# Modern Value Investing  ## Metadata - Author: [[Sven Carlin]] - Full Title: Modern Value Investing - Category: #books ## Highlights - You have to be a contrarian; fearful in frothy markets and convinced in panicky ones ([Location 212](https://readwise.io/to_kindle?action=open&asin=B07CNFFJ9J&location=212)) - Tags: [[blue]] - Differentiate between intrinsic value and market created, illusionary pricing ([Location 328](https://readwise.io/to_kindle?action=open&asin=B07CNFFJ9J&location=328)) - Tags: [[blue]] - In 2015 and 2016 a minimum price for most copper miners to operate positively was at least $5,000 per ton. In such a moment, as the years 2015 and 2016 were, it is clear that the price slump is temporary because the situation is not sustainable in the long term as the real supply demand balance for copper lies above the traded price. This creates an opportunity for the value investor to buy value where others see only a low price and panic. Needless to say, after just more than a year below $5,000 per ton, copper prices soon returned to a more natural price level in 2017. ([Location 341](https://readwise.io/to_kindle?action=open&asin=B07CNFFJ9J&location=341)) - Tags: [[blue]] - I will use Nevsun Resources (NYSE: NSU) as an example. Nevsun Resourses was a holding of mine in 2016, it is a Canadian miner with operations in an obscure country like Eritrea. Towards the end of 2015, NSU’s stock, usually trading above $4, started trading below its book value of $3.4 as commodity prices fell and the market was averse to all miners. However, NSU was a special case because of those $3.4 of book value, about $2.5 was in cash in Canadian banks and $0.5 was in highly liquid gold inventory while the company had no debt. This means that we had a situation where the liquidation value of the company was at least $3 per share while the upside was pretty large because the Eritrean mine was producing yearly free cash flows of around $0.4 per share. If I put an average price to cash flow ratio of 12 for miners to NSU’s cash flows I would get to a value of $4.8. By adding the $3 in highly liquid assets, NSU’s stock had an intrinsic value of $7. (Note: after 2016 many things happened with NSU but that is not the point of this example) ([Location 358](https://readwise.io/to_kindle?action=open&asin=B07CNFFJ9J&location=358)) - Tags: [[blue]] - Apart from individual stocks, a liquidity cushion must also be applied to the whole portfolio as, especially in market panics, the complete market can go to incredibly low levels! Seth Klarman, the manager of one of the most successful value hedge funds in the world, The Baupost Group and the author of the book Margin of Safety which provided me the inspiration for this book, is known to often have up to 50% of his portfolio in cash when there are no low risk bargains to be found, as was the case in the 2000 dot-com bubble. Having such a large stash of cash allows him to take advantage of future market pricing mistakes that always eventually arise, as sooner or later the market always enters some kind of irrational panic mode. ([Location 384](https://readwise.io/to_kindle?action=open&asin=B07CNFFJ9J&location=384)) - Tags: [[blue]] - A value investor’s core conviction is that financial markets are more often than not, completely irrational. This allows value investors to buy stocks at bargain prices and sell when the market values those stocks at a fair price again or is exuberant about stocks. ([Location 412](https://readwise.io/to_kindle?action=open&asin=B07CNFFJ9J&location=412)) - Tags: [[blue]] - According to the National Bureau of Economic Research, the average duration of a recession in the U.S. from 1945 to 2009 was just 11 months. ([Location 431](https://readwise.io/to_kindle?action=open&asin=B07CNFFJ9J&location=431)) - Tags: [[blue]] - You do not have to buy from the market, you can wait for the price to fall into your buying range. ([Location 468](https://readwise.io/to_kindle?action=open&asin=B07CNFFJ9J&location=468)) - Tags: [[blue]] - “I have a name for people who went to the extreme efficient market theory- which is ‘bonkers’. It was an intellectually consistent theory that enabled them to do pretty mathematics. So I understand its seductiveness to people with large mathematical gifts. I just had a difficulty in that fundamental assumption did not tie properly to reality” Charlie Munger ([Location 493](https://readwise.io/to_kindle?action=open&asin=B07CNFFJ9J&location=493)) - Tags: [[blue]] - The problem is that growth works fine as long as there is an uptrend in the economic cycle, but as soon as there is a recession, the growth stops, and many of those companies that were promising great things, suddenly find themselves with no opportunity for further capital injections and go bankrupt. ([Location 555](https://readwise.io/to_kindle?action=open&asin=B07CNFFJ9J&location=555)) - Tags: [[blue]] - This is the main point of value investing, by avoiding heavy losses during negative market periods that always happen even if in a bull market nobody thinks anything bad can happen, a value investor manages to achieve extraordinary returns over time. ([Location 628](https://readwise.io/to_kindle?action=open&asin=B07CNFFJ9J&location=628)) - Tags: [[blue]] - Note: A 50% loss requires a 100% gain just to break even again. Avoiding losses can lead to better compounding growth - This leads us to a concept of risk not used in academia and mainstream finance but that always occurs in discussions from those who have beaten the market for extremely long periods (Buffett, Munger, Graham, Klarman, Lynch…). A value investor defines risk as the probability of permanent capital loss. ([Location 715](https://readwise.io/to_kindle?action=open&asin=B07CNFFJ9J&location=715)) - Tags: [[blue]] - This is why the most important measure of risk for a value investor is the price he is paying in relation to the value he is buying. That’s it. The lower the price is, the lower the risk is. What happened in the stock market in the last month or year has nothing to do with the risk of an investment. ([Location 729](https://readwise.io/to_kindle?action=open&asin=B07CNFFJ9J&location=729)) - Tags: [[blue]] - what we have to avoid is overpaying for our investments and try to avoid stocks of companies that are seeing deteriorating fundamentals in sectors where the outlook isn’t positive. ([Location 779](https://readwise.io/to_kindle?action=open&asin=B07CNFFJ9J&location=779)) - Tags: [[blue]] - Let’s say you buy Company X at a price of $10 and a dividend yield of 5%. If next year the price drops to $5 while the fundamentals stay intact and you reinvest your dividend at that low price, your ultimate returns are much higher than if the stock price would have remained stable. ([Location 783](https://readwise.io/to_kindle?action=open&asin=B07CNFFJ9J&location=783)) - Tags: [[blue]] - Asymmetrical risk reward is the essence of investing in stocks, and is also essential for those who want to beat the market. An asymmetrical risk reward situation can be both positive and negative. A positive one is where you can only lose an amount that is smaller than the potential reward for the same probability. A negative risk reward situation is one where you can lose more than what the potential positive reward is. ([Location 801](https://readwise.io/to_kindle?action=open&asin=B07CNFFJ9J&location=801)) - Tags: [[blue]] - Indicators that limit risk can be fundamental or even qualitative. Fundamental risk indicators are the book value, stable cash flow, cash per share and others that limit the downside while the high potential earnings increase the upside.  A qualitative factor to look at is growth. A company that has a high probability of long term sustainable growth due to positive industry circumstances, macro or demographic trends, will potentially deliver much higher returns than companies with relatively high debt burdens constrained by a slow growing economy like as is the case for many constituents of the S&P 500. ([Location 840](https://readwise.io/to_kindle?action=open&asin=B07CNFFJ9J&location=840)) - Tags: [[blue]] - Investors that live in a jurisdiction with a capital gain tax have to calculate the tax cost into their strategy in order to know exactly why they are buying and when and why will they sell. It is extremely important to be knowledgeable about the taxation system related to investments in the country you live. ([Location 881](https://readwise.io/to_kindle?action=open&asin=B07CNFFJ9J&location=881)) - Tags: [[blue]] - if a stock falls for some irrational reason, such as a short attack, the created market panic and negative environment can make creditors withdraw their credit line which can consequently negatively affect the actual fundamentals of the company. Thus, a value investor has to be aware of the reflexivity the stock market has on business fundamentals because it explains a lot of the inexplicable cases of irrational behavior, margin of safety failures and value investing losses. On the other hand, understanding reflexivity can give you the extra patience to just wait a bit longer before buying, or before selling, and further increase your returns. The important pillars of the theory of reflexivity are our fallibility, self-reinforcing and self-correcting trends in a boom bust cycle and reflexivity. ([Location 952](https://readwise.io/to_kindle?action=open&asin=B07CNFFJ9J&location=952)) - Tags: [[blue]] - The fact that TSLA didn’t have a single profitable quarter from 2010 to 2017 but managed to increase the book value per share 10-fold during that period through new capital raising rounds explains how the stock price can have an effect on fundamentals, in this case a positive effect. ([Location 980](https://readwise.io/to_kindle?action=open&asin=B07CNFFJ9J&location=980)) - Tags: [[blue]] - The most common way that market prices affect fundamentals is the use of leverage, be it in debt or equity form. When a stock price of a company rises, then the equity becomes more valuable and a company can take advantage to make acquisitions or to borrow at lower costs. Both situations also improve the fundamentals and make the cycle self-reinforcing. When the stock price is low, creditors think that there is something negative going on with the company, are not willing to lend more to the company and the company’s fundamentals deteriorate. ([Location 1024](https://readwise.io/to_kindle?action=open&asin=B07CNFFJ9J&location=1024)) - Tags: [[blue]] - If we know that the U.S. economy has grown by 17% from 2007 to 2017, that the global economy has grown even more and that interest rates have been at historical lows, how come corporate America hasn’t grown its earnings? Well, they’ve been focused on only one thing; the stock price and not organic business growth. ([Location 2246](https://readwise.io/to_kindle?action=open&asin=B07CNFFJ9J&location=2246)) - Tags: [[blue]] - (NOTE: buybacks can create shareholder value in certain circumstances when the price is below book value or the earnings yield is above the long term cost of capital) ([Location 2305](https://readwise.io/to_kindle?action=open&asin=B07CNFFJ9J&location=2305)) - Tags: [[blue]] - it is better to be vaguely right than precisely wrong. The point is to limit the probabilities of being wrong by increasing the margin of safety. ([Location 2373](https://readwise.io/to_kindle?action=open&asin=B07CNFFJ9J&location=2373)) - Tags: [[blue]] - you just need to compare the current stock price to your range of values. If the stock price isn’t significantly below your calculated average values, you look for other opportunities. ([Location 2398](https://readwise.io/to_kindle?action=open&asin=B07CNFFJ9J&location=2398)) - Tags: [[blue]] - Many beautiful mathematical models use a plethora of past data to estimate future cash flows, discount those cash flows to a present value, and provide a target stock price. The problem is that the assumptions included in such valuation models constantly change. Therefore, it’s impossible to have a static number as a precise valuation figure because interest rates, currency rates, valuations, stock market premiums, market sentiment and practically everything related to financial markets is constantly on the move. For example, a small change in interest rates usually has a huge impact on bond values and consequently on all stock valuation models. ([Location 2408](https://readwise.io/to_kindle?action=open&asin=B07CNFFJ9J&location=2408)) - Tags: [[blue]] - Note: To forecast (long term) stock prices, you can’t just forecast cash flows. You need to forecast future PE ratios, market sentiment, prevailing geopolitical conditions, etc. It quickly devolved into forecast EVERYTHING. So stock price forecasting approaches should likely stick or very short timescales (intraday) where these conditions are likely to remain constant. For longer timeframes, things like value investing are better suited - The key to value investing is to buy when the current price is below your most pessimistic intrinsic value estimation. Then you are really buying a bargain with a margin of safety. ([Location 2428](https://readwise.io/to_kindle?action=open&asin=B07CNFFJ9J&location=2428)) - Tags: [[blue]] - The best way to create a valuable net present value analysis is to be conservative when estimating future cash flows. Being conservative in one’s estimations immediately creates a margin of safety and limits subjectivity. ([Location 2455](https://readwise.io/to_kindle?action=open&asin=B07CNFFJ9J&location=2455)) - Tags: [[blue]] - For investments like blue chip companies or businesses with a moat, a lower discount rate can be used, and the general way to do that is to add a stock risk premium to the 10-year Treasury yield. As the Treasury yield can be considered riskless, by adding a few percentage points, you get to a good expected return from stocks. The average equity premium has been between 1.2% (1999) and 6.45% (1979). Again, to be conservative it is better to use the higher end of that range. ([Location 2471](https://readwise.io/to_kindle?action=open&asin=B07CNFFJ9J&location=2471)) - Tags: [[blue]] - The liquidation value of a business is one where we estimate the net value of the tangible assets minus all of the liabilities. The liquidation value offers a very strong margin of safety as it analyzes what would be the value for shareholders if the company would stop being an ongoing concern. ([Location 2535](https://readwise.io/to_kindle?action=open&asin=B07CNFFJ9J&location=2535)) - Tags: [[blue]] - Book value is a metric that helps in determining liquidation value, but not all book values can be taken at face value. The book value of a company represents the accounting value of the company. It’s very rare to find a company that has its book value equal to its liquidation value. For example, buildings are usually depreciated within 20 to 50 years. So, if a company bought a building 40 years ago, the value of that building on the balance sheet could easily be zero, but if the company would put the same building for sale, the value would probably be much higher than what the company paid for it four decades ago. ([Location 2554](https://readwise.io/to_kindle?action=open&asin=B07CNFFJ9J&location=2554)) - Tags: [[blue]] - To determine the liquidation value, you have to: -          Calculate the fair value of the assets owned (probably discount them by 30% to 50% to cover for possible fire sales) -          Deduct the liabilities the company has -          Be very conservative when calculating the value of the assets. Intangible assets like goodwill can be immediately cancelled while it is important to check what is the fair value of various buildings, inventories, licenses, contracts the company owns. ([Location 2576](https://readwise.io/to_kindle?action=open&asin=B07CNFFJ9J&location=2576)) - Tags: [[blue]] - a company that has been using historical cost accounting and never revalued real estate properties could have a huge hidden value. Therefore, it is extremely important to estimate the real (or fair) value of the assets analyzed and look beyond the actual number on the balance sheet. ([Location 2585](https://readwise.io/to_kindle?action=open&asin=B07CNFFJ9J&location=2585)) - Tags: [[blue]] - Warren Buffett defines intrinsic value as “the discounted value of the cash that can be taken out of a business during its remaining life,” (Berkshire’s annual report of 2013) and considers it the only logical approach to evaluating the relative attractiveness of investments and businesses. ([Location 2630](https://readwise.io/to_kindle?action=open&asin=B07CNFFJ9J&location=2630)) - Tags: [[blue]] - In the long term, market values eventually catch up with intrinsic values, be it on the upside or downside. What’s essential is how much the book value increases each year and by how much the cash flows increase. The yearly change in book value is much more stable than the market’s irrational valuation and it is the only precise indicator of intrinsic value, i.e. the yearly change in intrinsic value. ([Location 2649](https://readwise.io/to_kindle?action=open&asin=B07CNFFJ9J&location=2649)) - Tags: [[blue]] - The definition of intrinsic value is simple: It is the discounted value of the cash that can be taken out of a business during its remaining life. The cash available for distribution is calculated by using the following formula: Cash available for distribution = (reported earnings + depreciation and other non-cash charges) - (capitalized expenditures for the business to maintain its operations as is + additional working capital needed) ([Location 2664](https://readwise.io/to_kindle?action=open&asin=B07CNFFJ9J&location=2664)) - Tags: [[blue]] - The first component of intrinsic value is the value of the investments an organization has made. This can be seen by looking at its book value. If the sector is in trouble, some investments should be impaired or cautiously analyzed. The liability side of a balance sheet has to always be taken at face value while one has to be extremely conservative when analyzing the asset side. ([Location 2675](https://readwise.io/to_kindle?action=open&asin=B07CNFFJ9J&location=2675)) - Tags: [[blue]] - The third component of intrinsic value is the expected future return on retained earnings which is the most subjective component of the three. A good approximation is to use the past returns on invested capital the management has achieved. ([Location 2692](https://readwise.io/to_kindle?action=open&asin=B07CNFFJ9J&location=2692)) - Tags: [[blue]] - “It’s obvious that if a company generates high returns on capital and reinvests at high returns, it will do well. But this wouldn’t sell books, so there’s a lot of twaddle and fuzzy concepts that have been introduced that don’t add much.” ([Location 2701](https://readwise.io/to_kindle?action=open&asin=B07CNFFJ9J&location=2701)) - Tags: [[blue]] - Return on invested capital shows how well the company is using its available capital. It is calculated by using the following formula: ROIC = net income / capital (equity plus long and short-term debt) ([Location 2705](https://readwise.io/to_kindle?action=open&asin=B07CNFFJ9J&location=2705)) - Tags: [[blue]] - Apple’s ROIC is almost 10 times better than Southern’s which according to Charlie Munger results in a similar long-term return on investment. Munger might not be far from the truth as Apple’s returns have been close to a 20% yearly return in the past 10 years while Southern’s have been closer to 2% excluding the dividends in both cases. ([Location 2726](https://readwise.io/to_kindle?action=open&asin=B07CNFFJ9J&location=2726)) - Tags: [[blue]] - Charlie Munger states that over the very long term, the return on capital is what determines the return that the stock will offer no matter the current discount. ([Location 2736](https://readwise.io/to_kindle?action=open&asin=B07CNFFJ9J&location=2736)) - Tags: [[blue]] - Using the ROIC tool for assessing investments implies two things; one is a long-term view on investing and the second is that you compare many investments to find the best one. The long-term view allows the investor to disregard temporary market sentiment as timing the market is impossible. However, a stable and high ROIC provides the necessary security that a permanent loss of capital is unlikely. ([Location 2741](https://readwise.io/to_kindle?action=open&asin=B07CNFFJ9J&location=2741)) - Tags: [[blue]] - as holding cash has a cost and market timing is something impossible to do, when you find a business that has a strong return on invested capital in comparison to other businesses, is fairly priced, and has a sustainable high return thanks to a strong moat you might want to invest in such a business. In case the business remains the same but the stock price drops, just buy more. ([Location 2746](https://readwise.io/to_kindle?action=open&asin=B07CNFFJ9J&location=2746)) - Tags: [[blue]] - By combining all three components, you should end up with a range of values that represent the intrinsic value of the company for you, the owner. The current book value adjusted by dividend payments and historical cost accounting issues will show you the value created in the past that you are buying now. Current earnings or the change in book value will show you the value that is created at the moment you are analyzing the stocks. The third component; return on capital will tell you what to expect in the long term as that is the actual future value creation. The higher the return on invested capital and the cheaper the stock from a valuation perspective, the better. ([Location 2753](https://readwise.io/to_kindle?action=open&asin=B07CNFFJ9J&location=2753)) - Tags: [[blue]] - Growth that destroys value burns cash and is not profitable while growth that creates value simply continuously replicates a business model that works with healthy returns on capital. ([Location 2798](https://readwise.io/to_kindle?action=open&asin=B07CNFFJ9J&location=2798)) - Tags: [[blue]] - the best way to include growth in the calculation of intrinsic value is to be conservative. For example, there is a much bigger possibility that Starbucks grows earnings at 5% per year than 12% over the next 10 years. A lower than expected growth rate provides your intrinsic value with a better margin of safety. ([Location 2816](https://readwise.io/to_kindle?action=open&asin=B07CNFFJ9J&location=2816)) - Tags: [[blue]] - By looking at the company’s cash flows you can see whether value is created or destroyed for the shareholder through growth. If there is no positive return on investment, value is being destroyed by growth. If there is a big possibility that the business model will create value for shareholders in the future, then one should look at margins. Margins that will likely improve with more scale will lead to value creation and vice versa. ([Location 2824](https://readwise.io/to_kindle?action=open&asin=B07CNFFJ9J&location=2824)) - Tags: [[blue]] - Companies that have healthy growth rates but valuations below the market average and a stable business model will probably deliver strong earnings in the long term even if their book values aren’t really indicating that there is much value there at the moment. ([Location 2833](https://readwise.io/to_kindle?action=open&asin=B07CNFFJ9J&location=2833)) - Tags: [[blue]] - The first advantage the CAPE ratio has over its shorter-term counterpart, the PE ratio, is that it is much less volatile as it uses long term average earnings. The second is that as it uses long term earnings that represent real business performance. In other words, the CAPE shows when a market is cheap or expensive from a value perspective. When earnings decline in a recession, the standard PE ratio spikes while the CAPE ratio declines alongside lower stock prices as it takes much more time than a recession for average earnings to decline. ([Location 2850](https://readwise.io/to_kindle?action=open&asin=B07CNFFJ9J&location=2850)) - Tags: [[blue]] - when the CAPE is low, future stock market returns are high and vice versa. 10-year yearly returns have always been below 5% when the CAPE was above 20, below 1% when the CAPE was above 25, and negative when the CAPE was above 28. ([Location 2869](https://readwise.io/to_kindle?action=open&asin=B07CNFFJ9J&location=2869)) - Tags: [[blue]] - As time goes by, CAPE ratios vary enormously across different sectors as sector profitability is impacted by its own cyclical patterns. All sectors experience wild swings in sentiment and, consequently, in their CAPE ratios. Long-term value investors can reap huge rewards by carefully rebalancing between cheap and expensive sectors over time. ([Location 2873](https://readwise.io/to_kindle?action=open&asin=B07CNFFJ9J&location=2873)) - Tags: [[blue]] - High CAPE ratios are mostly found in countries that have had strong easing monetary policies that inflated the money supply resulting in asset bubbles. Countries that didn’t stimulate too much, and perhaps had a political or economic crisis, have CAPE ratios that are sometimes even in the single digits. ([Location 2878](https://readwise.io/to_kindle?action=open&asin=B07CNFFJ9J&location=2878)) - Tags: [[blue]] - If you want even better returns than what you can get from rebalancing the S&P 500 and globally, you have to look at individual stocks that are in a temporarily weak sector but are still doing well and perhaps even growing. The growth might not be coming from earnings (as the sector is in trouble), but could come from acquisitions as the best acquisitions are made when assets are cheap. ([Location 2884](https://readwise.io/to_kindle?action=open&asin=B07CNFFJ9J&location=2884)) - Tags: [[blue]] - The point of the margin of safety is to find investments where the likelihood that you lose money in the long term is minimal. Let’s say a stock is trading at $5 per share while just the real estate it owns is worth $10 per share. We could easily say that the margin of safety is 50%. If the company is just barely profitable and has no debt, it is highly unlikely that you will lose money with such an investment over the long term because there is always the real estate that gives value to the stock, no matter what the business is doing. ([Location 2918](https://readwise.io/to_kindle?action=open&asin=B07CNFFJ9J&location=2918)) - Tags: [[blue]] - The essence of using a margin of safety while investing is limiting the potential for loss. By limiting the downside, an investor is more exposed to the upside and thus invests with less risk for the same or even higher expected returns than what the rest of the market will get. Another thing important when investing with a margin of safety is that it shines in a declining market because when corporate earnings start declining, investors look for safety and protection, which can only be found with stocks that offer a margin of safety no matter what happens with the economy in the short term. ([Location 2946](https://readwise.io/to_kindle?action=open&asin=B07CNFFJ9J&location=2946)) - Tags: [[blue]] - it is essential to constantly compare investments and buy those that offer the largest margin of safety or have catalysts that are going to unlock that value. ([Location 2960](https://readwise.io/to_kindle?action=open&asin=B07CNFFJ9J&location=2960)) - Tags: [[blue]] - If there is enough selling pressure on the sector, a stock can easily trade at a price below net cash per share. Net cash per share is determined by deducting total debt from cash and cash equivalents. Cash equivalents are all assets that can be relatively quickly turned into cash. ([Location 2978](https://readwise.io/to_kindle?action=open&asin=B07CNFFJ9J&location=2978)) - Tags: [[blue]] - However, not everything is as easy as calculating the net cash per share. If a company isn’t profitable and will burn through lots of cash in the future, we can’t really look at the cash as a margin of safety. Growth and biotechnology companies often have large cash balances due to capitalization rounds which makes them seem cheap, but given their cash burn rate, they aren’t. ([Location 2993](https://readwise.io/to_kindle?action=open&asin=B07CNFFJ9J&location=2993)) - Tags: [[blue]] - General Electric slashed its dividend only two times since the Great Depression. On February 27 2009 the company announced it will cut its dividend from 31 cents to 10 cents per quarter. The stock price dropped 59 cents or 6.9% on the announcement date, from $9.28 to $8.60, and dropped to a low of $5.87 in the following week for a 37% weekly drop. The stock recovered later but it shows how big of an impact a dividend cut can have, because as irrational as it may be, many see dividends as the holy grail of investing. ([Location 3009](https://readwise.io/to_kindle?action=open&asin=B07CNFFJ9J&location=3009)) - Tags: [[blue]] - if you’re looking for a margin of safety in the dividend a company is paying, the most important safety factor is the sustainability of the dividend. To check whether the dividend is sustainable one must check the available cash and also the operational cash flows, especially how those cash flows change during bad economic times. ([Location 3017](https://readwise.io/to_kindle?action=open&asin=B07CNFFJ9J&location=3017)) - Tags: [[blue]] - To see whether a dividend is sustainable one must look at the company’s current margins and estimate how a recession would affect those margins. Perhaps it is best to look at how the company fared during the last recession or cyclical downturn. If the margins are tight and even a small change in the form of competitor pressure would make the dividend questionable, then there is really no margin of safety there. If the business is sound, has a moat and its business is not that much affected by economic cycles, the dividend can be considered safer which increases the margin of safety. ([Location 3029](https://readwise.io/to_kindle?action=open&asin=B07CNFFJ9J&location=3029)) - Tags: [[blue]] - "You want to focus on risk before you focus on returns. A lot of it is focusing on multiple scenarios, what can go wrong? How much can you lose?" Seth Klarman ([Location 3055](https://readwise.io/to_kindle?action=open&asin=B07CNFFJ9J&location=3055)) - Tags: [[blue]] - the best way to go about analyzing moats is to compare the analyzed business with the competition and potential competition. If it is really difficult to find a threat to the business, that business might have a large moat. ([Location 3073](https://readwise.io/to_kindle?action=open&asin=B07CNFFJ9J&location=3073)) - Tags: [[blue]] - Buffett would describe a business with a durable competitive advantage, or moat, as having the following: “A truly great business must have an enduring ‘moat’ that protects excellent returns on invested capital. The dynamics of capitalism guarantee that competitors will repeatedly assault any business ‘castle’ that is earning high returns. Therefore, a formidable barrier such as a company’s being the low-cost producer (GEICO, Costco) or possessing powerful worldwide brands (Coca-Cola, Gillette, American Express) is essential for sustained success. Business history is filled with ‘Roman Candles,’ companies whose moats proved illusory and were soon crossed. Our criterion of ‘enduring’ causes us to rule out companies in industries prone to rapid and continuous change. Though capitalism’s ‘creative destruction’ is highly beneficial for society; it precludes investment certainty. A moat that must be continuously rebuilt will eventually be no moat at all.” ([Location 3075](https://readwise.io/to_kindle?action=open&asin=B07CNFFJ9J&location=3075)) - Investing can really be simple, if you buy a good business with quality management at a fair price, which needs to happen only a few times in your life. If this happens, you will almost certainly beat the market and do extremely well. ([Location 3148](https://readwise.io/to_kindle?action=open&asin=B07CNFFJ9J&location=3148)) - Tags: [[blue]] - The main factor in determining the margin of safety is the price you pay. If you overpay for a stock, the margin of safety will probably be non-existent. ([Location 3177](https://readwise.io/to_kindle?action=open&asin=B07CNFFJ9J&location=3177)) - Tags: [[blue]] - Given that it’s impossible to accurately determine the intrinsic value of a stock, the best thing to do is to buy with a large margin of safety in order to allow for human error. ([Location 3181](https://readwise.io/to_kindle?action=open&asin=B07CNFFJ9J&location=3181)) - Tags: [[blue]] - The essence of value investing is buying at a discount to the intrinsic value (thus, with a margin of safety). The actual discount to be looking for depends on one’s personal risk reward preferences and the easiest way to determine the searched discount is to look at the long-term business earnings and intrinsic value. If you aim to get a 15% return from your investments, then when the current stock price leads to a long-term average price-to-earnings ratio of 6.6, you know you have found a bargain. Someone who looks for 10% returns will have a smaller required discount as the required long-term average PE ratio will be 10. ([Location 3195](https://readwise.io/to_kindle?action=open&asin=B07CNFFJ9J&location=3195)) - Tags: [[blue]] - What is important is the discount to the intrinsic value, which means that a stock can be undervalued even if it is at all-time highs. ([Location 3207](https://readwise.io/to_kindle?action=open&asin=B07CNFFJ9J&location=3207)) - Tags: [[blue]] - If a stock is trading below what you estimate its intrinsic value is, it should have a margin of safety. The problem is that the market might never recognize the mispricing, and the stock could fall even more. Therefore, apart from finding value in stocks, an investor has to also look for catalysts that are going to unlock that value. If there aren’t any catalysts on the horizon, the stock could easily become a value trap. Future catalysts might come in the form of a takeover, increased or initiated dividend, higher earnings, improvement in business operations, cyclical turnaround, sale of asset, political perspective and many other forms. ([Location 3257](https://readwise.io/to_kindle?action=open&asin=B07CNFFJ9J&location=3257)) - Tags: [[blue]] - we’re looking at a bargain when the company has great fundamentals, operates in a growth sector with a large moat, has many possible catalysts lying ahead, has weak competition, has real and strong asset quality on the balance sheet, an easily sustainable dividend, and has a low current price due to reasons not related to the company or its business environment. ([Location 3329](https://readwise.io/to_kindle?action=open&asin=B07CNFFJ9J&location=3329)) - Tags: [[blue]] - In this market, liquidations will be rare. But as soon as a recession hits the economy there could be many bankruptcies and liquidation sales because lots of today’s businesses have been kept alive artificially by low interest rates on high-yield debt. ([Location 3363](https://readwise.io/to_kindle?action=open&asin=B07CNFFJ9J&location=3363)) - Tags: [[blue]] - owning stocks of companies that have the potential to be taken over at a significant premium to the current price is always a plus that is often completely free. So, if choosing between two similar investments where one might become an acquisition target and the other unlikely, the decision is easy. ([Location 3421](https://readwise.io/to_kindle?action=open&asin=B07CNFFJ9J&location=3421)) - Tags: [[blue]] - The focus lies on fundamental analysis, where a careful analysis of the most common metrics from the price-to-earnings ratios to book values leads to a fair estimation of the intrinsic value of the stock. When that value is safely above the stock price, an investor in looking at a bargain investment. ([Location 3559](https://readwise.io/to_kindle?action=open&asin=B07CNFFJ9J&location=3559)) - Tags: [[blue]] - A characteristic of the value investor is that he constantly analyzes security by security by using the fundamental bottom up approach and invests only when he finds an investment with low risk and a margin of safety, i.e. “whatever happens I don’t lose money,” and high potential returns. ([Location 3570](https://readwise.io/to_kindle?action=open&asin=B07CNFFJ9J&location=3570)) - Tags: [[blue]] - An illiquid investment is one where there is a significant cost attached to closing the position. Liquidity allows us to change our minds and sell when we no longer think of the investment in the same way. Buying an illiquid asset doesn’t offer the opportunity to sell. Therefore, the longer the expected illiquid period is, the higher the compensation for illiquidity should be because the more time there is, the more things can go wrong with an investment, ([Location 4081](https://readwise.io/to_kindle?action=open&asin=B07CNFFJ9J&location=4081)) - Tags: [[blue]] - it’s also very important to think about the general market’s liquidity. When the markets are stable, it’s usually not a problem to sell or buy something. However, when the market panics, the liquidity that was present in the bull period quickly evaporates as sellers rush to sell while buyers wait for the price to get even lower. To avoid getting trapped in an illiquid investment, it’s important to know your liquidity limits and invest accordingly. ([Location 4086](https://readwise.io/to_kindle?action=open&asin=B07CNFFJ9J&location=4086)) - Tags: [[blue]] - The best way is to have a straightforward table with the owned and followed investments that can be adjourned quarterly. Consequently, a value investor can lower his position with the stocks that have become riskier because the fundamentals remained the same but the stock price increased and he can increase or start a position in other stocks that are better bargains. To carefully assess what is going on, a value investor has to stay in touch with the markets and follow what happens. ([Location 4110](https://readwise.io/to_kindle?action=open&asin=B07CNFFJ9J&location=4110)) - Tags: [[blue]] - “I made my money by selling too soon” Bernard Baruch ([Location 4128](https://readwise.io/to_kindle?action=open&asin=B07CNFFJ9J&location=4128)) - Tags: [[blue]] - Investors like Buffett and Klarman define using stop-losses as a crazy activity and not at all a risk limiting tool. According to Klarman, it’s irrational to sell a holding when its price falls. If an investor bought the holding in the first place, based on proper value analysis, a new decline in price only means that it is a better bargain and averaging down will increase one’s return. Letting the market decide when you should sell is totally crazy according to Klarman. ([Location 4197](https://readwise.io/to_kindle?action=open&asin=B07CNFFJ9J&location=4197)) - Tags: [[blue]] - Market risk can’t be mitigated by diversification, but can be lowered through hedging. What many fail to understand is that a hedge is an investment like any other. It has a value and a price. Whenever the value is below the price, it can be bought with a margin of safety. So, the same principle that applies to normal investments applies to hedges too. ([Location 4222](https://readwise.io/to_kindle?action=open&asin=B07CNFFJ9J&location=4222)) - Tags: [[blue]] - The truth is that both stocks and bonds move in tandem, and opposite to interest rates. Since 1982, interest rates have been declining, pushing down the required returns and, consequently, inflating most asset prices, from real estate to stocks and bonds. Therefore, if you want to grasp the benefits of diversification hedges, you should really look for uncorrelated assets. ([Location 4238](https://readwise.io/to_kindle?action=open&asin=B07CNFFJ9J&location=4238)) - Tags: [[blue]] - The investing world isn’t as big as it looks and there are often just a few analysts covering a stock, especially if it is a small cap. Put more effort into analyzing the sector than what they are paid to do, and you’ll quickly get ahead of the competition. To novice investors, Wall Street might seem like an impenetrable castle, but the more you learn about it, the more you will see that it isn’t so deep and diligent value investors can find their place in the sun, especially with stocks that are poorly covered because Wall Street can’t gain good fees on a small cap for example. ([Location 4375](https://readwise.io/to_kindle?action=open&asin=B07CNFFJ9J&location=4375)) - Tags: [[blue]] - The benefit of temporal diversification is that you buy when assets are cheap and therefore have a higher dividend yield which fills your pockets with cash and enables you to buy other assets on the cheap later. You don’t switch to other stocks when they seem cheaper or a better opportunity at the moment because you still have a great yield if you look at it from the point of your initial investment. ([Location 4542](https://readwise.io/to_kindle?action=open&asin=B07CNFFJ9J&location=4542)) - Tags: [[blue]] - To conclude on extremistan investments, Taleb explains that it’s wrong to use averages to measure all things because what makes an average is so variegate, that many things will exceed what we’ve prepared for, both on the upside and downside. Consequently, if we are in the domain of extremistan, and we use analytical tools from mediocristan for prediction, risk management, etc., we can face enormous surprises. Some of these surprises may be positive and some may be negative, but their impact will likely exceed what we are prepared for. ([Location 4591](https://readwise.io/to_kindle?action=open&asin=B07CNFFJ9J&location=4591)) - Tags: [[blue]] - My theory is that by putting a few percentages of your portfolio into gold miners, you hedge yourself against anything that might happen while you don’t risk much as all you can lose are those few percentage points. ([Location 4627](https://readwise.io/to_kindle?action=open&asin=B07CNFFJ9J&location=4627)) - Tags: [[blue]]