Stock investors often define themselves as either value-oriented or growth-oriented, where in the former definition, the investor focuses on accounting fundamentals, and in the latter, the investor focuses on the product and whether it will become popular in time. But I think the two definitions are not mutually exclusive but complementary - a great investor looks at both the numbers and the product behind them.

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Noam Ganel is the Managing Director of Pen & Paper, a value-oriented stock research publication. Subscriptions are now available. He also serves as  Vice President in Capital Markets at Silvergate Bank and holds the Chartered Financial Analyst (CFA) credential. Click here for frequently asked questions.


What Trends in Global Health Can Teach Us

June 15, 2018

(1) The Gap Instinct

When a story describes a picture of two separate groups with a gap between them, the reality is often not polarized at all. Usually the majority is right there in the middle, where the gap is supposed to be.

Many investors define themselves as either value-oriented or growth-oriented, where in the former definition, the investor focuses on accounting fundamentals, and in the latter, the investor focuses on the product or service and whether it will become popular in time. But I think the two definitions are complementary - a great investor looks at both the numbers and the product behind them.

(2) The Negativity Instinct

“Information about bad events is much more likely to reach us. When things are getting better, we often don’t hear about them,” notes Hans Hasling, author of Factfulness. As an example, I purchased the stock of Patterson Companies amidst negative news about the company and its future.  Wall Street analysts commented that management had eliminated the dividend payout policy, that the CFO had resigned and that the earnings guidance decreased. But as I wrote in The one advantage of short term thinking: A cheap stock price, one a 15-year comparison, the company's did fairly well.

Let us now summarize 15 years of operations:  revenue increased to $5.6 billion from $1.7 billion, an increase of 229%. Earnings increased to $171 million, or $1.79 per share, compared to $119 million, or $1.75, an increase of 43%. And the number of outstanding shares only grew by 10%, to $92.6 million from $86 million. And a few more praiseworthy notes: the company did not report a single year of loss in earnings; since 2010, it had returned $615 million in dividends (at purchase price of $23 per share, the dividend yield is over 4%), and PDCO operates in an industry where time is your friend. Read: the need for dental and veterinary products is likely to increase with time. 

(3) The Straight Line Instinct 

A line will not necessarily continue to be straight. Straight lines, in reality, are rare. Think of a person’s weight or height as an example - when there is a gradual increase each year but eventually the growth stops. Capital markets often behave as if the price direction of a stock will either go down or up for perpetuity. Another example, from my portfolio of stocks: when I bought the stock of Vitamin Shoppe in September 2017 for $5, it had declined in price since February 2013. And the price decline didn’t stop with my purchase. I saw the value of position decline by 30% before the stock price recently changed its course.

(4) The Fear Instinct

 Frightening things get our attention, but they are not necessarily the most risky. “To control the fear instinct,” notes Hasling, “calculate the risk.”

Friends often ask whether it frightens me to see my net worth fluctuate with the movements of the capital market. But I don’t know of a better location to park savings than the U.S. stock market. The mattress of my bed is susceptible to theft; investing in fixed instruments, such as bonds and Treasuries is sensitive to the interest rate environment, and storing cash in a local’s bank savings account will expose you to inflation and will likely hurt your purchasing power in the long term. And while Indian culture may think differently, even buying gold, historically at least, has provided less than an adequate return. In Why Stocks Beat Gold and Bonds, Warren Buffett writes comments on this issue.

(5) The Size Instinct

A number by itself is often meaningless. What one often needs is a number to compare it to, or at least to divide it by some other relevant number. Take our perception of financial scams as an example: the Bernie Madoff Ponzi Scheme; the Theranos and Elizabeth Holmes debacle; the LIBOR manipulation scandal; the LTCM blow up. Shouldn’t we ask the proportion of these episodes compared to the possibilities? If you believe as I do that effectively every CEO of publicly traded companies can report false and misleading financial statements, then the proportion of scams is minuscule. Capital markets, at the end of the day, are a wonderful invention and a human achievement in both theory and in practice.

(6) The Generalization Instinct

Categories can be misleading. Just as we would be wrong to say that blondes are stupid, or that Persians are cheap, or that British are snobs, we would be wrong to classify that small capitalization stocks are risky and that large capitalization stocks are safe.

Half of marriages end up in divorce. But should we give the same weight to a couple who married after a month of dating compared to a couple that dated for five years?

(7) The Destiny Instinct

Even small changes gradually add up to big changes. In stock investing, this instinct directly relates to the principal of compound interest. Guy Spier brilliantly explains this concept:

When it comes to investment results, many investors focus on what happened in the past month, quarter, or year. They might compare quarterly or annual results to an index or to the results of other funds. Financially sophisticated investors may talk about the search for alpha (a fancy way of referring to above-average returns) or the pursuit of superior risk-adjusted returns. 
I pay as little attention as possible to these metrics because they distract me from the true task at hand. The only metric I find useful is thinking of long-term increases in net worth, or getting the miracle of compound interest to work in our favor. The table below illustrates the point that seemingly modest differences in the annual rate of return can generate profound differences in the ultimate gain over long periods of time. My goal is to compound wealth at a high rate, while minimizing the risk of permanent losses of capital. In order to keep my sights on the horizon, I frame the investing challenge as follows: I seek to double the Aquamarine Fund’s price per share as many times as possible over the course of my investing lifetime.
Taken from the 2017 Aquamarine Report to

(8) The Single Perspective Instinct

A single perspective can limit your imagination; it is better to look at problems from many angles. Before I present a loan transaction to our board of directors, I write the questions I expect to get asked. Since our board encompasses individuals with different risk profiles and real estate experience, the way they view the world is different. And I learned that imagining the varying questions, I grow my understanding of the risk and return of the transaction as well. 

(9) The Blame Instinct

Blaming an individual often distracts from the big issue at hand. And it is much wiser to look for causes instead. In my day to day career, as a commercial real estate lender, I am often pushed by aggressive customers. Initially, I had difficulty handling the adversary and blamed the brokers aggressiveness when a deal did not close. Over time, I realized that brokers, by being aggressive, believe that the transaction will close. Whether I like it or not, it is just the dynamic of the brokerage industry and I learned to live with it.     

(10) The Urgency Instinct

A decision often feels urgent but rarely is. In Michael Lewsis' latest book, The Undoing Project - A Friendship that Changed our Minds, he writes that Amos Tversky, the Israeli professor, used to say that the nice thing about urgent matters is that if you wait long enough, they aren't urgent anymore. One way to handle this instinct, which in the stock market often prevails, is to simply trade after the markets have closed. I copied this trick from Mohnish Pabrai.