Books 01 (May 08 - Oct 08)

[winston]

I read "Fortune's Formula" by William Poundstone some time back. Enjoyed it very much although some parts of the book is quite theoretical and dry..

Here is a review below:-

Poundstone provides decent biographies of mathematicians such as:-
1) Claude Shannon (the father of information theory),
2) Edward Thorpe (the inventor of blackjack card counting), and John Kelly.

While Kelly died young, his legacy is the namesake of the book: through a clever application of information theory, Kelly derived a money management scheme that has intrigued gamblers ever since. His paper is a clear and well-written piece of applied mathematics that is well worth reading on its own, although Poundstone gives a very good (and surprisingly detailed) discussion of the paper.

Kelly provides an approach to managing your money in gambling games that avoids gambler's ruin. Roughly, Kelly's scheme works as follows: invest a proportion of your capital on each bet in a way that balances the odds of winning versus your edge over the game.

Kelly's work piqued the interest of Claude Shannon who, in collaboration with colleague Edward Thorpe, developed a machine to beat roulette. Thorpe later became famous for blackjack card counting, with his initial "field work" funded by the mafia (unbeknownst to a naïve Thorpe).

After their foray into Vegas table games, both Shannon and Thorpe turned their attention to the stock market. Thorpe eventually went to work full-time for a highly successful Wall Street hedge fund, applying Kelly's ideas to some of the earliest computer models for stock trading.

Indeed, Thorpe claims (with no hint of envy) that his model was essentially the same as the famous Black-Scholes pricing equations for which Merton and Scholes shared the 1997 Nobel Prize in Economics. Poundstone's account of the rise and fall of Thorpe's company is a fascinating one, involving personalities such as Michael Milken and Rudy Giuliani.

Shannon's interest in the stock market never took him to Wall Street full time, but his investing success makes Thales' purchase of all those olive presses look like small potatoes. Poundstone pieces together the evidence, noting that when asked if it's possible to beat the market, Shannon said yes, through arbitrage.

Shannon also gave a lecture in the 1970s that showed how, at least in theory, one could make money on the random fluctuations in the stock market index. Poundstone engagingly pieces the evidence together and comes to a somewhat surprising conclusion about the secret to Shannon's success.

Economist Paul Samuelson, and other members of the "random walk cosa nostra", make an appearance in the book. Samuelson's pugnaciousness in defending his point of view is great fun; he even wrote an essay consisting of single syllable words, mocking the faith that "Kelly bettors" have in their system.

As a quick googling will attest, many sports bettors have a major like or dislike for the Kelly the system. Indeed, with its requirement for knowing your edge over the game, Kelly's system has sometimes raised eyebrows as being a system that needs insider information to work in practice.

[Musicwhiz]

Dear all,

I am reading Jason Zweig's* "Your Money and Your Brain" currently. A very good book on behavioural finance which sheds many insights into human behaviour and how we react towards money. I definitely recommend it !

*Note: Jason Zweig is the guy who wrote the commentary for Benjamin Graham's "The Intelligent Investor" (updated edition).

[la papillion]

The Bull Hunter – Dan Denning

This book is very meaningful to me. I remember in 2006, me and a friend just went over to DBS building there to just open a DBS Vickers account together (but not joint). After some time, my friend bought this same book and passed it to me for reading. I browsed a bit and realized that this book is not ‘locally contexted’ and hence dismissed it, saying that it’s not suitable for Singapore.

Who would have guessed that years later, in 2008, I was actually looking around in library for this book? I read and found out big my folly is. The book was written back in 2004 but the prediction and forecast are uncannily accurate. It detailed, among other things:

1. The dollar crisis of America
2. Sub prime crisis
3. Rise of China and India (esp China)
4. Rise in commodities like oil, gold, metals, soyabean, corns

I found it amusingly when the guy predicted that oil will one day rise to USD 100 per barrel. You can guess how much the price of oil overshot this forecast by now.

That was back in 2006, when I’m still new and ready to stand in front of a bear charging at me and thought it was a bull. Atlas, even if I had read that book back then, I doubt I would have the maturity and experience in me to really treat this book as it is. That’s life – cest la vie. But life is to be lived forward and understood backwards, so there’s no point regretting not reading the book when fate had thrown it to me earlier.

I particularly liked his insights into China and India. His general rule when investing in emerging markets will be this: Buy the biggest financial, energy/resource, telecommunications companies in these areas and you pretty much had the biggest growth area. I totally agree with him. Looking at china mobile, singtel looks a tad insignificant. M1 or Starhub must be like how Singapore looks like when one is looking at the world map of telecommunications.

The author recommended ETF as a cost efficient and safe way to invest, though he also mentioned that if one is savvy enough, individual stock picking can also be done. The key point here is that bull markets occur somewhere, one just have to open one’s eyes for opportunities. Just like when one place is daylight, another place falls into darkness, bull and bear market will chase each other till kingdom come. The important question when facing a bear market is this – are you investing in the right asset class?

An excellent book, this one is for me. It had truly come one full circle back in the days when I first came to know of the book in 2006.

[iam802]

Thanks for sharing.

You are a great writer.... as if it is part of the book's summary (or intro).

[la papillion]

Thanks for sharing.

You are a great writer.... as if it is part of the book's summary (or intro).

Haha, thks It's quite flattering for you to say that I always try to incorporate and internalise what I reflected by giving an example, so as to contextualise it in my perspective. Glad you enjoyed it

[la papillion]

The Intelligent Investor review

I've finally finished reading The intelligent investor by Benjamin Graham, though I bought the book last year. Well, it's going to be the first of my reading. I expect myself to re-read certain chapters again and again.

Actually I thought I'll never be able to finish. I don't really fancy his rather arcane way of writing - a little to rigid for me, though his content is as interesting in the past as in the present. To force myself to finish reading, I actually borrowed the same book from the library. Having a dateline of 3 weeks to finish the book before my book is due makes it an extra incentive to finish it.

To be frank, not all chapters are interesting. It's good that Jason Zweig's commentary after each chapter makes the dry bit a little more bearable. But past 1/4 mark, I think the stuff becomes more of a page turner, especially the infamous chapter 8 and chapter 20. May I add one more chapter too? It's under Appendixes, pg 537 - The Superinvestors of Graham-and-Doddsville by Warren Buffett. I think that chapter should be my guiding light when the market grows dim and the wind blew those candlesticks off - it's pretty inspiring.

Let me share my thoughts on this book:

1. First of all, I am puzzled by my definition of margin of safety. You know the usual drill...find the intrinsic value, slap in a margin of safety of say 40%, and you'll get a magic price where you know the company is 'cheap'. Nowhere in the book (i might be wrong) did I see Benjamin Graham (I shall call him Ben from now) mention that, and I truly wonder wherefore did I ever had that idea ingrained into me.

On page 515, it was stated in the footnotes that Ben gave a lecture in 1972. He mentioned that 'The margin of safety is the difference between the percentage rate of the earnings of the stock (also called earnings yield) at the price you pay for it and the rate of interest on bonds, and that margin of safety is the difference which would absorb unsatisfactory developments".

I see this written in Buffettology book too. That's one big realisation for me. Let's say the long term bond rate is 5%. We need to get an earnings yield of at least 5%, which translate to a PE of 20x. Anything more than 20x PE wouldn't have that margin of safety. I'm thinking 10% earnings yield will give me a good margin of safety, so a PE of 10 or less is more like it.

2. Another thing that I carried away with me after reading this classic is the idea of the hot sector. Never fling money at Mr.Market's latest, craziest fashions and remind oneself with quiet confidence that, "This, too, shall pass away".

3. I understand what is meant by an aggressive and defensive investor. It's not whether one can take risk. It's how much work one is willing to spend that determines which type of investor one belongs too. I am thus, by definition, an aggressive investor.

I wouldn't recommend this book to anyone without a true passion in investing. Firstly, it's very thick - and that alone is sure to repel casual readers away. Secondly, one needs to have at least a cursory knowledge of accountings. Without that, the book is an alien tome of indecipherable jargons. There are some chapters which deal with philosophy though, so perhaps I'm exaggerating a little here.

But for those who do want to read this classic, hear this from me. The investing world is dividend into two kinds of people - those who had read The Intelligent Investor and those who have not read it.

[kennynah]

hi lapap :

you appear to be an insightful person, seeing how your contextualise, as you put it, into your perspective the books you read...

and how opportune for me, that you now have completed this investment "bible"; The Intelligent Investor...

i have asked on several occasions, how value investors, factually and without a shred of doubt, determine the "value" of a company. i wonder if you will be inclined to share your thoughts on this issue.

thanks.

[la papillion]

i have asked on several occasions, how value investors, factually and without a shred of doubt, determine the "value" of a company. i wonder if you will be inclined to share your thoughts on this issue.

Hi K,

Thks for your kind comments First of all, it's not 'without a shred of doubt'. In fact, there are many doubts because the valuation machine is a black box with a few unknown and uncertain variables. Inputing different variables will give different results, thus if one throws in garbage, one gets garbage out - the valuation machine becomes GIGO (garbage in garbage out). Value is a range, never an exact price. After all, it's better to be approximately right than precisely wrong.

I doubt I'm good enough to share on this issue of valuation actually, since there are clearly more experts in this field than me. I can try...but let me piece it up first

[kennynah]

lapap : i appreciate this very much since i have never been able to get this Valuation methodology working for me... i will surely benefit greatly from your next post on this topic...but pls no rush...

thanks

have a great weekend ahead....

[Musicwhiz]

Value investing is not an exact science, it's more of a combination of art, science and common sense (intuition).

There is never an exact value of a company, one can only get an approximation which will change every other week/month as the company grows and evolves. Intrinsic value is the sum of not just the quantifiable parts of a company, but also the qualitative aspects which make it a good investment.

I am more inclined to look at the total package when deciding if a company is worth buying. Benjamin Graham focused too much on just the numbers, which I think in such modern times may be insufficient for one to invest intelligently.

Just my views.