The Practical Way

Howard Marks Investing Ideas, part 4

The “know” and “don’t know” schools

The “I know” school people believe they can discern what the future holds, and in their world investing is a simple matter:

• First you decide what the economy is going to do in the period under consideration.
• Then you figure out what the impact will be on interest rates.
• From this you infer how the securities markets will perform.
• You choose the industries that will do best in that environment.
• You make judgments about how the industries’ companies will fare in terms of profits.
• Based on all of this information, you pick stocks that are bound to appreciate.[...]

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Howard Marks Investing Ideas, part 3

Performance

A bit above average performance is not that bad if you can consistently do it for many years. You do not need to swing for the fences in order to achieve long term gain. If you are willing to take huge bets on assets to gain the spectacular results you should be ready to fail some times and then have huge losses. That will give you an average return over the years, unless of course you can be right about the future most of the times. Not an easy task to accomplish.[...]

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Howard Marks Investing Ideas, part 2

Telling the future

Making market forecasts on a consistent basis is not an easy thing. Many people try and none succeed on it. If you are always crying ‘wolf’ then at some point you will be right, but that does not tell us about your ability to forecast market movements. A useful market forecast is only useful if it is in contrary to popular belief. If everyone predicts it then this is already reflected in the price of assets. [...]

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Howard Marks Investing Ideas, part 1

When the world’s self-made billionaires speak it is good to listen. Then when you find out who they follow on a regular basis, maybe you should look at them too. This is how I learned about Howard Marks. Howard is the chairman of Oaktree since 1995. His approach to money management is based on a simple motto: “if we avoid the losers, the winners will take care of themselves”. His memos to clients are a must read for investors. Here are some pieces of advice taken directly from his memos.[...]

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“Common Stocks and Uncommon Profits” by Philip A. Fisher

Philip Fisher was in investor for many years and he was a very successful one. In his book “Common Stocks and Uncommon Profits” he outlines some of his ideas that have helped him to be a successful investor.

He regularly used to go out on the field and speak with employees of the companies, with suppliers, competitors and the management and was able to gather valuable information from them. Of course, he did a lot of preparation work before he went to the meetings to show to people that he was a serious investor.

Here are 15 points that he was looking for in companies that he wanted to invest in. Many of them are more difficult to quantify than a simple P/E ratio, but none the less very important.[...]

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The lessons of the 2007 crash

Howard Marks from Oaktree capital wrote in a memo the lessons that the market crash of 2007 should have thought us. A lot of these lessons are not new ones, but a repetition of old lessons that investors did not learn last time. Or maybe their memory is short term. Maybe more attention should be paid this time and learn these lessons to avoid repeating them next time. Because there will surely be a next time. Here are the lessons:[...]

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This time it is not different

Mark Howard of Oaktree Capital Management wrote in one of his memos about the times that are unchanged. Here is his notes:

Why do the mistakes repeat? That’s a good question, but not much of a mystery. First, few investors have been around long enough to recognize reoccurrence of the errors of twenty or forty years ago. And second, the greed that argues for ignoring “the old rules” easily trumps caution; hope truly does spring eternal. That’s especially true when the good times are rolling. The tendency to ignore the rules invariably reaches its apex in periods when following them has cost people money. It is thus, as Galbraith points out, that those who harp on the lessons of the past are dismissed as old fogies. What are some of the recurring mistakes investors make?[...]

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The most important thing

Mark Howard of Oaktree Capital Management wrote in one of his memos that a lot of people ask him what is the most important thing he has learned throughout his years of investing. After been asked this question a lot, he decided to compile a list of the answers he has given to various people, because he has given various answers. Here is the list:

• The most important thing – above all – is the relationship between price and value.
• The most important thing is a solidly based, strongly held estimate of intrinsic value.

[...]

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How to build a successful partnership

Mark Howard of Oaktree Capital Management wrote in one of his memos some very good ideas about building a successful partnership:

If an organization is to be the best, it must find, train and retain the best. Not only does turnover drain off your best people, but it also takes their institutional memory and leaves you bogged down in hiring and training their replacements.

We always have placed great emphasis on preventing turnover, and the results are visible – in the very small number of senior professionals who have moved on to other employment in my 25 years in portfolio management, and in the investment performance that my long-term colleagues have produced.[...]

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Compound interest

Compound interest is when the interest you have earned gains interest itself. For example, if you deposit £1000 in the bank and you get 10% interest per year, at the end of year 1 you will have £1100. Then at the end of year 2, you will have £1210. During the second year the interest is applied to your original amount (£1000) and to the interest that you gained at the 1st year (£10). This is how money multiplies over the years and it works for you. Notice that you have only deposited £1000, but then the money that you gain from interest multiplies by itself (together with your original amount) and works for you. This is the secret of how to become rich. Many of the richest people in the world have used this simple idea to create their fortunes, e.g. Warren Buffet, John D. Rockefeller.[...]

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A Lesson on Elementary, Worldly Wisdom As It Relates To Investment Management & Business

Charles Munger
USC Business School
1994

I’m going to play a minor trick on you today – because the subject of my talk is the art of stock picking as a subdivision of the art of worldly wisdom. That enables me to start talking about worldly wisdom – a much broader topic that interests me because I think all too little of it is delivered by modern educational systems, at least in an effective way.

And therefore, the talk is sort of along the lines that some behaviorist psychologists call Grandma’s rule after the wisdom of Grandma when she said that you have to eat the carrots before you get the dessert.[...]

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How to combat a financial crisis

A lot of people are confused on what to do in this difficult economic climate. People are losing their jobs, governments are raising taxes, goods are becoming more expensive, currencies are devalued, etc. This is not a nice picture and many people are feeling helpless in this doom and gloom.

Maybe this is not the best way to think, but you have to consider how all this affects you. Maybe the general economy is bad, maybe companies are not doing so well, but the real question is how are you doing? What does all this mean for you? What can you do to avoid the chaos and (to take it a step further) profit from all this? Do not think that this is totally selfish, it partially is. But looking after yourself, you can survive and then you can provide for the people that matter to you. You can provide to them in the form of money, but even better you can provide to them in the form of knowledge.[...]

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Warren Buffett’s Business Evaluation Filters

At a press conference in 2001, when Warren Buffett was asked how he evaluated new business ideas, he said he used 4 criteria as filters.

• Can I understand it (Is it predictable. Do I have a reasonable probability of being able to assess where the business will be in 10 years)?[...]

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Charlie Munger Investment Principles Checklist

I finished reading “Poor Charlie’s Almanack” that details the thinking principles of Charlie Munger about investments and life in general. The book is an amazing read, because it shows how Charlie thinks about problems using many different ways. This helps him to avoid the “Man with a hammer” syndrome and allows him to see other aspects of problems and try many different ways to solve them.

In the book he shares a checklist he is using in evaluating companies.[...]

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Dollar Cost Averaging

A lot of people are trying to time the market, but very few are able to do it consistently. The old advice of buy low and sell high is not that easy to implement and many people end up doing the exact opposite. An easy way to invest in the stock market is dollar-cost averaging. Here is a helpful post from fool.com that explain how it works:

Let’s begin with a definition. Dollar-cost averaging is a fancy term for periodic investments of fixed sums of money. Simply put, dollar-cost averaging involves investing a set amount of cash ($100, $500, $1,000) at regular intervals (monthly, quarterly, yearly) into a stock, a group of stocks or a fund. The key to its success is consistency. Investing the same amount each time on a set schedule can really help grow your portfolio over time.[...]

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Enterprise Value

When you are evaluating a company you need many tools that will help you to look at the company in different ways. One such tool is enterprise value. Here is a very good article from fool.com that explains what it is:

When trying to determine the value for a given company, a metric that many investors use religiously is market capitalization, better known by the shortened, slightly sassier term “market cap.” It’s simple enough to figure out — all you do is multiply the company’s shares outstanding by its current share price.[...]

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The Art of Stock Valuation, part 1

When you are looking to invest your money in the stock market you need to go through thousands of companies and decide which ones will prosper in the future and which ones will not. The way to decide which ones will prosper is more of an art than it is science. Unfortunately, there is no secret formula for this although many people have tried unsuccessfully to create one that will work over the years. Many of these theories have been created based on mathematical models and all of them failed in due course.

This series of posts will look at people who have been successful at picking prosperous businesses over the years and will try to reverse engineer their successful approach. We will look at both quantitative and qualitative measures that can be used to evaluate companies. The data available for each of these companies is so vast that we need to sort through it, ignoring the noise and concentrate on the key metrics that really matter.[...]

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Option Strategies

There are a lot of option strategies and each one of them should be used in the appropriate situation. The guide below is a summary of a series of articles about the stock strategies. This summary will help you to identify which strategy to use in which situation so you can maximise your profits and reduce your loses. I will update the list below as a find new information about the strategies or as I learn new ones.[...]

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Bearish Spreads

Fool.com
By Jeff Fischer
February 11, 2010

Why use bearish spreads?

• To profit on a falling stock or index while capping your risk.
• To earn strong percentage returns on a moderate move in an underlying investment.
• To lower the cost of bearish put option purchases.[...]

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Bull Call Spreads

Fool.com
By Jim Gillies
August 25, 2009

Why use bull call spreads?

• Capital gains: To profit on a stock you feel relatively bullish on.
• Defense: To limit your capital at risk and lower your break-even point compared with just buying calls alone.
• Leverage: To land an oversized potential return on your net cost, although you sacrifice additional upside.[...]

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An Introduction to Spreads

Fool.com
By Jeff Fischer
February 11, 2010

Why use spreads:

• To profit on the movement in a stock while capping your potential loss at a pre-determined amount — though you cap your potential profit as well.
• To purchase options with less cash up-front, which in turn helps leverage your potential returns.
• To earn sizable percentage gains even on modest moves in the underlying stock.[...]

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Writing Straddles

Fool.com
By Jeff Fischer
November 18, 2009

Why write a straddle?

• You believe a stock or index is going to hold steady or stay in a tight range.
• You believe a stock that was recently volatile will settle down considerably.
• You believe the market’s overall volatility is going to decrease.[...]

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Buying Straddles

Fool.com
By Jeff Fischer
October 7, 2009

Why buy a straddle?

• You believe a stock or index will move dramatically, but you don’t know which way.
• You believe volatility will increase in general, so the value of the options you’re buying will increase.
• You want to leverage potential returns when the underlying investment moves meaningfully in either direction, but limit your risk.[...]

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Strangles

Fool.com
By Jeff Fischer
March 12, 2010

Why use strangles?

• You buy (“buy to open”) a strangle to profit on a sharp move in a stock, whether up or down.
• You write (“sell to open”) a covered strangle to profit when a stock stays within a wide range — or, if it doesn’t, to get a better buy price on new shares or a higher sell price on existing shares.[...]

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Diagonal Calls

Fool.com
By Jim Gillies
September 28, 2009

Why use diagonal calls?

1. If you’re mildly bullish on a stock and want to generate income from a leveraged investment.
2. To profit from a range-bound stock.
3. If your underlying stock is chosen well, and you’re handed a little market luck, you can wake up a year or two hence with a significantly in-the-money call option that effectively costs you nothing.[...]

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Stock Repair

Fool.com
By Jeff Fischer
August 10, 2009

Who should use the stock repair strategy? Someone who is:

• Down 15% to 25% on a stock and willing to forego profits to sell at breakeven.
• Not interested in averaging down or holding for the long haul.
• Using a margin-approved account and can write call options.[...]

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Synthetic Shorts

Fool.com By Jeff Fischer August 10, 2009 Feeling bearish? If you’re looking to profit when stock prices slip, there’s a way to use options to mimic shorting a stock — but with distinct advantages. To set up this “synthetic short” position, you sell a call option and simultaneously buy a put option, using the same [...]

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Synthetic Longs

Fool.com
By Jeff Fischer
August 10, 2009

Are you confident about a stock, but reluctant to pony up the cash to buy it today? A synthetic long may be just the ticket.

This option strategy works nearly the same as owning the underlying stock outright — except you don’t need to pay up front. Usually, you’ll set up a synthetic long on a stock if you foresee a strong catalyst for appreciation in the next 18 months or so. As the stock price goes up, your options gain value along with it, sometimes to a much greater degree.[...]

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Protective Collars

Fool.com
By Jeff Fischer
August 10, 2009

Protective collars are useful in bear markets or when you’re uncertain about a stock’s valuation risk. They can also be a prudent way to protect your gains on stocks that have recently leaped in price, nearing your estimate of fair value. Let’s explain how collars work, starting from the beginning.[...]

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Writing Covered Calls

Fool.com
By Jeff Fischer
August 10, 2009

Why use covered calls?

• Income: To generate cash on a stable stock.
• Defense: To profit if a stock you own slips in price.
• A better sell price: To obtain a higher price when you’re ready to sell.[...]

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Writing Puts

Fool.com
By Jeff Fischer
August 10, 2009

Why write puts?

• Income: To make money while waiting for your preferred buy price on a stock.
• Advantage: To buy stocks at a lower net cost.
• Profit: To earn income from stocks you believe will hold steady or increase modestly.[...]

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Buying Puts

Buying a put gives you the right to sell the underlying stock at a set price (the strike price) by a specified date (the expiration date). Your maximum loss with a put is limited to what you pay for the option up front (the premium).

Buying put options is a great way to profit from a stock’s fall while putting less of your cash at risk. In addition, you can buy puts to protect a stock – one that you’re bullish on for the longer term – from a near-term price drop. Buying protective puts can also help make your portfolio immune to a market crash.[...]

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Buying Calls

Fool.com
By Nick Crow
August 12, 2009

Why buy calls:

• You believe a stock has a strong catalyst for appreciation over the coming months or few years.
• You want to benefit from a stock’s upside, but put less capital at risk than buying the stock outright.
• You want to leverage your bullish expectations on a stock you already own.[...]

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Options Glossary

American style: Options contracts that can be exercised at any time after purchase and before the expiration date.

Assignment: When the options writer (also called the seller) is forced to buy (for a put writer) or sell (for a call writer) the underlying stock. Essentially, your counterparty has exercised its option contract, which you wrote, to buy or sell the underlying stock.

At-the-money: An option whose underlying stock is trading at its strike price.

Bearish: An options strategy (and outlook) that achieves its maximum payoff when the underlying stock drops in price. For example, if you are bearish on a stock you know well, you could buy a put or a bear put spread.[...]

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Introduction to Options

Why Options?

Options are excellent tools for generating income, protecting profits, hedging, and, ultimately, earning outsized gains. They can generate returns in flat markets, cushion the blow of down markets, and be outstanding performers in decent markets. Whatever your investment goals, options can be a powerful addition to your portfolio, used to hedge, to short, to produce income, and to obtain better buy and sell prices.

What Are Options?

Stock options formally debuted on the Chicago Board Options Exchange in 1973, although option contracts (the right to buy or sell something in the future) have been around for thousands of years. An option gives the holder the right, but not the obligation, to buy or sell an underlying stock at a set price (the strike price) by a set date (the expiration date). The option contract allows you to profit if a stock moves in your favor before the contract expires. Not all stocks have options, only those with enough interest and volume. There are only two types of options: calls and puts. A call appreciates when the underlying stock rises, so you buy a call if you are bullish on that company. A put appreciates when a stock declines. You buy a put if you believe a stock will fall or to hedge a stock that you already own.[...]

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