Investment adages from the rich and famous

There are a lot of sayings in the business of investing.

An “adage” is defined as “a short, usually philosophical but memorable saying which holds some important fact of experience that is considered true by many people, or that has gained some credibility through long use”.

The term in my mind has a connotation of wisdom. There is no definitive list of Wall Street adages. New expressions become popularised from time to time. Warren Buffett, who is brilliantly articulate and a wonderful employer of metaphors, has certainly added to the list.

Some expressions are quite profound and it has long fascinated me that some great figures have an expression on a desk or a wall plaque to be a constant visible reminder. Perhaps the most famous was President Truman’s desk plaque “The Buck Stops Here”. However, the ones that I elaborate on here are the six that I have on my office walls. They include the wall plaques of J.P. Morgan and John Templeton and a desk plaque of Dr H.C. “Nuggett” Coombs (a former Governor of the Reserve Bank of Australia). Plus quotes from John Maynard Keynes and Barton Biggs as well as the favourite motto of Karl Marx, make up my six.

Before getting on to those, which I think deserve some elaboration, it is worth listing some of the common adages and expressions to make the point that some of them are wise, some are inconsistent and some, in my view, are simply wrong or at least inappropriate for some investors. And some are simply flippant and funny. When someone gives you investment advice employing a “Wall Street adage” or a clever expression, it pays to question the fallibility of the “wisdom” being espoused. This is a potpourri of expressions, in no particular order.

Let me start with a common expression.

“The higher the risk, the higher the return”

To obtain a higher return you have to accept a higher level of risk. There is a risk-return trade-off. True or false?

If you instinctively answered “true”, you got it wrong. The correct answer is: sometimes yes, sometimes no. Consider a stock trading at 65c. You assess its intrinsic value to be $1.00. Value investors regard the difference between value and price as the “margin of safety”. Value investors profit from price approaching intrinsic value. Now the share price falls to 45c but your assessment of intrinsic value is unchanged at $1.00. The margin of safety has widened from 35c to 55c. This example simply illustrates an investment where the risk has lowered but the prospective return has increased. If the price had shot up, it would be a case of higher risk and lower prospective return. Such is the essence of value investing as espoused by Benjamin Graham and Warren Buffett.

Now take sovereign debt – bonds issued by a foreign government. If you bought US 10-year bonds you would buy them on a yield of around 2.5 per cent. However, if you bought Brazilian 10-year debt offering around 9 per cent, or chose to be more bold and bought Egyptian debt, (yielding around 18 per cent), the yields available increase dramatically. Most definitely a case of the greater the risk, the greater the return. Hence the answer to the “true or false” question is: “it depends”. It is the same with corporate debt. The higher the risk the greater the return. (The degree to which you should rely on ratings agencies to rate and effectively price government and corporate debt is a separate question).

“Don’t put all your eggs in one basket”

“Put all your eggs in one basket and watch the basket”.

Diversification. One of the above says diversify. The other says don’t. Buffett has said “diversification is protection against ignorance; it makes little sense if you know what you are doing.” I have even read the statement: “diversification is an investment sin”.

What should a self-managed super fund investor make of all these one liners? For starters, it illustrates how a complex subject such as diversification does not lend itself to being distilled into a single sentence. The rich lists are well represented by successful entrepreneurs who have not diversified but who have pursued a single business venture. But this is different: the context here is diversification in a share portfolio.

Diversification is the second safety net for an investor, the first being margin of safety. Diversification, spreading your bets, provides an insurance benefit and makes eminent sense. It does not just protect you from “ignorance” as Buffett somewhat pejoratively puts it, but against unforeseen surprises which might stem from competition, management change, technology change, regulatory change, withdrawal of banking support and so on. So the question becomes, to what extent should you diversify? What would constitute under-diversification (too much risk) and what would constitute over-diversification? Over-diversification simply means you own too many stocks, you have gone beyond the insurance benefit and have spread yourself too thin. How well do you know your 20th stock, your 20th best idea?

You can’t be guided by the number of stocks you see a successful funds manager own. Peter Lynch is said to have owned as many as 1400 stocks, but apart from being brilliant and a workaholic, he would have had strong analyst support. (How many hours or even minutes a year would you get to devote to a single company if you owned 1400, or 800, or 50 stocks?) The lowest number I have seen by a professional funds manager is four stocks.

Diversification is a bespoke thing. It should depend on many things, in particular on how well you know your stocks, the types of companies in which you invest and the size of your portfolio. As a guide, Buffett has indicated that five stocks comprising 80 per cent of the portfolio is sensible concentration. Other prominent investors have indicated that that is too concentrated for them, 10 to 15 being more of a comfort range. Some would suggest that 20 stocks is over-diversifying. For most of my investment career I have over-diversified, perhaps enjoying the excitement too much of a new idea and maybe being a sucker for a new story. They all have stories.

“Bulls make money, bears make money, pigs lose (get slaughtered)”.

“I’m not a bull. I’m not a bear. I’m a chicken”.

The Wall Street menagerie. Sheep everywhere. There are even snakes. But here I only want to comment on chickens and pigs. The chicken quote is by the late Charles Allmon. I was reminded of the chicken label when I read the following from Howard Marks. “Investing scared, requiring good value and a substantial margin for error, and being conscious of what you don’t know and can’t control are hallmarks of the best investors I know”. It is sensible to be a chicken at all times.

It is not sensible to be a pig at a market peak. You can indeed get slaughtered. But at a market bottom it can be very sensible to be a pig. Being greedy when others are fearful, as Buffett puts it. Being greedy also makes sense when you patiently wait for and finally get a great investment idea. In September 1992 George Soros and Stanley Druckenmiller famously shorted the British pound, reportedly making a profit of over £1 billion in a transaction which has been described as “the trade of the century” and “breaking the Bank of England”. Druckenmiller’s motto is, “it takes courage to be a pig” and he is said to keep a ceramic pig on his desk. When you get that very high conviction great idea, “bet the ranch” Druckenmiller says. (“Load up the truck” is my expression).

What per cent of the portfolio should a great idea become? How piggish should you get? Buffett’s bet on American Express became 40 per cent of his portfolio back when he was a conventional portfolio manager. Thirty per cent in one stock was about the highest percentage I have ever permitted. Soros and Druckenmiller not only leveraged but took far greater percentage bets. Here we are talking about the propensity to accept concentration risk. There are no rules on this. Each to his own. It is a comfort, or one might say “courage” thing. It does indeed take courage to be a pig.

“Leave some for the next bloke”.

“Feed the ducks when they are quacking”.

“You never go broke taking a profit”.

The last of these three, which all relate to selling, has long irked me. If you are fortunate enough to find a wonderful value stock which has in front of it many years of sustained growth, you sure won’t go broke selling it in year two, but you could be making a huge investment mistake. The first two make more sense in that I believe in selling in tranches on the way up, in “feeding the ducks while they are quacking”. For me it makes sense to sell probably “too early” rather than wait for a stock to peak and try and sell it on the way down. Selling in tranches and perhaps “too early” makes sense for me in that I typically deal in stocks with limited liquidity. This practice may not make sense for a holder of highly liquid stocks. Of course, one should not always sell when the ducks are quacking. I frequently reject bids for lines of stock I own. However, when the time comes from a value point of view to sell, it is much easier if the ducks are quacking.

“Cut your losses, let your profits run”.

This one is probably applicable to a momentum investor employing stop loss orders. It often makes sense for a value investor, confronted with an initial loss because the stock has gone down, to not sell and “cut the loss short” but to buy more because cheap has become cheaper. This “adage” may make sense to some investors but it does not make sense to me in so far as it suggests selling if the stock declines shortly after purchase.

“Buy some good stock and hold it till it goes up, then sell it. If it don’t go up, don’t buy it”.

This is simply a droll joke by Will Rogers.

“To err is human, but to be paid for it is devine”.

A very funny line by Howard Ruff, a newsletter writer.

“In a bear market money returns to its rightful owners”. (Robert Holmes a Court).

“Never invest in anything that eats or needs repairing”.

“When companies report profits but bleed cash, believe the cash”. (Fidelity funds manager Joel Tillinghast).

“Earnings are an opinion. Dividends are a fact”.

“Do you know the only thing that gives me pleasure? It’s to see my dividends coming in”.

Comment by John. D Rockefeller (1839 – 1937), America’s first billionaire, in 1908.

“Buy the rumour, sell the news”.

This might be relevant for a short-term trader, as opposed to an investor. Value investors make buying and selling decisions on value considerations. If you were thinking of selling a fully priced stock which you thought was about to announce a very positive profit announcement, should you time your sale to sell before or after the announcement? No “adage” will answer that one. Flip a coin for the answer. You’ll know the answer in hindsight.

“A stock-picker’s market”

Market commentators sometimes use this expression. Another expression sometimes used in a stock market context is “a rising tide lifts all boats” meaning most stocks will rise when the market overall is trending upwards. The obverse also applies in that a receding tide lowers all boats. So the expression “stock-picker’s market” presumably relates to the latter: to make money when the market is going down one has to stock-pick rather than rely on a general market rise to make you money. The reality for value investors is that it is always a stock-picker’s market. One has to be selective on the basis of value in bull markets, flat markets and bear markets. Jason Zweig, in his very funny “Devil’s Financial Dictionary”, says the following: “when someone tells you that this is a stock-picker’s market now try asking : why wasn’t it before? Were the stock-pickers all picking flowers or their toes or their noses instead?”

“Don’t confuse brains with a bull market”. Humphrey Neill.

“The public is right during the trends, but wrong at both ends”. Humphrey Neill.

Humphrey Neill, the Vermont Ruminator, has been called the father of contrarian investing. In my view a profound thinker and one of the greats. Here he is making the point that identifying a crowd consensus and betting against it will certainly be contrarian, but it might well be stupid because the crowd gets it right much of the time. Humphrey Neill was very much about observing crowd behaviour at market extremes, when it can pay to bet against the crowd.

“Don’t try and catch a falling knife”.

Lehman Brothers filed for Chapter 11 bankruptcy on September 15, 2008. This was a major event in the so-called “great recession” or “global financial crisis” which had begun in late 2007. Bear Stearns had been bailed out in March and the fact Lehman Brothers, this major Wall Street house was allowed to collapse led to the market spiralling down and not bottoming until March 2009. This was a demonstration of fear being more powerful than greed, manifested by individual stocks and the market as a whole falling faster than it rises. Down in the lift (and up in the escalator). The market sure went down in the lift following the Lehman Brothers collapse.

With the benefit of hindsight, the market offered great bargains during this period for those brave enough to buy. I remember the head of a major Australian funds management group saying to me at the time: “buying is like touching a chain saw. It hurts and you are disinclined to do it again”. The more common metaphor or expression to describe buying in a plunging market is “catching a falling knife”.

I disagree with this “adage”. The alternative is to wait until the market has shown clear signs of having bottomed, and by that time the great bargain prices might be gone. I remember in late February 2009 buying a large line of shares (units) in Challenger Kenedix Japan Trust. This was simply a REIT which was listed on the Australian Stock Exchange, but all of its property assets were in Japan. Stated book value was above $2.00. The shares plunged from $1.00 in October 2008 and I was able to acquire a large line at 23c in late February 2009. The knife was falling. I had met with management who had told me that a UK institution wanted to sell. The shares fell even further to around 15c after I bought, but on miniscule volumes which meant that “on paper” and from a portfolio valuation point of view I had sustained an almost immediate large loss. This REIT was taken over at $1.05 within 12 months of purchase. Had I waited for the shares to bounce off the bottom it is unlikely I would have been able to obtain a meaningful quantity of stock and almost certainly not at 23c. It paid to catch the falling knife. The confidence to buy, even though one might be very nervous about timing, is of course based on one’s assessment of value.

It takes courage to buy when fear is so predominant. Buffett says he attempts “to be fearful when others are greedy and to be greedy only when others are fearful”. Being “greedy when others are fearful” might sound easy but it does require strength and conviction and also the preparedness to know that one may not have picked the bottom and one might be made to look very foolish in the short term.

“This time it’s different”.

John Templeton has described these as “the four most dangerous words in investing”. (Maybe it’s five words). In the late 1990s when the dot com boom was in full swing there were those who thought it was different this time and the market would long continue its upward trajectory. It was the justification for paying enormous multiples for dot com companies. Similarly, in the depths of the global financial crisis in late 2008 and early 2009, there were fears of a systemic breakdown, fears of the whole banking system breaking down, fears that it indeed was different this time. A simple glance at a long-term chart of market indices shows that the market is cyclical and inexorably moves from despondency with fear predominating at the bottom to euphoria with greed predominating at the top. Market conditions vary all the time, but market cyclicality swinging from euphoria to despair is rooted in human nature and I believe forever will be thus. Templeton’s admonition is not that things can never be different but that it can be a dangerous assumption to make when valuations are at extremes.

“You don’t have to make it back the way you lost it”.

On a number of occasions, I have had a large position in a small company which has gotten into trouble and I have been approached to participate in a capital raising and had it put to me that if I did not participate I could put in jeopardy my original investment because the company could fail. On such occasions it pays to recall that “you don’t have to make it back the way you lost it”. You should only invest more if it is a sensible value proposition having regard to all the other investment opportunities before you.

When you buy a stock and it goes down, possibly for sound fundamental reasons, you should not be fixated on your original cost price nor should you buy more simply because the shares have gone down. Value considerations should at all times dictate subsequent investments.

“To know the market you must first know yourself”.

I read this once as a Wall Street adage. I have been unable to find where I read it and Googling it comes up blank. Nevertheless, I love it. I don’t have it as a wall plaque because it is indelibly imprinted in my brain.

“All models are wrong, but some are useful”.

“Not everything that counts can be counted, and not everything that can be counted, counts”.

The first is a quote from the late statistician George E.P. Box. The second is a sign that was in Einstein’s office at Princeton. They are reminders of the fallibility of modelling. All DCFers (discounted cash flows) would do well to have these as wall plaques near their desks. Brilliant mathematical minds were behind LTCM (which collapsed in 1998) and the quant funds which suffered meltdowns in August 2007. Visible reminders of these two messages might have induced some humility and moderation and lessened the systemic damage which ensued. An “Alphaville” poster, exhibited for many years in the quant section at Morgan Stanley, is more likely to promote hubris.

“What the wise man does in the beginning, the fool does in the end”.

Howard Marks describes this as his favourite adage. There are very useful and sensible financial devices such as derivatives and packaging of mortgages. Wall Street seems to have a tendency to take these things to an extreme as happened in 2007. What starts as a good idea, taken to an extreme can become a very bad idea.

“At some point, being too early is indistinguishable from error”.

I first heard these words at a Peter Cundill investment conference and they always stuck in my mind. Much later I read in Howard Marks’ wonderful book “being too far ahead of your time is indistinguishable from being wrong”, and he describes this as his second key adage. The saying might relate to buying or selling a stock too early and it might relate to a market call. There are people who make market calls and some are “permabears”. A bearish projection is normally good for publicity. There is a difference between being “too early” and being “way too early”. Which is why it has been said that if you must forecast, forecast often.

“The airport trade”.

I have never seen anyone do this but it refers to a last throw of the dice trade (investment) by a desperate, at risk of going out of business, investor or funds manager. He leverages up and buys an enormous amount of something, maybe an option, and also a one-way ticket to Rio de Janeiro. As Simon Lack describes it in his book “The Hedge Fund Mirage” – “at the airport before boarding you call to check on how the trade has worked out. If it’s a winner you take a cab back home. If it’s a loser you get on that plane”. The serious side of this joke is that many funds managers with performance fees have what is called a high watermark, meaning essentially that if $100 goes down to $80 and then back to $100, no performance fee is payable on the recovery from $80 back to $100. A funds manager who has suffered big losses such that he has no hope of getting above the high watermark (back into performance fee potential), might not buy a one-way ticket to Rio and do an airport trade, but he might be tempted to take big risks and swing for the fences.

“When there is nothing to do, do nothing”

A Buffett quote. A beautifully worded passage in the Bible (Ecclesiastes – 3) reminds us that “there is a time for everything, and a season for every activity under the heavens”. There is a time to buy and a time to sell and a time to sit on one’s hands and do nothing.

Time is the friend of the good business and the enemy of the bad.

Another Buffett quote. Worthwhile remembering, especially when investing in distress stocks and turnarounds.

“The race is not always to the swift but to those who keep running”.

A rewording of part of Ecclesiastes -9. A poster of a jogger containing those words is an advocacy of patience and persistence. Similar lines include: “investing is a marathon, not a sprint”. And “get rich slow”. Then there is also Calvin Coolidge’s very famous “persistence and determination” quote. “Nothing in the world can take the place of persistence. Talent will not; nothing is more common than unsuccessful men with talent. Genius will not; unrewarded genius is almost a proverb. Education will not; the world is full of educated derelicts. Persistence and determination alone are omnipotent. The slogan ‘Press On’ has always solved and will always solve the problems of the human race”.

The light at the end of the tunnel.

There are various investment plays on this line but the one that amuses me the most is: the optimist sees the light at the end of the tunnel. The pessimist sees no light at the end of the tunnel. The realist sees that the light is a train. The train driver sees only three fools on the track.

“100% of the information you have about a company represents the past. And 100% of a stock’s valuation depends on the future”. (Bill Miller of Legg Mason).

I like this quote, this one-liner from a great US funds manager. However, an elaborating comment rather than a qualifying comment should be made. Forecasting future cash flows to undertake discounted cash flow analysis to arrive at an intrinsic value number (or range) is fraught with hazards. Now take Baby Bunting, Australia’s leading baby goods retailer. It IPO’d in October 2015 when it had 33 stores. I had invested in it several years before when it only had four stores, all in Melbourne. Today it has over 50 stores, with across Australia coverage to be reached when they have over 80 stores. It is growing at five to eight stores per annum. Now a DCF valuation would probably estimate future cash flows based on a continuation of store growth, and therefore include, as a component of value, stores not only yet to be opened but where store locations may not have yet been identified. And typically, at the end of the forecast period, an analyst will determine a “terminal value” based on a company valuation likely derived by applying a multiple to the last forecast year’s numbers.

This is theoretically legitimate, and I don’t criticise its purity as a methodology. However, many DCF valuations are based on spurious forecasts and the “terminal Value” component might be as high as 90 per cent or more of the calculated (net present) intrinsic value. I know a great New York investor who sits with me on the advisory board of a fund which invests with numerous funds managers. He gently puts to funds managers who use DCF analysis as the basis of stock selection a favourite question: “I can’t forecast what I am going to have for dinner tonight. How can you make cash flow forecasts going forward for years”?

Now think of a growth company like Baby Bunting where a valuation necessarily entails factoring in future numbers going out for as many years as the analyst chooses, and compare it with a stock selling at below cash backing. Or a stock selling perhaps not below cash backing but well below liquidation value. Or an investment company selling well below its asset backing.

This is not to suggest that one type of stock is superior to another type. But I make the point that stocks vary on the “future” component of their valuations. This is why Aesop, believed to have been born around 620BC, is said to be the world’s first value investor because of his “a bird in the hand is worth two in the bush” fable.

So Bill Miller’s line is obviously perfectly correct, but it certainly make sense to differentiate between “bird in the hand” value and “bird in the bush “value.

Six desk or wall plaques.

“Pense moult, parle peu, ecris rien”. Desk plaque of John Pierpont Morgan.

“Trouble is Opportunity”. Wall plaque of Sir John Templeton.

“I beseech you, in the bowels of Christ, think it possible you may be mistaken”. Desk plaque of Dr H.C. “Nuggett” Coombs, a former Governor of the Reserve Bank of Australia.

And three of my favourite quotes I have as wall plaques:

“When the facts change, I change my mind. What do you do, sir?” John Maynard Keynes.

“More money has been lost reaching for yield than at the point of a gun”. Barton Biggs.

“De omnibus dubitandum”. Favourite motto of Karl Marx.

Now a brief discussion on each of these.

The J.P. Morgan desk plaque translated means “think a lot, say little, write nothing”. It is apparently a Provencal proverb and in the dialect of Provence in southern France rather than French. “Moult” I believe is not a French word. The plaque resonated with me because thinking is the basis of successful investing. Ben Graham used to write under the nom de plume “Cogitator” and Humphrey Neill was known as the “Ruminator”.

As for “saying little” I was amused to read the following from Jean Strouse, author of “Morgan: American Financier”, that “Morgan’s silence acquired considerable renown. After he attended a dinner in his honour in Chicago in 1908, the Tribune ran the headline: ‘Money Talks but Morgan doesn’t’”. As for the “write nothing” part of the J P Morgan quote, he died in 1913 and perhaps today, over 100 years later he would prefer “email rien”.

The Templeton wall plaque would resonate with all true value investors. By “true” value investors I mean value investors who do not just seek value in wonderful businesses, which are not frequently available at wonderful (ie cheap) prices, but who also seek value in companies of varying quality where the attraction is the bargain price. Often bargains can be found in companies in “trouble”. The trouble might be a single part of the company which has some sort of difficulty but where the main business is intact. Warren Buffett famously bought 5 per cent of American Express in 1963 when its shares were impacted by what came to be known as the “salad oil scandal”. Or “trouble” might be very serious where a company might teeter on bankruptcy and an astute investor might opportunistically buy shares as a turnaround opportunity or buy debt securities of the company. Or “trouble” might not be company specific as in late 2008 and early 2009 when the whole market plunged during the so called global financial crisis.

Churchill said, “never let a good crisis go to waste”. A financial manifestation of that sentiment is encapsulated in Templeton’s wall plaque.

Jennifer Wallace, a New York funds manager, once told me that the great man himself, Warren Buffett, had in conversation with her, and used the expression “wounded athletes”. Of the many Buffett metaphors I had never read this one. It refers to companies in some “trouble” and certainly would describe Buffett’s purchase of American Express. Jennifer described it as follows: you find, say, a high jumper who consistently can jump six feet. But right now he is only jumping five feet. You need to ascertain that his problem is a sprained ankle, not a shattered foot. This is a very useful metaphor when thinking about “turnaround” opportunities. Essentially, the value opportunity is created by market overreaction to a temporary company problem.

The quite extraordinary “bowels of Christ” quote was apparently one of a number of quotes which Nuggett Coombs had his PA feature by rotation on his desk. The remark was made by Oliver Cromwell in 1650 in an address to the General Assembly of the Church of Scotland. Cromwell (1599 – 1658) was prominent in those who executed King Charles 1 in 1649. He had been elected a member of parliament in 1628 but parliament was dismissed by Charles who as an absolute monarch, refused to be subservient to parliament. The execution of Charles followed a long period of civil war. Cromwell became chairman of a Council of State which ruled the republic until 1653 when Cromwell became Lord Protector of England, ruling England, Scotland and Ireland until his death in 1658.

It’s a natural tendency to have “confirmation bias” where one tends to hear what one wants to hear and not hear disconfirming views. “Think it possible you might be mistaken” is a worthwhile message to seriously consider as an antidote to confirmation bias.

There seems to be some controversy over whether Keynes actually said the quote which is widely attributed to him. Even so it is a simple profound message which is much the same as “think it possible you might be mistaken”. In the same vein, George Soros said “I’m only rich because I know when I’m wrong”.

The Barton Biggs quote comes from his book “Hedgehogging” (page 142). Biggs attributes the saying to “a wag”. I don’t know who the wag was but it’s a colourful way of making a very, very serious point. I have made big investing mistakes being seduced by yield and this saying hangs on my wall as a constant reminder. One has to recognise that sometimes we are in times of low returns. For all asset classes. In such times there can be a temptation to take on excessive risk reaching for yield, reaching for return.

Hopefully it is clear that one should be careful with investment expressions, one-liners, so-called adages. They can be wise, sometimes unwise, sometimes contradictory and often amusing. I will finish with a one-liner from the late Humphrey Neill, The Ruminator, who I quote often. “If you don’t think things through, you’re through thinking”.