Category Archives: Investing

What they Used to Teach You at Stanford Business School

Source: http://www.Portfolio.com

Chris Wyser-Pratte, who got his MBA from Stanford in 1972 and then spent the next 23 years as an investment banker, sent me the following note last night. I’m reprinting it here with his permission:

I learned exactly seven things at Stanford Graduate School of Business getting an MBA degree in 1972. I always used them and never wavered. They were principles that enabled me to put the cookbook formulas that everyone revered in context and in perspective. I think they served my clients (and perhaps me) rather well. Here are those seven principles, and who taught them to me:

  1. Don’t use many financial ratios or formulas, and when you’ve picked the few that will actually tell you what you want to know, don’t believe them very much (Prof. James T.S. Porterfield);
  2. Remember that any damn fool can compute an IRR or DCF. The trick is to find a business that can return 20% after tax, understand its critical indigenous and exogenous variables, and then run it so it meets its return target. (Prof. Alexander Robichek.)
  3. Always ask what can go wrong (Porterfield);
  4. Never extrapolate beyond the observed points of a distribution, you have absolutely no information outside the observed range (Prof. J. Michael Harrison);
  5. Remember that you can always break the bank at Monte Carlo by doubling your bet on red at the roulette table every time you lose. The problem is it will break you first; It’s called “the takeout.” Therefore, always manage your financial structure so that takeout is not an issue. (Porterfield.)
  6. Big M (today Nassim Taleb’s Black Swan) is never a part of the optimal solution. If it shows up in the answer with any coefficient greater than zero, you have the wrong answer and have to continue to do program iterations. (Harrison.)
  7. There is never any excuse for looking through the substance of an economic transaction, whatever the accounting, and if the accounting permits you to do so, it’s wrong (Prof. Charles T. Horngren.)

Conspicuously absent from this list are Prof. Jack McDonald and his Efficient Market Theory and Random Walk, Prof. William Sharpe, Nobel Prize winning author of the Capital Asset Pricing Model (which he later acknowledged didn’t work because his data were wrong, but it’s still used everywhere and they didn’t take away his prize) and Prof. James Van Horne, who believed that the Fed actually controlled the economy through its monetary policy actions. Gene Webb — who at least tried to improve my people skills — and Ezra Solomon in International Finance deserve honorable mention.

The conclusion I derive from your interesting article is that the reason the economy was destroyed by Wall Street, which died in the fire it created, was that they violated, ignored and were probably ignorant of all seven principles listed above. They not only couldn’t do the math, they were mesmerized by its precision because they used a black box and believed in its oracular power even though they didn’t understand how it worked, believed what occurred before could be expected to occur again, hadn’t a clue about what risks were indigenous and exogenous to their own business (or which were which), how probable those risks were and what the consequences were of ignoring the takeout risk, in particular. They also thought financial sleight of hand had meaning. In short, they had their head stuck where the sun don’t shine and deserved what they got. We, the world, didn’t.

What Wyser-Pratt doesn’t mention is that in 1972, business school students largely expected to go into business, as opposed to finance. And insofar as banks hired MBAs, it was because they wanted employees who understood business. Over the following decades, MBAs, and the bankers they turned into, became increasingly expert in finance, while knowing less and less about business. Eventually we ended up living in a world where a major retail operation like Sears could be owned and run by a financial engineer who thought that the answer to any question was simply to spend yet more of the company’s precious cashflow on stock buybacks.

Essentially, we moved from a world where banks were run by businessmen, to a world where businesses were run by financiers. Let’s hope that the pendulum will now swing back (only with more women in charge this time around), and that business schools will start de-emphasizing finance in their curricula. But that might be too much to hope for. Even in 1972 students were being taught CAPM. And the vast majority of them failed to ignore it.

Read more: http://www.portfolio.com/views/blogs/market-movers/2009/03/29/what-they-used-to-teach-you-at-stanford-business-school#ixzz12JJDD2MB

Advertisements

Leave a comment

Filed under Economy, Investing, Life

There is no substitute for preparation.

“Give me 6 hours to chop down a tree and I will spend the first 4 hours sharpening the axe.” – Abraham Lincoln

7 Must Read Life Lessons from Abraham Lincoln

Of course, one should never buy a stock without making necessary preparations.

The first step would be to draw as much information about the company as possible. If not you will find yourself popping a truckload of sleeping pills.

A few basic questions that need to be answered before buying a stock

A stock-picker with scant regard for economic forecasts

And if you feel that a 3-7 (and above) year horizon isn’t your kind of thing and are looking for something shorter, here are  some wise words by Wong Kok Hoi from APS Asset Management – ” Act when you do not have complete information. This sounds rather counter intuitive but it is what most successful investors do. More often that not it will be too late to act when you have gotten all the information that you need to make a decision. I am not suggesting that you make decisions before doing your research. There is a world of difference between knowing just enough to make a decision and not knowing enough before making a decision”

Sounds kind of like poker.

Picking their way through

Had the privilege of having a quick chat with the fund managers from Lumiere Capital. That hour or so of coffee with them probably formed the inspiration behind my investment philosophy. Here’s an article featuring the both of them on Pulses magazine. A must read for all budding value investors.

Leave a comment

Filed under Investing, Life

So, The greater fool theory

The world depends on fools.

Your friend gets punched in a club while drunk-touching girls. He is a fool. Others laugh.
Dude at Geylang thinks he owns the road. He is a fool. He gets rammed by a greater fool. And again, others laugh.
You sell your Dragonball card to your buddy back in primary school for 5 bucks. He (me) is a fool. You laugh your way to the bank.

We all derive some form of incentive from fools.

So, the greater fool theory, as described by good ol’ Investopedia:

When acting in accordance with the greater fool theory, an investor buys questionable securities without any regard to their quality, but with the hope of quickly selling them off to another investor (the greater fool), who might also be hoping to flip them quickly. Unfortunately, speculative bubbles always burst eventually, leading to a rapid depreciation in share price due to the selloff.

This is the reason why Japanese men hang themselves or jump from Mount Fuji.

Lesson 1 – Do not be a fool or you just might end up rotting somewhere in a forest.

So, how does the share price of a company rise other than being affected by the collective dumbness (supply and demand, sentiments) of all the other speculators?

There several  theories that try to explain why prices move the way they do. But just like every other theory that is based off the nature of human beings, none of them hold true unless there are a bunch of fixed assumptions. Even at IPO stage, prices can shoot sky high or sink to the depths of hell because valuations are also subjective.

There are, however, certain fundamentals that value investors like to look at, which will affect market sentiments and eventually share price – things like profits, future growth potential, cash flow, debt and a bunch formulas like EPS or P/E Ratio. Basically indicators of an already-good-but-could-be-way-way-way-way-better company because, like it or not, a a sweet juicy orange will always cost more if it becomes a bigger sweet  juicy orange. The whole point is to buy a piece of that orange and wait for it to grow bigger so that the other fools will start to take more notice of it.

Perhaps this is the reason why the markets are becoming more and more volatile.

Anyway, I will look more in depth into things and post them as I learn.

Leave a comment

Filed under Investing