishing the newsletter, which in the age of computers was not really read by anyone outside their family office any more:

"Why do we bother this?" [Chris] asked Davis, "when nobody reads it."

"It's not for the readers," Davis said. "It's for us. We write it for ourselves. Putting ideas on paper forces you think things through." 

That's an excellent insight and applies well beyond investing. In the realm of investing, I have followed Jason Zweig's guidance in Your Money and Your Brain, where he advises that investors write out an Investment Policy Statement (IPS). Zweig says "The best way to prevent yourself from being knocked off track by your emotions is spell out your investment policies and procedures in advance in an IPS"

From Zweig's book and IPS should include:

"Purpose of Portfolio

Return Expectations

Time Horizon

Diversification

Rebalancing

Benchmarks and Review

Frequency of Evaluation

Adding and Subtracting

We Will Never..."

I think the last category is the most vital, because the IPS is essentially a mistake avoidance tool. The We Will Never rules to avoid act as guardrails. And writing them down is the first step. 

The Davis Dynasty Book Review

The Davis Dynasty is a different kind of investing book. Its part biography, part history of investing business, and part how to succeed as a long term investor.

The Davis Dynasty tells the story of three generations of investors - Shelby Davis, Shelby Cullom Davis and Chris Davis. The latter still actively engaged at the Davis Venture Fund.

One of the common threads that run through the three generation is a substantially longer term focus this side of anyone outside of Omaha. This pays off in the long run. All investors know the power of compounding, but long term focus means that you are positioned to improve with age- 1 to 2 is nice, 2 to 4 is better, and when you get to 4 to 8 that is really great.

The end of the book summarizes the Davis principles of investing:

1. "Avoid Cheap stocks"

2. "Avoid expensive stocks" - the combined effect of rule 1 and rule 2, means that the Davis' occupy a middle ground between classic growth and classic value. When I look at the holdings of the Davis Venture Fund - Wells Fargo, Costco, Google, Bank of NY Mellon, Amazon, Berkshire, CVS -  I am left with the impression that its a quality at a reasonable price focus. Avoiding expensive stocks is obvious, but rule 1 is counterintuitive. I agree that most of the time stocks are cheap for a reason.

3. "Buy moderately priced stocks in companies that grow moderately fast"- look for companies that grow faster than the earnings multiple. That way you lock in a good chance for the Davis double play - higher earnings plus higher valuation. This takes time.

4. "Wait until the price is right" - as the Davis saying goes - "you make most of your money in bear markets, you just don't realize it at the time." Many investors from 2008 and beyond can relate to this. A corollary rule here is that you want to avoid losing most of your money in bull markets (not realizing you lost it until later).

5. "Don't fight progress" - seems obvious, but doubly important once you realize the time component. Progress can grind down your competitive advantages, to give the double play a chance to materialize you cannot swim against the tides for long periods.

6. "Invest in a theme"

7. "Let your winners ride"

8. "Bet on superior management"

9. "Ignore the rear view mirror'

10. " Stay the course"

Overall, its a very interesting read if you like market history. The book will not likely add new tactics to your investing toolset, but it does a good job of reinforcing long term investing principles and shows how these principles interact with real world markets through many decades of gyrations.

Analyzing Dividend Stocks with Vitaliy Katsenelson's Quality, Valuation, Growth Framework

Vitaliy Katsenelson has written two books,  that cover a similar theme: how to deal with flat, range bound markets that sort meander around nowhere in particular. The first is called Active Value Investing and the follow up The Little Book of Sideways Markets.

The author has a knack for illustrating concepts with examples such as using Tevye the milkman to look at how to value a business. Vitaliy Katsenelson is a very good writer, but what appeals to me the most is the clarity of his thought in developing frameworks for how to think about investing. Like a chess teacher explaining big picture strategy (opening, middle game, end game) and connecting them to little picture tactics (forks, pins), the clarity Active Value Investing comes in how the author distills investing strategy into an overall strategic framework and then illustrates how to analyze each area. So its a mix of top down and bottom up.

The main framework that he uses is called QVG - Quality, Valuation, Growth. The basic idea is to use these three factors to manage the effects of range bound markets - avoiding P/E compression and so on.

I think the basic components in the QVG framework are useful beyond value investing, they serve well in analyzing dividend stocks, too. In fact, one the themes of the books is on the role of dividends in range bound markets.

In terms of the value of dividends, the Active Value Investing book shows some compelling data on the source of total returns and the role that dividends play.

Source of Total Returns for S&P 500 from 1/31/1900-12/31/2000

• Price: 4.6%
• Dividends: 5.5%
• Total Return: 10.4%
• % of Total Return from Dividends: 45%

Those numbers highlight the importance of dividends in long term investing. Now let's look at QVG framework as an analytical tool for how it can inform selecting better dividend stocks.

The overall approach in range bound markets in Katsenelson's view, which I agree with, is to remain defensive. Losses always hurt, but in a bull market you can make it back in theory. In a range bound market, a loss can really gut your returns. To protect against losses, Katsenelson factors in three adjustments:

1. Increasing the required margin of safety
2. Increasing earnings (cash flows) growth rates
3. Increasing dividend yield requirements for stocks in the portfolio

The analytics used in QVG are defensive in nature. Some of them apply directly to dividends, others indirectly, and the overall approach dovetails quite nicely with analysis a dividend investor needs to do. Let's dive in.

Quality

For Katsenelson, quality begins with having a moat - a long term competitive advantage. He discusses many of the major types and why they matter. That's probably the biggest factor, its qualitative though, what about quantitative factors? In terms of quality metrics: 

• Predictable earnings - look for companies with recurring revenues. A great example is Becton Dickenson, even in 2008 hospitals didn't reuse syringes! Use, throw away, reorder. Rinse, repeat - that's recurring revenue. 
• Strong balance sheet - Katsenelson makes allowances for companies to have debt assuming they can afford it - meaning stable earnings and cash flow with high return on capital. He does not discuss Clorox but that seems to me to be a good example of a company high debt that meets the other requirements. Otherwise, seek to avoid companies that have the combination of high debt and volatile cash flows.
• Free Cash Flow  - here we come to the single most important metric for dividend investors. Katsenelson describes other benefits of FCF - ability to weather economic storms, not relying on outside financing for operations, and relatively low capital intensive. The main thing for dividend investors to add to QVG is the FCF Cover for the dividend
• Return on Capital - high return on capital is a good indicator of a strong competitive advantage

Each of the quality metrics and the moat concept should be factored in to any dividend investing decision. We are off to a good start with using QVG to analyze dividend stocks, let's look at Growth.

Growth

Quality is sort of intuitively obvious that its something dividend investors should care about, but growth? Growth? That's for biotech investors! 

Well not exactly. As Neil Woodford said, dividend growth matters:

"In the short-term, share prices are buffeted by all sorts of influences, but over longer-time periods fundamentals shine through. Dividend growth is the key determinant of long-term share price movements, the rest is sentiment."

In the short term in range bond markets, Katsenelson finds that the importance of dividends quadruples. So even in the short run, you can have cases where most of the total return is from the dividend. He also describes the tradeoffs of buybacks and dividends, concluding that the former can be beneficial but only if certain conditions, i.e. cheap price, are met.

Valuation
Valuation depends in large part on margin of safety. Katsenelson shows two distinct properties that are derived from the margin of safety. First as a source of returns. Assuming you are correct then the price should return to somewhere close to your estimate. And second, as a risk absorber.

Active Value Investing describes is an in depth analysis of the Absolute P/E and margin of safety to arrive at a Buy price (on a P/E basis).

Of course,  unless we are talking March 2009, its not very likely that you can find a high quality, high growth, low price company. Mostly we are talking about tow out of three at best. Active Value Investing makes the case that one out of three QVG factors is a non-starter. Quality and Growth by themselves are worth considering. Quality and Value as well. However, the most dangerous combination is Valuation and Growth, this is the combination to avoid and may indicate an eroding moat, over leverage, and/or undependable revenue stream.

Applying QVG to Dividend Stocks
While QVG wasn't designed an income investor framework, with some minor tweaks and additions, I see QVG framework as extremely applicable to dividend investors. Its a great addition to the analytical tool box. Dividend coverage and dividend growth specifically need to be brought in, but they fit in well alongside the other quality and growth metrics.

Active Value Investing is a very well written, well thought out book. The author's clarity of thought shows through in the framework, and the practical experience is demonstrated in the numerous detailed examples. The author clearly has "time in cockpit" with the many concepts as is evidenced by the discussions of second and third order effects that fall out of various decisions taken. The framework can be used to improve a portfolio's defensiveness and long term total return through value and income.

Manual of Ideas Book Review

Manual of Ideas is a great title and the book delivers on that promise. This is a different kind of investing book. Its not wedded to one approach, rather its a survey of many different techniques across the value investing spectrum.

Its very useful to practitioners because the author John Mihaljevic covers a lot of different value investing techniques. In this sense its kind of a cookbook. There are not many books like it, one that comes to mind is Joel Greenblatt's You can be a Stock market Genius, which does an excellent job of showing how special situations result in mispricings.

The Manual of Ideas is a very good cookbook but it adds two things that make it even more helpful for investors. First, the author shows not just how a specific technique works, but also describes when and how a technique may fail. For example, there's extensive coverage on screening, but this approach has its limitations and Mihaljevic goes into lots of detail as to what things the screens will miss. The chapter on Deep Value gives a good description on Graham's approach but shows its limitations for an investor looking for long term and low turnover.This shows "time in cockpit" and more importantly can help investors avoid mistakes.

The second thing, the Manual of Ideas does beyond a cookbook is that it puts each technique into a context of where and how the analytical tools may be useful. In this way, it helps to highlight the right tool for the right job.

The Deep Value chapter is one of the best, its at the intersection of quantitative and qualitative analysis. A good example - is finding a Net Net in a non-capital intensive business an oxymoron or an opportunity?

There are second and third level questions to push Graham "bargains" through to a more in depth understanding. Once your Deep Value screen uncovers "bargains" - is their value growing, staying flat or shrinking? As to the famed liquidation value, the text rightly observes that "In reality, a liquidation scenario would most likely play out in conditions of industry distress, in which it might be exceedingly difficult to find buyers." That's an important model flaw to account for. What you paid for your seat on the ship doesn't matter to buyers if the ship is sinking.

The book is a good source of ideas from many investors. I particularly enjoyed this one from Josh Tarasoff of Greenlea Capital, "One of the most powerful ideas I have ever encountered is the one-decision stock: a company you can simply hold for a decade or two and receive an outstanding outcome. My ideal investment would be to purchase a company like this at a significant discount to intrinsic value, and then hold it for a very long time. This approach is a combination of letting the economics of a great business play out, while opportunistically  taking advantage of market inefficiencies." Great idea, easier said than done of course, but the book goes on to connect the dots as to how an investor may achieve this - look for businesses with pricing power, specifically those that can raise prices higher than the rate of inflation.

The chapter on Small Caps illustrates the importance of bottom up research. Eric Khrom reflects on lessons learned from Patient Safety Technologies 8-K, "There is a lot of time pressure in the operating room, and there are 32 million procedures done annually...there are about 4,000 retained sponges (at a cost to the industry of $1.7 billion)...the hospitals that have used their system have had zero retained sponges...Reading the 8-K was very interesting because they pretty much announced in one sentence that they signed  on the second largest hospital operator in the United States. They went from having about 80 hospitals to immediately having 255 hospitals."

One criticism is the chapter on International Investing. The author lists some sources for global investing such as the FT's global equity screener, and includes a long list of investors to follow by country. So if you are interested in Japan or New Zealand or the Czech Republic to name a few, there are names to check into. But would be maybe more helpful to talk about these markets and investors in greater detail to give a fuller picture. That may be too much to ask or it may be book in itself. Beyond that quibble, the International Investing chapter is worthwhile and talks about key questions for certain reqions (Europe: how global is the business?) and advocates for excluding countries from analysis based on downside risk.

The Manual of Ideas brings together in one place many valuable insights found elsewhere, some unique analysis, and delivers the context that shows how the ideas hang together. Most practically, the book gives sober guidance on where the ideas may not work and this alone separates its from 90% of the books on the investing bookshelf. Worth your time.