Reading, resolutions and "research"

"Please don't bother me right now, I'm reading about railcar loading trends for 1842, the year of the great hog debacle.  I think I can see parallels between that and the current coal environment."  Ever run into a value investor like that?  Head so deep in a history book that everything current is just a repeat of the past?  Reading is to value investing as ice skates are to hockey.

Reading is so embedded in the value investing mantra that I've seen debates break out over who reads the more.  One of Warren Buffett's protege investors was mis-quoted in an interview saying he read 500 pages a day.  Soon message boards were full of posts positing that if Buffett deputies read 500 pages a day then that must be the path to success.  It wasn't long before legions of investors were burned out trying to plow through the equivalent of a Stephen King novel a day, seven days a week barely giving themselves time to eat or use the restroom, let alone think about what they were reading!  Eventually said deputy clarified that they only read 500 pages a week, but the damage had been done.

This is the time of the year when investors are making resolutions "I'll research more before making the next investment." "I won't sell as quickly" "I'll be more patient" "I won't chase story stock" etc.  One resolution many will make is they want to read more and deepen the research before investing.

By nature I'm a goal type of person, I'm first born, and driven (often go together), and like to accomplish things, even fabricated goals.  For years I'd set new year gold.  I'd build little systems to hit my goals and once I accomplished them I'd fall off my system for the rest of the year leaving the goal just a memory.  The goals were nice milestones, but at each goal I either realized it wasn't worth pursing the activity further, or I was discontent and set another goal further afield.

As I've knocked down goal after goal and grown older I've realized there's a better way.  Instead of setting fixed goals each year I now strive to build sustainable systems.  For example, a few years ago I set a weekly goal of running a certain number of miles.  I found myself in two situations, I'd run 80% of the miles the first three days of the week and then I'd slack off and do an easy run on Friday to make my goal.  Or I'd be busy Mon-Wed and Thursday and Friday would run too much putting myself at risk for injury trying to reach the weekly goal.  The better way is to say that I plan on exercising three to four days a week.  Since I'm not holding myself to an arbitrary number I can be satisfied if I get outside a consistent number of days.  The beauty of this system is that it's sustainable, run (or exercise) three days a week.  If I'm tired maybe I'll walk, or in the summer I might swap a run with a bike ride, but regardless I am out exercising, not maintaining a spreadsheet.

I've spoken in the past about building an investing system.  You need to invest in a way that fits your personality.  This is where reading comes into play.  There are many different ways to be a value investor.  Value investing is simply buying something of a measurable value for a substantial discount to that measurable value.  The thing is that to do this you don't need to keep your nose in a book constantly, even if Buffett does.

Have you ever seen someone say the following: "I'm interested in value investing, what should I do?" and the response is to throw a library of value investing books at the person asking a question. "Oh you need to read all of Buffett's letters, plus Security Analysis, plus thirty other books and 10-Ks and 10-Qs and the Farmers Almanac back to 1910 and then you'll be ready to begin.."

The approach we use to teach value investing is strange, almost foreign compared to most other things we learned in life.  Consider a sport.  The student is taught a number of basic rules and techniques and then told to practice.  As they practice and improve they are then taught more difficult techniques.  Or what about a pilot?  Piloting a plane is complicated, but a pilot learns the basics first then gets in a plane and practices with a teacher.  Once they know the basics they learn by doing.  Almost any type of learning I can think of follows this same pattern.  Discover the basics, practice, improve, learn more, practice more, improve etc.

Yet in the world of investing we have it backwards.  We tell a beginning student to read expert level books and never dip their toe in the pool until they've mastered the material.  Value investing is no more complicated compared to flying a plane, yet we're treating it like rocket science.

Maybe we do this because investing is a serious business where we're putting our money into something with the potential for a loss.  It's ironic that we hesitate to invest money where a potential for loss exists but where there's also a potential for gain, because most of our money is spent on things that are a 100% loss.  If I spend money on a burger and a beer, I enjoy it for a few minutes and after that the money's gone for good.  Sure, it converts into energy for a bit, but a few hours later I'm hungry again and need to consume more food (money turned into energy).  Same with almost anything else, food, electric for the house, gas for the car and on and on.  Consumers regularly part with the majority of their paycheck, or in some cases more than their paycheck for 'spent' things.  Items that have no potential for gain.  Yet when it comes to investing, where a potential for gain exists people are like deer in the headlights because they might lose money.  It's nothing to walk into a dealer and spend $25k on a car, but save $200 a month..yikes!

One does not need to be a rocket scientist to be a successful investor.  A simple index fund will result in a gain given enough time.  If an investor wishes to explore the value side of the world basic screens are a great start.  Buy 50 stocks trading for 75% of book value and sell when they hit 1.25x, rinse, repeat.  Will this investor buy bad companies, yup, will they own duds, yup, will it work out over time, yup.

In the new year I'd advise you to ditch resolutions to read more (unless you don't read at all, which is unlikely if you're reading this) and instead treat investing like any other activity.  Learn the basics, then practice and improve.  Once the basics have been mastered move into the next level, add more complicated techniques and work on mastering those.  Continue to improve and master each technique before moving to the next.  It's possible you might never advance beyond the basics, but that's alright, master those basics and stay at a level that you're comfortable with.  Investors get into trouble when they venture far from their abilities.  Sometimes you'll need a book or two to cross the chasm between what you know and what you want to do, that's when it's appropriate to shove your nose in a book.  But not before you're at that chasm.

Let me make a few concrete recommendations.  If you're new to investing I'd make sure you understand how financial statements work before committing any money.  You don't need a Masters level education to understand financial statements, just the ability to read and understand the mechanics.  The heuristic I learned was this: The income statement shows if a company can price their products for more than it costs to make them.  The cash flow statement shows if they're lying, and the balance sheet is a snapshot in time of this process.

If you have been at this for a while look to add a new technique this year.  Maybe it'll be spin-offs, or options, or liquidations.  Make it specific, not broad.  Don't say "I'll invest in special situations", be specific "I'll invest in a liquidation".  Then do what's necessary to learn the basics and practice.

Practice is what internalizes the book knowledge we've read.  Reading without practicing holds little value.  Yet we can learn a lot that's not in a book through practice and experience.  Don't get lost in the weeds reading about the details, get out there and experience it!

So how does research fit into my investing system? I outline my full process here.