Jason Fung's book about what causes obesity has valuable lessons for students of financial markets. The first lesson is that investing requires a lattice work of mental models . The second lesson is that investors should be wary of the brokerage industry's agenda. The third lesson is that we tend to reduce our knowledge to sound bites, but we should carefully examine our choices. This article is about my favorite highlights from the Obesity Code.
Just as there is no single factor that causes obesity, there is no single formula for identifying value. There are multifactorial reasons which, when put together, bring the analyst closer to the economic truth. Some of the common multifactorial reasons include: industry, competitive landscape, management, brand awareness, franchise value, the company's relative and absolute valuation  and financial information, such as valuation and leverage ratios.
"The multifactorial nature of obesity is the crucial missing link. There is no one single cause of obesity. Do calories cause obesity? yes, partially. Do carbohydrates cause obesity? Yes, partially. Does fiber protect us from obesity? Yes, partially. Does insulin resistance cause obesity? Yes, partially. Does sugar cause obesity? Yes, partially." [page 216]
Investing is more art than math. Investors should read about management; decipher its character and integrity as those qualities are more important than any price to earnings or price to book value ratios. While it is fairly easy to arrive at the return on invested capital ratios or trends in net profit margin, investors should use the bulk of their understanding on whether the company's product or service will be in demand a decade from today. And numbers won't always answer this question.
The relationship among the factors is important, too . Consider the following example of how various factors are related: home prices rise, lenders are loaded with capital to deploy, middleman (such as brokers) are hungry for deals and you get the 2007 real estate debacle.
How to market services and products is now studied as an academic degree. It is little surprise that with growing research into how our minds work, marketing's influence on us is growing each year. (Almost all MBA programs now require candidates to read Robert Cialdini’s Influence: The Psychology of Persuasion as part of their required reading list).
"In 1988, the American Heart Association decided that it would be a good idea to start accepting cash to put its Heart Check symbol on foods of otherwise dubious nutritional quality."[page 110]
Brokerage firms, not unlike health companies, may not have your wellbeing in mind. Brokerage firms earn more money the more you execute trades. They also earn money by lending the capital they hold (similar to the banking business model.) So, the industry welcomes frenzy stock trading activity.
The brokerage industry will also sell practically any investment product, be it an ETF, option or cryptocurrency, as long as there are investors willing to buy it.
Yet the brokerage industry often gets it wrong. For instance, it took over 30 years for the industry to embrace index-fund trading. In an interview with CNBC, the late John Bogle said he was accused of being "un-American." In short, the brokerage industry has an agenda. And it may not coincide with yours.
Nassim Taleb called the phenomenon of taking complex issues and simplifying them to the point they become meaningless as soundbite culture. He was describing Wall Street culture: where stock commentators are bullish on stocks because of rumors; because management is buying back the stock; or because of the industry's tailwinds. Stock commentators break apart a business into its individual parts. But to make a sensible investment, investors need to put the parts back together.
"An avocado, for instance, is not simply 88 percent fat, 16 percent carbohydrate and 5 percent protein with 4.9 grams of fiber. This sort of nutritional reductionism is how avocados became classified for decades as "bad" food due to their high fat content, only to be reclassified today as a "super food." [page 205]
Reductionism does not work in business analysis because business fundamentals change over time. When the price of crude oil was about $100 in 2014, investors valued gas and oil companies at 15 to 20 times the earnings multiple. As crude oil prices halved to $54 by 2018, valuations of gas and oil companies dropped to the single digits.
In The Obesity Code, Fung demystifies type two diabetes. When we eat food - be it carbs, fats or protein - insulin kicks in. Insulin, in return, regulates how much sugar is in our blood. If we eat all the time, insulin is constantly working and its effect on the body eventually wears off.
"The human body is characterized by the fundamental biological principle homeostasis. If things change in one direction, the body reacts by changing in the opposite direction to return closer to its original status. For instance, if we become very cold, the body adapts by increasing body-heat generation. If we become very hot, the body sweats to try to cool itself."
While reading about insulin resistance, I thought about my ill-habit of daily checking the price of stocks in my portfolio. Colleagues of mine even get notified when a stock price jumps or declines in value every hour; it is a subtle, subconscious trigger to act .
Fung's answer to reduce the probability of type two diabetes is intermittent fasting , which focuses on the time between meals. I am taking that advice to stock investing. To reduce fatigue, I intend to delete the five stock trading apps on my iPhone and to monitor business actions (8-k filings) from now on, and not price movements.
"My number one priority in life, above my happiness, above my family, above my work, is my own health," said Naval Ravikant, AngelList founder, on a Farnam Street Podcast. "Because my physical health became my number one priority, then I could never say I don't have time...I do not start my day, and I don't care if the world is imploding and melting down, it can wait another 30 minutes until I'm done working out."
Both physical exercise and nutrition are important for us. The two constitute a large part of our wellbeing. Visit Doctor Fung's website for details.
Hiller the Elder, who lived in the first century before the common era, said that we should first take care of ourselves so that we can take care of others. Not unlike his comment, I research companies for my own benefit but hope that others may benefit from the research too.
The topic of this meditation is what attracted me to stock research in the first place. I will then mention three reasons why I decided to not let others manage money and three reasons why I decided to buy stocks on my own.
The first reason is cost. Gabelli Funds, a mutual fund, charges 1.35% management fee. That means that if I was to give them $100,000 to manage, they would charge $1,350 a year.
To put in perspective what the fee of $1,350 is, excluding transaction costs, it is more than what I pay for all research and trading software. Guru focus annual fee is $450. Seeking Alpha annual fee is $200. The annual subscription fee for Barron's, WSJ, The Economist and Forbes is less than $300 in total.
And the high fee didn't meet higher return. Open to investors since 1986, the fund's average annual return is 9.98% after fees. The S&P 500 return, which you can buy for a management fee of less than 0.10% was 10.07% during this time.
The second reason is that I don't believe in neither the Noah Approach to investing. Consider the Gabelli fund again. The fund has an equity interest in over 40 sectors of the economy, from airlines and computer hardware to telecommunications and machinery. And the fund owns over 700 stocks.
To me, successful investing is not about consistently beating a performance index. And since every mutual fund’s manager knows their performance will be judged quarterly - even monthly - they focus on the flawed metrics, such as Sharp Ratio, Alpha and Beta. This is also known as the Greek approach to investing.
As a business hobbyist I enjoy reading about companies; researching their profit margins, risks and business plans. My friends remind me that when I was eight or nine, I bragged to everybody that I bought a bargain: a pen on which I didn't have to pay taxes since it was bought in the city of Eilat. (In contrast to Tel Aviv where you would pay VAT. )
I am also contrarian. I ride my bike to the office and hardly drive. I much prefer to exercise alone than in a groups and you will not see me on social media. So, if the common convention is to let someone else - be it a financial advisor or a mutual fund manager - manage money, perhaps I chose the opposite just to prove a point.
There is a wealth of information that is widely available. This is a key point I believe many do not fully appreciate. It was only two decades ago that if you wanted to read the financial statements of a company, you would call the United States Securities and Exchange Commission (SEC), pay for the shipping of the statements to be delivered to your home and wait for a few weeks. Today, you can get the information in less than five clicks.
Another boon to investors was the SEC's requirement of Form 13F filing. Today the SEC requires anyone who manages above $100 million and more to publicly disclose which stocks they bought and sold. Using websites such as Guru Focus or WhaleWisdom , you can read what legendary funds and investors, such as Third Street Avenue or Mohnish Pabrai, are doing. In the last quarter of 2018, Third Avenue bought the stock of PNC Financial, Hawaiian Holding. Pabrai bought shares of Micron Technology.
Trading costs are minimal too. If you decide to sell your home, the real estate commission and other fees can eat up about 10 percent of the sale price, according to Bankrate.com. Yet if you would like to sell your stock in, you could easily do so and it would cost you $4.95.
Your parents paid a much higher transaction fee. According to a Columbia University study, in December 1968, to trade 100 shares with a value of $400 (about $3,000 in today's currency) would cost you $3 of 1968 currency (which is about $22 today) plus 2% of the amount traded. So, it would cost a total of $82 to sell a position, about 16-fold higher than the cost of today' markets.
I believe in taking responsibility. If I lose money, I would much rather blame myself for an omission of thought than to blame another person. Jerry Seinfeld, perhaps, said it best:
"People always tell me, you should have money working for you. I've decided I'll do the work. I'm gonna let the money relax."
My favorite tables shows the power of compounding. Taken from the Aquamarine 2017 annual report, the table has just three columns and four rows. The table shows what happens to an investment after 20, 40 and 60 years of operations assuming 7%, 12% and 18% rates of return.
How can we not marvel that a 12% rate of return will multiply the original investment by 10 times in 20 years?
Glancing at the table every once in a while, I am reminded that (1) stock investing is a long term game, (2) not losing money is more important than maximizing return and (3) a reasonable rate of return, say 7% to 10%, will result in a wonderful investment outcome over a long period of time.
Yet it is unbelievably difficult to focus on year 2039 and beyond. The anticipation of whether a company will report higher sales numbers or net earnings is just too exciting to pass on and it results in both wide mood swings and in swinging market prices.
It is a self-fulling prophecy: if investors expect stock prices to move as a result of quarterly projections then -whether the business fundamental changed what so ever - the stock price indeed moves.
According to Warren Buffett and Jamie Dimon, the quarterly projection of earnings per share is bad both to shareholders and to the economy as a whole. In an Op-Ed to the Wall Street Journal, they write:
Companies frequently hold back on technology spending, hiring and research and development to meet quarterly earnings forecasts that may be affected by factors outside of the company's control.
A few examples from my own portfolio: When Weight Watchers', which I bought in March, management reported to investors in April 2019 of expected softening in sales, the stock dropped to $17 from $27 in less than 24 hours. Yet when the same management reported last week of an expected uptick in sales, the stock immediately jumped to $30. Another example is Hyster-Yale which I bought a few months ago. Here too when management reported on an uptick in sales, the stock climbed to $63 from $55. In short, when management projects earnings, capital markets do what they do best - they react.
Yet between stimulus and response there is space. And I argue that the price movement after a quarterly announcement is the wrong response. Can we reasonably expect a company such as Mednax for example, which I wrote about last week, with over 16,000 employees and a fresh senior executive leadership, to make meaning changes in 90 days?
Wall Street certainly expects more reporting today. In The Art of Speculation, written in 1930 ,the legendary investor Phillip Carrett, writes that "many companies publish annual statements that confine themselves to balance sheets and even those publishing income statements omit many details."
More remarkable than the little amount of information companies reported back then is that investors were drawn to the stock market just as much as they are today.
But today's companies report much more. Consider Hawaiian Airline’s management, which provides guidance on expected gallons of jet fuel consumed (expected to be 1.0 to 2.0% less); that available seat miles will be up between 1.5% and 2.5%. It further breaks down the quarterly earnings report by available operating revenue per ASM of 13.81 cents, compared to 14.25 cents a year ago.
This level of reporting takes much energy. I can only imagine how much time senior management spends in preparing for analysts’ questions and how both legal counsel and public relations people advise them. Legal counsel may ask them to use words such as "we believe" or "it is likely that" while public relations people will tell them to emphasize words such as "we exceeded" and "we are positive" and "we see growth."
Research shows that daily meditation or religious practice assists in developing more tolerant, kind behavior. People who have such daily practices are less prone to get upset while driving and are more kind to random strangers.
And just as spiritual meditation on why we are here, how did we get here and how we should live our lives is helpful, I believe that a quarterly- let alone daily - outlook on stock movements is harmful.
To that I suggest three remedies: First, to develop meta-rules, such as "will not sell a stock for at least two years." This will reinforce the attitude that a quarter is just one piece of the puzzle.
Second, to garden. There is no better reminder that change takes time than nature. That There are simply no shortcuts.
Third, cut, paste, print and regularly view and meditate on the Aquamarine table.
Three ways to get inspiration from investment managers: first is to follow what current investment managers are doing. For example, listen to Mohnish Pabrai and you will be inspired to cut management fees to zero and to free your calendar as, according to Pabri, "Meeting humans can be very distracting and time consuming."
Second way is to go back in time. Perhaps, a few several decades ago when Warren Buffett was still an unknown investment manager with a last name no one knew how to correctly spell. Students of finance who follow the second way read Security Analysis by Benjamin Graham or The Art of Speculation by Philip L. Carrett.
The Third way, also the subject of this essay, is to find inspiration in great individuals who lived at times when stock markets had yet to be invented. These great individuals were not stock investors. But they have much to inspire us about stock investing.
Born in the 15th century, Leonardo Da Vinci was such individual. Da Vinci worked as both a painter and engineer for Louis XII. At the age of 37, he studied anatomy and architecture, worked on military strategies for Cesare Borgia (who was a major inspiration for the The Prince by Machiavelli) and attempted to invent a flying machine. At a later age, he dissected bodies in his spare time. In short, he was a Polymath.
The 21th century stock investor needs to hone varied skills, too. Investing time in understanding a few concepts in psychology, statistics (probability theory and statistical analysis) and biology will serve investors better than if they were to read and follow current “wisdom” of large money managers (Principles by Ray Dalio is a prime example).
According to his latest biographer, Walter Isaacson, Da Vinci was never motivated by wealth or material possessions. Da Vinci decried "men who desire nothing but material riches and are absolutely devoid of the desire for wisdom, which is the sustenance and truly dependable wealth of the mind."
And just as Da Vinci did not paint so that someone would buy the painting from him, stock investors should have other reasons to study stock markets than money-making. I believe that for Da Vinci the stock market would be a playground to test out ideas about life and about our mindset. For example, he would study cryptocurrency, not to determine the value of bitcoin (if there is one) but to understand how and in what way the world may benefit from digital currency.
In Isaacson’s biography of Da Vinci, he brings a fascinating story. How Da Vinci was fascinated by the tongue of a woodpecker as it could extend more than three times the length of its bill. He also studied optics and how our muscles worked so that he could have a dimension of movement and depth in his art. "He could stare at a wall," wrote Isaacson, "and observe with precision the variations of each stone and other factual details." Da Vinci, in short, was a curious individual.
That sense of wonder is often missing from the art of stock investing. In investing, a doctrine where the right hemisphere is praised, and the left hemisphere ignored, a sense of curiosity never appears to be a requirement for successful investing.
But it is curiosity that will allow you to find the next investment opportunity. It is curiosity that will make you attractive to potential investors in your fund, and it is genuine curiosity, I believe, that makes successful investors wake up in the morning.
"Though I have no power to quote from authors as they have," said Da Vinci, "I shall rely on a far more worthy thing – on experience." Da Vinci was autodidact that thought experience to be the best teacher.
Indeed, the lessons I learned about stocks did not come from books but from actual buying stocks. As Walter Scholls, the fame value-investor, once said, "you never know a stock until you own it." (You can read about his wisdom in The Walter Schloss Archive.)
Another reason why experience triumphs theory is that stock markets change. By the time a book is written about a certain strategy, it is likely not relevant any more. Besides, I am wary of authors who write of stock investment ideas in general. Why would anyone give up profits?
Da Vinci used knowledge of how blood circulates to think of ideas how to circumvent waste. He studied the neck muscles so that he could paint real facial expressions. He had an uncanny ability to not only think of novel ideas - a mechanical device that will fly us, for example - but an ability to draw conclusions and analogies from different fields.
Another way to understand how latticework may affect our thinking is by comparing Ginevra Benci and Mona Lisa, two figures that Da Vinci had painted. As Isaacson wrote:
"Ginevra Benci was made by a young artist with astonishing skills of observation. The Mona Lisa is the work of a man who had used those skills to immerse himself in a lifetime of intellectual passions."
Latticework is one of the most important skills you can hone as an investor. "What you need is a latticework of mental models in your head,” said Charlie Munger in Poor Charlie’s Almanack. "And, with that system, things gradually get to fit together in a way that enhances cognition."
Most great individuals were not stock pickers. Yet they have much to teach us about stocks and about our approach to life. In this article, I argue that inspiration from great individuals will serve us well. Yet the idea was not originally mine. Guess who inspired Charlie Munger?
Two great individuals: Cato the Great and Benjamin Franklin.
It's a no secret formula that great investors have. Investors such Warren Buffett and Charlie Munger rarely calculate net present value of future cash flow and they don't follow a grand finance theory that only they understand.
The opposite is true. Great investors read about the operating performance of publicly traded firms from resources that are available to us all. Their business understanding is within everyone's reach.
The qualities that make a great investors are the topic of this meditation. As finance theory and finance engineering evolve and as more convoluted ways to determine value are taught in academia, the more I look for simple, common-sense tools that Benjamin Franklin could have easily understood and are likely to be used a century from today.
Serious investors are avid readers, because reading provides perspective. Understanding the past, reflecting on the present and thinking of the future are crucial. This is because they allow to stay calm when market are shaky. Consider the passionate Bitcoin traders of our days. They buy the currency so that they can sell it at a higher price. For them, reading Charles Mackay's Extraordinary Popular Delusion and The Madness of Crowds would serve well. The kindle version only costs $0.56 as a side note.
For entrepreneurs who subscribe to Fortune or Forbes Magazine, that dream of amassing wealth in Silicon Valley, reading The Age of Gold: The California Gold Rush and the New American Dream link will force them to ask better questions about life. For example, are there truly shortcuts to building wealth?
One of Buffett's most known principles is that he will not purchase the stock of a business that he does not understand. Readers of the The Education of Value Investor know that one of Guy Spier's principles is to never buy a stock on margin. And if you visit the Magical Formula website, you will see that Joel Greenblatt looks for companies with high earnings on tangible equity.
What one investor may look for in a stock is not what other investor will. But it is clear that each great investors have a keen understanding of who they are. This is what drives their stock investing decisions, not the market. In the words of the Third Avenue's legendary founder, Marty Whitman:
"Short-run market considerations, the life blood of the Efficient Market Theory, are unimportant in value investing. It is not that the value analyst has access to superior information vis-a-vis the OPMI market but rather that the value analyst uses the available information in a superior manner."
The more you know yourself, the more your stock purchases will be independent of market sentiment. When I buy a stock, I imagine the purchase to be as similar as if I had bought a house in a community that I know well and who’s members I cherish; where I know that the property is adjacent to great schools and offers a convenient commute to work. In such a scenario, it is unlikely that I will sell the home – even if the real estate market drops by a third in value.
Observe the great investors and you will see that all have enough money. They don't have to work. Yet they choose to wake up each morning, commute to their offices, read financial reports in the morning and make capital allocation decisions by the afternoon.
The great investors buy stocks for other reasons than profit. In my opinion, either (1) they have something to prove, (2) they regard stock investing as joyful activity, (3) they are interested in understanding how businesses work (Buffet called once himself a "business hobbyist") or (4) they look at stock investing as an extension of their personality.
You will do poorly if you place your wealth with a money manager who never admits to mistakes. Great investors always describe, both verbally and in written format, their investing errors.
In The Education of Value Investor mentioned above, Spier describes why he bought the stock of Tupperware and analyzes what went wrong. Mohnish Pabrai disclosed to investors, in plain English, that he made a mistake when he had bought the stock of Horsehead. More recently, Buffett said that he had overpaid for Heintz Kraft. In short, honesty matters.
What all great investors share is contentment in life. They don't seek more capital to manage or to change their personalities. They stick to their investing philosophy even if there are trendier investment areas. Great investors follow the maxim: "Be yourself," which I believe results in an almost mystical aura surrounding them. This quality, which cannot be achieved by having an ample number of followers on Instagram, makes you want to be around them and hear what they have to say.
On the surface, their life contentment seems accidental; almost as if these great investors stumbled upon the life that is most suited for them. I find that hard to believe. The great investors are in a constant self-improvement mode, hacking for better habits and challenging themselves to become better decision makers.
While it is hard to define what makes and what will make someone content, it is obvious to see when one is not content. Think about that the next time you talk to your an investment manager.