Book review: Good Stocks Cheap: Value Investing with Confidence for a Lifetime of Stock Market Outperformance: Value Investing with Confidence for a Lifetime of Stock Market Outperformance by Marshall, Kenneth Jeffrey
Finished reading: 1 January 2018
The book covers the investing basics focussing on value investing which, as an experienced investor, I skimmed over, however I found it instructed in the structure how to think about investments.
- 1. Do you understand the business and what it does?
- 2. Is it a high quality business. Quantitatively measured from the past?
- 3. Is it likely to continue to be a high quality business going forward? This requires a strategic analysis.
- 4. Management
- 5. Is this business undervalued?
- 6. Are the decision being made being influenced by cognitive biases.
- 1. Define the business along six parameters: 1. Products 2. Customers 3. Industry 4. Form 5. Geography 6. Status
- 2. Various financial ratios are discussed.
- 3. The second discipline, strategy, shows which companies with successful pasts promise to have successful futures. It’s qualitative. It involves thinking about what sets a company apart from its peers, and picturing it years onward. The first is what I call breadth analysis. It asks two questions. One, is the company’s customer base broad, and unlikely to consolidate? And two, is the company’s supplier base broad, and unlikely to consolidate? The business isn’t good unless the answer to both is yes. I define a broad customer base as one where no single customer accounts for over a tenth of revenue. Similarly, I define a broad supplier base as one where no single supplier accounts for over a tenth of cost of goods sold or operating expenses. A second qualitative tool is forces analysis. It’s my cheap rendition of the five forces model introduced by business school professor Michael E. Porter in 1979.
A third qualitative tool is what I call moat identification. A moat is a barrier that protects a business from competition. It’s a defense that lasts.
The first is government.
A second source of moat is network. Network is an accumulation of users or customers. It constitutes a moat if it yields a product benefit derived from the other users of a product.
A third source of moat is cost. Sometimes a company has a low cost structure that enables it to produce a product for less than competitors.
A fourth source of moat is brand. Some brands are so strong that customers rarely consider substitutes.
A fifth source of moat is switching costs
A fourth qualitative tool is market growth assessment. This is a straightforward view on whether a company’s market is growing or not. It’s important because a business with an expanding market—everything else being equal—has a brighter future than one that doesn’t.
- 4. The first indicator is compensation and ownership. What executives and board members earn and own shapes their incentives. We’d like these incentives to be as aligned with ours as possible.
- 5. Generally a business trading over 25x EV/Operating Earnings is considered expensive.
- 6. The third, psychology, is about the restraint necessary to reject the misjudgments that naturally arise from one’s inborn biases. Humans think funny. It’s not that we’re silly or wrong. It’s just that we’re people. To be mindful of the bad calls we’re likely to make is to maximize the chance that we’ll catch them before they hurt us.
1. Affinity 2. Reciprocity 3. Anchoring 4. Authority 5. Availability 6. Cleverness 7. Incomprehensibility 8. Consensus 9. Peculiarity 10. Intermixing 11. Consistency 12. Confirmation 13. Hope 14. Lossophobia 15. Scarcity 16. Hotness 17. Miscontrast 18. Windfallapathy. Investor misaction is caused by one of two forms of akrasia: 1. Impetuosity 2. Weakness
The book provides a lot of commonsense observations such as the below:
Stated differently, value investors know what’s going to happen, but they don’t know when.
The first three steps of the value investing model—do I understand it? is it good? and is it inexpensive?—form a row.
To do it is to decisively take action when it’s time to do so. It means, for example, to buy when an understood, good business is underpriced. This turns out to be impossible for most people. It requires one to commit capital to a stock at the precise moment when everyone else seems to be selling it.
It’s absurd to insist that lousy operating results from a cyclical company in a down cycle are permanent.
If I’m not comfortable putting at least a tenth of the portfolio into an equity, I don’t want the equity. If my conviction is lower I don’t buy less, I buy none.
My focus on company quality reflects three of my other preferences: inactivism, concentration, and a long holding period.
Sequestered cash is best held in the same currency as one’s expenses. If it isn’t, foreign exchange rate fluctuations can hurt one’s ability to meet obligations.
Above subsistence and below gluttony, there’s little correlation between net worth and happiness. Money just doesn’t produce life’s great joys. Those come from those loved ones, from health, and from other sources that don’t care much about geometric means, depreciation schedules, or enterprise values. But an absence of money can keep one from the great joys.
Conclusion
Although the books stazrted off with basic concepts the second half of the book I took value from the simple and concise approach to thinking about investments using material originated from other thinkers. I will incorporate some of the thoughts to my own investment process going forward.
