Posts In: Mental Models

Becoming a Better Investor: Reading One 10k After Another

I’m a big process guy. I believe if you have the correct processes in place and develop the right habits over time, you will succeed in whatever it is that you want to accomplish. Geoff and I get asked all the time a variation of: How do I become a better investor? The answer is simple, but not easy. I would say it really boils down to reading. A lot. Okay okay yes, I know if you are a Buffett / Munger fan you probably already know that. But, what should you read to get better? I believe people waste their time reading too many books on theory, when really, they can become a better investor overtime by reading one 10k after another. Geoff said it best in one of his blog posts when he said: if you’re reading more books than 10ks, you’re doing it all wrong. Truth be told, I once fell into this category. I felt like If I read more investing theory books it would help me overall as an investor. While this is true, I feel like once you have the basics down and a solid rational way of thinking about stocks and the market, from there on out all you will need to do is read and learn about different businesses and practice valuing them. If someone came to me today and asked me how to get started in investing, I would point them in this direction:

1. Learn the basics of accounting and how the financial statements “work”. There are tons of free resources out there on Google, YouTube, etc.
2. Read Warren Buffetts shareholder letters
3. Read Howard Marks’ Memos
4. Read “You Can Be A Stock Market Genius”
5. Read Joel Greenblatts Audited Class notes (I’ve read these probably over 5 times in my life)
6. Read Focused Compounding ?

While reading books of course is beneficial and fun, I believe if you want to get better as an investor the 6 things I just listed above is all you need to know fundamentally speaking. From there you can proceed to reading 10k’s, which is the main activity that will make you better. As you may or may not know, Geoff and I meet 1-2 times a week. This topic of “how to get better” and “focus” is one that we talk about often and is one of great interest to me. Here is some tough love on how to get better. Stop being so lazy. If you want to get better, then get better. The opportunity is 100% there. I always say we are living in the luckiest time in life because of the technology that’s available to us that allows us to get access to whatever it is we want to learn about. Think about how much that has changed within the last 15-20 years. Being in Dallas, I could have a package shipped to China tomorrow if I wanted to. Technology has changed and gotten better, so we must adapt to get better. Think …

Psychological Tendencies to Guard Against In Investing

“The first principle is that you must not fool yourself and you are the easiest person to fool”

-Richard Feynman

Do Something Bias, Social Proof and Confirmation Bias… Let’s walk through a theoretical situation where these three powerful Biases can destroy someone in the field of investing:

A new Investment Manager named Benjamin just signed-on a new client for his investment firm and is very excited about it. The new client, let’s call him “Thomas”, rolled over his IRA account of $500,000 and assured Benjamin that there will be more capital behind it if Benjamin performs well. Benjamin automatically feels a sense of pressure to find some ideas to put the cash to work because he does not want to disappoint Thomas, and he also wants to show performance so he can acquire his other assets as well. Benjamin naturally starts to scroll through Twitter, Value Investors Club, Seeking Alpha and wale wisdom – scouring for potential ideas from other “smart investors”. He finds an interesting idea through Value Investors Club and then proceeds to type the ticker into Seeking Alpha to see what other people think about the particular stock. There are a ton of write-ups and almost every single post along with the comments on the thread seem favorable and promising. Benjamin starts to get excited. To compound this feeling of confidence, he also learns that a very well known, astute hedge fund manager has a very large long position in the company. What could go wrong with this investment? He decides to further his “research” and reads the investment presentation that the hedge fund giant created for the company, talking about how wonderful the business is and even comparing it to being the next Berkshire Hathaway. By now, Benjamin feels so confident in the business that he buys a 20% position at $150 per share and rationalizes it to himself that the other smart investors had to have done more research than he ever could do to understand the company, so if they feel confident, than it must be a good investment.

As time goes on, this company continues to roar on and is now at the high price of $250 per share! Benjamin looks like a hero, his clients love him and he feels like he has found a true compounder. October 21 comes along and an investment research firm puts out a very negative piece about Benjamin’s beloved company and compares it to being the next Enron. There is no slight sense of positivity that can come out of a statement like that, and Benjamin deep down knows that. Frozen, he does not know what to do. After all, he realizes he does not know much about the company at all and was only riding the coattails of other smart investors in this investment. The company that he has loved and that has made so much money is now falling by 51% in a single day. Not knowing what to do, he waits …

“Go Where There Are Network Effects”

“Go Where There Are Network Effects” – Zero to One book, Peter Thiel

A business that has a strong and enduring Network Effect can be a great business to invest in. It is one of my favorite tools in my mental-model toolbox, and is one that I look for and think about often. The best part about a business that has a strong network effect is just like compound interest, it only gets better as the numbers get bigger. The simplest way to describe a network effect is when a product or service becomes more valuable as more people use it. For example, companies like Airbnb, Facebook, Microsoft, PayPal, eBay, Match Group and Twitter all have strong network effects. If a business can profit on this effect the rewards can be quite enormous. It can be a great starting point for investors seeking to find a business that has a wide and deep moat and a long runway for many years ahead.

• People use Airbnb because they know there is a variety of different options to choose from when it comes to renting a place to stay, and “Hosts” list their houses on Airbnb because they know there’s an endless amount of people who are looking to rent instead of staying in a hotel.
• People sign up and use Facebook because their friends and peers are signed up and use the website as well.
• People continue to play video games on Xbox live because they know other people are gaming and competing on Xbox live. 
• PayPal is convenient because it is so popular, which encourages companies to accept payments from it.
• Buyers use eBay because they know there will be a lot of sellers selling items, and sellers use eBay because they know there will be a lot of buyers buying items.
• People swipe on Tinder because they know other people are swiping on Tinder.
• People use Twitter because no one wants to miss Donald Trump’s tweets….  (I’m half-kidding here)

You get the point, right?  Network effects can become significant after a certain number of users have been reached: this is the “Critical Mass” point. When the critical mass point has been achieved, the value obtained from this network effect can be greater than or equal to the price paid for the effect. What does that mean? It’s the point at which a growing company becomes more efficient, and no longer needs additional investment to remain economically sustainable. Charlie Munger always talks about learning the “big ideas” across many different disciplines, and critical mass comes from Nuclear Physics; where critical mass is defined as the smallest mass that can sustain a nuclear reaction at a constant level. When bringing this phenomenon into the investing world, it is about when a business becomes self-sustaining. Aiming to hit this critical mass point is the challenging part of business. This is why most tech companies are so focused on user growth and are often valued by user-progression, as opposed to traditional valuation …

It’s All About the Long Term: Amazon’s 1997 Shareholder Letter

“Jeff Bezos is the most remarkable business person of our age, I’ve never seen a guy succeed in two businesses almost simultaneously that are really quite divergent in terms of customers and all the operations.” – Warren Buffett

I really do agree with Warren in the statement above. Anyone who knows me, knows I am a complete Amazon advocate. Not only does my firm own Amazon stock, but I am a frequent user of the website and really have developed into some sort of fanboy. It is a company that, in my opinion, is virtually certain to be bigger 5-10 years from now than it is today. Every year it leaves me flabbergasted that Amazon continuously knocks it out of the park. Companies that are doing 100B+ in revenue annually should not be continuously growing sales by 25+% per year. To me it is extraordinary. And it is certainly a case study in action that we can all learn from and add to our investing-wisdom toolbox, whether you are a shareholder or not. But before we talk about the present, I think it can help all of us as investors to go back to the beginning and study the company. After all, investing is all about pattern recognition. The beauty of hindsight is that it’s always 20/20. Let’s use this hindsight to our advantage and learn from it.

In this series, we are going to go back and review every Annual Letter to Shareholders written by Jeff Bezos. I really encourage everyone to do this yourself here. I have printed off every Shareholder Letter and have read them multiple times and, like any good literature, I take away something new from it each time. When reading, I encourage everyone to continuously ask yourself this: “Is there any information in this writing that I can take with me to make myself a better investor?” One of the greatest things about investing is that we are constantly learning and all information in life is relative –meaning you can read books completely unrelated to business, read newspapers, watch movies, you name it, and still take away some sort of insight or wisdom that can relate to investing. That’s essentially what we are trying to do here at Focused Compounding; compounding both capital and wisdom. If you have not already, I deeply encourage everyone to read the book “The Everything Store” by Brad Stone. It is a great book that will help you get familiar with the beginnings of Amazon, and more specifically with Jeff Bezos as a CEO.

Let’s go back to 1997 when Jeff Bezos wrote his first letter to shareholders. Anyone who is familiar with the company will know this letter serves as the groundwork of principles that Amazon still embodies today. In fact, Jeff has posted the 1997 letter at the end of every Letter to Shareholders every year since writing it to keep the standards top of mind.

A manager who doesn’t just talk the talk but actually walks …