I just finished reading Guy Spier’s “Education of a Value Investor: My Transformative quest for Wealth, Wisdom, and Enlightenment“. The author first made news when he and Mohnish Pabrai bid $650,000 for one lunch with Warren Buffett. This book talks about what led to that lunch and what he learnt from it. More importantly, it’s a tell-all autobiography of how he went from the often subtly, sometimes blatantly immoral world of investment banking to setting up his own fund, modeled on the principles espoused by the legendary Buffett. In the process he provides an unvarnished look into the arrogance, hubris and insecurities that stem from being a product of elite ivy league schools, and how, over time, with a lot of introspection and a fanatical devotion to self-improvement, he created his own version of Buffett’s environment to run a successful hedge fund (Aquamarine Fund).
After the 2008 credit crisis, Guy became particularly aware of the periodic bouts of irrationality that grip all investors, him included. He then set out to make his own process more rational and less susceptible to the next such crisis. In his words “Some of these rules are broadly applicable; others are more idiosyncratic and may work better for me than for you”
So here are Guy Spier’s eight value investing rules and my own take on how applicable I find them to the Calm Investing process:
1. Stop checking the stock price
“There’s a particular glitch in our brain that somehow makes us think the stock knows we’re watching it. We may even have a nagging fear that if we stop paying constant attention, something bad will happen. Maybe a big news story will sideswipe us while we’re not watching and the stock will suddenly blow up. Seeing the stock price on the monitor gives the investor a false measure of reassurance that everything is ok, that the earth is still revolving in it’s usual orbit.”
The Calm Investing Approach (# of solid stars represent degree to which I subscribe to the rule):
I’ve made many a rant against how trying to track minute-by-minute updates on your stocks is like to trying to drink from a fire hydrant. On a day to day basis, stock prices move for no apparent reason. It is a better use of the investor’s time to read on varied subjects or to even go out for a walk than to stay glued to the stock price ticker.
2. If someone tries to sell you something, don’t buy it
“The problem is that my brain (and most likely your brain too) is awful at making rational decisions when confronted with a well-argued, detailed pitch from a gifted salesperson. So I adopted a simple rule that has proved extraordinarily beneficial. When people call to pitch me anything at all, I reply in as pleasant a manner as possible “I’m sorry. But I have a rule that I don’t allow myself to buy anything that’s being sold to me”
The point here is of course that the seller almost always has a self-interest when they sell you something. This is not exactly a blinding piece of insight. But one that we often forget when the seller is the investment bank representing the owner of a privately owned firm, i.e. Initial Public Offerings (IPOs). Benjamin Graham, referred to IPOs as Imaginary Profits Only and when I did a historical analysis of IPOs in India, that expansion seems apt. I had drawn a parallel between an IPO being timed similar to a lemonade stand opening on a hot sunny day in this quora answer.
3. Don’t talk to management
“The trouble is, senior managers, particularly CEOs, tend to be highly skilled salespeople. No matter how their business is performing, they have a gift for making the listener feel optimistic about the company’s prospects. This ability to win over their audience, including board members and shareholders, maybe the most important talent that got them to the top of the corporate food chain.”
This is a logical extension of #2, considering most top management is partly compensated in company stock, it’s in their interest to tell a positive story about its prospects. That said, I don’t fully subscribe to this view because more information, even if (un)intentionally incorrect, is useful to improve your understanding of what a company is about. If company management only goes on about how fantastic the prospects are with no heed or acknowledgment of sticky economic conditions, you know to lower their credibility rating. Quality management won’t hesitate to give you bad news and that’s an important part of the investors’ checklist for a good investment. Think of it as a way of understanding, not the company, but the kind of people running it.
4. Gather investment research in the right order
“We know from Munger’s speech on the causes of human misjudgment that the first idea to enter the brain tends to be the one that sticks. As he explained “the human mind is a lot like the human egg, and the human egg has a shut-off device. When one sperm gets in, it shuts down so the next one can’t get in. The human mind has a big tendency of the same sort….My routine is to start with the least biased and most objective sources. Annual reports, then to less objective documents like earnings announcements, press releases, and transcripts of conference calls”
Guy goes on to talk about how he minimizes distraction by reading physical editions of news sources like Wall Street Journal, Financial Times and so on. He specifically avoids equity research reports by brokerages given the inherent bias that they might be susceptible to.
This is an interesting one. One that I hadn’t paid much attention to. Just like restaurants use design features on their menus to get you to spend more, like drawing a box around desirable items, placing items strategically on the page, and making it more difficult to scan prices at a glance, the order in which you consume information could influence your decision. I’ve found, I have a ‘credibility meter’ for any source of information I consume. If it’s a press release or a puff piece in a largely advertiser-driven media outlet, that meter registers a low rating. Conversely a thoroughly researched piece in a newspaper of repute scores high. In fact, repeated positive coverage of a company raises alarm bells about management’s attention on PR and should make you wonder what’s coming.
5. Discuss your investment ideas only with people who have no axe to grind
“If I want somebody else’s perspective, I find it more useful to seek out the opinion of a trusted peer on the buy side…I’ve found investment discussions work best when they adhere to three ground rules…First, the conversation must be strictly confidential. Second, neither person can tell the other what to do as this tends to make people feel judged, so they become defensive. Third, we can’t have any business relationship because this could skew the conversation by adding a financial agenda.”
It’s vital to block out the noise when it comes to evaluating companies. More than the “no axe to grind”, I’ve found it useful to cultivate a select set of people who’s opinion you respect to be able to discuss and debate investment ideas. Also, given I’m unlikely to have access to investors of the caliber that Guy routinely speaks with, I’d err on the side of sharing my ideas with too many people than too few in the spirit of life learnings for investors.
6. Never buy or sell stocks when the market is open
“Wall street (brokerages) is rewarded for activity. While I and my shareholders are rewarded for inactivity…To help myself function this way, I need a series of circuit breakers that slow me down and prevent me from acting precipitously…So I have a rule, inspired by Mohnish, that I don’t trade stocks while the market is open. Instead I prefer to wait until trading hours have ended. I then email my broker, preferring not to speak with them directly, and ask to trade the stock at the average price for the upcoming day.”
Given all my trading is self-executed through an online brokerage, this rule isn’t directly implementable for me. However, the spirit of it makes complete sense i.e. to not be swayed in your decision to buy or sell the stock based on the intra-day variations in the price of a stock. As a value investor, a 3-4% move in the price of a stock should not make a good investment bad or vice versa. Nor should that kind of drop immediately after you buy it unnerve the value investor.
7. If a stock tumbles after you buy it, don’t sell it for two years
“Mohnish developed this rule to deal with the psychological forces: if be buys a stock and it goes down, he won’t allow himself to sell it for two years…it acts as a circuit breaker, a way to slow me down and improve my odds of making rational decisions. Even more important, it forces me to be more careful before buying a stock since I know that I’ll have to live with my mistakes for atleast two years.”
The underlying principle on which the rule is based is sound – so every purchase is carefully considered. However, the reason this rule would not work for me at all is, I’ve noticed I have a different problem. That of holding on to stocks precisely because they have gone down. This comes from the part of the brain that is averse to losses and wants to atleast recover the buying price before selling, irrespective of whether the company’s fundamentals suggest it. This has been a big enough problem that it figures at #2 on my list of my three biggest investment mistakes. My approach has largely been to be willing to cut losses once I know I’ve been wrong than to let it simmer in the portfolio, accumulating opportunity cost.
8. Don’t talk about your current investments
“Once we’ve made a public statement, it’s psychologically difficult to back away from what you’ve said, even if we’ve come to regret that opinion.”
He goes on to explain the principle from Robert Cialdini’s “Influence: Science and Practice” as the “commitment and consistency principle” where we find it difficult to change our position once we’ve publicly expressed an opinion even if we have enough reason to.
Found this one particularly insightful, that is also easy to fall prey to. On more than one occasion I’ve mentioned a stock as a good pick after someone pressed me for my opinion. A few months later, even if my refreshed view of the stock might’ve changed, I felt it would be disingenuous to go ahead and sell the stock because I had expressed a positive view on it at some point. At the same time, talking about my current investments with the right set of people (as identified in Rule 5), can be a valuable source of insight that I might have missed and therefore can factor into my understanding.
In summary, a fascinating set of rules or principles to apply, of which I can fully identify with some, partly with others and not at all, with one. Any investor should consider and then apply those that work for your unique temperament as an investor.