Some quick thoughts on the books I’ve read recently.
1. Netherland, by Joseph O’Neill. Truly an excellent novel. The back of the book quotes Michiko Kakutani of The New York Times describing it as having “echoes of The Great Gatsby” and “stunning.” I agree. It’s an exceptionally told story of a 30-something man who works for a firm that can only be Morgan Stanley in New York (referred to in the book as “M———–”) going through a difficult relationship transition and the ensuing what-does-it-all-mean reflection. It was suggested to me by a friend who knew I used to work at Morgan Stanley in New York and had “transitions” of my own to deal with. Much of the story is about the hodge podge of other immigrants the protagonist meets while playing cricket and defining one’s identity in a foreign, but familiar enough, country. There’s an ostensible background of New York in the days after September 11, but to me, it was more of a plot mechanism than a central theme.
One great excerpt comes about in our protagonist’s explanation of his lack of excitement around meeting a new woman: “No, it was simply that I was uninterested in making, as I saw it, a Xerox of some old emotional state. I was in my mid-thirties, with a marriage more or less behind me. I was no longer vulnerable to curiosity’s enormous momentum.”
It’s wonderful and one of the best novels I’ve read in years.
2. The Drunkard’s Walk, by Leonard Mlodinow. One of my favorite classes at Berkeley, and not coincidentally the class I did the best in, was statistics. The beauty about statistics is that it’s based on logic — it hones one’s thinking. Yet, even in a quantitative field like finance, only slim portions of statistics are ever used, even if those portions are used over and over again. I thought Drunkard’s Walk would freshen up my memory on things like the equation for a permutation, and while I was disappointed in meeting this goal, it was a fun read. It’s a book that’s clearly trying to fit in the box of “pop science” that publishers must be pushing science professors into these days. Mlodinow doesn’t quite have the Gladwell-esque aplomb to pull off the “pop” portion of the moniker, which causes a few cringes.
The most memorable, and the most educational, part of the book comes when the author receives a diagnosis from a doctor that he has tested positive for HIV and that there’s a 99.9% chance he has it. The HIV test only produces a false positive in only 1 out of 1,000 samples. Yikes. Most people, including his doctor, would conclude that if someone tests positive on this test, there’s a 999 out of 1,000 chance that the person has HIV. But that’s wrong. The rate of false positives is not the same thing as the percent chance that it’s correct for a given person. Mlodinow, being a straight non-IV-drug-user, was in a demographic where the chances of him having HIV was only 1 in 10,000. The rate of the test being wrong was 10 times the chances of him having HIV. In other words, of 10,000 straight, non-heroin-using males who took the HIV test, 10 of those people tested positive. Only one actually had HIV. It wasn’t Mlodinow.
3. Supreme Conflict, by Jan Crawford Greenburg. Despite the decline of journalism, the media reveals quite a bit of the decision-making process of Congress and the White House. There is not the same level of scrutiny of the Supreme Court; the press closely follows the result of the decisions, not how the Court arrived at them. Greenburg does a great investigative reporting job on the back story to the appointments to the Supreme Court over the past 20 years, with more detail on the recent Bush II appointments. It’s also an interesting insight into how groups make decisions.
4. Alchemy of Finance, by George Soros. Alchemy of Finance is supposed to be Soros’s opus on how he invests. He dedicates the first portion of the book to his idea of “reflexivity,” an intriguing idea: There is a difference between the reality of a situation and people’s perception of that reality. The difference can then cause the original reality to change. A rumor about a bank being insolvent can cause a run on a bank, which will then cause it to be insolvent, even if it was healthy to begin with.
Unfortunately, his discourse on reflexivity is the only interesting part of the book. His writing style is spasmodic and sort of like a more erudite Nassim Taleb. He takes readers along for anecdotal stories about his trading wins, but fails to create a framework for thinking about investing. His greatest strength seems to be the ability to know when he’s wrong quickly. Explaining his strengths to others is not a strength, which is possibly a type of reflexivity.
5. One Up on Wall Street, by Peter Lynch. Speaking of mediocre investment books, there’s Peter Lynch’s One Up on Wall Street. Some consider Lynch to be in the canon of great American investors of the last century, and his returns imply it, though he doesn’t have the longevity of the true greats. Through the book, we see that Lynch’s core talent was the ability to find young companies on the verge of non-obvious growth. He ignored obvious-growth, but bad-economics, companies like computer components, and would instead find steadily growing companies with good economics before they saturated the market. Unfortunately, Lynch isn’t capable of even articulating that eloquently and instead drags the reader through boring anecdotes couched in artificially peppy prose. In one bizarre passage (bizarre because Lynch is a professional investor and is so wildly and obviously wrong), he claims that the ratio of a companies’ price-to-earnings should equal its growth rate. This implies that a company growing at 1% a year is only worth 1x earnings. I’ll buy those from Peter all day.
6. Pioneering Portfolio Management, by David Swenson. After a streak of poor investing books, it was nice to be saved by Yale CIO David Swenson. He’s one of the clearest thinkers in asset management. It’s a great book for those interested in the field, and it’s become the seminal book on how to run an endowment. His writing style is professorially didactic, but his superpower is his reasoning, not his prose. He’s an independent thinker without being intentionally iconoclastic. He acknowledges that there are degrees of efficiency across different markets — most people in finance fall into binary camps — and he also believes that corporate debt shouldn’t be a core asset class since the risk-return ratio is not as attractive as risk-free US Treasuries and higher return equities. Curiously, Swenson never fully addresses how to determine asset allocation percentages. He’s at his best when deconstructing asset classes and providing a framework of what to look for in an investment manager, particularly delineating the conflicts (and alignments) of interest.
1 response so far ↓
Taunter // June 26, 2009 at 4:51 am |
I would prefer to get paid to take a company with (1%) earnings growth…
Lynch’s focus on PEG has had such an enormous effect on the industry that it is hard to tell cause from effect anymore. Look through consensus EPS “long-term growth” numbers and you will find something rather strange: just about all firms are expected to deliver 12-15% EPS growth.
This is rather strange. The long-term return from American equities is somewhere between 8% and 12%, depending on which years you use (the fact that the variance is so high depending on specific endpoints of a ninety year sample should say something about inherent risk of equity). That is less than what analysts think of individual companies, which would lead to the strange conclusion that P/E ratios should be declining, when quite the opposite is actually true.
Analysts dramatically overstate earnings growth estimates, and I can’t help but wonder if one of the reasons is that they believe Lynch’s identity theorem. If a company is trading at 15x, there is a powerful bias to think the company SHOULD grow at 15%, and to go from there to the assumption that it MUST grow at 15%. And companies are all too happy to oblige by cooking the books to deliver 15% for several years, taking an “extraordinary” charge every so often to reset the baseline.
The value of a stream of growing cash flows is the cash flow divided by (discount rate less growth rate). As the growth rate converges on the discount rate, the value grows without bound. Lynch is trying to posit a world in which a company can indefinitely grow (he is envisioning a world in which the growth rate is GREATER than the discount rate). It doesn’t make a lot of sense.
I would suggest the more intellectually honest question is how long – and by how much – a company will earn excess returns before time and the market catch up. That’s the value an investor is trying to capture, and it is unlikely to lend itself to a pithy formula.