Book recommendation: The World is Flat by Thomas Friedman

On a recommendation from my father-in-law, I recently started Thomas Friedman’s The World Is Flat. I’m really enjoying it.

Friedman’s thesis is that the world has become “flat” within the last decade because of globalization and technology. He doesn’t mean physically flat, he means the playing field has been flattened such that people can more easily compete with each other. Improved education, free trade, fiber optics, more open political systems have allowed people the world over to compete with each other for jobs, work, etc.

The good news is that around 1.3 billion people in China and 1.1 billion people in India are really benefiting from this. They will get paid more and have more interesting jobs. Their opportunity set in life has dramatically increased over the last decade. The majority of people outside of China and India will benefit, too, with cheaper products and more specialization.

The bad news is that some people in the United States and Europe are having a hard time competing with these new workers. Both blue and white collar jobs are getting transferred to those workers who have the most to offer at the lowest price.

I don’t agree with everything Friedman has to say, but he makes some really great points and does a wonderful job of illustrating the changes occurring. I find it particularly interesting as an investor and as a soon to be father. If you’re curious how the world economy may evolve going forward and what risks and rewards lie in wait, I highly recommend this book.

Nothing in this blog should be considered investment, financial, tax, or legal advice. The opinions, estimates and projections contained herein are subject to change without notice. Information throughout this blog has been obtained from sources believed to be accurate and reliable, but such accuracy cannot be guaranteed.

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Process versus results

One of the hardest things to do when investing is to keep my focus on process instead of results.

Does that mean that results are unimportant? No. But, it does mean that an over-emphasis on short term results can prevent me from achieving truly unique investing performance.

I find that an analogy, here, helps me grasp this difference. I believe that being honest is necessary to achieving happiness. But, being honest at any particular time does not mean that happiness will instantaneously follow. Honesty is a virtue–like all others–that yields results over the fullness of time.

It seems that everyone has heard of an unscrupulous salesperson that has made a fortune while being less than honest. Such salespeople may do very well in the short term, but over the long term they’re going to pay the price for treating others poorly. It may take decades for this price to be paid, but rest assured that it’s always paid.

The same is true with investing. Those who focus on short term results seem to always be chasing the latest hot thing. They inevitably end up buying high and selling low because they are too focused on results and not enough on process.

Generating truly excellent investment results over the fullness of time requires an intense focus on process: the process of researching, analyzing, valuing, purchasing and selling partial ownership of businesses. Any focus on short term results that distracts an investor from this process will lead to sub par results. An intense focus on short term results will lead to disastrous decisions. Trust me, I’ve made them myself.

It’s hard to focus on process at times. Sometime an investment’s price will go down as business value goes up. Sometimes price will go up much faster than underlying value. Price is important, but it can distract you from underlying value.

The key is to have a process and discipline that you know will work, and to make sure you don’t get distracted by short term results when you know long term results are what’s important.

Even after 11 years of investing, I still find myself getting distracted by short term results. What do I do? I realize I’m letting it happen, then promptly and none too gently refocus myself back on the process. And, so far, that works.

Nothing in this blog should be considered investment, financial, tax, or legal advice. The opinions, estimates and projections contained herein are subject to change without notice. Information throughout this blog has been obtained from sources believed to be accurate and reliable, but such accuracy cannot be guaranteed.

Do what you love, love what you do

I believe one of the most important things in life is to find work that you love.

This may sound simple, but it isn’t. Most people seem to get stuck in a rut of doing what they need to get by, instead of seizing the day and chasing their passion. It doesn’t have to be that way.

In many ways I feel lucky to be pursuing my passion for a living, but I also remember the path that got me here.

Having gone through the Air Force Academy, I became a pilot at first. I didn’t like that, so I got out of it. I started a masters degree in operations research, but it turned out that wasn’t right for me, either. I started and finished an MBA program and liked that, but wasn’t sure how to apply it. I got to manage people in the Air Force and did okay, but wasn’t really thrilled about doing that for a living, either.

I took every career aptitude and interest survey I could find. I read and did all the exercises in What Color is Your Parachute. I talked to people in every career field I was interested in to find out what they did and didn’t like about their field. I networked with people in hopes that at some point I could use such contacts to help me find a job.

I read about anything that interested me, from philosophy, to politics, to history, to psychology, to business, to investing. With investing, I really hit on something that jazzed me, and I read a ton more about it. I put myself to work learning everything I could about investing and applying it to my own money. Eventually, I realized I wanted to be an investor for a living, so I pursued the CFA designation to make myself more qualified.

I worked for 8 years figuring out what I wanted to do for a living. I started two masters degrees and finished one. I talked to dozens of people about different career fields. I compared my talents, interests and tendencies to each career option I faced. I went down many paths before I discovered one that was right for me.

I made gobs of mistakes in this process. I’d been in two career fields that weren’t right for me. I pursued education several times I didn’t use. I spent a ton of time and money, I missed out on entertainment and social activities, I was repeatedly frustrated. But, it was all worth it.

Spinoza once said, “All things excellent are as difficult as they are rare.” As my wife would put it, boy howdy.

Finding the right career was a long, arduous path, but waking up excited to work every day makes it so worth the effort.

Nothing in this blog should be considered investment, financial, tax, or legal advice. The opinions, estimates and projections contained herein are subject to change without notice. Information throughout this blog has been obtained from sources believed to be accurate and reliable, but such accuracy cannot be guaranteed.

Judging investor performance

One of the hardest things for investors to do is judge the performance of an investment manager.

Most financial periodicals emphasize quarterly, 1, 3 and 5 year records, but is that enough time to look at?

The problem is that there’s a lot of noise present in investment returns. What do I mean by noise? Noise is what you hear in between AM radio stations, it’s the static you see on TV channels where no content is broadcast. Investors need signal to make good decisions, so paying attention to noise can be a real problem.

Why is there so much noise in investment data? Part of the reason is that many “investors” are really speculators–buying and selling stocks at the drop of a hat instead of purchasing partial ownership of an underlying company. Those traders create noise because they aren’t trading on fundamentals in most cases, they are trading based on chart patterns and intuition.

Another reason for noise is that a lot of estimates go into financial reporting. Companies must estimate how much of the credit they extend won’t be paid, how much their inventory will be worth, how long their factory and equipment will last, how much they will have to pay into pension plans, etc. It can take years to see what these numbers really turn out to be. That’s why so many companies must restate their financials over time.

A third reason is simply human psychology. People tend to over-emphasize recent data and under-emphasize old data. They tend to anchor themselves to a price they paid or a price they want to buy or sell at. They tend to follow the herd instead of gathering and analyzing relevant data. These psychological tendencies lead prices to trend too far in one direction and then the other.

That’s only a few of the reasons, but you get the idea. Stock prices, in the short run, reflect a whole bunch of noise and very little signal. You have to look at the data over much longer periods of time to start to see signal. It’s like trying to pick a good place to farm based on a weeks worth of rain and temperature data. A week just isn’t a long enough period of time to look at–you need to look at YEARS worth of data.

How many years of investment performance do you need to distinguish signal from noise? It depends (I must sound like an economist). But, the absolute minimum you should use is 3 years, it’s better to use 5 years, and even better still to use 10 years.

This may seem like a stiff test, especially when a manager has a limited record to observe. But, think of it like you would about picking a place to farm, too little data is just plain gambling, so wait until you have enough information before you act.

Nothing in this blog should be considered investment, financial, tax, or legal advice. The opinions, estimates and projections contained herein are subject to change without notice. Information throughout this blog has been obtained from sources believed to be accurate and reliable, but such accuracy cannot be guaranteed.

Headlines frequently call the bottom

One of the amusing things I’ve learned as an investor is how the popular press almost always gets it wrong, especially when it comes to investing or the economy.

One popular magazine called the bottom with their headline about the death of equities in the early 1980’s. Doing the opposite of what this headline seems to suggest–by investing in equities–would have been very profitable.

If you were awake during the late 1990’s, you were inundated with headlines about the telecom, internet and technology companies that were going to grow forever. Once again, doing the opposite–by shorting telecom, technology or internet businesses, or investing in brick and mortar companies–was quite profitable.

More recently, the craze for flipping homes or condos as investments made headlines in the popular press during 2005 and early 2006. Want to guess how thats turning out?

Why does the popular press get it wrong? They don’t tend to ferret out breaking news, they tend to report what is happening. In fact, they only tend to report such news once everyone already knows about it. In other words, they reflect popular sentiment more than anything else.

If everyone believes something is a great deal, they tend to buy it for themselves before they tell everyone how great it is. If everyone knows something is great, then price will already reflect that enthusiasm. If you wait for that enthusiasm to be obvious everywhere, then everyone will have already bought. And, when everyone has already bought, prices almost have to go down from there.

The bust in the housing market and home loans seems to be making the news a lot lately. But, I’m not sure it’s hit page one of a popular weekly magazine, yet, so perhaps it’s not quite time to act on this one.

Nothing in this blog should be considered investment, financial, tax, or legal advice. The opinions, estimates and projections contained herein are subject to change without notice. Information throughout this blog has been obtained from sources believed to be accurate and reliable, but such accuracy cannot be guaranteed.

General Motors + Chrysler = ???

The recent buzz is that GM may be thinking about buying Chrysler. I’m not certain this is a good plan.

I don’t think either GM or Chrysler have problems that can really be solved by additional scale. In fact, one could easily argue that they both have too much scale right now, not too little. They both need tremendous downsizing to target narrower markets and to alter their cost structure to be able to make profitably the few things they can do well.

So what benefit will accrue if they combine? Will they have greater bargaining power to deal with the UAW? Perhaps, but couldn’t gaining the upper hand on their unionized workers possbily lead to additional product quality problems? If their problems are scale, products and costs, will tackling costs alone really help?

Will their combined engineering and design teams suddenly be able to make higher quality cars that people really want? Would the combined company be capable of streamlining their supply chains, further integrating their suppliers and buyers? I doubt it. In fact, a larger, more bureaucratic company with at least two, probably many more, dissimilar cultures will find it even more difficult to solve such problems.

Although I think GM looks like a statistically cheap investment right now, I think its problems are too big to solve this way. I have no reason to believe that Daimler Benz wants to sell Chrysler because they believe its their crown jewel, and the fact that Daimler’s stock price took off on the rumor seems to indicate many investors agree. So, GM is thinking about buying the red-headed step-child from a better company that couldn’t fix its operations, in hopes that they can both right Chrysler’s and their own operations in a heroic effort. Wow, that sounds silly.

Both GM and Chrysler need to scale back operations, vastly improve the quality of their vehicles, and produce niche designs that they can sell at a profit, while also dealing with their legacy cost structure that needs immediate overhauling. Can they really work on this problem together and hope to succeed, or should they get their own house in order first before combining with others?

I really don’t know the answer, but I do know what bet I’m NOT making.

Nothing in this blog should be considered investment, financial, tax, or legal advice. The opinions, estimates and projections contained herein are subject to change without notice. Information throughout this blog has been obtained from sources believed to be accurate and reliable, but such accuracy cannot be guaranteed.

“I made my fortune by selling too early”

Baron Rothschild once said, “I made my fortune by selling too early.” What did he mean by that?

Some “investors” think they can buy an investment as it bottoms and then sell right before it tops. I call such “investors,” speculators. There is too much speculative movement in price to precisely time tops and bottoms.

But, because so many speculators pursue this ideal, they tend to laugh at those who sell too early. Hence, Rothschild’s quote is in response to them.

Investors like Rothschild spend time figuring out what an investment is worth. Only then do they try to buy low and sell high. With the reference point of worth, or value, they can try to buy things below value and sell them above value. Not surprisingly, speculative stock movements lead them to buy before a stock bottoms and sell before it tops. In buying investments below value and selling them above value, though, they make fortunes over the fullness of time.

In other words, Rothschild has the last laugh. Speculators make fun of him for selling too early. But, his ability to sell too early is the reason why he keeps his gains, while the speculators end up holding investments on the way down. Using the rational reference of value, Rothschild buys low and sells high (and too early in most cases), while speculators frequently buy high and sell low trying to time tops and bottoms.

Nothing in this blog should be considered investment, financial, tax, or legal advice. The opinions, estimates and projections contained herein are subject to change without notice. Information throughout this blog has been obtained from sources believed to be accurate and reliable, but such accuracy cannot be guaranteed.