More thoughts from Phil Fisher on selling a great (and growing) business...

From Common Stocks and Uncommon Profits:

There is still one other argument investors sometimes use to separate themselves from the profits they would otherwise make. This one is the most ridiculous of all. It is that the stock they own has had a huge advance. Therefore, just because it has gone up, it has probably used up most of its potential. Consequently they should sell it and buy some-thing that hasn't gone up yet. Outstanding companies, the only type which I believe the investor should buy, just don't function this way. How they do function might best be understood by considering the following somewhat fanciful analogy: 

Suppose it is the day you graduated from college. If you did not go to college, consider it to be the day of your high school graduation; from the standpoint of our example it will make no difference whatsoever. Now suppose that on this day each of your male classmates had an urgent need of immediate cash. Each offered you the same deal. If you would give them a sum of money equivalent to ten times whatever they might earn during the first twelve months after they had gone to work, that classmate would for the balance of his life turn over to you one quarter of each year's earnings! Finally let us suppose that, while you thought this was an excellent proposition, you only had spare cash on hand sufficient to make such a deal with three of your classmates.  

At this point, your reasoning would closely resemble that of the investor using sound investment principles in selecting common stocks. You would immediately start analyzing your classmates, not from the standpoint of how pleasant they might be or even how talented they might be in other ways, but solely to determine how much money they might make. If you were part of a large class, you would probably eliminate quite a number solely on the ground of not knowing them sufficiently well to be able to pass worthwhile judgment on just how financially proficient they actually would get to be. Here again, the analogy with intelligent common stock buying runs very close. 

Eventually you would pick the three classmates you felt would have the greatest future earning power. You would make your deal with them. Ten years have passed. One of your three has done sensationally. Going to work for a large corporation, he has won promotion after promotion. Already insiders in the company are saying that the president has his eye on him and that in another ten years he will probably take the top job. He will be in line for the large compensation, stock options, and pension benefits that go with that job.  

Under these circumstances, what would even the writers of stock market reports who urge taking profits on superb stocks that “have gotten ahead of the market”think of your selling out your contract with this former classmate, just because someone has offered you 600 per cent on your original investment? You would think that anyone would need to have his head examined if he were to advise you to sell this contract and replace it with one with another former classmate whose annual earnings still were about the same as when he left school ten years before. The argument that your successful classmate had had his advance while the advance of your (financially) unsuccessful classmate still lay ahead of him would probably sound rather silly. If you know your common stocks equally well, many of the arguments commonly heard for selling the good one sound equally silly.  

You may be thinking all this sounds fine, but actually classmates are not common stocks. To be sure, there is one major difference. That difference increases rather than decreases the reason for never selling the outstanding common stock just because it has had a huge rise and may be temporarily overpriced. This difference is that the classmate is finite, may die soon and is sure to die eventually. There is no similar life span for the common stock. The company behind the common stock can have a practice of selecting management talent in depth and training such talent in company policies, methods, and techniques in a way which will retain and pass on the corporate vigor for generations.

Some thoughts from Phil Fisher on selling a great (and growing) business...

From Common Stocks and Uncommon Profits:

A word of caution may not be amiss, however, in regard to too readily selling a common stock in the hope of switching these funds into a still better one. There is always the risk that some major element in the picture has been misjudged. If this happens, the investment probably will not turn out nearly as well as anticipated. In contrast, an alert investor who has held a good stock for some time usually gets to know its less desirable as well as its more desirable characteristics. Therefore, before selling a rather satisfactory holding in order to get a still better one, there is need of the greatest care in trying to appraise accurately all elements of the situation. 

At this point the critical reader has probably discerned a basic investment principle which by and large seems only to be understood by a small minority of successful investors. This is that once a stock has been properly selected and has borne the test of time, it is only occasionally that there is any reason for selling it at all. However, recommendations and comments continue to pour out of the financial community giving other types of reasons for selling outstanding common stocks. 

... 

There is another and even more costly reason why an investor should never sell out of an outstanding situation because of the possibility that an ordinary bear market may be about to occur. If the company is really a right one, the next bull market should see the stock making a new peak well above those so far attained. How is the investor to know when to buy back? Theoretically it should be after the coming decline. However, this presupposes that the investor will know when the decline will end. I have seen many investors dispose of a holding that was to show stupendous gain in the years ahead because of this fear of a coming bear market. Frequently the bear market never came and the stock went right on up. When a bear market has come, I have not seen one time in ten when the investor actually got back into the same shares before they had gone up above his selling price. Usually he either waited for them to go far lower than they actually dropped, or, when they were way down, fear of something else happening still prevented their reinstatement. 

This brings us to another line of reasoning so often used to cause well-intentioned but unsophisticated investors to miss huge future profits. This is the argument that an outstanding stock has become overpriced and therefore should be sold. What is more logical than this? If a stock is overpriced, why not sell it rather than keep it? 

Before reaching hasty conclusions, let us look a little bit below the surface. Just what is overpriced? What are we trying to accomplish? Any really good stock will sell and should sell at a higher ratio to current earnings than a stock with a stable rather than an expanding earning power. After all, this probability of participating in continued growth is obviously worth something. When we say that the stock is overpriced, we may mean that it is selling at an even higher ratio in relation to this expected earning power than we believe it should be. Possibly we may mean that it is selling at an even higher ratio than are other comparable stocks with similar prospects of materially increasing their future earnings. 

All of this is trying to measure something with a greater degree of preciseness than is possible. The investor cannot pinpoint just how much per share a particular company will earn two years from now. He can at best judge this within such general and non-mathematical limits as “about the same,” “up moderately,” “up a lot,” or “up tremendously.” As a matter of fact, the company's top management cannot come a great deal closer than this. Either they or the investor should come pretty close in judging whether a sizable increase in average earnings is likely to occur a few years from now. But just how much increase, or the exact year in which it will occur, usually involves guessing on enough variables to make precise predictions impossible. 

Under these circumstances, how can anyone say with even moderate precision just what is overpriced for an outstanding company with an unusually rapid growth rate? Suppose that instead of selling at twenty-five times earnings, as usually happens, the stock is now at thirty-five times earnings. Perhaps there are new products in the immediate future, the real economic importance of which the financial community has not yet grasped. Perhaps there are not any such products. If the growth rate is so good that in another ten years the company might well have quadrupled, is it really of such great concern whether at the moment the stock might or might not be 35 per cent overpriced? That which really matters is not to disturb a position that is going to be worth a great deal more later.

Charlie Munger on what makes investment hard

From Poor Charlie's Almanack:

What makes investment hard...is that it's easy to see that some companies have better businesses than others. But the price of the stock goes up so high that, all of a sudden, the question of which stock is the best to buy gets quite difficult. 

We've never eliminated the difficulty of that problem. And ninety-eight percent of the time, our attitude toward the market is ... [that] we're agnostics. We don't know. Is GM valued properly vis-à-vis Ford? We don't know. 

We're always looking for something where we think we have an insight which gives us a big statistical advantage. And sometimes it comes from psychology, but often it comes from something else. And we only find a few -- maybe one or two a year. We have no system for having automatic good judgment on all investment decisions that can be made. Ours is a totally different system. 

We just look for no-brainer decisions. As Buffett and I say over and over again, we don't leap seven-foot fences. Instead, we look for one-foot fences with big rewards on the other side. So we've succeeded by making the world easy for ourselves, not by solving hard problems. 

... 

It doesn't help us merely for favorable odds to exist. They have to be in a place where we can recognize them. So it takes a mispriced opportunity that we're smart enough to recognize. And that combination doesn't occur often. 

But it doesn't have to. If you wait for the big opportunity and have the courage and vigor to grasp it firmly when it arrives, how many do you need? For example, take the top ten business investments Berkshire Hathaway's ever made. We would be very rich if we'd never done anything else-in two lifetimes. 

So, once again, we don't have any system for giving you perfect investment judgment on all subjects at all times. That would be ridiculous. I'm just trying to give you a method you can use to sift reality to obtain an occasional opportunity for rational reaction. 

If you take that method into something as competitive as common stock picking, you're competing with many brilliant people. So, even with our method, we only get a few opportunities. Fortunately, that happens to be enough.

Links

I will be mostly without internet for the next couple of weeks. I have a few quotes and book excerpts scheduled, but this may be the last compilation of links during that time.

AMA on Charlie Munger: What did Charlie Munger Learn from Phil Fisher? (LINK)

Farnam Street: Lifelong Learning (LINK)

The Root of Wisdom: Why Old People Learn Better (LINK)

Track and Measure (LINK)

If you listed the habits of successful people, tracking and measuring would be near the top of that list. I see it with people, companies, and teams that I work with. I see it in my own behavior.

Ron Baron interviews Elon Musk at the Baron Investment Conference (video) [H/T ValueWalk] (LINK)

Related book: Elon Musk: Tesla, SpaceX, and the Quest for a Fantastic Future

Richard Duncan: Yuan Devaluation Likely (LINK)

Hussman Weekly Market Comment: Psychological Whiplash (LINK)

On a 10-12 year horizon, we expect the total return of the S&P 500 to fall short of 1% annually, and given that more than that amount is likely to represent dividends, it follows that we expect the level of the S&P 500 Index to be lower 10-12 years from now than it is today (recall a similar outcome after the 2000 peak). On a shorter horizon, market action remains unfavorable as well, which leaves prospective outcomes skewed to the downside, but we don’t need to take a particularly strong near-term view. Stocks appear to be in an extended top formation much like 2000 and 2007, so our inclination is more toward patient discipline than aggressive expectations of imminent market losses.

Ray Dalio Talks Meditating With Martin Scorsese (video) (LINK)

Stoic movie review: The Martian [H/T @TimHarford] (LINK)

In 5 Minutes, He Lets the Blind See (article and video) (LINK)

When the Sun Went Medieval on Our Planet (LINK)

Here's a link to a post from earlier this year that I've been discussing among friends, related to position-sizing: A quick diversification thought...

Which also reminded me of this quote from Warren Buffett that I posted around the same time:

"If you are a professional and have confidence, then I would advocate lots of concentration. For everyone else, if it’s not your game, participate in total diversification... If it’s your game, diversification doesn’t make sense. It’s crazy to put money into your 20th choice rather than your 1st choice... Charlie and I operated mostly with 5 positions. If I were running 50, 100, 200 million, I would have 80% in 5 positions, with 25% for the largest. In 1964 I found a position I was willing to go heavier into, up to 40%. I told investors they could pull their money out. None did. The position was American Express after the Salad Oil Scandal. In 1951 I put the bulk of my net worth into GEICO. Later in 1998, LTCM was in trouble. With the spread between the on-the-run versus off-the-run 30 year Treasury bonds, I would have been willing to put 75% of my portfolio into it. There were various times I would have gone up to 75%, even in the past few years. If it’s your game and you really know your business, you can load up."

On Twitter, Ian Cassel also posted a great quote from Charlie Munger:

"Students learn corporate finance at business schools. They are taught that the whole secret is diversification. But the exact rule is the opposite. The ‘know-nothing’ investor should practice diversification, but it is crazy if you are an expert. The goal of investment is to find situations where it is safe not to diversify. If you only put 20% into the opportunity of a life-time, you are not being rational. Very seldom do we get to buy as much of any good idea as we would like to."

Related book to the above (Kelly formula): Fortune's Formula

Book of the day: Merchants of Doubt: How a Handful of Scientists Obscured the Truth on Issues from Tobacco Smoke to Global Warming

Links

Cure for low commodities prices is staring us in the face (LINK) [The book discussed in the article is one I'm really looking forward to: Capital Returns: Investing Through the Capital Cycle: A Money Manager's Reports 2002-15. It is a collection of London-based Marathon Asset Management's letters from 2002-2015. I've mentioned their previous collection several times before: Capital Account: A Fund Manager Reports on a Turbulent Decade, 1993-2002. And if someone from the publisher is reading this, I'd love to review an advanced copy of the new book.]

Oil Slump Forces Deep Cuts by Service Providers [H/T Matt] (LINK)

Notes From Invest For Kids Chicago 2015: Burbank, Sandler, Tananbaum & More (LINK)

Jim Chanos Pitches Short Position in Alibaba (LINK)

Glad to see Jake back with Season 2... Five Good Questions for Andrew Palmer about his book, Smart Money (LINK)

Phil Ordway's "Hall of Fame" Reading List (LINK) [I can't argue with the names on Phil's list. I have my own list HERE.]

Gene editing saves girl dying from leukaemia in world first (LINK)

Book of the day: A Guide to Rational Living

Links

Baupost letter gives a rare glimpse into one of the world's most secretive — and most successful — hedge funds [H/T Will] (LINK)

We can do this successfully because we have a culture of patience. Even though we work hard every day trying to uncover the next great investment, we only deploy our capital when we have real conviction that we have found one. When we don’t find interesting ideas, we do nothing and hold cash. For this reason, I’ve often joked that I’m 97% unproductive. While this means I better be damn productive the other 3% of the time, it also means exercising patience often and waiting for great opportunities. On the flip side, when an idea has been analyzed and is fully baked, we drop whatever else we are doing, discuss the investment, and make a decision. Our portfolio decision process must be incredibly efficient, as we recognize that good ideas are scarce and may prove fleeting. 

Warren Buffett said, 'Big opportunities come infrequently. When it's raining gold, reach for a bucket, not a thimble.' When a great opportunity comes around, it is imperative to size it correctly. 

... 

One of the most common misconceptions regarding Baupost is that most outsiders think we have generated good risk-adjusted returns despite holding cash. Most insiders, on the other hand, believe we have generated those returns BECAUSE of that cash. Without that cash, it would be impossible to deploy capital when we enter a tide market and great opportunities become widespread. Seth has said on a number of occasions in both types of markets, 'If you have great ideas, you will have capital to deploy.' This is incredibly motivating to our investment team.

The video of Michael Mauboussin interviewing Daniel Kahneman from last month (LINK)

More videos from the Fortune Global Forum are starting to be put online (LINK) [Such as Jamie Dimon, Sheryl Sandberg and Marc Andreessen, Paul Tudor Jones, How biology and big data converge in the medicine world, a VC panel on future growth opportunities, a panel on 100-year-old companies, Peter Diamandis on What You Can Learn From Kodak’s Demise, etc.]

Wells Fargo and the Incredible Predictability of Deposit Growth (LINK)

Wall Street is starting to believe what Jim Chanos has been saying about Valeant all along (LINK)

Back in May of 2014, Chanos went on CNBC and said: "We're short [Valeant] because it's a roll-up. And roll-ups present a unique set of problems." 

Chanos added: "Roll-ups are generally accounting-driven, and we certainly think that's the case in [Valeant]. We think [Valeant] is playing some very aggressive accounting games when they buy companies, write down the assets, and also engaged in what we call spring-loading." Spring loading is a practice in which a company grants investors options before it knows good news is about to come out.

Valeant 'Witch Hunt' Going Too Far for Brave Warrior's Greenberg (LINK)

Collection of old Enron sell-side research (LINK)

Related books:  

Conspiracy of Fools (a Charlie Munger recommendation as well) 

The Smartest Guys in the Room

How an F Student Became America's Most Prolific Inventor [H/T David] (LINK)

Book of the day (recommended by Marc Andreessen): Tricky Dick and the Pink Lady

Links

Latticework of Mental Models: Twaddle Tendency (LINK)

Charlie Munger: Valeant Isn’t Enron or American Express [H/T Linc] (LINK)

Buffett's BYD Vs. Musk's Tesla: Electric Vehicle Race Still Undecided [H/T Linc] (LINK)

Related book: The Great Race: The Global Quest for the Car of the Future

Baupost Is Said to Decline 3.8% in September on Energy, Biotech [H/T Will] (LINK)

DealBook Conference 2015 videos:

Stanley Druckenmiller 

Carl Icahn 

Peter Thiel and Chris Sacca  (Related book: Zero to One)

Reed Hastings (Netflix) 

Max Levchin (Affirm)

James Gorman (Morgan Stanley) 

Gary Cohn (Goldman Sachs) 

Muhtar Kent (Coca-Cola) 

Ginni Rometty (IBM) 

Nico Sell (cybersecurity) 

John Carlin (cybersecurity) 

Al Gore

What makes a historical arsonist? A conversation with Dan Carlin. (podcast) (LINK)

El Niño Paints the World's Driest Place with Color (LINK)

TED Talk - Patrícia Medici: The coolest animal you know nothing about ... and how we can save it (LINK)

Although the tapir is one of the world's largest land mammals, the lives of these solitary, nocturnal creatures have remained a mystery. Known as "the living fossil," the very same tapir that roams the forests and grasslands of South America today arrived on the evolutionary scene more than 5 million years ago. Today, threats from poachers, deforestation and pollution, especially in quickly industrializing Brazil, threaten this longevity. In this insightful talk, conservation biologist, tapir expert and TED Fellow Patrícia Medici shares her work with these amazing animals and challenges us with a question: Do we want to be responsible for their extinction?

Links

Larry Page Talks Alphabet, Warren Buffett and Project Loon at Fortune Global Forum 2015 (video) [H/T Linc] (LINK)

Howard Buffett Is Getting His Hands Dirty [H/T Linc] (LINK)

Related book: 40 Chances

The Light-Beam Rider - by Walter Isaacson (LINK)

Related book: Einstein: His Life and Universe

Amazon Killed the Bookstore. So It’s Opening a Bookstore (LINK)

Sam Altman: The Tech Bust of 2015 (LINK)

So where is the problem?  Late-stage private valuations.  But perhaps the answer is that these “investments” aren’t really equity—they’re much more like debt. [1] I saw terms recently that had a 2x liquidation preference (i.e. the investors got the first 2x their money out of the company when it exited) and a 3x liquidation cap (i.e. after they made 3x their money, they didn’t get any more of the proceeds). 

This is hardly an equity instrument at all. [2] The example here is an extreme case, but not wildly so.  Investors are buying debt but dressing it up close enough to equity to maintain their venture capital fund exemption status.  In a world of 0 percent interest rates, people become pretty focused on finding new sources for fixed income.

Links

Charlie Munger Isn't Done Bashing Valeant [H/T Will and Linc] (LINK)

Ackman said during the presentation that he spoke with Munger about his March remarks. The Berkshire vice chairman’s objections focused on leverage, tax rates and acquisitions, and Munger explained that he says what comes to his mind, according to Ackman. 

Munger elaborated on Saturday: Valeant relied on “gamesmanship” to run up its value. Its strategy, using acquisitions and price increases, is different from ITT, but it still created a “phony growth record,” he said. Unlike Enron, Valeant’s stock isn’t a house of cards because it has some some valuable properties, including its portfolio of treatments, he said. He isn’t holding or shorting the shares. 

..... 

Munger’s critique has been a topic of conversation at the fund manager. At a May investor meeting for Ruane Cunniff, someone asked what Goldfarb and his colleagues thought about the dig from Buffett’s right-hand man, according to a transcript of the event. 

Ruane Cunniff dismissed the comparison to ITT, saying that Valeant is more concentrated in a single industry and less likely to dilute shareholders by issuing stock to fund deals. The share plunge in recent weeks has pushed Sequoia’s current managers to publicly defend their pick to investors. 

..... 

It’s easy to see why investors have been so taken with the stock, Munger said. "It looks kind of Buffett-like,” because Chief Executive Officer Mike Pearson “cut out all the glitz” of running a drug company, he said. However, Valeant’s tumbling share price shows why morals should still be a part of the calculation for making an investment, Munger said. 

“They’re deeply intertwined,” he said. "I don’t think that investing should be divorced from reality."

Pharmacist at center of Valeant scandal accuses drugmaker of 'massive fraud' [H/T Will] (LINK)

John Kay discusses his latest book, Other People's Money, at Google (video) (LINK)

The Absolute Return Letter - November 2015 (LINK)

Hussman Weekly Market Comment: Last Gasp Saloon (LINK)

At present, the valuation measures we find most strongly correlated with actual subsequent S&P 500 total returns suggest zero total returns for the S&P 500 over the coming 10 years, and total returns averaging only about 1% annually over the coming 12-year period. After inflation, we estimate negative prospective real returns on both horizons. Over shorter horizons, market internals, and the investor risk-preferences they convey, are the hinge that determines how stocks are likely to respond to a broad range of other factors, including valuations, interest rates, Fed action, and economic activity.

Exponential Wisdom podcast: Ripe For Disruption… Agriculture and Transportation (LINK)

The Power of Nudges, for Good and Bad (LINK)

Related book: Nudge (and currently only $5.95 on Audible)

Pluto’s Moon Charon Has an Ammonia Leak (LINK)

Book of the day: On Writing: A Memoir of the Craft - by Stephen King

Links

A big thanks to everyone who responded to the Downloading Earnings Calls post. I'll experiment a bit and try and get back with another update.

A Dozen Things Learned from Charlie Munger (Distilled to less than 500 Words) (LINK)

Related book: Charlie Munger: The Complete Investor

Trust and Consequences: A Survey of Berkshire Hathaway Operating Managers [H/T Linc] (LINK)

A great presentation on Texas Instruments' Capital Management Strategy [H/T @AlexRubalcava] (LINK)

Paul Graham: A Way to Detect Bias (LINK)

Two Sequoia Fund Directors Resign as Valeant Losses Mount (LINK)

Mutual Fund Observer, November 2015 [with some Sequoia Fund discussion] (LINK)

The Pershing slides on the Valeant call (LINK) [And in case you missed the largely opposite conclusions: John Hempton's take]

Inside the Secretive Circle That Rules a $14 Trillion Market (video) [H/T Matt] (LINK)

The Closing of a Newsroom’s Mind - by Donald Graham (LINK)

The Rise and Fall of For-Profit Colleges (LINK)

Stoic Week 2015 Handbook (LINK)

Related previous post: Stoicism quotes, thoughts, and readings