Pathik Shah

The Dumbest Idea In The World: Maximizing Shareholder Value

Excellent argument.

The real market vs the expectations market

In today’s paradoxical world of maximizing shareholder value, which Jack Welch himself has called “the dumbest idea in the world”, the situation is the reverse. CEOs and their top managers have massive incentives to focus most of their attentions on the expectations market, rather than the real job of running the company producing real products and services.

The “real market,” Martin explains, is the world in which factories are built, products are designed and produced, real products and services are bought and sold, revenues are earned, expenses are paid, and real dollars of profit show up on the bottom line. That is the world that executives control—at least to some extent.

The expectations market is the world in which shares in companies are traded between investors—in other words, the stock market. In this market, investors assess the real market activities of a company today and, on the basis of that assessment, form expectations as to how the company is likely to perform in the future. The consensus view of all investors and potential investors as to expectations of future performance shapes the stock price of the company.

“What would lead [a CEO],” asks Martin, “to do the hard, long-term work of substantially improving real-market performance when she can choose to work on simply raising expectations instead? Even if she has a performance bonus tied to real-market metrics, the size of that bonus now typically pales in comparison with the size of her stock-based incentives. Expectations are where the money is. And of course, improving real-market performance is the hardest and slowest way to increase expectations from the existing level.”

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Value Investing – The Super Investors of Graham and Doddsville

Here’s an article that everyone interested in value investing should definitely read. It was adapted from a speech given by Warren Buffett back in 1984 promoting value investing, and highlights the returns of 9 successful investment funds managed by people following Ben Graham’s Value Investing approach.

An excerpt:

The common intellectual theme of the investors from Graham-and-Doddsville is this: they search for discrepancies between the value of a business and the price of small pieces of that business in the market. Essentially, they exploit those discrepancies without the efficient market theorist’s concern as to whether the stocks are bought on Monday or Thursday, or whether it is January or July, etc. Incidentally, when businessmen buy businesses, which is just what our Graham & Dodd investors are doing through the purchase of marketable stocks — I doubt that many are cranking into their purchase decision the day of the week or the month in which the transaction is going to occur. If it doesn’t make any difference whether all of a business is being bought on a Monday or a Friday, I am baffled why academicians invest extensive time and effort to see whether it makes a difference when buying small pieces of those same businesses. Our Graham & Dodd investors, needless to say, do not discuss beta, the capital asset pricing model, or covariance in returns among securities. These are not subjects of any interest to them. In fact, most of them would have difficulty defining those terms. The investors simply focus on two variables: price and value.

It explains the basic principles of value investing, with 9 real life examples. Most of it continues to be true to this day. Highly recommended.

Download PDF: The Superinvestors of Graham-and-Doddsville

How to Make Money in the Stock Market

Here are some foolproof ways to make money in the stock market, since, obviously, investing your own money isn’t a very good option.

1. Start a Broking Firm

Get some idiot investors to buy and sell stocks daily and earn brokerage on their transactions. Convincing them that they are the next Warren Buffett or Rakesh Jhunjhunwala might help.

2. Start a Research Firm

Convince other idiot investors that you have the ‘key’ to becoming rich instantly – your valuable ‘research’ which will point them to the next multibaggers, and sell it to them. It works better if you are also their broker.

3. Start a Hedge Fund

Start a hedge fund, preferably a closed-end one. Convince people that you are the next Warren Buffett, and get them to invest in your fund. Once you have their money, invest in the riskiest securities you can find. Your bonuses are tied to the performance of your fund, and you are playing with other people’s money. Is there any better way to get rich? You have tremendous upside, limited only by the amount of risk you can take, and zero downside. Even if you fail miserably, you will still get a 2% fixed fee. If you do well, you will get the 2% fee + a 10-20% share of the profits.

Note: This will work only if you can convince other people to let you handle their money.

4. Start an Investment Bank

First of all, try to become as big as possible, by actually doing all the boring stuff that investment banks are supposed to do – IPOs, M&As, underwriting etc. When you become “too big to fail”, put all your clients’ money in the riskiest shit you can find. Start a proprietary trading division to invest your clients’ funds, and create synthetic instruments no one can understand easily. By the time they do, the world will have collapsed and the system will have to bail you out.

Even if they don’t, and your firm goes under, you still have your multi-million dollar bonuses, right?

Why Active Investing is a Waste of Time | Why You Should Just Invest in a Passive Index Fund

There are two basic ways to invest your money in stocks:

1. Active

You invest your money in select stocks or in funds which try to beat the market and continually monitor and adjust your portfolio in order to get good returns.

2. Passive

You invest your money in a passive index fund or ETFs which track the index, thus incurring the minimum investing fees and just trying to achieve market returns.

Why Active Investing is a Waste of Time

To be able to consistently beat the market in terms of risk adjusted returns, you have to be either

1. A fucking genius
2. Very fucking lucky

The probability of you being a big fucking genius or at least smart enough to beat the market is very low, tending to zero. There are many very intelligent people who have tried to do it, and have failed miserably.

There is one who has done very well – Warren Buffett, and he definitely isn’t a proponent of active investing, at least not in the form that most of you practice it. Buffett swears by the power of passive investing, even though he doesn’t do it himself.

Buffett can be considered to be the most successful investor on Earth, and he has always believed in value investing and passive (indexed) investing. If he says something, I’m surely inclined to believe him. Even history shows that passive investing is the best way to invest in the long term.

Coming to the second point, the probability that you will make a good amount of money by just being lucky is also quite low. There are seven billion people in the world. Assuming that there are 10000 people who will be able to beat the market by sheer luck, the probability that you will be one of them is 1 in 700,000. The odds are just too low to even try.

Buffett is probably both – a genius and very lucky, and as you can see, there is only one of him. If you believe that you are smarter than him, or the many smart people who have tried to beat the market, and failed, you need to read this.

Active Investing is very much a waste of time, as all EMH proponents will tell you.

The only easy way to make a risk-free killing in the market is to have some informational advantage (inside information), which I assure you, that you as a normal investor, never will.

Here are some other ways to make money in the stock market.

Stop trying to beat the market by acting on ‘sure’ tips by your broker or your grandmother’s neighbor’s watchman, just because someone you know got lucky and made some money in the market, and now you feel that if that idiot could, you can too. Instead, invest in some equities or commodities index, and divert your energy to something productive, and actually create something of value. You will have a much better chance of getting rich that way.

Note: I know that you probably think that you are the next Warren Buffett, and that you are smarter than all the idiots who couldn’t make shitloads of money in the stock market, including me, and that you are going to take a shot at it anyway. Here’s a tip: You aren’t. And don’t.

Facebook’s Valuation is Now $85 Billion

Shares of Facebook touched a new high of $34 in the latest SharesPost auction, implying a valuation of $85 billion. Considering its 2010 revenues ($1.86 billion) and profit ($400 million), it is now trading at a P/E ratio of 212.5, which is almost ten times that of Google and Apple, as well as the S&P 500.

Mark Zuckerberg, who has a 24% stake in Facebook, would now have a net worth of $20.4 billion, which would propel him to number 23 in Forbes’ list of the world’s billionaires, just ahead of Larry Page and Sergey Brin, the founders of Google.

If Facebook was a country, it would be the 60th largest one (if its valuation was compared with their nominal GDPs). Assuming 600 million users and 2000 employees, each user is valued at $140, and each employee is valued at $42.5 million.