Investment books I have read

A reader  recently asked me for a list of books that I’d recommend for other investors. Flattered that anyone would care what I though, I’ve decided to do a post on that very subject, and here it is. This is a list of the books and studies that have most influenced my thinking so far, both positively and negatively.

Secrets for Profit in Bull and Bear Markets (Stan Weinstein)

This is a book about technical analysis. I spent a short while trying to apply technical techniques and failed miserably. Of course this means I now think this approach is of no value.

How to Make Money in Stocks (William O’Neil)

Covers both technical and fundamental analysis, including things like earnings, new products, management, growth, that sort of thing. It also covers technical strategies to help time your purchase, like “buy on a new high from a properly formed base”. I tried this approach for a while but found the chart aspects too ambiguous and too much work.

Various books by Jim Rogers of the Quantum Fund

I got into macro economic predictions for a while, playing the game that almost everybody else plays (which is why it’s such a bad game to get into). It didn’t take me long to see that this was either a game for short term traders or for people who wanted to bet on decade long themes… neither of which was me.

The Intelligent Asset Allocator (William Bernstein)

This book is awesome (dude). Just about everything I know now is down to this book. It very clearly lays out the ideas behind Modern Portfolio Theory and easily sold me on it since it requires almost no effort to apply. After reading this I adjusted my portfolio to a split between US, UK, European and Japanese index trackers and I think a bond tracker too. I’m still on the side of the efficient market to a large extent, certainly for people who don’t have an interest in stock picking. However, this book also covers bubbles in history and how markets may be predictable. It also talks about how value investing has the best long term results, how good companies are usually bad investments and bad companies are usually good investments.

The Intelligent Investor (Benjamin Graham)

I was moved to by this book because it is mentioned in The Intelligent Asset Allocator. This is my favorite investing book so far. It clearly demonstrates how the market swings from one extreme to another, extrapolating the last year’s earnings off into the distant future instead of taking them as part and parcel of any normal business cycle. I have the 1946 version and will at some point get the newest version to see what the differences are.

What Has Worked in Investing (Tweedy Browne)

This booklet is largely responsible for my current approach to value investing. The studies go over and over the idea that portfolios made up of low PE or low PB small companies are the best performers. It talks about debt levels (lower is often better) and past earnings growth (the more past earnings growth the less there is likely to be in the future and vice versa). It is a very compelling read if you like academic studies that are tested in the real world.

Time and The Payoff to Value Investing (Rousseau, Rensburg)

This study looks at high and low PE portfolios held over various time periods. “The conclusion is that on an annualised basis the returns to value portfolios become noticeably higher at time horizons extended beyond 12 months”. In other words, value investors can take advantage of the short time horizon of the average investor by taking a longer view.

Corporate Turnaround (Stuart Slatter)

I guess by this point I’d invested in Ennstone and watched it crash into the ground like a dart. So understandably I became interested in what killed companies, what sort of thing you’d do to turn a company around and what sort of thing a turnaround specialist would be looking for in a company before he decided if it was doable or not. From my point of view this is important as I’m looking to invest in struggling companies which can quite often be classed as borderline turnarounds.

Financial Control (David Irwin)

This is a book for someone running a small business or doing the books for a small business (which I had recently become). I found it useful for learning about some accounting ratios, specifically balance sheet ratios like quick, current, credit and debt turnover rates, how long a company can survive without sales etc.

Testing Benjamin Graham’s Net Current Asset Value Strategy in London (Xiao, Arnold)

This is another study of low PB stocks, but in this case specifically the classic net-net Graham stocks. The results are compelling and motivating and possibly astounding. If you have the guts to invest all of your capital in perhaps less than 5 companies (see 1997), all of which are basket cases, then you are welcome to the excess returns and you’re a more brave than I.

Saying that, I still would like to set up a portfolio based on net-net stocks, but I’d mitigate the extreme risk by holding a portion in cash depending on the value of the overall market. That way when the market is cheap and there are more net-nets around you are more diversified and need less cash, but when the market is expensive and net-nets can be counted on one hand, you hold a lot of cash so even if they all blow up you aren’t burned too badly.

The Superinvestors of Graham-and-Doddsville (Warren Buffett)

A well written set of arguments against the efficient market and in favour of value investors (of course).

Wall Street Revalued (Andrew Smithers)

This book, along with The Intelligent Asset Allocator, is where I really formed my current ideas on the timing and valuation of markets. Smithers shows, as others have done, that sensible measures of value do exist for markets. It is therefore possible to say something about whether a market is over or under priced and by how much, at least relative to historic norms. This allows you to estimate expected future returns based on history and produce some nice bell curves. In the future you can compare these with the return distribution predicted by the standard model (a distribution that does not change over time as far as I’m aware, or at least does not change with market value) and see who was right.

The Snowball (Alice Schroeder)

Not really an investing book but it’s still a great read if you’re interested in Buffett and has a lot of ideas about investing and perhaps most importantly to me, the idea of building your snowball as early and as fast as you can. The most important factor in personal investing, orders of magnitude more important than investing style, is to start saving more money earlier, the more and the earlier the better.

Value Investing : The Use of Historical Financial Statement Information to Separate Winners From Losers (Piotroski)

Richard Beddard is a big user of the F-score (the subject of this paper) and it does seem to have some merit. I have started to integrate this into my screens and am also going to watch my current holdings to see if there is any evidence that high F-score companies turn around quicker than low F-score companies.

Determining Value (Richard Barker)

Finally, my chosen approach doesn’t really pay too much attention to things like discounted cash flows or dividend growth models etc. So I’m working through this book to gain a better perspective of how more mainstream value investors do their work and come up with their values. That way I’ll be able to have a more meaningful conversation with them and perhaps it will add to my understanding of value.

Well that’s one man’s journey from indexer to deep value, feel free to outline some other books that you’ve found useful in shaping your investing worldview.

Patience is required

Investing can be a bit like religion in that it requires a good dose of faith.  When you buy into a company it could be years before you get any feedback on whether it was a good idea or not.  In the mean time you just have to kneel before a picture of Ben Graham and say “I believe” before you go to bed each night.  The same goes for the portfolio as a whole where you might under perform a simple stock/bond split for what seems like an eternity. 

As well as faith and patience, it also helps if you get your kicks somewhere other than the stock market.  Or, if you really want to get your kicks from your investments then perhaps take up day trading.  Put bluntly, the market can move sideways longer than you can stand the inaction (see 2010 for a good example).

Value investing as I practice it seems to sit rather uncomfortably in the middle of the active/passive continuum.  At one end you have passive indexing, where you don’t do anything at all for huge stretches of time and frankly don’t give a damn.  Once a year or so you get out of bed and rebalance and that’s about it.  At the other end you have day trading, or variations thereof.  Here you get to trade a lot, every day.  If you close your positions at the end of the day you see your realised profit and loss each day which is a nice time scale for feedback.  

The old school value investor has neither of these pleasures.  You just get to sit and watch, in my case once a week, watching the prices go up and down and up and down again.  Occasionally a dividend drops in which livens things up a bit.  Months may tick by (in the last year I’ve bought into four new companies) in which nothing happens.  Your faith will be tested by the grinding inactivity of it all and only the patient will stick with the game plan.

Value investing is not hard.  It is not complicated.  It is out there for all to see and should have long ago been vaporised by the efficient market.  But it is beyond dull for most people and that dullness is an effective barrier to entry.  That barrier is high enough to require a premium before anyone will do it, so in one sense the value premium is a dullness premium.  Remember the employees of Graham and Dodd, in their grey coats with stacks of forms, filling out a form for each company, checking to see if the numbers met their criteria?  That is the definition of boring to me.  

And to put the boot in one more time, Gordon Gekko was not a value investor, the masters of the universe were not value investors, nor the dot com venture capital crowd.  Value investing has a you-are-not-cool premium too.

I can’t do much about coolness, but to combat the dullness I’ve tried looking at value investing like a very slow game of chess with a certain Mr Market.  The moves come perhaps only once every quarter, the outcome is uncertain, but seeing the process as a game definitely helps to gets me in the right frame of mind.  More importantly, it keeps me in the game.

Bought and Sold

Nothing whatsoever, which is precisely the point of this post.


J Smart paid out a small dividend which brings the realised gains from that company to 3.5%, or 4.6% annualised.  Titon, now my largest holding by market value, paid out yet another dividend, taking realised returns to 8.5% or 4.6% annualised.  So although this was a down month for the market values of both the FTSE100 and my portfolio, my book value still went up very slightly, which to me is the most important thing.

FTSE 100 value

Today the FTSE 100 stands at 4916.  My rather patchy data puts the current 10 year real PE at 12, Richard Beddard thinks it’s 14 (although I think that’s nominal rather than real), which is close enough for me.  I’m currently estimating the long term average real PE10 as 13.8 (an amalgamation of various sources) so we are slightly on the cheap side.  On this basis I would allocate 75/25 to UK stocks/bonds in an ETF portfolio, using my asset allocation method that I’ve written about previously.

House prices

I think prices are likely to end up between 3 and 4 times average earnings.  Anything over 5x is crazy.  We are currently at about 5.5, which means I won’t be buying again any time soon.

Charts and tables

I’ve updated the current holdings, trade history and benchmark pages with the latest data, feel free to browse around.

Building Asset Value

I thought I’d say a little something about how I decide to buy and sell companies, and what my rationale is behind each trade. There is some discretion involved, but not much, and this is certainly a fair summary of what I do.

Let’s say I start with £1000 in cash.  I look for a company where I can pay £1000 for something worth at least £1,500. ‘Worth’ is a slippery term, but to me it means shareholder equity or book value, and I prefer tangible real assets to intangible assets. I realise that book value isn’t always the actual net value of the company assets, what with ‘cooking the books’ and all. However, I don’t have the time or interest in digging out all the details so I imagine that the good and bad net each other out. To be on the safe side I use a wide margin of safety.

So I head out into the market and find some companies where I can buy a pound fifty of book value for a pound. These companies are typically quite sick, often making losses, often unloved by almost everybody. Because they are often losing money they need to be able to weather their current problems. They need a bomb-proof balance sheet, or as near as can be. Typically this means they don’t have a lot of debt and have at least fair liquidity.Debt is often what gets a company killed. If the banks refuse to lend to a company which is dependent on debt it’s game over and the companies I buy are not top of many banks lend-to lists.  Debt can be measured in many ways, but I tend to use net gearing, which is gearing based on net debt, which is interest bearing debt minus cash and equivalents. What exactly is low debt is debatable and I don’t have a hard rule, but certainly less than 100% of tangible equity.

Once I have added a nice cheap strong company to my portfolio I only check on it’s market value once a week. Each week I take a quick look to see if the market value has reached the book value. The answer is usually no. It’s usually no for many months if not longer. Sometimes there will be a dividend, for which I am truly grateful, but these aren’t that common since many of my holdings are loss making. Something has to happen to move the market price, so I sit and wait for something to happen. Alba was a good example of this. They sold the Alba name to Argos and de-listed down to the AIM. They completely restructured the business getting rid of all sorts of non-core bits and that was enough to make Mr Market happy. The share price shot up and I got out.

And talking of getting out, if I can sell a company and turn its book value into cold hard cash then I will. Once the market price equals the book price I see no sense in hanging on. During my holding period the original £1,000 has turned into £1,500, perhaps with some small dividend paid out in the year or three I had to wait. Now I have £1,500 cash in my hands, so I go right back to the market looking for that pound fifty on sale for a pound, or in this case £2,250, at which point it all begins again.

As you can see, the focus is always very much on building up the total book value of my holdings.  Of course, it isn’t always a happy ending. Sometimes the managers manage to burn a big chunk of my book value up. Sometimes I wake up and the new annual report says my company is worth 30% less than it was yesterday and suddenly the market price is above book value. It might even be worth less than I paid for it. From here there are two courses of action. I can ignore the paper loss, turn a blind eye and say “I will only sell if I have a gain”. But this is not logically consistent. It smacks of making up the rules as you go along and one of the keys to investing I think is to make up the rules and then stick to them! So what I should do – and have done so far on the one occasion it’s happened – is to sell at a loss, try to work out where it all went wrong, swear at the management and start looking for the next unloved but robust company to back.

Holding Periods

After reading a post on The Div-Net, I started to think about how I differ from dividend investors and why.  The first point to make is that I’m not a dividend investor, in fact I consider myself a trader rather than an investor.  An investor to me is someone who buys something with no explicit intention to sell it.  This typically means they are either buying it for the income (dividend investors, landlords, Warren Buffett etc) or perhaps they are buying it to let the capital appreciate for decades or to let the kids inherit.

So why would I trade rather than invest?  Well, there is some evidence that the returns are better if it’s done properly (which I’ll try to cover at some point), and more importantly it’s a better fit with my personality.

Since I’m buying with the intention to sell, how long do I expect to hold my stock?
It usually doesn’t take long for someone reading up on value investing to realise that it’s usually a long term game.  As Ben Graham said in The Intelligent Investor:

The fact that both the favorable and unfavorable situations are part of any normal long-term picture (and as a consequence both should be accepted without undue excitement) is evidently not part of the stock market’s philosophy.  The latter seems to be grounded on the feeling that, since nothing is really permanemt, it is logical enough to treat the temporary as if it were going to be parmanent – even though we know it is not.

So the stock market’s view is short-term, the next few quarters or perhaps a year.  Current earnings are bad, a new competitor has arrived, the CEO has quit, etc etc.  Mr Market is depressed about the company and wants to get shot of it now since it is unlikely to produce a good return, and may even go down further, in the next six to twelve months.  The intelligent investor steps in, happy to buy such a ‘poor’ investment.  How long will it be before things start looking up and Mr Market is knocking on our door offering a fair price for the company?

One study that does much to show how value shares outperform over a longer time horizon, but perhaps even more importantly, that they do not usually outperform over short time horizons and may even underperform in the months after your purchase, is Time and the Payoff to Value Investing.  This study of South African value stocks splits the market by current P/E (a poor but easy to use measure of value) and holds the various portfolios for periods from six to thirty months.

The graphs clearly show how there is no meaningful difference in performance between the high and low P/E stocks within a six month timeframe.  But by eighteen months the expected returns of low P/E stocks are clearly better.  Their Figure 2 shows how the lowest 10% of stocks by P/E, over a 30 month period, outperform the average of their sample on an annualised basis by about 20%.  That’s 20% annualised outperformance.  Of course the standard deviation is higher but I (like many Grahamites) don’t use that as a measure of risk; perhaps the subject of another post.

Looking at my own Trade History, my average holding period has been 199 days.  Somewhat shorter than a year, but that’s probably largely to do with the huge bounce in FTSE shares since March 2009.  On top of that I’m still holding several companies which I bought in late 2008, where the holding period is now approaching eighteen months.

So next time I buy into a company, only to see if fall, and fall, for months on end, and then for it to flounder somewhere slightly below where I bought it for a year or more, I can look back at this article to assure myself that the odds are on my side and to quit worrying.  That’s the theory at least.

Statistical Investing

I recently read “Painting by Numbers – An Ode to Quan” by James Montier and Dresner Klienwort via a link from Richard Beddard to Greenbackd.  This paper, and the papers it refers to, have helped strengthen some of my existing opinions about stock picking and investing in general. 

My opinions are also those of Ben Graham towards the end of his life, that “I am no longer an advocate of elaborate techniques of security analysis in order to find superior value opportunities. This was a rewarding activity, say, 40 years ago, when our textbook “Graham and Dodd” was first published; but the situation has changed a great deal since then. In the old days any well-trained security analyst could do a good professional job of selecting undervalued issues through detailed studies; but in the light of the enormous amount of research now being carried on, I doubt whether in most cases such extensive efforts will generate sufficiently superior selections to justify their cost” (

Painting by Numbers backs the argument that human judgement typically offers no benefit to decision making where that decision can be made instead using simple quantatative methods.  Many examples are given of decisions made by doctors, judges, parole boards, purchase managers, wine experts, and in almost all cases the application of simple statistics produced better (or at least as good) outcomes.  A breif example which comes to mind is of a parole board deciding whether to let a prisoner out early.  Is the best decision (on average) made by the experts on the board, or by calculating the odds that the prisoner will re-offend based on data like sex, age, background, criminal record, offences commited inside prison, etc.  With hindsight the quantatative approach produces the better answer most of the time.  Although I’m sure there are many studies to counter this argument.

This tied in somewhat loosely with a TV program on the other night called The Secret Life of Chaos.  In the ‘secret life’ one of the scientists commented on how all the glorious patterns and structure in the universe can emerge from a relatively simple set of rules; or at least simple in relation to the patterns and structures they can generate.  He said, more or less, that if there was a job for God it it was to set the initial conditions for the system and then let it do its thing.  No further tweaking or interference is either desirable or required.

From a statistical investing point of view, this means it is probably better to play the odds.  By finding out the quantatative features of those companies that have, in the past, done best over the following 1-5 years (or whatever your investing timeline is), it may be possible to have an opinion on which companies are more likely to do better in the next 1-5 years.

Research gathered by Tweedy Browne in What Has Worked In Investing among many others, shows that this is possible (or at least, probably possible).  The lesson for me is: build a mechanical investing system; set it in motion; and as much as is humanly possible, leave it alone.

Buying Assets and Financial Strength

Over the past 6 months I’ve worked on my approach to finding good investments and I think I’m quite happy for now. I started out just looking at price to book, which often gave me companies with lots of debt, i.e. Ennstone, which then fall over at the first sign of trouble. Then I looked at liquidation value and cash flow, to protect against such a failure. However, I’ve now simplified it so that I pretty much just look at liquidity (current and quick ratios) and debt to equity ratios. Once the companies are filtered by those criteria I just buy whatever is cheapest to book, with half book being the most I’ll pay.  The ratios I use aren’t set in stone, but they are ball parks to get me started and the amounts come from various texts as ‘reasonable’ amounts.

Ennstone teaches me an important lesson

I think it can be difficult to learn anything without actually living it. So handily Ennstone, my first purchase of a value stock using not much more than price to book, has fallen over into the abyss. This is good for a number of reasons, although of course not so good for the staff.

The collapse of Ennstone has helped me re-think my approach to value investing and most importantly helped me to clarify to myself what it means to me to invest at all.

Risk to Returns and Principle. I’m beginning to think that’s what it’s all about. For example, let’s say I have some money to invest, ignoring fees etc I could invest it in:

1. My matress – risk to principle of fire or theft, but no risk to income as there isn’t any.

2. A bank savings account – risk to principle is none as the government guarantees deposits, risk to the about 2-3% income is small and varies with interest rates.

3. Government bonds – no risk to principle and no risk to the about 4% income.

4. Corporate bonds – now here’s the first big risk to principle. If I give my money to a company where the assets don’t cover the debts then if the company goes bust I’ll only get back a fraction of my principle. In a worst case scenario I could get back nothing if assets are mostly intangible. The risk to income is if the company goes bust.

5. Company shares – Of course this can carry the greatest risk to both income and principle. A company can easily cancel income to shareholders, the dividend. You can also easily lose all you’re principle if the company goes bust since any fire sale of assets goes to bond holders first. Shareholders only get what, if anything, is left.

That fear of loosing the principle is where the net net or liquidation value approach to investing comes. If there’s enough assets to probably pay everyone back in the event the company fails then the risk to principle is as controlled as it can be for a shareholder. Unless of course you invest in large ‘moat’ companies that are unlikely to fail in your lifetime.

So my first investment rule, which I had been kind of using from a while back and which would have barred Ennstone from entry to my portfolio, is:

A company must be trading for less than the value of 100% of its current assets plus 0% of its fixed assets minus all debts, or 80% of it’s current assets plus 50% of it’s fixed assets minus all debts.

Both of those are reasonable estimates of the liquidation value of a company. Depending on the ratio of fixed to current assets sometimes one is higher than the other. If a company passes either test then I’m interested. However, a slight caveat is that I’ll also consider companies slightly above this level if the company is generating enough cash.

Once I think my principle is reasonably safe, I’ll look at the cash generated and returned to shareholders over the last 5 years. If the company returned 15% cash returns at the current price to shareholders and had cash flows greater than that (i.e. they weren’t paying out to shareholders more cash than they were making) then I’m interested. The 15% is a number I read that Mr Buffet was happy with, so if it’s good enough for him then it’s good enough for me.

So I end up with a company that has enough assets to privide me with some reasonable downside protection to my principle, and has historically returned 15% to shareholders over the last few years, my assumption being that the next 5 years will look something like the last few years. Without my crystal ball I cannot assume anything else.

At 15% returns most investors would love to own such a stock. The idea is that when confidence returns for this company then investors will pile in. Once Mr Market offers me a price such that I can buy more assets and earnings power elsewhere (perhaps if he offers double my purchase price) then I will sell. If no such offer arises then I’ll sit and hold hopefully getting my 15%. If I don’t even get that then I’ll sell out after 5 years and go panning for gold again.