Big Mistakes The Best Investors and Their Worst Investments ( PDFDrive ) PDF

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TableofContents Cover Preface CHAPTER1:BenjaminGraham Notes CHAPTER2:JesseLivermore Notes CHAPTER3:MarkTwain Notes CHAPTER4:JohnMeriwether Notes CHAPTER5:JackBogle Notes CHAPTER6:MichaelSteinhardt Notes CHAPTER7:JerryTsai Notes CHAPTER8:WarrenBuffett Notes CHAPTER9:BillAckman Notes CHAPTER10:StanleyDruckenmiller Notes CHAPTER11:Sequoia Notes CHAPTER12:JohnMaynardKeynes Notes CHAPTER13:JohnPaulson Notes

CHAPTER14:CharlieMunger Notes CHAPTER15:ChrisSacca Notes CHAPTER16:MichaelBatnick Notes AbouttheAuthor Index EndUserLicenseAgreement

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BIGMISTAKES TheBestInvestorsandTheirWorstInvestments

MichaelBatnick

Copyright©2018byJohnWiley&Sons,Inc.Allrightsreserved. PublishedbyJohnWiley&Sons,Inc.,Hoboken,NewJersey. PublishedsimultaneouslyinCanada. Nopartofthispublicationmaybereproduced,storedinaretrievalsystem,ortransmittedinanyformorby anymeans,electronic,mechanical,photocopying,recording,scanning,orotherwise,exceptaspermitted underSection107or108ofthe1976UnitedStatesCopyrightAct,withouteitherthepriorwritten permissionofthePublisher,orauthorizationthroughpaymentoftheappropriateper-copyfeetothe CopyrightClearanceCenter,Inc.,222RosewoodDrive,Danvers,MA01923,(978)750–8400,fax(978) 646–8600,orontheWebatwww.copyright.com.RequeststothePublisherforpermissionshouldbe addressedtothePermissionsDepartment,JohnWiley&Sons,Inc.,111RiverStreet,Hoboken,NJ07030, (201)748–6011,fax(201)748–6008,oronlineatwww.wiley.com/go/permissions. LimitofLiability/DisclaimerofWarranty:Whilethepublisherandauthorhaveusedtheirbesteffortsin preparingthisbook,theymakenorepresentationsorwarrantieswithrespecttotheaccuracyor completenessofthecontentsofthisbookandspecificallydisclaimanyimpliedwarrantiesof merchantabilityorfitnessforaparticularpurpose.Nowarrantymaybecreatedorextendedbysales representativesorwrittensalesmaterials.Theadviceandstrategiescontainedhereinmaynotbesuitablefor yoursituation.Youshouldconsultwithaprofessionalwhereappropriate.Neitherthepublishernorauthor shallbeliableforanylossofprofitoranyothercommercialdamages,includingbutnotlimitedtospecial, incidental,consequential,orotherdamages. Forgeneralinformationonourotherproductsandservicesorfortechnicalsupport,pleasecontactour CustomerCareDepartmentwithintheUnitedStatesat(800)762–2974,outsidetheUnitedStatesat(317) 572–3993,orfax(317)572–4002. Wileypublishesinavarietyofprintandelectronicformatsandbyprint-on‐demand.Somematerial includedwithstandardprintversionsofthisbookmaynotbeincludedine-booksorinprint-on‐demand.If thisbookreferstomediasuchasaCDorDVDthatisnotincludedintheversionyoupurchased,youmay downloadthismaterialathttp://booksupport.wiley.com.FormoreinformationaboutWileyproducts,visit www.wiley.com. LibraryofCongressCataloging-in‐PublicationData: Names:Batnick,Michael,1985-author. Title:Bigmistakes:thebestinvestorsandtheirworstinvestments/MichaelBatnick. Description:Hoboken:BloombergPress,2018.|Series:Bloomberg|Includesindex.| Identifiers:LCCN2018008845(print)|LCCN2018011282(ebook)|ISBN9781119366416(epub)|ISBN 9781119366430(pdf)|ISBN9781119366553(hardback)Subjects:LCSH:Investments.|Securities.| BISAC:BUSINESS&ECONOMICS/Investments&Securities. Classification:LCCHG4521(ebook)|LCCHG4521.B382018(print)|DDC332.6—dc23 LCrecordavailableathttps://lccn.loc.gov/2018008845 CoverDesign:Wiley CoverImage:©LUHUANFENG/iStockphoto

Tomymotherandfatherwholetmemakemistakes,andtoRobynwhostuck withmewhenImadethem

Preface Bythreemethodsmaywelearnwisdom:

—Confucius Makingmoneyinthestockmarketisdifficult.Whetheryou'rerunningahedge fundoryourownbrokerageaccount,therewillbetimeswhenyoufeelreally foolish.Intheeventofamarketdownturn,thismiserywillbeaccompaniedby others,butothertimes,you'llbeallaloneonanisland.Youmightbuya particularstockafteritdoubledonlytoseeitheadsouthafteryourpurchase,or worse,youwillthrowinthetowelonaloseonlytoseeitdoubleinthenext twelvemonths.Sometimesitcanfeelasifthemarketgodsaretauntingyou. Thebestwaytolearnhowhardinvestingcanbeistodoitforyourself.The secondbestway,whichisthepurposebehindthisbook,istoexaminethe biggestmistakescommittedbytheworld'smostsuccessfulinvestors.

This bookaimstohelpthereaderrelatetosomeoftheirblundersandunderstandthat temporarysetbackshaveknockedonallofourdoors. Allinvestors,fromPeterLynchtotheaverageJoe,arehard-wiredwithhuman emotions.We'reriskaverse,weanchortoourpurchasepoint,andwe'reall manipulatedbyhindsightbias.Andwhenweexperiencefailure,usuallyit'sselfinflicted,whichmakesdealingwithitobjectivelyaverydauntingtask.Difficult asitis,wemustfigureouthowtopreventpreviousmistakesfrominterfering withfuturedecisions. Peopletypicallystrivetoreplicatesuccess.KobeBryantstudiedMichaelJordan andPaulTudorJonesstudiedJesseLivermore.Thismakesintuitivesense. Otherstakeadifferentapproachandstudystoriesoffailureandtrytoavoid whateveritisthattrippedthatpersonorcompanyup.LikeCharlieMungersaid, “TellmewhereI'mgoingtodiesoInevergothere.”Thisbooktakesadifferent anglealtogether,itfocusesonthemostsuccessfulinvestors'failures.Thereason

isnotsothatwecansay,“Oh,thisdidn'twork,don'tdothat,”butrathersothat whenwedomakeamistake,werecognizeitforwhatitis,apartofthegame. Perhapslikenootherendeavor,learningtoinvestcanonlybedonethrough practice.Youcannomorelearntoinvestthroughreadingabookthanyoucan readaboutheartsurgeryandperformatriplebypass.Youjusthavetodoitover andoverandoveragain. Thisisnotahow-tobook.If

Themostimportantthingsuccessfulinvestorshaveincommonisworrying aboutwhattheycancontrol.

.WarrenBuffettsaid,

IhopeyouenjoyreadingthisasmuchasIenjoyedwritingit. MichaelBatnick

CHAPTER1 BenjaminGraham ThereAreNoIron-CladLaws InmynearlyfiftyyearsofexperienceinWallStreetI'vefoundthatIknow lessandlessaboutwhatthestockmarketisgoingtodobutIknowmoreand moreaboutwhatinvestorsoughttodo;andthat'saprettyvitalchangein attitude. —BenjaminGraham In200years,nobodywillrememberBillAckman'scrusadeagainstHerbalife. JohnPaulson'sbetagainstthehousingbubblewillbelongforgotten.Charlie's Mungerismswillberelegatedtothedustbinofthetwenty-firstcentury.Great investorscomeandgo,andmostoftheonesfeaturedinthisbookwillbeloston futuregenerations. . TheDeanofWallStreet,ashewasknown,willberememberedforeverbecause histeachingsaretimeless.Thelessonsheprovidedinhisseminalwork,Security Analysis,arejustasrelevanttodayastheywerein1934andwillbe200years hence.Thepassageoftimewon'tchangehumannatureorthefactthat“in applyinganalysistothefieldofsecuritiesweencountertheseriousobstaclethat investmentisbynaturenotanexactscience.”1AsgiftedasGrahamwasin mathematics,heunderstoodthatthelawsofphysicsdonotgovernsecurity analysis.It'sdifficulttooverstatehowmanytrailsheblazed.JasonZweigwrote, .”2

Grahamunderstoodwhatfewdidatthetime–thatthestockpricesquotedinthe newspaperandtheunderlyingvalueinthebusinessarenotequivalent.Sticking withtheWrightbrothers,Grahamwrote: IntheWrightAeronauticalexample,theearliersituationpresentedasetof factswhichdemonstratedthatthebusinesswasworthsubstantiallymore than$8pershare….Inthelateryear,thefactswereequallyconclusivethat

thebusinessdidnothaveareasonablevalueof$280pershare….Itwould havebeendifficultfortheanalysttodeterminewhetherWright Aeronauticalwasactuallyworth$20or$40ashare…oractuallyworth$50 or$80….Butfortunatelyitwasnotnecessarytodecidethesepointsin ordertoconcludethattheshareswereattractiveat$8andunattractive, intrinsically,at$280.3 SecurityAnalysiswaswrittenfortheWallStreetprofessional.Howeverit'sThe IntelligentInvestorthatwillkeepGraham'snamealiveforever.Thisisthefirst financialbookthatIeverread,anditleftsuchastrongimpressionthatIchoseit asthenamesakeformyblog,TheIrrelevantInvestor.UnlikeSecurityAnalysis, TheIntelligentInvestorwasintendedforlaymen,and,withmorethanamillion copiessold,itreacheditstarget.WarrenBuffettsaid,“Ireadthefirsteditionof thisbookearlyin1950,whenIwasnineteen.Ithoughtthenthatitwasbyfarthe bestbookaboutinvestingeverwritten.Istillthinkitis.”4Aslongaspeople wanttolearnaboutinvesting,theywillfindGraham,whotranslatedanexotic languagewithtermslikenetworkingcapitalandreturnonequityintoplain Englishwithwordslikepriceandvalue. BenGrahaminventedthefieldoffinancialanalysis.RogerLowensteinsaid, “InvestingwithoutGrahamwouldbelikecommunismwithoutMarx–the disciplewouldscarcelyexist.”5HewasapolymathwhomCharlieMunger called“abrilliantman”and“theonlyintellectualintheinvestingbusinessatthe time.”6 . Overwhelmedbytheseoffers,heturnedtoColumbia'sdeanforadvice.Bya strokeofluck,amemberoftheNewYorkStockExchangehappenedtocomein toseethedeanatthesametimeandaskedhimtorecommendoneofhis strongeststudents.Withouthesitation,heintroducedhimtoBenGraham. GrahambeganhiscareeronWallStreetin1914,justbeforetheNewYorkStock Exchangewouldcloseforfourmonths,itslongestshutdownever,inlightofthe eventssurroundingtheGreat

. BenGrahamtaughtatColumbiaBusinessSchoolfor28years,beginningin 1928,andsimultaneouslytaughtattheNewYorkStockExchange'sschool,now knownastheNewYorkInstituteofFinance,foradecade.Heattractedstudents

likeWalterSchloss,IrvingKahn,andBillRuane.Hismostfamouspupil,of course,isWarrenBuffett,whobecametherichestmanontheplanetbyusing theprinciplesthatBenGrahamtaughthim. GrahamisontheMountRushmoreofinvesting,anddespitetheenormous successhehadmanagingmoneyandteachingfuturegenerationshowtodothe same,hiscareer,likeeverybodyelse's,includedsometryingtimes.Thelessons thatGrahamprovidedintheclassroom,whichhetranslatedintobooks,willlive forever.Butwecanalsolearnalotfromhisfailures.

Someinvestorssearchforcompaniesthattheyexpectwillgrowtheirearnings significantlyfasterthanthebroadermarket.Othersprefertolookforcompanies whosefutureprospectsaren'tnearlyasbadastheirsharepricesreflect.Whether youconsideryourselfagrowthinvestor,avalueinvestor,somethinginbetween

WhenSecurityAnalysiswaspublished,theDowJonesIndustrialAveragewas tradingat100.Today,84yearslaterandhoveringnear22,000,it'sdelivered 6.7%ayear,notincludingdividends.Someofthebest-knowninvestors, devoteesofvalueinvestingbroughtmainstreambyGraham,haveearnedfar greaterreturnsbyfollowingafewsimplerules.Theserulesallboildownto whatGrahamreferredtoasa“marginofsafety.”Grahamdefinedthisas“the discountatwhichthestockissellingbelowitsminimumintrinsicvalue.”7Yes, therewereformulasinvolved,buttheydidn'tneedtobecomplicated.Graham likedstockssellingforone-thirdlessthantheirnetworkingcapital.Heonce pointedout,“Someextraordinaryresultscouldhavebeenobtainedsince1933by buyingeachyearthesharesofthesixcompaniesintheDowJonesIndustrial Averagewhichsoldatthelowestmultiplieroftheirrecentearnings.”8 WhatmadeGrahamsobrilliantisnotthecalculationsheperformedtodetermine intrinsicvalue,butrathertheunderstandingthatdeterminingexactvaluesare bothimpossibleandnotaprerequisiteforsuccess.“Itisquitepossibletodecide byinspectionthatawomanisoldenoughtovotewithoutknowingherageor thatamanisheavierthanheshouldbewithoutknowinghisexactweight.”9

Grahamwasfaraheadofhistime,writingaboutbehavioraleconomics,thestudy ofhowpsychologyaffectsfinancialdecisionmaking,longbeforethetermeven existed.SecurityAnalysiswaspublishedthesameyearthatNobellaureate DanielKahneman,whotookthisfieldmainstream,wasborn.Grahamidentified someofthecognitiveandemotionalbiasesthatcausedinvestorstosendastrong companydiving50%in12months.HeexaminedthecaseofGeneralElectric, whichthestockmarketvaluedat$1.87billionin1937and$784millionjustone yearlater.Grahamsummarizeditthisway: Certainlynothinghadhappenedwithintwelvemonths'timetodestroymore thanhalfthevalueofthispowerfulenterprise,nordidinvestorseven pretendtoclaimthatthefallingoffinearningsfrom1937to1938hadany permanentsignificanceforthefutureofthecompany.GeneralElectricsold at64⅞becausethepublicwasinanoptimisticframeofmindandat27¼ becausethesamepeoplewerepessimistic.Tospeakofthesepricesas representing“investmentvalues”orthe“appraisalofinvestors”istodo violenceeithertotheEnglishlanguageortocommonsense,orboth.10 Grahamtaughthisstudentsandhisreadersthatpricesfluctuatemorethanvalue, becauseitishumanswhosetprice,whilebusinessessetvalue. InTheIntelligentInvestor,hesummedupthewildswingsinpricewithastory hetoldaboutahypotheticalMr.Market: Imaginethatinsomeprivatebusinessyouownasmallsharethatcostyou $1,000.Oneofyourpartners,namedMr.Market,isveryobligingindeed. Everydayhetellsyouwhathethinksyourinterestisworthand furthermoreofferseithertobuyyououtortosellyouanadditionalinterest onthatbasis.Sometimeshisideaofvalueappearsplausibleandjustifiedby businessdevelopmentsandprospectsasyouknowthem.Often,onthe otherhand,Mr.Marketletshisenthusiasmorhisfearsrunawaywithhim, andthevalueheproposesseemstoyoulittleshortofsilly.11 ThefinancialworldlooksmarkedlydifferenttodaythanitdidwhenGrahamwas practicingandteaching.In1934,atotalof323millionsharesweretradedonthe NewYorkStockExchange.12AsIwrite,onAugust9,2017,thetotalvolumeof sharestradedontheNYSEwas3.2billion.Morethan10timesasmanyshares tradedyesterdayasallthesharestradedduring1934!Today,supercomputers instantlyparsethewordscontainedineconomicreportsandcompany statements.BackinGraham'stimes,whilequarterlystatementswereconsidered standard,theywerenotthelaw.Andofthecompaniesthatmadethis

informationavailable,therewasnouniformity;thereportsvariedfromonlynet earningstoalineitemedincomestatementandbalancesheet.Grahamlooked fortheincomestatementtocontainaminimumof:sales,netearnings, depreciation,interestcharges,nonoperatingincome,incometaxes,dividends paid,andsurplusadjustments.PriortotheSecuritiesandExchangeAct,less thanhalfofindustrialcorporationssuppliedthisbreakdown.

IfGrahamwerestill alive,hewouldn'tunderstandhowsomecompaniesarevaluedtoday.For example,overthelastfiveyears,Walmarthasearned$75billionon$2.4trillion inrevenue.Itsnetmarginshavebeen3.15%andit'slost$3.6billioninmarket capitalization.Amazon,ontheotherhand,hasearned$3.5billionon$490 billionofrevenue.Itsnetmarginshavebeen0.73%,andoverthistimeithas added$350billioninmarketcapitalization.13Whilevalueinvestingintuitively makesalotofsense,humanemotionscanoverwhelmcommonsense.Pricescan bedrivenbothwaybelowliquidatingvalueandfarpastwhatanycompanycan reasonablybeexpectedtogrowinto.

. RogerLowensteinsaid,“IttookGraham20years–whichistosay,acomplete cyclefromthebullmarketoftheRoaringTwentiesthroughthedark,nearly ruinousdaysoftheearly1930s–torefinehisinvestmentphilosophyintoa disciplinethatwasasrigorousastheEuclideantheoremshehadstudiedin college.”14Let'sreturntothebeginning. Grahamfirststartedaninvestmentpartnershipin1923,theGrahamCorporation wherehewouldapplyarbitragetechniques,thesimultaneouspurchaseof undervaluedsecurities,andshortsaleofovervaluedsecurities.Thisoperation lastedfortwoyears,andin1926,hesetuptheBenjaminGrahamJointAccount Inthisstructure,hewouldreceive20%ofthefirst20%return,30%ofthenext 30%,and50%ofthebalance. Wordofhissuccessspreadthroughout WallStreetandthefamousfinancierBernardBaruchaskedGrahamtobecome hispartner.Grahamwasflattered,buthavingmade$600,000thepreviousyear,

hehadnoreasontoaccepttheinvitation.15Hebeganwith$450,000,which balloonedto$2,500,000injustthreeyears.Butthisisabookaboutlessonswe canlearnfromthefailuresofthebestinvestorsever.Graham'swasrightaround thecorner. Inthefinalyearofthegreatbullmarketofthe1920s,theJointAccountgained 60%,outpacingthe49.47%advanceintheDow.Inthefinalmonthsof1929 whenthemarketturnedviolentlylower,Grahamcoveredhisshortsandheld ontohisconvertiblepreferredsecurities,thinkingthatpricesweretoolowand thatMr.Marketwastalkingcrazy.Hefinishedtheyeardown20%,whilethe Dowfell17%.Grahamwasabouttolearnthatmarginsofsafetydon'tmatter whenthebabyisgettingthrownoutwiththeproverbialbathwater. In1930,thinkingtheworstwasover,Grahamwentallinandthensome.He usedmargintoleveragewhathethoughtwouldbeterrificreturns.Buttheworst wasnotover,andwhentheDowcollapsed,Grahamhadhisworstyearever, losing50%.“Hepersonallywaswipedoutinthecrash. 

In1932,justweeksbeforestocksbottomed,Grahamwrotethreearticlesin Forbes.Inone,“InflatedTreasuriesandDeflatedStockholders,”hewrote: Thereareliterallydozensofothercompanieswhichalsohaveaquoted valuelessthantheircashinbank….Thismeansthatagreatnumberof Americanbusinessesarequotedinliquidatingvalue;thatinthebestrecent judgmentofWallStreet,thesebusinessesareworthmoredeadthanalive.17 Inthisarticle,BenGrahamwasavoiceofreasoninamoboffinancially depressedzombies: Itistime,andhightime,thatthemillionsofAmericanshareholdersturned theireyesfromthedailymarketreportslongenoughtogivesomeattention totheenterprisesthemselvesofwhichtheyaretheproprietors,andwhich existfortheirbenefitandattheirpleasure.18

Thefactthatheremainedsteadfastin

hisconvictionthatsecurityanalysiswasaworthwhileendeavorisnothingshort ofremarkable. Thepartnershipearned6%ayearfrom1926to1935,comparedto5.8%forthe S&P500and3.8%fortheDow.19Despitethehardtimesandenormous drawdown,Grahamwouldcontinuetooperateundertheassumptionthatvalue investingisthemostintelligent...