Decline in Market Price of holdings is not true risk or loss.

It is our conviction that the bona fide investor does not lose money merely because the market price of his holdings declines.  

Hence, the fact the decline may occur does not mean that he is running a true risk or loss.

If a group of well-selected common stock investment shows a satisfactory overall return as measured through a fair number of years then this group of investment has proved to be safe.

During that period, its market value was bound to fluctuate and likely than not, would sell for a while under the buyer's cost.

If that fall makes the investment risky, it would then have to be called both risky and safe at the same time.

This confusion may be avoided if we apply the concept of risk solely to a loss in value which:

• either is realized through an actual sale 
• or is caused by significant deterioration in the company's position 
• or more frequently, perhaps is the result of paying an excessive price in relation to the intrinsic worth of the security.

Many common stocks involve risks of such deterioration but it is our thesis that a properly executed group of investment in common stocks does not carry any substantial risk of this sort.


Ref:   Intelligent Investor by Benjamin Graham



Additional notes:

It is conventional to speak of good bonds as less risky than good preferred and that the latter as less risky than good common stocks.

From this was derived the popular prejudice against common stocks because they are not safe but we believe that what is here involved is not a true risk in the useful sense of the term.

If an investor's list has been competently selected in the first instance, there should be no need for frequent or numerous changes to the portfolio.

Charlie Munger

Exclusive ValueWalk series on Charlie Munger’s life

• Charlie Munger — Part One: The Beginning
• Charlie Munger — Part Two: Quality Over Value
• Charlie Munger – Part Three: Sit On Your A$$
• Charlie Munger — Part Four: Investment Advice
• Charlie Munger — Part Five: Checklist Investing
• Charlie Munger — Part Six: The Daily Journal
• Charlie Munger — Part Seven: Poor Charlie’s Almanack
• Charlie Munger — Part Eight: Berkshire At 50
• Charlie Munger -- Part Nine: Colorful Charlie And The Cinderella Principle
• Charlie Munger — Part Ten: Conclusion

Charlie Munger's full resource page can be found here.

Cost leadership

Companies with large fixed costs and able to deliver their products most efficiently have a strong advantage and can achieve superior financial performance.

Firms don't usually advertise their cost structures per se.

To get an idea about how efficiently a company operates, look at its fixed asset turnover, operating margins, and ROIC - and compare its numbers to industry peers.

Unique assets

When limited assets are required to fullfill the delivery of a particular service, ownership of those assets is key.

Companies with well-located landfill assets represent a significant competitive advantage and barrier to entry in the waste management market because it is unlikely that enough new landfill locations will get government approval to diminish its share of this business.

Prudent financing

Having a load of debt is not itself a bad thing.

Having a loa of debt that cannot be easily financed by the cash flow of the business is a recipe for disaster.

When analysing companies with high debt, always be sure that the debt can be serviced from free cash flow, even under a downside scenario.

Examine growth expectations

Understand what kind of growth rates are incorporated into the share price.

If the rates of growth are unrealistic, avoid the stock.

Size the market opportunity

Industries with big, untapped market opportunities provide an attractive environment for high growth.

In addition, companies chasing markets perceived to be big enough to accommodate growth for all industry participants are less likely to compete on price alone.

Focus on cash flow

Investors timely earn returns based on a company's cash-generating ability.

Avoid investments that are not expected to generate adequate cash flow.

Look for recurring revenue

Long term customer contracts can guarantee certain levels of revenue for years into the future.  This can provide a degree of stability in financial results.

Look for scale and operating leverage.

Economies of scale and operating leverage are characteristics that can provide significant barriers to entry and lead to impressive financial performance.

Know the business. Understand the business model.

Understand the business model is important as this will provide insight as to the kind of financial results the company may produce.

Tell tale signs of good cash generation: Dividends, Share Buybacks and Accumulation of Cash on the Balance Sheet

Economies of scale refers to a company's ability to leverage its fixed cost infrastructure across more and more clients.

The result of scale economies should be operating leverage, whereby profits are able to grow faster than sales.

The combination of operating leverage and low ongoing capital requirements suggest that the firms should have plenty of free cash to throw around.

Tell tale signs of good cash generation are dividends, share buybacks, and an accumulation of cash on the balance sheet.

Another characteristic to look for when evaluating investments is predictable sales and profits. That makes financial results more stable and predictable.

Should there be high barriers to entry into this business, the firms in this business tend to have wide, defensible moats.

When they are trading at cheap prices, they are usually worth a good look.

Whole life insurance versus Renewable term insurance. The problems with whole life insurance.

Term insurance:

With term insurance all you pay for and get is protection.  If you die, they pay.

Term insurance rates start very low but go up every year.

Whole life insurance:  

With whole life you are buying a tax-sheltered savings plan as well.  Your policy accumulates "cash values."

Whole life rates start high but remain constant.



Insurance salesmen are eager to sell whole-life policies because their commissions are so much higher.

But you would be wiser to buy renewable term insurance and do your saving separately.  (With renewable policy you are assured of continuing coverage even if your health deteriorates.)


The problems with whole life:

• Many policies pay low interest.
• It is impossible for a non-expert to tell a good policy from a bad one.
• There is tremendous penalty for dropping the policy, as many people do, after just a few years.
• Most young families cannot afford the protection they need if they buy whole life.  The same dollars will buy five or six times term insurance.
• In later years, and particularly beyond the age of 50 or 55, term insurance premiums rise rapidly.  But by then you may have a less urgent need for life insurance.  The kids may be grown, the mortgage paid off, the pension benefits vested.  You will still need to build substantial assets for retirement, and to protect your spouse; but there are better ways to save for old age than whole life.   

Ref:  The Only Investment Guide you'll Ever Need  by Andrew Tobias

Read also:

Term Life Insurance is Value for Money

It is easier to make money in some industries than in others.

It is easier to make money in some industries than in others.

Some industries lend themselves to the creation of economic moats more so than others.

These are the industries where you will want ot spend most of your time.

The economics of some industries are superior to others.

You should spend more time learning about attractive industries than unattractive ones.

Every industry has its own unique dynamics and set of jargon.

Some industries (such as financial services ) even have financial statements that look very different from others.

Wade through the different economics of each industry and understand how companies in each industry can create economic moats - which strategies work and how you can identify companies pursuing those strategies.

Here are some areas of the market that are definitely worth more of your time exploring.

• Banks and Financial Services
• Business Services
• Health Care
• Media

These are not the four areas of the market with worthwhile investments.

They are highlighted because they contain so many wide-moat companies.

There are great firms in even the least likely areas of the stock market.

The goal is to help answer a few essential questions:

• How do companies in this industry make money?
• How can they create economic moats:
• What quirks does this industry have that an investor should know about?
• How can you separate successful from unsuccessful firms in each industry?
• What pitfalls should you watch out for?

Over the long haul, a big part of successful investing is building a mental database of companies and industries on which you can draw as the need arises.

That will make you a better investor.

Super-profitable companies with too much cash pile up on the balance sheet. Be proactive.

Company ABC

It has no long-term debt.

Its current ratio is around 4; rather high for a company with no debt to worry about.

It has consistently kept around 15% of total assets in cash.

You must be able to value the business better than Mr. Market to be in this game

In describing the irrationality of the market, Graham uses the metaphor of Mr. Market.

An investor is free to take advantage of Mr. Market, but on no account should the investor fall under his influence.

If someone is not certain that he can value his business far better than Mr. Market can, then he doesn't belong in the game.

As they say in poker, "If you have been in the game 30 minutes and you don't know who the patsy is, you are the patsy."  (Buffett)


Related:

Benjamin Graham's Mr. Market, a stubborn business partner who sometimes offer great deals or very expensive prices.

Businesses with challenging fundamentals - commodity type businesses

Producers of relatively undifferentiated goods in capital intensive businesses must earn inadequate returns except under conditions of tight supply or real shortage.

As long as excess productive capacity exits, prices tend to reflect direct operating costs rather than capital employed. (Buffett)

This means that the prices of finished goods are lower than the full production cost, which should include amortization.

The capital employed not only does not earn a return, but also does not reinstate itself.

After Berkshire Hathaway's textile business closed in 1985, Buffett commented that over the years, there had always been the possibility of making a large capital investment in the textile business that would have resulted in a reduction of variable costs.

Those investment opportunities, if viewed throught the prism of standard return on investment tests, would have brought greater economic gains than if similar investments had been made in other Berkshire businesses (candy and newspapers).

However, the potential benefits from investing in the textile industry were imaginary.

Berkshire's competitors were implementing the same types of capital expenditures, and once a certain proportion of the industry participants had made these investments, the reduced cost base in the industry would have resulted in a reduction in prices.

Considered individually, each company's investments appears to be justified, but viewed collectively, these decisions affected every company and did not benefit the individual players ("just as happens when each person watching a parade decides he can see a little better if he stands on tiptoes").

After each cycle of capital investment, all the companies had more money tied up in the bsiness, but their returns did not improve.

As Buffett's parade revelers rising on tiptoes demonstrate, the managerial decisions of individual participants in uniform industries are intertwined.

Poor judgment by a single manager may lead to future losses for all involved.

"In a business selling a commodity-type product, it is impossible to be a lot smarter than your dumbest competitor."  (Buffett)

If your competitors set prices at a level that is lower than your production costs, then you also must set prices at that level and suffer the losses if you are to remain in business.

"The trick is to have no competitors.  That means having something that distinguishes itself." (Buffett)

While the degree to which it is possible to introduce product differentiation within an industry may change because of technology developments or the evolution of consumer preferences, in many industries differentiation among products may be simply impossible to implement.

A few producers in such industries may consistently do well if they have a wide sustainable cost advantage, but such exceptions are rare or, in many industries, nonexistent.

For the great majority of companies selling "commodity-type" products, persistent overcapacaity without regulated prices (or costs) results in poor profitability.

Overcapacity may eventually self-correct as capacity shrinks or demand expands, but such corrections are often long delyaed, and "when they finally occur, the rebound to prosperity frequently produces a pervasive enthusiasm for expansion that, within a few years, again creates ovecapacity and a new profitless environment."  (Buffett)

The best type of business to own

Businesses with Good Fundamentals - the best type of business to own


The best type of business to own is "one that over an extended period can employ large amounts of incremental capital at very high rates of return."  (Buffett)

In practice, most high-return businesses need relatively little capital.  (Buffett)

While the highest return attainable as a criterion is understandable, how capital intensive is a business is a very important consideration.

Buffett opines that between two "wonderful" busineesss one should choose the least capital intensive.  He admits that it took Charlie Munger and him 25 years to figure this out.  (Buffett).

Warnings for calling your investment long term when they were meant to be short-term

Buffett warns against calling long-term those investments that were meant to be short-term but became long-term because the investors could not achieve the desired results quickly.

Buffett recommends being suspicious of those managers who fail to deliver in the short term and blame it on their long-term focus.

Arguing against market timing

1.  While waiting for the market to fall, it is possible to miss out on growth in companies with good prospects (some ten-baggers made their biggest moves during bad markets).

2.  Following the fashionable trend may lead to serious mistakes in the choice of investment targets.


The market is overvalued when there are no suitable investments at suitable prices.

There is no reason to worry about an overvalued market.

The way you will know when the market is overvalued is when you cannot find a single company that is reasonably priced or that meets your other criteria for investment.  (Lynch and Rothchild, 2000)

Peter Lynch holds the same view as Buffett on market timing.

Lynch doesn't believe in predicting markets, but believes in buying great companies - "especially companies that are undervalued, and/or under-appreciated."

"Things inside humans make them terrible stock market timers.  The unwary investor continually passes in and out of three emotional states:  concern, complacency, and capitulation."

Both investors prefer falling markets.

A good 300 point drop creates some bargains that are the "holy grail of the true stock picker."

The loss of 10 to 30% of  net worth in a market sell-off is of little importance.

Peter Lynch views a correction not as a disaster, but as an opportunity to add to a portfolio at low prices:  

"This is how great fortunes are made over time."