You can read Part 1 of this interview here.
Dev: As a long-term investor, how should one control oneself to not to panic? Also, when should one panic (say, panic to buy more when markets falls a lot)?
John: This just comes from maintaining a discipline about your investment philosophy.
I think it’s helpful to keep in mind that stocks aren’t trading vehicles, but pieces of real businesses. And if you’re buying a business that produces x amount of cash flow, the lower the price, the better.
As Buffett says, whether it’s stocks or socks, we like buying merchandise when it’s marked down.
Dev: I am a conservative investor who focuses a lot more on Return of Capital than on just return on capital. Though every individual’s risk and investing profile is different, do you think that focusing on mistake-reduction is what investors should focus on? Or lets say that just like in the game of Tennis, its best to first work towards reducing unforced errors. Does it help in winning the game of investing too?
John: Absolutely. I think the vast majority of investment mistakes come from “stretching” too far for upside potential at the expense of downside risk.
The tennis analogy is a good one—amateur tennis players win matches not by making the most forehand winners, but by making the fewest mistakes. Just hit the ball over the net. In investing, it’s very difficult to make up for losses. So keeping a relentless focus on preventing losses has always been at the core of my investment approach.
To use one more sports analogy—focus on base hits, not home runs.
Dev: As an investor, hardest thing about investing is to find a balance between 1) riding out periods temporarily unfavorable to your views and 2) realizing your views are wrong and moving on. How should an investor maintain that balance?
John: This varies case by case, but certainly you have to be honest with yourself. If you’ve made a mistake (which all investors do, and will continue to do), you should be honest in your assessment, sell the stock, and move on.
Of course, the market is volatile so sometimes general market conditions take all stocks lower, and this volatility might have nothing to do with the intrinsic value of stocks in your portfolio.
So company specific situations should be differentiated from general market volatility.
Dev: In his book Thinking, Fast and Slow, Daniel Kahneman talks about two approaches to thinking. System-1 (which is fast, instinctive and emotional) and System-2 (which is slow, effortful and calculating). How can an investor make use of these two systems to invest? At the face of it, System-2 seems like a better choice. But are there any market situations, where thinking in System-1 mode can work wonders for long-term investors?
John: I’m not very familiar with Kahneman’s work, although I’m familiar with his ideas you referenced.
I think generally speaking, my style of investing falls very much in category #2. Thinking logically, rationally, and patiently has always been beneficial to me.
Dev: Do you think lack of preparedness is what causes most investors to miss out on wealth creation opportunities in stock markets? (Both mental as well as financial preparedness)
John: I think that has a lot to do with it. But I think the biggest reason investors probably fall short of what they hope to achieve is lack of discipline (selling during downturns, and buying when outlooks are more optimistic). Generally, investors need to do the opposite to do well over time.
For people with full-time jobs and excess earnings, building wealth is a very simple formula.
Spend less than you earn, and invest in a basket of good businesses (or a broad index fund) over long periods of time.
In America especially, earnings of S&P 500 companies will be much higher 10 and 20 years from now, dividends will be two or three times the levels they are now collectively, and stocks will be much higher.
Dollar cost averaging works – as long as you’re not buying into bubble-level valuations (like 2000). Try to buy stocks when they are down, save more than you earn, and you can’t help but become wealthy over a working lifetime.
Dev: How do you manage your own money? Funds? Direct Stocks? How do you go about it?
John: I invest in stocks. Saber’s strategy is to buy well-managed businesses with stable competitive positions, predictable cash flow, and high returns on capital. I try to invest in these high quality compounders when they are priced well below my estimate of their fair value (or the value a private owner would pay for the entire business).
Because of my standard of looking for both high quality and discounted price, I tend to only invest in a small group of stocks at any given time.
I feel that owning a few things that I understand very well is much less risky than owning a lot of things that I don’t know so well.
Dev: What is your advise for those who are just starting their investing journey?
John: Read about value investing – specially Warren Buffett. I think the simple logic of value investing makes intuitive sense, and it works over long periods of time.
I think investors who don’t have time to manage their own money should invest in index funds, or possibly with an investment manager who uses a straightforward value investing approach, but the best way to learn is through practice.
Those who want to learn to manage their own investments should get in the habit of reading a lot. Study Warren Buffett’s letters, and begin reading company annual reports. Knowledge is cumulative, and it’s possible to do well in investing with the right approach combined with the right temperament.
Dev: For most common investors, it’s suggested that they should Dollar-Cost Average through mutual funds. Not trade much in individual stocks. Buy some shares directly here and there. Tell me what is wrong about this that these people fail to understand?
John: I believe this is good advice generally, but I would say that instead of mutual funds, I would prefer most investors using simple, low-cost index funds (ETFs). These are similar to funds in that they are diversified with hundreds of stocks, but different in that they are passively managed (they are designed to match the performance of an index, such as the S&P 500 in the US).
The costs of these index funds are much lower than the cost of actively managed funds. Of course, a good investment manager can outperform the index over time, but these managers are rare and it’s often easier to focus on just putting money into one or two diversified passively managed index funds.
Dollar cost averaging simply means putting more money to work over time, and I think this is a good approach for working people because they are steadily getting more money each month from their paycheck. Some months will be making purchases at higher prices, but some months will be at lower prices.
This mechanical method is helpful because—if one sticks to it—can help you be disciplined when bear markets (and fear of stocks) come around again. That is the time to buy as much as possible.
Dev: As someone who spends his day in midst of financial data and news, how do you filter out what is good and what is not to get to your daily reading list? How to become a good consumer of financial content?
John: I generally stick to my routine. I get up each day at 5am, read the Wall Street Journal (and sometimes a few other papers), and then (after spending an hour helping my family/kids get ready for the day) I begin working on whatever research project I have going on at the current time.
I don’t pay much attention at all to mainstream media (CNBC, Bloomberg, etc…). I spend most of my time reading primary materials (company reports, industry reports, trade magazines, etc…). I also make phone calls to people to learn more about businesses, but most of my time is spent reading. So I pretty much stay away from mainstream business media.
Dev: What is your daily reading list?
John: Wall Street Journal, Economist are daily reads (Economist comes each week, but I read a few articles each day).
I also read NY Times, Financial Timesand a few other papers, but not necessarily daily.
But most of my time is spent reading about companies through books, annual reports, industry research, etc… this varies from day to day, but each day involves a lot of reading.
Dev: 5 quotes that should be framed and put on every investor’s desk?
John:
- There are two rules of investing: #1: Don’t lose money. #2: Don’t forget rule #1. – Warren Buffett
- I will tell you how to become rich: Be fearful when others are greedy, and be greedy when others are fearful. – Warren Buffett
- An investment in knowledge pays the best interest. – Ben Franklin
- Just practice diligently and you will do very well. – Johann Sebastian Bach
- And the one thing that all those winner bettors in the whole history of people who’ve beaten the pari-mutuel system have is quite simple. They bet very seldom. – Charlie Munger
- It’s not given to human beings to have such talent that they can just know everything about everything all the time. But it is given to human beings who work hard at it – who look and sift the world for a mispriced bet – that they can occasionally find one. – Charlie Munger (an extension from the previous quote).
Dev: 5 books that everyone looking to become better investor must read. Atleast one each from domains of building processes, psychology and financial analysis.
John:
- Warren Buffett’s letters (not a book, but must reads. Excellent for developing your investment process as well. Larry Cunningham wrote a book summarizing these letters also)
- The Snowball
- The Intelligent Investor
- Anything by Mark Twain (I don’t read much fiction, but Mark Twain books are excellent, and indirectly have a lot of discussion on general human behavior)
- You Can Be a Stock Market Genius by Joel Greenblatt (bad title, as many have pointed out, but an excellent book on developing a process for special situation investing).
Dev: Lastly, I know this might sound funny, but how to find a company like Google, Apple, Tesla, Berkshire, etc. early on. And more importantly, how to have the conviction to stay with them?
John: This one is tough. We should all be so fortunate to find one of these in a lifetime, but most of us won’t. The good news is, you don’t need to find the next Google or Microsoft to become a very good investor over time.
I’m not sure there is a specific way to describe how one could locate such an investment.
It’s part preparation, paying attention, working very hard, and learning about a variety of companies.
But to find an investment of the kind you mentioned, it’s also part luck – being in the right place at the right time.
If you find such a great business, it takes discipline and foresight to stick with it through periods of seemingly overvaluation and short-term underperformance.
It’s hard to specifically set out to find such an investment. I think focusing on working a specific investment process is a better approach. Look for base hits, and maybe one day you’ll come across a home run idea.
Ben Graham made 20% per year buying bargains, and then happened across GEICO, which made him very wealthy. He had many base hits, and one home run. But the home run wasn’t necessary to produce.
Dev: That’s all from my side John. I thank you for answering my questions. It was wonderful to have you share your insights.
John: Thanks Dev.
