I think, therefore I laugh by John Allen Paulos

The book aims to teach philosophy through parables and jokes. There were only three stories which kind of made me chuckle.

The first one is on a story which shows that two very contradictory conclusions can be drawn from the same story.

There is an ancient story about the sophist philosopher Protagoras who agreed to instruct Euathlus in rhetoric so the latter could practice law. Euathlus in turn agreed to pay Protagoras his fee only after winning his first case. Euathlus, however, chose not to practice law upon completing his training and so Protagoras sued him for fee. Protagoras maintained that he should be paid no matter what. He argued that if he won the case then  he should be paid by the order of the court, while if he lost he should be paid by the terms of his agreement with Euathlus. Euathlus, who had learned something from his study with Protagoras, maintained that he should not pay no matter what. He argued that if he won the case he should not pay by the order of the court and while if he los, he should not pay by the terms of his agreement with Protagoras.

The second is how people tend to find complicated and far reaching rules to save a barely serviceable theory and often they favor a complicated one to simpler ones.

Two subjects A and B are asked to recognize the difference between healthy and sick cells. The experiment set up is as follows. A and B see the same cell – sitting in a different room. Each one can only respond with “Healthy” or “Sick”. There is a green light in each room. Both A and B are told that the light will signal if their answers are correct.

In reality, only A’s response are greeted with the light signal. B’s response are answered by a light signal only when A’s response was correct. Whether B responds “Healthy” or “Sick” has no effect on the light signal that he sees.

Afterward each one of them is asked to propose a theory of healthy cells. A’s theory is simple, concrete and generally straightforward; while B’s ideas are long winding, elaborate and quite complex. Both of them listen to each other’s theories and A is impressed by B’s theory; so much so that he does much worse in the next trial.

The third story shows the limits of observational science.

A scientist has two jars before him. One is full of fleas and the other is empty. He puts both jars on a table and then one by one picks a flea up from the jar, puts him on the table and shouts “jump”. At this point the flea jumps into the empty jar. This goes on until the empty jar is full of fleas and the other is empty. Now he takes the fleas out one by one again. He removes their back legs, puts them on the table and shouts “jump”. No flea jumps into the empty jar. The scientist concludes – a flea when his back legs are pulled off, cannot hear !

If you liked the stories and have no idea about logic and philosophy – this may provide you a lite reading material. Otherwise, the book is quite avoidable.

Monthly update: Mar 2013

This month was marked by a significant increase in the value of my portfolio. The reasons were twofold – a) I put in an additional Sfr 20,121 in my account, and b) the market continued to climb up; pulling my portfolio along.

Dell as well as HP kept their upward march – I hold significant positions in both. Meanwhile, ArcelorMittal, France Telecom, E.On, Banco Santander, Alcoa and CAF gave me opportunities to add to my position. I also sold a put option on National Oilwell Varco (NOV). I am willing to pay $60 or less for the shares but not more. As the stock remains nearly 10% above my buy price – I will wait it out.

Here is the list of trades I made.

CAF.MC +3@€293
FTE +60@$10.02
MT +100@$13.61, 50@$12.99
SAN +48@$6.61
E.On +50@€12.725
AA 17Jan15 $5 Call +2@$3.75
MT 17Jan15 $8 Call +1@$6.45, +1@$5.75
MT 18Jan14 $15 Put -1@$3
MT 17Jan14 $13 Put -1@$2.44
NOV 17Jan15 $57.5 Put -1@$7.35

CLOSED POSITIONS
AMAT 18JAN14 10.0 Call Sold 3 at a profit of $744.84
HPQ 18JAN14 10.0 Call Sold 1 at a profit of $277.85

All in all – I took quite a few long positions. Given that the market is climbing new peaks every few days; I am surprised at my activity. I take heart in the fact that the stocks I am buying are selling for their multi-year lows.

Dividend = Sfr 183.75 (Roche) + $11.25 (INTC) + $5 (BAC) = $209.51
Witholding tax = $70.22
Transaction tax = $1.2
Fee = $10 +$5 (CFD)
Interest paid = $31.53
Realised profit = $1022.69

Profit = 1022.69-47.73 (charges)+139.39 (dividend) = $1,114.55

I have updated my performance page.

Superfreakonomics

by Steven Levitt and Stephen Dubner

Decidedly weaker than Freakonomics and by a large margin.

Freakonomics looked into the idea that economics can be thought of as a “study of incentives”. Furthermore, it also argued that even small/hard to notice and obvious changes can have unintended consequences.

Superfreakonomics, on the other hand, brings nothing new on the table. The second chapter which talks about patterns and details (hockey players having mostly born in Jan, Muslim children being weaker if born in the month of May) was already quite well covered in Freakonomics. The global warming chapter, the chapter on prostitutes and how pimps offer more value for prostitutes than real estate agents, the chapter on unintended consequences and altruisms – were all interesting but nothing in them offered a new view point or idea which was not already covered in Freakonomics. Plus I felt that the global warming, altruism and murder of Kitty Genovese decidedly lacked facts and were very heavy on conjectures.

My recommendation is to study Freakonomics and read Superfreakonomics.

Predictably irrational by Dan Ariely

Dan Ariely is a fantastic researcher. To test his theories or discover new ones he (with his collaborators) came up with quite interesting experiments. Some of them are highly intelligent and the excitement he feels while doing them is palpable from the text. The idea of the book is to break the assumption that we are rational beings *all the time*. Most of the early economics assumes that humans are rational and will behave in the rational way – given the conditions as they are. But with experiments Ariely argues that we are irrational and in a predictable sort of way. Each of us, given a certain situation – will behave similarly. For example – we will walk 10 mins to a new shop if we are getting a 50% discount on a $14 pen but we will not walk the same 10 mins if we are getting a $7 saving on a $480 suit. Rationality on the other hand says that it does not matter if the product costs $4 or $400, the only question we need to ask is – is walking 10 mins is worth $7 for us or not ? The book is filled with examples in social norms vs market norms (lawyers will help people pro bono but will not help them by giving them a huge discount), influence of arousals (we behave differently when aroused or emotionally charged), procrastination (and how to avoid it), overvaluing what we own, keeping our options open even when they make no sense, effect of expectations (if you want to like something, you will), dishonesty and the power of price and its perceived effect on value (we think highly of things which are overpriced). Overall, a very good book. At times though the book goes into explanations and conjectures which I don’t really like. Conjectures when put into practice more often then not lead to unintended consequences and most of the time they simply don’t work. The chapter on zero price is also quite week. The arguments there are not very well thought of and coming so early on the book – it had a negative influence on my perception of the quality of the book. I would still highly recommend it.

How to win friends and influence people by Dale Carnegie

This was almost a perfect book. The teachings come from someone who has spent a lot of time thinking and interacting with people. Dale Carnegie was one of the major influences on Warren Buffett, who was afraid of public speaking when he was young. The book tells you a few rules to keep in mind if you want to leave a good impression: remember the name, smile, try to be genuinely interested in the people you are conversing with, listen to them, talk in terms of their need and interests, do not argue, and if you must – criticise yourself before criticising someone else. These are timeless teachings and practicing them will help even a great salesman. I was surprised  that a self help book could affect me so.

Rate of return

I have been saving money since 2009. The following table lists the amount of money I have saved in a particular fiscal year.

Year Savings (in CHF)
2009 5,000
2010 20,000
2011 25,000
2012 25,000

Calculating the rate of return in such cases has complications. I have then decided to simplify things. I will assume that the money saved in a particular fiscal year is only invested at the beginning of the next year. This way on Jan 1, 2012, the 5,000 saved in 2009 had 3 years to appreciate while the 25,000 in 2011 had only one. If we assume the rate of return to be x then on Jan 1, 2012 my account will have

5*(1+x)^3+20*(1+x)^2+25*(1+x)

Looking at the portfolio I found that as of today (Mar 21, 2013) it is worth 6,000 more than the total money I have put in.

Solving for x gives me a compounded rate of return i.e., x = 7.3%.

Nothing great and much below my goal of 20% rate of return. But given that I made some major mistakes in 2009, 2010 and 2011 … I am happy that I have been able to beat the savings account in Switzerland (1.5% at most) by a wide margin.

Investment philosophy

As the name of the blog suggests, I am interested in absolute performance – not relative. So, I am not going to try to beat the S&P or Dow. Instead, my goal will be an absolute return.

My absolute return goal is: 20%. I am not going to achieve this every year, but over long stretches of time, say 5 years or so.

It is very important to understand how I am going to generate such a return. Here are the rules I select my investments with:

Financial Strength: A very good balance sheet. I look at litigation risk, interest cover, pension liabilities and most importantly Net Debt should not be larger than 3 times EBITDA.

Management: The company should run by reasonable and honest management. I look at management’s compensation practices, their contract when leaving the business, as well as write offs. Write offs suggest that the management has made mistakes in allocating capital. Ideally, I would like the board to be run by the owner family with skin in the game or a management with large holding of the company stock.

Competitive Advantage: I try to ascertain what the sustainable competitive advantage of the business are. This is akin to finding out the depth of the moat. A good question to ask is: Is the business going to be around in 10 years ? Furthermore, I also like to ascertain the risk of regulation of the industry.

Price, Margin of safety and circle of competence: I should be able to come up with a reasonable estimate of the price of the company. Given the estimate, I would like to have a large margin of safety. If its a great business with a huge moat than the margin of safety can be smaller. But I generally target for something between 30%-50%. I will not buy anything with a smaller margin of safety than 30%.

Confidence: An important aspect of value investing is patience. If the people around you are panicking then there is only one way you can maintain your composure: a confidence in your analysis. A very good test of confidence is asking following two questions before you buy a stock 1. Will you buy more if the stock price drops by 50% tomorrow ? and, 2. Will you be comfortable in putting 25% of your portfolio in this one stock ?

Some of the stocks I have do not qualify one some of the requirements I describe above. These were bought in the early years of my investments and they were undervalued enough that I have kept on holding them. The situation should change as my portfolio recovers from those early mistakes.