financial market books to read

[hawk59]

barron,

If some guy on the street sells you an entire privately held business that you are confident is worth $200mm, but he is offering to sell it for $40mm then what is your risk? If some guy on Wall Street offers to sell you a share of stock for a business that you are confident is worth $200mm, but the market cap is only $40mm then what is your risk? If you can really argue that in the first case your risk is measured by obvious business related things, but in the second case is measured by the volatility of the stock price then you deserve a prize. The most important point of the article isn't the returns that buffet lists, it is the way that he describes the relationship between risk and reward.

[DcifrThs]

[ QUOTE ]
barron,

If some guy on the street sells you an entire privately held business that you are confident is worth $200mm, but he is offering to sell it for $40mm then what is your risk? If some guy on Wall Street offers to sell you a share of stock for a business that you are confident is worth $200mm, but the market cap is only $40mm then what is your risk? If you can really argue that in the first case your risk is measured by obvious business related things, but in the second case is measured by the volatility of the stock price then you deserve a prize. The most important point of the article isn't the returns that buffet lists, it is the way that he describes the relationship between risk and reward.

[/ QUOTE ]

yea i missed that completely. i got too hung up on thinking about the volatility in their individual return streams.

he makes the following statement: take a stock's mkt cap that is $80mm. Assume you can sell all of the assets to many buyers for $400mm. now assume that in a short period of time, the overall value of the shares of that stock fall to $40mm. in terms of price volatility, this stock has now become riskier, however if the assessment of $400mm is correct, then it is even cheaper and is less risky in terms of the margin of safety you have between the amt you pay and the amt the assets are worth.

from that statement though comes an interesting point. he's bringing up that equity markets cannot possibly be effecient because of something inherent to how equities are "priced." they are priced based on the discounted value of future earnings. i don't recall seeing a stock price model that looks at the balance sheet of the company. the balance sheeet can easily affect the price of the stock, but what i mean here is there doesn't seem to be a place in the stock price model for "what could i sell the assets of this company for?"

it kinda makes sense though. i mean, could you or i go and purchase a company? in most cases, no or not directly. but we can purchase stock and invest (in the total return of the security rather than the $ we could make from a fire sale so to speak). so those who want to get backers or financing, or have the capital themselves to purchase companies (PE firms like KKR) are beholden to the value model, whereas joe shmoe, who is attempting to create stock portfolio is beholden to the price model.

thats a really cool way to think about it. i think that methodology did take hold though and spawned "corporate raiders" during the 80s & some now common hostile takeover defenses.

thanks for the insight.

Barron

[derosnec]

Some of the books I've had to read/use for my finance courses in my MBA program. These were the primary textbooks for class (not supplemental):

"Introduction to Mathematical Finance: Discrete Time Models", by Stanley R. Pliska

"Principles of Corporate Finance," Brealey, Meyes, and Allen

"Fixed Income Securities," Bruce Tuckman

"Damodaran on Valuation"

"Options, Futures and Other Derivatives," Hull

"Investments," Bodie, Kane, and Marcus

"Modern Portfolio Theory and Investment Analysis," Elton, Gruber etc.

[NajdorfDefense]

Those are all well-used and well-read classics, fo sho.

Really, aside from the Intelligent Investor the only other book you need on your shelf is Fabozzi on Bonds whatever edition.

But I'll do another post tomorrow with what's on my shelf.

SM is right, HHogging sux.

[hawk59]

[ QUOTE ]
[ QUOTE ]
barron,

If some guy on the street sells you an entire privately held business that you are confident is worth $200mm, but he is offering to sell it for $40mm then what is your risk? If some guy on Wall Street offers to sell you a share of stock for a business that you are confident is worth $200mm, but the market cap is only $40mm then what is your risk? If you can really argue that in the first case your risk is measured by obvious business related things, but in the second case is measured by the volatility of the stock price then you deserve a prize. The most important point of the article isn't the returns that buffet lists, it is the way that he describes the relationship between risk and reward.

[/ QUOTE ]

yea i missed that completely. i got too hung up on thinking about the volatility in their individual return streams.

he makes the following statement: take a stock's mkt cap that is $80mm. Assume you can sell all of the assets to many buyers for $400mm. now assume that in a short period of time, the overall value of the shares of that stock fall to $40mm. in terms of price volatility, this stock has now become riskier, however if the assessment of $400mm is correct, then it is even cheaper and is less risky in terms of the margin of safety you have between the amt you pay and the amt the assets are worth.

from that statement though comes an interesting point. he's bringing up that equity markets cannot possibly be effecient because of something inherent to how equities are "priced." they are priced based on the discounted value of future earnings. i don't recall seeing a stock price model that looks at the balance sheet of the company. the balance sheeet can easily affect the price of the stock, but what i mean here is there doesn't seem to be a place in the stock price model for "what could i sell the assets of this company for?"

it kinda makes sense though. i mean, could you or i go and purchase a company? in most cases, no or not directly. but we can purchase stock and invest (in the total return of the security rather than the $ we could make from a fire sale so to speak). so those who want to get backers or financing, or have the capital themselves to purchase companies (PE firms like KKR) are beholden to the value model, whereas joe shmoe, who is attempting to create stock portfolio is beholden to the price model.

thats a really cool way to think about it. i think that methodology did take hold though and spawned "corporate raiders" during the 80s & some now common hostile takeover defenses.

thanks for the insight.

Barron

[/ QUOTE ]

Well when it really comes down to it valuing a business on earnings and valuing it on asset value is really the same thing. Because after all an assets value is derived from it's ability to make money.

Which is why many companies are worth more than book value and some companies are worth less. A $10 bill is worth $10, but a company with $10 book value that can sustain a return on equity of 30% is clearly worth much more than $10.

I don't think it's anything wrong with how assets are priced moreso that people are very focused on the short run and think quarterly results(and whether you beat or miss) are very important. They also tend to sell just because the stock is declining, and buy just because it is going up. You can write a million page book on psychological experiments showing how irrational people can be sometimes, but some people say that the price of a stock is right at all times.

[rsliu]

Barron,

For an interesting case study on what Buffett is talking about, read up on what Edward Lampert did with K-Mart.

It is surprising to me that people always use Buffet as an example of skilled investing. What Buffet is good at (buying shares of a company and then using his leverage to help unlock the hidden value of that company) is not something normal investors can duplicate. Contrary to popular belief, Buffet's primary skill is not stock picking, which is why no one in the investment community labels him a long/short equity manager. What he does is more akin to what private equity firms do.

As an individual investor, you can't achieve his IR by stock picking. What you can do is what most long short equity hedge funds are doing, which is to say a lot of due diligence on companies followed by some concentrated investments. I haven't done the research on this, but I would be pretty surprised if you could achieve anywhere close to a 1 IR by following this approach.

And some books:
Liar's Poker (not a huge amount of informational value but a fun read)
The Misbehavior of Markets (argues that much of the mathematical underpinning of investing is wrong)
Reminiscences of a Stock Operator (Useful as a psychological analysis of how to approach investing, but I think you probably 'know' much of what this book says through playing poker)
http://hedgefund.blogspot.com/ (this is a pretty good blog that I follow; it cuts through a lot of the BS you read in newspapers and magazines written by journalists who don't really understand finance)

Rob

[DcifrThs]

personally, im much more macro oriented than equity managers. currencies, govt nom & IL bonds, EMD, commodities, overall equity markets and portfolio construction/maintenance are what i enjoy thinking about most so i tend not to dig too deep with equities.

i dont see why one can't be a value investor without tons of capital though...maybe not with such a high IR, but i mean if you see something that is markedly underpriced, then purchasing its shares should provide for returns in the form of both dividends and price increases so long as the fundamental value you've assessed becomes reflected in the price over time and that the price isn't too volatile (and your portfolio not too concentrated) so that you're around when it converges.

thanks for the book recommendations though. i've read Liars Poker, just started When Genius Failed, and have ordered many of the books on this list...Misbehavior of markets looks like a good one but something i've probably read in different ways before (i've read a bunch about why CAPM isn't applicable in full form but i'm sure i can still learn a bunch from a book like that)

thanks,
Barron

[rsliu]

It's not that you can't be a value investor, it's just that Buffet is not a good example of value investing. You can find stocks of companies that you think have hidden value not reflected in the stock price, but unless someone (like Buffet) comes along and unlocks that value, you're not getting paid. So as an individual, you have to find companies that are undervalued AND are likely to eventually be correctly priced by the market.

[Tupacia]

Barron, given your description of your macro orientation and the fact that you read the Economist, I would highly highly highly recommend Inside the House of Money. It profiles the best macro hedge fund traders in the world and is just an incredible book. It's perhaps the best book I've ever read on the market, and I've read a billion.