Monday, December 2, 2013

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.

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