In crazy times like today, all one could and actually should ask for is sanity. Yes, sanity–a clear mind free of noise to deal with the insanity that is thrust upon us by a volatile and noise-making machine also known as the stock market. We find ourselves glued to the computer screens or CNBC waiting to find out what the Dow’s next tick is going to be. Unfortunately, we are left with only a headache and wasted time. OK, what’s next? Here is my advice–read. Read books that will bring you sanity, the ones that will snap you back into the shell of investor and out of the sorry shell of nervous observer of the daily stock market melodrama. The following books are excellent choices and will come with plenty of sanity and sage advice.
I’ll start with Its When You Sell That Counts 3rd Edition by Donald Cassidy. Selling is usually as popular as candy the day after Halloween. During secular bull markets selling is frowned upon as buy and hold turns into investing religion. And since sell violates the “hold” covenant of that religion, the investor who buys and sells is labeled as a nonbeliever, or even worse, trader (if you say ‘trader’ fast enough it sounds like ‘traitor’).
Selling is usually as popular as candy the day after Halloween. During secular bull markets selling is frowned upon as buy and hold turns into investing religion. And since sell violates the “hold” covenant of that religion, the investor who buys and sells is labeled as a nonbeliever, or even worse, trader (if you say ‘trader’ fast enough it sounds like ‘traitor’). In secular bull markets, on average, sell decisions are not as rewarding as hold decisions, as market valuations are expanding and even second caliber dogs (stocks) start looking like pedigreed cocker spaniels. Every investor is now a “long-term” investor and sell becomes a four letter word. But being a long-term investor is not about longevity of your hold decisions but it is an attitude. Holding a stock because you bought it is a fallacy; you should only hold a stock if future risk adjusted return warrants it. Warren Buffett has been mistakenly promoted (though, I’d argue demoted) into the god status of this buy and hold temple. Let’s correct this mistake. Warren Buffett became a buy and hold investor when his portfolio and positions became big enough, pushing $60 billion, when selling became a difficult undertaking. In his early career, before “Oracle of Omaha” became his middle name, he was a buy and sell investor. Being on the board of some of his biggest holdings (like Coke and Washington Post) made selling even more difficult.
One doesn’t need the benefit of hindsight to know that at 55 times earnings Coke was tremendously overvalued in 1999. Coke, like the majority of his top public holdings (Washington Post, Procter & Gamble, Johnson and Jonson and many others), did not go anywhere in a decade. I dare you to take a look at his top public holdings and tell me if he would have done a lot better if he sold them when they became fully valued (or slightly overvalued). In most cases it would have been a decade ago.
Emotions pour from different directions when we face a sell decision: If it is a losing investment we want to wait to break even. This is the wrong attitude. Our purchase prices and sell decision should not be related (the only exception I can think of is tax selling). Or when it comes to selling a winner–we want to sell only at the top. Again this is the wrong attitude: the top is only apparent in hindsight, when it is usually too late. We should sell the stock when it reaches our price or valuation target, determined at the time of purchase. We (our emotions and false goals to be exact) are our biggest enemy when it comes to investing and especially selling. This wonderful book has been written to fix this. Its objective is to recalibrate your mind and free you from imprisonment of past decisions, break you free from the buy and hold state of mind and turn you into a buy and sell investor.
OK, this is a bit of a long introduction to this book, but this is a terrific and a very important book. A proper sell discipline will decide between great or mediocre returns for even the best-crafted buy decisions. Pros may want to skip a few chapters, but it is an important read for everyone, especially in today’s environment.
Behave and think like an investor
These books should help you to think like an investor, forcing you to think beyond stock tickers and focus on what is under the hood–the businesses and the people who run them. The first one is The Essays of Warren Buffett: Lessons for Corporate America, Second Edition. It’s a compilation of Warren Buffett’s letters to shareholders from annual reports dating back to the 1970s. Before this book came out (or at least before I was aware of its existence) I had my students read Buffett’s annual reports, which as you may expect were very repetitious. His wisdom doesn’t vary that much from year to year. This book organizes main concepts and removes annoying redundancy.
Another book is The Entrepreneurial Investor: The Art, Science, and Business of Value Investing, written by my friends at West Coast Asset Management. It accomplishes many objectives of Buffett’s essays plus has plenty of cultural references, humor and common sense. All of these things make it a fun and enjoyable read. I made this book suggested reading in my graduate investment class. The Super Analysts by Andrew Leeming is a book I think few people have heard of. The author interviews successful investors (not academics), and they discuss their approach to investing and analysis of common stocks and some specific industries.
You Can Be a Stock Market Genius: Uncover the Secret Hiding Places of Stock Market Profits by Joel Greenblatt is one of those books that should be read more than once. Joel shares very unique approaches of how to find undervalued stocks. On top of being a very good investor, he has a healthy sense of humor. Joel also has written The Little Book That Beats the Market (Little Books. Big Profits). I plan to read this book with my son when he gets older as it is a great introduction to investing. At the end of the book Joel offers a “magic formula,” a screen that has beaten the market over a long period of time.
The magic screen is very simple: buy low price to earnings stocks that have high return on capital. Low P/E is an indication of cheapness, high return on capital is an indication of competitive advantage (at least in the past) and possibility to grow earnings at high rates. Here is the book’s Web site, which provides a weekly list of stocks that score high on both measures.
The right temperament is crucial in investing. Being a critical thinker and knowing how to value stocks is important, but it is all a waste if your emotions get the better of you. The following books will help you to recognize the shortcomings of your hard-wiring and help you to devise strategies to deal with it. Psychology of Investing (3rd Edition) by John R. Nofsinger is short and to the point. You’ll become an expert on behavioral investing in about an hour. Well, not quite, but close.
Why Smart People Make Big Money Mistakes And How To Correct Them: Lessons From The New Science Of Behavioral Economics by Gary Belsky and Thomas Gilovich is a fun and easy read. It also addresses how shortcomings in our wiring impact other parts of money decisions, like buying cars and stereos. Gary Belsky and Thomas Gilovich is a fun and easy read. It also addresses how shortcomings in our wiring impact other parts of money decisions, like buying cars and stereos.
Your Money and Your Brain: How the New Science of Neuroeconomics Can Help Make You Rich by Jason Zweig is another selection. I have to admit that the first two books cover many topics in this book (though offers new angles and insights) and are likely to be a more exciting reads, but Chapter 10 is what makes this book a must read–it addresses happiness–yes happiness. Though as most of us know money doesn’t buy happiness (unless you are starving or living on the street), money spent on acquisitions–things–brings a bust of happiness that quickly fades away. Think of your level of happiness when you bought the car of your dreams. Money spent on experiences–being–brings a higher utility of happiness. Recollecting experience brings happiness. I plan to re-read this chapter at least a couple of times a year. Zweig also provides a list of things you can do that will make you happy, and none of them require you to spend a penny, which is a big positive in today’s economy.
Politicians, God rest their souls, always try to appeal to the lowest common denominator. They try to “protect” us from evil doers by insisting on minimum wage laws or rent controls, or threatening windfall taxes on oil companies. They sound like heroes fighting for the little guy against the evil doers. However, all they are doing is feeding on the economic illiteracy of the Average Joe. This is why the following two books should be a required reading in high schools and colleges: Basic Economics 3rd Ed: A Common Sense Guide to the Economy by Thomas Sowell and A World of Wealth: How Capitalism Turns Profits into Progress by Thomas G. Donlan.
You may think Alan Greenspan has had a hand in today’s crisis. I know I do. He took interest rates down to incredibly low levels and kept them there for too long, causing the real estate bubble. He also did not think Wall Street needed regulation. But this doesn’t make his book, The Age of Turbulence: Adventures in a New World, any less of an excellent read. It is not written in Fed-speak. It seems that Sir Alan, after he left the Fed, learned how to use English in a very clear and engaging way. This is not just another biography, either. The book goes far beyond that. It covers the workings of the Fed, lessons on macro economy and history and perspective on American politics from an insider who served under or worked with the last eight presidents.
Stock Market History
I’ve really enjoyed reading Stocks for the Long Run, 4th Edition: The Definitive Guide to Financial Market Returns And Long Term Investment Strategies by Jeremy Siegel, but it took me a while to recognize how dangerous this book is.
It is well written and provides a very good overview of the performance of different asset classes over last two centuries. But the book needs a different title, maybe something like Stocks for the Really, Really… Really, Long Run. This way, it would not lure investors into false sense of security when it comes to stocks. It preaches that stocks (stock market as a whole) are always a buy, no matter what valuations as they do better than other asset classes in the long-run, and that a 7% real rate of return is a birthright for stock investors no matter if the stock market is extremely cheap or ridiculously expensive. This is very true if your time horizon is 30 years or you plan to live forever. It is also true if you can tolerate seeing your portfolio go nowhere for a decade or longer. Unfortunately, most of us don’t have this time horizon. We need to send kids to school, pay for weddings, boats, etc. I don’t know anyone who has the patience to see their portfolio of stocks do nothing for decades.
This is why this book should only be read with the following antidote: Unexpected Returns: Understanding Secular Stock Market Cycles, which is a truly terrific book by Ed Easterling. Unlike Siegel, Easterling shows that despite stocks being a great investment for the (really, really) long-run, they have periods when their returns are unspectacular. Ed calls these periods bear markets. I call them range-bound markets, which is a difference in just semantics. Those bear (range-bound) markets take place after secular bull markets.
The appropriate way to look at risk
The following two books, Fooled by Randomness: The Hidden Role of Chance in Life and in the Markets and The Black Swan: The Impact of the Highly Improbable are written by Nassim Taleb. These books address risk and rare events (the Black Swans).
Fooled by Randomness is my favorite nonfiction book, period. I’ve read it at least five times. This book turns the way we are taught to look at risk upside down. Nassim rebels against the current establishment of finance that measures risk with elegant formulas that receive Nobel Prizes but lack common sense. Any model that solely focuses on past observations and dismisses outcomes that lie outside of what happened in the past is worthless and more importantly dangerous. One way of understanding how randomness works is by studying alternative historical paths. This means more than just focusing on what took place in the past–the definite (since it already happened), observed history, but one that beforehand was actually still just one of many possible random outcomes. One should focus on what could have taken place, what alternative paths may have existed. This allows us to think creatively about what could have happened and with that added insight then to predict and prepare for what may happen in the future.
Let’s take the current crisis: Wall Street and rating agencies dismissed a possibility that housing prices may decline nationwide–this hadn’t happened since World War II–well, then it will not happen in the future. Therefore, Wall Street took sub-prime (risky) mortgages originated in different parts of the country, put them together in mortgaged backed securities and–voila!–the risk had been diversified away. Junk was turned to gold. Since rating agencies used the same underlying assumption–housing never declines nationwide–they announced to the world that the junk is AAA and should be bought in truck loads and they were. We know how this story played out. The Black Swan is a follow up to Fooled by Randomness. Nassim takes a lot of the concepts discussed in Fooled by Randomness and explains them in greater detail, providing new unexpected insights. I have to warn you that The Black Swan is not easy. This book has more insight per page than most, but it is not a beach read.
Books for the soul
What would you do and what would you share with others if you only had months to live? This is the theme of the following two books: Tuesdays with Morrie: An Old Man, a Young Man and Life’s Greatest Lesson by Mitch Albom and The Last Lecture by Randy Pausch and Jeffrey Zaslow. In both cases terminally ill teachers share their life lessons with readers.
Another book I’ll add to this category is The Snowball: Warren Buffett and the Business of Life by Alice Schroeder. This is an authorized biography of Warren Buffett. I am not sure this is the best book to read if you want to learn to invest like Mr. Buffett, but it gives a very different and interesting view into his life. There are many great lessons we can learn from Mr. Buffett that go far beyond investing, like about honesty and treasuring one’s reputation. But I thought this book was important for a very different reason in that it shows that Warren Buffett is not a perfect human being and we can learn from the maestro but in a different way: by not repeating his mistakes. He achieved his unparalleled success in his business life at the expense of his personal life, unfortunately.
Especially in today’s environment I find myself wanting to work 24/7 (and I probably do). This is truly a stock picker’s market. There are a lot of cheap stocks, but a lot of them are deceptively cheap and there are so many risks lurking from so many directions that semi normal working hours are not enough. I bring my laptop home, read The Wall Street Journal at the dinner table, and my work life starts pushing out my personal life. This book made me realize that no professional success is worth regretting 20 years down the road that you didn’t spend enough time with your kids. Unfortunately, Buffett has that regret.