16 April 2013
Books and More…
Hello everyone! We have several topics to cover in this Blog entry so let’s dive right in.
1. So far I have had three rejections while conducting my agent search for the new edition of The Focus Investor.
2. Lawrence Cunningham has published an updated version of his great reference, The Essays of Warren Buffett: Lessons for Corporate America (Third Edition). The unique feature of this book is that it presents the material contained in Warren Buffett’s shareholder letters by topic which makes it much easier to find what Warren has said concerning a specific topic. This book has been a valuable time saving resource for me and I would certainly recommend it to everyone.
3. What’s Behind the Numbers?: A Guide to Exposing Financial Chicanery and Avoiding Huge Losses in Your Portfolio by John Del Vecchio and Tom Jacobs (Disclosure: I was provided a review copy by Mr. Jacobs.)
The first thing I want to tell readers is that I really enjoyed the material in this book. It’s well written and it’s a book that both “professional” investors and those who do their own investment work will find insightful.
I’m always interested in learning more about forensic accounting techniques and when I saw this book on Amazon I was immediately interested. I recognized one of authors of the book right away as I had followed Mr. Jacobs career for many years dating back to his Motley Fool days. I was also intrigued when I read that Mr. Vecchio had worked for David Tice AND Dr. Howard Schilit, both legends in the forensic accounting field.
For those that haven’t read the book yet it certainly covers forensic accounting, and does so using real examples in an easy to understand format, but it also contains much more. So just what is the thesis of the book? They explain it on page 19:
“With the tools in this book, investors will increase their chances of achieving high real returns by weeding out or avoiding the stocks that perform so poorly that they will ruin overall returns and possibly destroy capital permanently.”
To reach this goal they advocate using an investment approach that combines a small-cap value strategy (while also participating in select special situations) with a short component.
I found their short thinking quite interesting as they state not to short companies “…based on overvaluation, fads, frauds, or poor business models” which is what I would have considered to be perfect short candidates. They instead advocate waiting until the aggressive accounting methods discussed in the book are used by companies, i.e. “wait until there are negative catalysts for profits in the near future – a year or two at most, the rough time period that the value-with-catalyst investor seeks.”
The material is presently effectively with looks of real world examples that highlight the strategies that have successfully employed and investors will surely find it useful.
Detailed Review (For those blog readers who really want to get into the details):
The first chapter lays out the base case on why it’s important to know what’s behind the numbers and discusses a variety of topics that touch upon the psychology of investing and what pitfalls the individual investor typically make in their investing process. It highlights the importance of real returns, why it’s hard for most people to follow a dollar cost averaging program and lays the foundation for their investment thesis.
I found Chapters 2-5 to be exactly what I was looking for in this book: forensic accounting techniques. Chapter 2 covered the income statement and examined such topics as aggressive revenue recognition, channel stuffing, and accounts receivables. The chapter teaches you how to spot problems and provides examples of problems they discovered and how they discovered the examples using the company’s SEC filings. The remaining Chapters 3-5 also use the same format to cover other areas in the financial statements that investors can use to try and spot potential problem areas. This was the part of the book I thoroughly enjoyed and has material that every focus investor needs to be aware of to be an effective investor.
In Chapter 6 Tom develops his thesis for the long portion of the investment program the book advocates. I think focus investors will find most of his ideas to be quite consistent with the focus investing style and he is obviously heavily influenced by an excellent research paper written by Tweedy Browne: “What has Worked in Investing.” My main reservation about this chapter will come as no surprise, no mention is made of portfolio concentration. Tom’s approach is obviously very heavily influenced by Ben Graham who certainly did not follow a concentrated investing style. While I favor a more concentrated investing approach I can find no fault with anyone that follows the example of Mr. Graham.
The next section of the book is where the trouble begins. If you have read this blog, this site, or my book you know that I am no fan of using charts to aid in the investment decision process and since this Chapter 7 covers that topic I would recommend skipping Chapter 7.
I have the hardest time with Chapter 8 as it deals with suggestion on how to avoid “massive bear market losses.” I would suggest focus investor read it as it does present several interesting indicators that investors might want to be aware of but I also want to caution focus investor practitioners to not become so focused on the subject that you get completely out of the market as people have proven time and time again that they get out when they should be buying stocks. Market timing has no place in the focus investing strategy. In fact focus investors should structure their financial situation so that they possess the ability to not only ride out bear markets but also be able to take advantage of them. This requires a different mentality and temperament and is not for everyone.
The best part of the book dealt with forensic accounting which sections contained plenty of information that their readers can put to good use immediately. I thought they covered shorting in an interesting and compelling manner though they didn’t convince me to participate. Not that I think shorting is wrong, I just don’t find it appealing personally. As they mention in the book even if you don’t short stocks yourself “…the short-selling expert’s tools – and the shorting mindset – can lead to successful investing, simply by avoiding the statistical basement revealed by the data.”
I didn’t find Chapters 7 and 8 to my liking and would have to recommend skipping those sections. In my experience technical analysis and market timing are not rewarding areas for focus investors to be spending time on.
Overall I found the book to be quite interesting and think that it’s certainly worth including in your investing library.
4. I found this article in the New York Times on April 12, 2013 by James Stewart, When Shareholder Democracy is Sham Democracy to be quite disturbing even though it matches the experiences I have had in the decade or so I have been involved in the investment industry. In the opening paragraph the author discusses how he thought that it was “..hard to imagine a more compelling case for ousting directors than the posed by Hewlett-Packard” and I certainly would have no argument with that as they presided over a significant level of shareholder value destruction.
Now I have seen how high the levels of shareholder atrophy is for years and Ben Graham talked about how shareholders acted like sheep back in his book, Security Analysis, written in the 30s, so this shouldn’t come as a surprise that Hewlett-Packard’s board members mainly survived the period of bad decision making. What the author goes on to state next did surprise me, he found 41 cases in which “…the director actually lost their elections last year, meaning that more than 50 percent of the shareholders withheld their votes of approval. Yet despite these resounding votes of no confidence, they remained at their posts.”
He gives several examples of how companies are blatantly disregarding their shareholders with one example being particular egregious. Iris International had all nine of their directors nominees rejected by shareholders. They resigned as required be Delaware corporate law but they then voted to reject THEIR OWN RESIGNATIONS.
In my experience many companies, especially under performing ones, have no desire to speak with their shareholders and only do so grudgingly. Management and directors both in most cases seem to think of their shareholders as adversaries and not someone that owns part of the company. The incorporation laws in Delaware have caused the tipping point to favor management to such a large extent that shareholders are left without a voice that carries any weight. It’s sad to see shareholders have such an unimportant voice in a country founded on democratic principles.
Link to article: http://www.nytimes.com/2013/04/13/business/sham-shareholder-democracy.html?pagewanted=all&_r=0