Reading Roundup: August 2022
This month we read:
One Up on Wall Street by Peter Lynch
The Great Depression: A Diary by Benjamin Roth
The Constitution of Knowledge by Jonathan Rauch
Building a Second Brain: A Proven Method to Organize Your Digital Life and Unlock Your Creative Potential by Tiago Forte
One up on Wall Street by Peter Lynch
It’s likely I’ll read certain books every year, and no matter how long I’ve been investing Peter Lynch books will be on that list. Lynch was a legendary investor and One up on Wall Street is his most famous book. It details his common sense approach to investing and explains why so many professional and individual investor cannot or will not follow his advice.
It’s often misconstrued that Peter Lynch was a “growth” investor in the same way people think about today’s growth investors. While Lynch did love companies with long growth runways, he avoided businesses growing too fast (more than ~20%), in hot industries, and generally those that were unpredictable or unprofitable. This is a far cry from many of today’s growth investors buying unprofitable businesses growing 80% per year in hot sectors and paying 15-20x revenue.
My favorite quote from the book is:
Many people prefer to invest in a high growth industry, where there’s a lot of sound and fury. Not me. I prefer to invest in a low growth industry like plastic knives and forks, but only if I can’t find a no growth industry like funerals. That’s where the biggest winners are developed.
He also was disciplined in terms of price. While maybe not a bargain hunter, he had a rule of thumb to never pay more than a percentage of growth for each turn of the valuation multiple. In other words, never pay more than 15x for a business growing 15%, or 20x for a business growing 20%, and avoid anything growing faster or valued higher than that as it’s too unpredictable and bound to crash.
The classic Lynch investment was to find a mis-priced stock that was growing solidly in a low or no-growth industry and was stealing market share because of a superior mouse trap. Sounds a lot like a value investor to me.
Lynch also loved niches, he talks about rock pits and patent-protected chemical companies in the book. Just another way of describing businesses that have an enduring competitive advantage.
Finally, like virtually every great investor throughout history, Lynch is vehemently against attempting to time the market and regards regular bear markets and occasional crashes as table stakes to earning above-average returns. He remained 100% invested in stocks his entire career and life. Like Buffett, he explains there is always something to worry about. His commentary in 1990 sounds similar to the worrywarts of today.
I hear every day that AIDS will do us in, the drought will do us in, inflation will do us in, recession will do us in, the budget deficit will do us in, the trade deficit will do us in, and the weak dollar will do us in. Whoops. Make that the strong dollar will do us in. They tell me real estate prices are going to collapse. Last month people started worrying about that. This month they’re worrying about the ozone layer. If you believe the old investment adage that the stock market climbs a “wall of worry”, take note that the worry wall is fairly good-sized now and growing every day.
There are myriad more gems and insights in the book, go give it a read and when you’re done, read it again.
Dan
The Great Depression: A Diary by Benjamin Roth
The problem with history — especially financial history — is hindsight bias. When we read history, we know how it ends.
Hindsight bias explains why past drawdowns look like buying opportunities but future drawdowns look like risks. The antidote to hindsight bias is to read history written as events unfolded, not written in retrospect.
The Great Depression: A Diary is the history of the Great Depression written without hindsight bias. Benjamin Roth, the author, was a lawyer in Youngstown, Ohio during the Great Depression. He understood that he was living in a historic time and decided to keep a diary to record the events for posterity’s sake. Roth’s son published the diary in 2009.
Below are some notes I made related to the book’s themes. The bullet points are direct quotes.
No one knew they were living in a depression until they were well into it. Similarly, no one knew they were out of the depression until the recovery was well underway.
The bottom was reached in summer 1932 and the upturn gradually started. There had been so many false starts however that it was not until 1934-5 that people really realized that the turn had been passed.
Professionals suffered as much as blue collar workers. Many businesses perceived to be non-cyclical proved cyclical.
Our family dentist stopped me today and urged me to continue to send my family in for dental work even tho we could not pay promptly. This was a very unusual thing for him to do but people have simply stopped worrying about dental needs. If a tooth aches they have it extracted but neglect all other dental services that might be expensive.
A good many doctors and dentists have given up their down-town office and are using their home. Same with lawyers. It is the old story of expanding too far and living too high.
There is nothing to do but work harder for less money and cut expenses to the bone.
People knew assets were cheap but no one had no money to buy them.
This is a good time to buy summer resort homes or even large mansions of the rich people. Nobody wants them at any price because they are too expensive to carry.
It is generally believed that good stocks and bonds can now be bought at very attractive prices. The difficulty is that nobody has the cash to buy.
I see now how very important it is for the professional man to build up a surplus in normal times. A surplus capital of $2,500 wisely invested during the depression might have meant financial security for the rest of his life.
Many bought the dip too early and saw their investment decline 2/3rds.
Those who bought “bargains” in stocks in 1931 now find they were too quick and these same stocks are now selling at 1/3 of 1931 prices. If they can hold on long enough they will come out alright but it is a soul-trying period of waiting.
I talked to Miss K—this morning. She says that at time of Bethlehem Sheet & Tube merger fight, she was owner of 1,200 Sheet & Tube common. Sold most of it to the highest bidder at $165 per share and almost immediately re-invested in Republic Steel at 70. She did not realize that she would have to pay a huge income tax and later was hard put to raise cash to pay this tax because in the meanwhile the banks had closed and Republic Steel was selling at about $3 per share.
Bankruptcy lawyers earned record profits. Counter-cyclical cash flows are extraordinarily valuable, as Charlie Munger and The Daily Journal shareholders discovered in ‘07-’09. I think the countercyclical cash flows at AutoZone and Dollar General are under-appreciated.
Lawyers in large cities like New York and Chicago are reaping a harvest in foreclosures and receivership involving large office buildings and apartments which were erected in the years of frenzied finance.
Real estate didn’t fare any better than stocks. Tenants stopped paying rent and many left cities for farms. Landlords without tenants still had to spend money on property taxes and maintenance.
The worst feature about real estate in a depression is that it is illiquid and cannot be sold at any price. If it is free of mortgage the owner may hold on until normal times—but in most cases it is subject to mortgage—he cannot collect his rent from the tenants—and cannot pay on his mortgage or taxes and eventually loses his equity by the foreclosure route.
Another client had 10 buildings razed because he could not collect rents and the taxes are exorbitant. This is a popular way to reduce taxes.
Most of the buildings have been torn down by the owners rather than to pay the taxes and small gardens have taken the place of former store buildings.
The depression changed the nation’s psychology. People become cynical and began to entertain extreme ideas like socialism, communism, and “helicopter money.”
The psychology of 1928 is different from that of today. In 1928 people were excited about big profits on the stock market: they read literature about investments, lived high and talked about the “new era.” Today their outlook is gloomy, they think the depression will never end, the stock market is an abomination, real estate is no good, everybody is cynical, etc. Just as the public was mistaken in its excessive optimism of 1928 I believe it is mistaken in its excessive gloom.
It has become popular to wear old clothes—to brag about poverty and how much you lost in the 1929 crash. It is almost bad taste to give a big party or to drive a new car.
Socialism, Communism, more equitable distribution of wealth, new currency and other panaceas became ordinary table talk.
There is simply no money in circulation. This scarcity of money is what makes people think if more money were printed business would be better. This is a false and vicious theory.
Congress is now passing a bill to give the President seven billion dollars to carry out the terms of the lease-lend bill. This increases the debt to $53 billion with no limit in sight and yet there is no excitement or talk of inflation. People have become calloused to an increase of the debt.
People lost faith in banks and the financial system.
People seem to have lost all confidence in banks and are quietly withdrawing their funds and putting it in safety vaults.
Banks are absolutely terrible in their insistence on payments on notes and mortgages. It is the old story of lending you an umbrella when the sun is shining and then demanding it back when it rains. If a depositor asks for his money he is regarded with suspicion—sometimes he is sent to one of the officials who wants to know why he wants the money—if they think he is hoarding it they try to shame him out of a withdrawal and only if he becomes unpleasant and insistent does he get his money. It is a good time not to owe money to a bank and many businesses are being ruined because the banks insist on liquidating their loans. Some businesses owe the banks so much money that the banks are afraid to press them too far for fear they will go into bankruptcy and thus avoid the whole loan.
Violence and fraud increased.
Hold-ups and killings are becoming more frequent and it becomes dangerous to walk the streets after dark.
The depression is bringing out many cases of misuse of funds by lawyers, banks, etc.
Signs of the times: French premier shot and killed by a fanatic. Five people killed in Chicago communistic rioting. Community chest drive opens tomorrow with much greater needs and little chance of getting it. Dr. Philo [a Youngstown rabbi] chooses as his topic last night “If I Were Dictator of the U.S.” He makes numerous radical statements.
Signs of the time: Japanese Premier is assassinated. This is the second Japanese premier to die this way in the past year.
Gambling became popular. We saw this in 2020 too with the rise of online sports betting and meme stocks.
People lost all confidence in the old virtues of saving. They were willing to bet small amounts in the hope of getting large returns. They wanted something to occupy their minds and they wanted some gamble to buoy their hopes.
Roth concludes that successful investing requires frugality, patience, and courage.
It is my conclusion that the successful investor must cultivate the habit of “patience.” He must be able to hold his money and wait until it is really the time to buy. In this panic it meant waiting over 3 years until stocks were really at rock bottom and selling at less than 1/10 of their normal value.
Patience to wait for the right moment—courage to buy or sell when that time arrives—and liquid capital—these are the 3 essentials as I see it now. When stocks reached their all-time low in July of 1932 (when Sheet & Tube sold at 6; Republic 1 1/2; Truscon 2; U.S. Steel 20, etc.) it would have taken plenty of courage to buy because receiverships and bankruptcies threatened the largest companies and most of the banks in the country were closed or refusing to permit withdrawals.
Very few people bought in 1932 and held until now. They usually sold where they could double or treble their money. If they had held on they could have gotten 20 or 30 to 1.
Overall the book is a fascinating must-read for investors.
Matt
The Constitution of Knowledge by Jonathan Rauch
In The Constitution of Knowledge Rauch addresses two of the more prominent social trends over the last few years: misinformation/trolling and canceling. Both of these timely issues wage war against what the author calls the Constitution of Knowledge or the “reality based community”. I think of it as an argument of why rationality ultimately should prevail despite repeated attempts by cults and social media hysterics to claim otherwise. The book refreshingly dismisses both far left and far right quacks who engage is intentional misinformation campaigns and cancel culture.
Rauch outlines how to remain rational and how to spot whether or not a group of people (or country/company/etc.) is engaging in thoughtful decision making or emotion-drive irrational behavior. I think the checklist is a great one for investors to keep on hand as a gut check for themselves. According to Rauch, reality-based people possess certain traits:
Fallibilism: Any of us can be wrong about almost anything, at any time. Never fall in love with an idea and always be on the hunt for disconfirming evidence and challenge closely held beliefs.
Objectivity: Something is true because it can be proven to any who cares to listen, “nothing is true merely because you feel it is true, or because your boss or priest or tribe feels it to be true”.
Exclusivity: There is only one objective reality. “Unless truth be recognized as public, as that of which any person would come to be convinced if he carried his inquiry, his sincere search for immovable belief, far enough”.
Disconfirmation: Reality-based folks welcome challenges to their beliefs and findings from informed people studying the same topic.
Other tenants of those who uphold the Constitution of Knowledge include accountability, pluralism, professionalism, institutionalism, and, my favorite, no bullshitting.
Another lesson directly applicable to investing is that of the printing press. Much has been made about the unprecedented speed at which false or otherwise undesirable information can spread in the age of social media. While this is true, it’s really not without precedent. For a few hundred years after the printing press was invented conspiracy theories and fake news spread far faster than could have been done by word of mouth alone. After all, anyone with enough money could buy a printing press and publish and distribute wild claims such as a publication that swept across Europe in the 1400s claiming witches lurked everyone which inspired panics and thousands of murders.
Many prominent politicians wanted to ban printing presses to control the spread of misinformation. Of course, eventually the dissemination of real news was upheld by prominent newspapers and journalists, resulting in a by and large trustworthy community of reporters. Social media is undergoing a similar transformation nowadays. It won’t be without bumps, but as these companies start to implement systems to regain some control over what is spreading on their platforms, it’s likely only to cement their economic moats; a great thing for shareholders.
Dan
Building a Second Brain: A Proven Method to Organize Your Digital Life and Unlock Your Creative Potential by Tiago Forte
According to the New York Times, the average person’s daily consumption of information now adds up to a remarkable 34 gigabytes. But information is worthless if it can’t be retrieved and applied.
Tiago Forte proposes a solution — build a Second Brain. A Second Brain is basically a digital commonplace book. What’s a commonplace book?
Early modern Englishmen read in fits and starts and jumped from book to book. They broke texts into fragments and assembled them into new patterns by transcribing them in different sections of their notebooks. Then they reread the copies and rearranged the patterns while adding more excerpts. Reading and writing were therefore inseparable activities. They belonged to a continuous effort to make sense of things, for the world was full of signs: you could read your way through it; and by keeping an account of your readings, you made a book of your own, one stamped with your personality.
Forte says to organize notes based on where they’re going, not where they’ve come from.
The best way to organize your notes is to organize for action, according to the active projects you are working on right now. Consider new information in terms of its utility, asking, “How is this going to help me move forward one of my current projects?”
Organize your notes based on the questions you’re trying to answer. This is how Nobel prize winning physicist Richard Feynman operated.
You have to keep a dozen of your favorite problems constantly present in your mind, although by and large they will lay in a dormant state. Every time you hear or read a new trick or a new result, test it against each of your twelve problems to see whether it helps. Every once in a while there will be a hit, and people will say, “How did he do it? He must be a genius!”
Next, use Forte’s CODE Method — Capture, Organize, Distill, and Express.
Once you have identified the kinds of questions you want your Second Brain to answer, it’s time to choose specifically which pieces of information will be most useful.
The biggest pitfall is saving too much. The more economically you capture, the less time and effort you’ll expend in the future organizing, distilling, and expressing the captured ideas.
Send new notes to an inbox in your Second Brain and periodically review them. Keep what will be useful long term and discard what merely resonated in the moment. Annotate and summarize the key ideas (progressive summarization) so that they are obvious in the future.
Knowledge compounds over time and so will the value of a well-kept Digital Brain.
Matt
The Best of the Rest
An Examination of the Often Controversial Buyback as a Capital Allocation Tool. “AZO has bought back over 90% of its stock since its share repurchase program began in 1998, a stunning amount of buyback rivaling Teledyne.”
Chris Mayer: Dare to be Naïve. “I don’t want to invest just because I have the cash. I want the opportunity set to drive the decision.”
Chris Mayer: Ouch. “So, if the company is better positioned today than it was a year ago, why is the stock price so much lower than it was a year ago?”
Ben Thompson: Political Chips. “Last Friday AMD surpassed Intel in market capitalization.”
Ben Thompson: Instagram, TikTok, and the Three Trends. “Facebook’s next two decades are coming into sharper focus than ever; it is how well it navigates the TikTok minefield over the next two years that will determine if that long-term vision becomes a reality.”
BRK Daily: What’s a reasonable pre-tax multiple to apply to Berkshire's non-insurance earnings? “Under today’s conditions (2012), I would love to buy those (Berkshire subsidiaries) at certainly nine times pretax earnings, maybe 10 times pretax earnings. I’m not talking about EBITDA or anything like that, which is nonsense. I’m talking about regular pretax earnings. If they have similar characteristics, we’d probably pay a little more than that, because we know so much more about them than we might know about some other businesses.”
Jamie Dimon sounds off on... almost everything. “I never sold a share of [JPM]. I bought shares. I still buy my own stocks. I don't have many. I don't have any long-term Treasuries. I think Mexico is going to be a great set up. I bought a Mexican ETF. Did you know their labor is cheaper in Mexico than in China? And it is a secured supply chain. If you are a manufacturer, it is a no-brainer. Green infrastructure will be big.”
How a Gift of Coke Shares Helped Make These Colleges Richer. “A $7 million gift in 1953 has grown to almost $3 billion worth of Coca-Cola stock, buffering college endowments against low returns.”
Dakota Value Funds — What The Greatest Investors In History Did That So Few Every Do. “Meanwhile the Chandler brothers made 37% a year from 1986 to 2006 buying countries’ crown jewel assets at 1-2x earnings, often after those countries’ stock markets had experienced utter collapse. But once again the thesis didn’t require a paradigm shift or a clever prediction, just a mundane return to historical precedent.”
Dakota Value Funds — Draper's Carousel. “Growth is a bet on change. Value is a bet on sameness. Value trumps growth because life stays the same far more than it changes.”
JP Morgan Energy Transition White Paper. “The prior chart on US vehicle preferences gets at a major issue: what to do about US gasoline “super-users”? As shown below, the top 10% of gasoline consumers in the US account for almost one third of all gasoline consumption, more than the bottom 60% of gasoline consumers combined. Who are these gasoline super-users?
They drive 3x more miles than the average driver
They are more likely to drive pickups and SUVs
They are more likely to live in rural areas
They have similar income and education levels as the general population
They spend 8%-13% of their income on gasoline, which is over 2x as much as the average driver
Andrew Walker: Natural Gas Deep Dive
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