Invest Like a Guru: How to Generate Higher Returns at Reduced Risk with Value Investing, by Charlie Tian

The author is a physics PhD who was a novice investor and got burned in the tech bubble in the early 2000s. He vowed to learn about investing, studying the greats: Warren Buffet, Peter Lynch, Don Yacktman, etc., and eventually founded the website GuruFocus. He claims to write the book to share his investment wisdom with his children. His strategy is an amalgamation of his favorite gurus—simply, buy quality companies at cheap prices. I think he makes a clear and convincing case, using a combination of historical analyses, company stories, and his gurus’ sound advice. I found the book relatable, approachable, and instructive, and I think a diligent and moderately experienced individual investor can follow his advice. I will incorporate many of the general points laid out in the book for my factor investing strategy, namely in profitability, safety, cheapness, and business/ management evaluation. One off-putting quibble I have is that the author too often touts the capabilities of his website. 

  • Peter Lynch
    • Focus on earning: “the earnings waggle the wiggle.”
    • Avoid debt: “a company with no debt can’t go bankrupt.”
    • Simple businesses: “go for a business that any idiot can run—because sooner or later any idiot will probably be running it.”
  • Warren Buffett
    • Prefer good business to a good price: “it’s far better to buy a wonderful company at a fair price than a fair company at a wonderful price.” “Our favorite holding period is forever.”
    • Competitive advantage: moat and margins (high and growing)
    • Asset-light: low CapExand high ROIC 
    • Diversification: if you’re a “know-something” investor, don’t “de-worsify”. Concentrate in 5-10 stocks.
    • Continued learning: “read 500 pages a day. That’s how knowledge builds up, like compound interest.”
  • Donald Yacktman
    • Good businesses that are not cyclical: short customer repurchase cycles yet long product cycles. Ex: toothpaste.
    • Good management actions: business reinvestment, share buyback, debt payback, dividend payout, reasonable compensation
    • Hurdle rate: Forward Rate of Return
  • Deep Value investing:
    • Increasingly conservative liquidation value: Tangible Book Value > NCAV > Net-Net Working Capital > Net Cash.
    • Companies are generally poorly run. Time is the enemy: value erodes and new problems pop up. Ex: Sears.
    • Strategy of buying “cigar butts” at <66% of NCAV worked well for Ben Graham, but the strategy nowadays has largely been arbitraged. Unless during a market panic/ crash, deep bargains have dried up.
  • Buy only “good” companies: businesses that can continue to grow value over time.
    • Advantages: timing not critical, can hold forever, tax-efficient, less risk, less headaches 
    • Consistently profitable: demonstrated earning power for 7+ years (full business cycle); low debt
    • Asset-light: low CapExleads to higher ROIC and ROE 
    • Growing: generally reflects strong competitive position
    • Steady future: moat in unexciting business with little change in products or industry dynamics
    • Simple: “can be run by any idiot”; economics dependent on the business rather than management
  • “Good” companies are typically more conservative than Lynch’s investment universe:
    • Asset Plays: avoid, time sinks
    • Turnarounds: generally avoid; distinguish between a localized problem and a fundamental change
    • Cyclicals: generally avoid; inconsistent and difficult to hold long term; Materials and Energy: commoditized products with little pricing power
    • Slow Growers: if cheap, good for portfolio ballast and income
    • Stalwarts (moderate Growers): best choice; monitor for any change in business/ industry dynamics
    • Fast Growers: high potential but risky; typically expensive with little performance history
  • Sectors:
    • Consumer Staples and Healthcare: except retail businesses, consistent quality companies usually found here
    • Tech: software can be sticky business but largely risky; hardware tends to be capital-intensive and constantly changing; 
    • Biotech are lottery stocks with average poor performance
    • Banking: avoid large banks, typically complex and highly leveraged
  • In steady bull markets, opportunities are rare. Be prepared to act contrarian in turbulent markets. 
    • Broad market panic: during recessions or when market collapsed (e.g. Black Monday, tech bubble, September 11); investors capitulate and sell indiscriminately; easiest time to buy good companies 
    • Industry distress: a specific segment of the market is out of favor (e.g. energy in 2017); time to look in that sector
  • To instill discipline, like Walter Schloss, Philip Fisher, and Peter Lynch, investors should utilize checklists. Quantitative and qualitative criteria for the business/ industry, profitability, growth, financial strength, valuation, and management signals. Also look for Warning signs (distress scores, capital issuance, accounts receivable inefficiency, short selling) and Positive signs (share buyback, raising dividends, debt paydown).
  • Don’t buy ‘wrong’ companies: promising young company in exciting transformative industry; company with one hot product growing too fast; seller of commodity products in a competitive industry; industry facing regulatory changes; serial acquirers; value traps.
  • Avoid options, margins, and shorts. These instruments have time working against you. “Markets can remain irrational a lot longer than you can remain solvent.” —Keynes
  • Keep it simple. Buffett: in investments, you don’t get rewarded more for more difficult moves like in gymnastics. He has three categories: “yes”, “no”, and “too hard”. Most ideas fall in the “too hard” category.
  • Valuation approaches:
    1. Value Ratios:
      • P/E: Can be used across industries. Beware cyclical businesses (use normalized earnings) and non-recurring items (e.g. one-time sales or write-offs).
      • P/S:  best for cyclical businesses and for historical comparisons. Bad for commodity producers, which are highly dependent on cyclical commodity prices.
      • P/B: best for asset-heavy businesses whose earnings are derived from tangible assets. Good for financials, which are marked to market. Bad for asset-light businesses.
      • P/FCF: theoretically sound but earnings is smoother than FCF and more correlated to stock price
    2. Intrinsic value:
      • Discounted cash flows: sensitive to assumptions in growth rates, discount rates, and terminal value; only usable on companies with consistent earnings. Use as a rough estimate only.
      • Peter Lynch Fair Value = (roughly) company’s earnings growth rate
  • Rate of return: can be compared to other assets, like bonds, real estate, etc. 
    • EBIT/EV: theoretically sound but ignores interest and taxes, which are valid costs
    • Forward Rate of Return = Normalized FCF + FCF Growth Rate
  • Market valuation principles: 
    • o Markets go up over the long term: though in the shorter term they can go down or sideways. “Buy when there is blood in the streets, even if the blood is your own.” 
    • o Markets are cyclical: driven by economic cycles and investor emotions 
    • o Higher market valuations lead to lower future returns: currently (circa 2017) Shiller CAPE and Buffett Total Market Cap / GNP indicate highly overvalued markets

Finished: 31-Mar-2019. Rating: 7/10.