Book Reviews – Page 23 – The Aleph Blog

Book Review: Expectations Investing

Posted on 14 October 200912 February 2011 by David Merkel

Why don’t average investors use discounted cash flow analyses?? Typically, they don’t use them for several reasons.

Most people don’t want to use an algebraic formula to estimate anything.? As some legendary trader reputedly yelled at a quant, “No formulas!? You can make me add, subtract, multiply, and divide!…? And don’t make me to divide too often!”
It is not intuitive to most.? It takes a bond-like or actuarial approach to analyzing stocks — forecasting future free cash flows and discounting them at the firm’s cost of capital.
It is highly sensitive to assumptions one employs.? Small changes in growth rates or discount rates can make a big difference in the estimate of value.? It lends itself easily to garbage in, garbage out.? (I remember a Dilbert cartoon where an analyst told Dogbert that scientific decision analysis required forecasting future free cash flows and discounting them.? He added that the discount rate had to be right or the analysis would be garbage.? Dogbert’s comment was to the point: “Go away.”)
It takes a lot of work, and shortcuts are easier, providing most of the analysis with less effort.

Now, most professional investors don’t use DCF either, for many of the above reasons.? But there are a number that do, among them Buffett.? Morningstar uses DCF for its stock recommendations.? It’s not a bad system after one makes the effort as an organization to standardize your free cash flow estimates and discount rates.? Most professionals invert the process, and rather than trying estimate what a stock is worth, they estimate what they think the company will return at the current market price.

Expectations Investing is one way to formalize DCF, and a rather comprehensive one.? It would be a good way for an investment organization to formalize its investment process, but is way too complex for one person implement, unless one is following some type of simplifying system like Morningstar, ValuEngine or any of the other purveyors of DCF analyses out there.

In the process of formalizing DCF, the book explains the problems with traditional P/E analysis, and how a focus on free cash flow can remedy the problems.? A weak spot in the book is their discussion of cost of capital.? Their cost of equity capital analysis relies on beta, which is not a stable parameter, nor does it really capture what risk is.? That said, inverted DCF can work without discount rates.? The book takes the approach that the discount rates are the less critical factor, because when they change for one firm, they typically change for all firms.? The book’s solution is to use current prices to drive DCF backwards and determine market free cash flow expectations for a stock.

The analyst can then look at those expectations, and try to determine whether they are too high or too low.? The analyst can also look at whether there might be changes due to unit growth, product price changes, operating leverage, economies of scale, cost efficiencies, and changes in the marginal efficiency of capital.? After the analysis, usually one or two factors will stand out capturing a large portion of the variability.? The analyst then focuses on those, and what drives them.? Unexpected changes lead to revisions to the analyst’s model, and the game continues.

Beyond that, the analyst needs to understand how the company in question fits into its industry.? The book discusses Michael Porter’s five forces, the value chain, disruptive technologies, and the economics of information.? Beyond that, the book touches on:

Real Options — the ability of a company to pursue value enhancing projects or not.
Buybacks — do them when the company has no better opportunity, and the shares are undervalued.
Mergers and Acquisitions — how to tell when are they good or bad ideas.
Reflexivity — Are there situations where a higher or lower stock price affects the business?? High/low valuation makes financing easy/difficult.
Understanding management incentives — how will they affect financial results and management behavior over the short and long runs.

At 195 pages in the body of the book, Expectations Investing is not a long book for what it covers.? The flip side of that is that is breezes over much of the complexity inherent in what they propose.? One other shortcoming is that little time is spent on financials, which are a large part of the market, and for which it is intensely difficult to calculate free cash flow.? After reading the book, I would have no idea on how to apply their DCF model to valuing a bank or an insurance company.

Aside from financials, if someone were to ask me, “Is this how valuation should be done?” I would say, yes, ideally so.? But it brings up one more critique: though I hinted at it above, most of the shortcuts that investors use are special adaptations and first approximations of the DCF model.? That is why shortcuts have validity — if you know the critical factors that drive profitability for a given company or industry, why waste your time on a big model with many inputs?? Cut to the chase, and use simpler models industry by industry.

Who would benefit from this book: someone who either wants a detailed means of calculating a DCF model, or a taste of the issues that an analyst/investor has to consider as he evaluates the worth of a company’s stock.

This is a neutral review from me.? I neither encourage or discourage the purchase of the book.? It has its good and bad points.? But if you want to purchase it, you can find it here: Expectations Investing: Reading Stock Prices for Better Returns.? I have a copy of Damodaran’s The Dark Side of Valuation: Valuing Young, Distressed, and Complex Businesses (2nd Edition), weighing in at 575 pages, as well as his book Investment Valuation: Tools and Techniques for Determining the Value of Any Asset, Second Edition (similar size, with a quarter inch of dust on my shelf.? Guess I don’t use it that much).

I could do a review of one or both of those, but if Expectations Investing is overkill for the average investor, and light for the professional, then either of Damodaran’s books are for the professional only.? At best I think it would only produce a review on the weaknesses of DCF analysis.

Full disclosure: If you enter Amazon through my site, if you buy something there, I get a small commission.? Your price does not change.? I review old and new books, and I don’t like them all; my goal is to direct readers to the books that can best help them.

Book Review: Think Twice

Posted on 13 October 200913 October 2009 by David Merkel

Since I met him at a Baltimore CFA Society meeting in 2001, I have? appreciated the intelligence of Mike Mauboussin.? (My old boss was his roommate in college, so I was told, the name is pronounced “MOE-bus-son.”)? He was early to pick up on the value of behavioral economics and nonlinear dynamics (“chaos theory”).

Think Twice is an effort to get all decisionmakers to take a step back and ask whether they are making decisions from shorthand rules, or from carefully analyzed data.? The book is full of examples of how people are easily fooled by irrelevant data.? Most of the examples I was aware of, becauseI have studied this stuff intensively.? There were a few surprises for me, though.

Did you know that at the craps tables in Las Vegas, on average, when someone wants a higher number, they throw the dice hard, and when they want a low number, they give it a gentle toss?? I found that to be an amusing example of the illusion of control in? a case where humans have no control.

This book helps answer a number of tough questions:

When are crowds better than experts, and vice-versa?
Why don’t we go get data, rather than listening to anecdotes?
Why does an initial estimate play such a large role in estimating the final value?? (Why don’t people ignore the estimates, and start from scratch?? It’s too much work!? Never underestimate the power of laziness.)
Can subliminal cues lead people to make different decisions?
Do I have to understand the whole system to understand the piece of the system that I am interested in?
When can you outsource production, and when does it not make sense?
When do catastrophic events occur, and why?
How does one sort out happenstance (so-called “luck”) versus skill?

The clear message of the book is don’t be lazy; do your homework on any task.? Try to be objective as possible, ignoring the opinions of others, and using as much data and cold logic as one possesses to confront the problem.? Be aware of the mental shortcuts that hinder good decisonmaking.

I recommend this book, but with a quibble.? It is not written in a truly user-friendly way.? There are technical terms used and not defined that many average people will blink at, and maybe get part of the meaning through context, but not get it in full.? If we Flesch-tested the book, it would come up at “college level” for reading.? (As for me, I am to be understood at a high school level.)

Who can benefit from this book?? Anyone who makes economic decisions could benefit.? It would help them be more self aware of the pitfalls involved in decisionmaking.? I found it to be a breezy read at 143 pages of main text, and the writing style is entertaining.

You can buy the book here: Think Twice: Harnessing the Power of Counterintuition.

Full Disclosure: Anyone entering Amazon through a link on my site, and buying something — I get a small commission.? Your costs remain the same.

To my readers, if you want me to review Mauboussin’s other book, Expectations Investing, I would be more than happy to, because I read it five years ago.? If you have other books you would like me to review, let me know… my time is limited, but if I get a lot of people asking for the same book, I will give it a shot.

PS — look at the book cover — what is the hidden message? (which never gets mentioned once in the book…)

Book Review: Fallen Giant

Posted on 26 September 200926 September 2009 by David Merkel

I am glad I read this book, but I found it less than satisfactory.? Why?? Wait a moment on that question, while I tell you about the book’s strong points, which I appreciated.

AIG’s founder was Cornelius Vander (C.V.) Starr, sometimes called Neil Starr.? (Alas, but the book does not explain the nickname.)? He was an amazing guy who worked like crazy to create an insurance brokerage in China for US companies, and then brokered insurance in many other places in the world.? The success was so significant that the company returned to the US and bought up some of the companies that it had placed business with.

C. V. Starr was a fascinating man who appreciated art, skiing, golf, global travel, and was open-minded toward other cultures, incorporating bright local managers into his firm.? He had an aptitude for sensing management talent, which seemed to correlate with willingness to embrace multiple cultures.? He was also a business animal, which led to a tight-knit culture with his top lieutenants, and an inability to keep a wife acquired later in life happy.

He created a complex corporate structure to reward significant long-termers with AIG.? That would later prove to be a major source of contention when Greenberg was forced out.

The book divides into four sections:

The Life of C. V. Starr
The Arrival and Success of Maurice Raymond (M. R. “Hank”) Greenberg.
The author’s experiences working for AIG (1973-mid-80’s).? He was a lieutenant of Hank’s dealing with foreign affairs.
The fall of Hank Greenberg and the demise of AIG.

Do you see the big gap?? The story jumps from the mid-’80s to 2005.? There is a 20-year gap of which little is said.? There are snippets, yes, but there is nothing comprehensive.? The book is written chronologically in a micro-sense, but not in a macro sense.? Chapters are topical, but chronological within the chapters.? The chapters are chronological, but the periods overlap, chapter to chapter.

There are other weaknesses to the book as well:

It doesn’t really explain how Greenberg became so influential at AIG, and gained the trust of Starr.? (There are stories that I heard, but I have no idea how true they were.)
It doesn’t tell the story of growth in the middle years.? Why did they succeed?? What of the takeovers that they missed?
It doesn’t deal with critical business decisions like why AIG acquired ILFC, SunAmerica, and American General.? With the latter two, why was Greenberg willing to pay up?? That was not his style in prior days, which was why AIG did not buy The Equitable.
How the strategy of AIG changed from nimbleness (entering and leaving markets at will) to omnipresence (we do business everywhere.
Not recognizing the continuing increase in debt at AIG.
The author sees the “small” issues that led to the ouster of Greenberg, but does not find anything larger that merits attention.? The Financial Products unit gets a mention, but the insolvency of the life companies does not.
For the lawsuits that emerged after Greenberg’s ouster, the author takes a slightly pro-Greenberg slant.

Who would benefit from this book?? Anyone who wants to learn about the amazing C.V. Starr.? That is the main benefit of this book.? If you are looking for a history of AIG, well, this may be the best book out there, but it has the inadequacies that I listed above.

Unlike other reviewers, I read every book I review, and in the few cases where I scan a book, I disclose it.? Any reader entering Amazon through my site and buying anythig there, I get a small commission.? You can buy today’s book here: Fallen Giant: The Amazing Story of Hank Greenberg and the History of AIG

Book Review: Finding Alpha

Posted on 3 September 2009 by David Merkel

I found this book both easy and hard to review.? Easy, because it adopts two of my biases: Modern portfolio theory doesn’t work, and the equity premium is near zero.? Hard, because the book needed a better editor, and plods in the middle.? I don’t ordinarily do this, but I felt the reviews at Amazon were valuable, particularly the most critical one, which still liked the book.? I liked the book, despite its weaknesses.

One core idea of the book is that risk is not rewarded on net.? It doesn’t matter if you measure risk by standard deviation of returns, beta, or credit rating (with junk bonds).? Junk underperforms investment grade bonds on average.? Lower beta and standard deviation stocks overperform on average.

A second core idea is that some people are so risk averse that they only accept the safest investments, which leaves investment opportunities for those that are willing to compromise a little with credit quality or maturity.? Moving from money markets to one year out is an almost riskless move for most, and usually adds a lot of excess return.? Bond ladders do the same thing, though Falkenstein does not discuss those.

Also, the move from high investment grade to low investment grade does not involve a lot more investment risk, but it does offer more yield on a risk adjusted basis.

A third core idea is that equities, though more risky than high quality bonds, have not returned that much more than bonds when the returns are measured properly.? See this post for more details.

A fourth core idea is that people are more willing to take risks to be wealthy than theory would admit.? Most of those risks lose money on average , but people still pursue them.

A fifth core idea is that alpha is hard to define.? Helpfully, Falkenstein defines alpha as comparative advantage.? Focus on what you can do better than anyone else.

A sixth core idea is that leverage, however obtained, does not add alpha of itself.? This should be obvious, but people like to try to hit home runs.

A seventh core idea is that when an alpha generation technique becomes well-known, it loses its potency.

An eighth core idea is that people are more envious than greedy; they care more about their relative position in this world than their absolute well-being.

One idea he could have developed more fully is that retail investors are easily deluded by yield.? They underestimate the amount of yield needed to compensate for illiquidity, optionality, and default.? Wall Street makes money out of jamming retail with yieldy investments that deliver capital losses.

Another idea he he could have developed is that strategies that lose their potency lose investors, and tend to become less efficiently priced, leading to new opportunities.? Investment ideas go in and out of fashion, leading to overshooting and washouts.

How one achieves alpha is not defined — Falkenstein leaves that blank, because there is no simple formula, and I respect him for that.? He encourages readers to devise their own methods in areas where there is not a lot of competition.? Alpha? comes from being better than your competition.

Summary

What this all says to me is that investors are too hopeful.? They look for the big wins and ignore smaller ways to make extra money.? They swing for the fences and get an “out,” rather than blooping singles with some regularity.? I like blooping singles with regularity.

I recommend this book for quantitative investors who can find a way to buy it for less than $40.? The sticker price is $95, though it can be obtained for less than $60.? Try to find a way to borrow the book, through interlibrary loan if necessary — that was how I read Margin of Safety by Seth Klarman.? Klarman’s book is not worth $1000.? Falkenstein’s book is not worth $95.? Falkenstein’s very good blog will give you much of what you need to know for free, and even more than he has covered in his book.

This book would also be valuable for academics and asset allocators wedded to Modern Portfolio Theory and a large value for the equity premium, though some would snipe at aspects of the presentation.? Parts of the book are more rigorous than others.

If you still want to buy the book at the non-discounted price, you can buy it here: Finding Alpha: The Search for Alpha When Risk and Return Break Down (Wiley Finance)

PS: Unless I state otherwise, I read the books cover-to-cover, unlike most book reviewers.? The books are often different from what the PR flacks encourage reviewers to think.? If you enter Amazon through my site and buy anything, I get a small commission.

Book Review: The Flaw of Averages

Posted on 27 August 2009 by David Merkel

“Just give me the number, willya?”? Ugh.? I’ve had the question asked many times in my life working in or alongside financial reporting in a company.? They need a number for the budget, even though that number will certainly be wrong, leading to numerous explanations for why we are mistracking the budget.

The truth is though there will be one result for the question you ask prospectively, hypothetical answers will often systematically mis-estimate the result when average inputs are fed into models.

As I have experienced in the insurance industry many times, good companies accept feedback from claim experience? into new product pricing, and consider the potential downside risks.? Bad companies rely on industry tables (averages), and assume that downside deviations are just random.

Would we manage companies better if we shared data on how uncertain our estimates are?? Certainly, but the whole company would have to be geared toward understanding how to deal with risk and uncertainty.

Often there is option-like behavior in companies, where if sales are low, expenses will be cut back to a baseline level, but if they are high, expenses will run.? Average expense numbers rarely express the likely result.

Most people/companies assume that things will be stable.? If we look at projections of investment results, stability is the norm.? But our world is unstable.? There are booms and busts; there are wars.? Plans lose their validity when the real world appears.

“The Flaw of Averages” is a popular book on statistics.? It points out many ways in which statistics are abused.? This book will make you a skeptical and reasoned consumer of statistics.

Quibble:? My main difficultly with the book, is that much as the author tries to simplify the concept of complex simulations, is that in the ninth part of the book, he seems to overly encourage use of his own software.

Aside from that, the average reader will learn many ways that statistics such as averages can deceive.? As Benjamin Disraeli, once said, “There are three kinds of lies: lies, damned lies, and statistics.”? This book will help you avoid the last sort of lie.? I recommend this book.

If you want to buy it, you can buy it here: The Flaw of Averages: Why We Underestimate Risk in the Face of Uncertainty

Full disclosure: All purchases from Amazon entering through my site give me a small commission.? Your price at Amazon does not change as a result of the commission.

Book Review: Making Sense of the Dollar

Posted on 25 August 200912 February 2011 by David Merkel

Many people think in non-systematic terms.? They consider the US current account deficit to be an unmitigated disaster.? They look at one side of the issue and conclude that the US has become less competitive.

Understanding accounting, the books must balance.? Not everyone can run a current account surplus.? Some countries must run deficits in order to purchase goods from those that run surpluses.? Capital account surpluses balance out current account deficits; net foreign investment fills the gap.

Marc Chandler, with whom I became acquainted while writing for RealMoney, has written a book for the average reader to explain the basics of international economics and foreign exchange.? The book deals with common myths that arise in the discussion of trade and currencies.

Why do we lose industrial jobs in the US?? It’s not foreign competition, though that may occasionally play a role when countries subsidize their industries.? We lose industrial jobs because of technological improvements that require less labor in the manufacturing processes.? As I have said, Nucor was a bigger risk to the rest of the steel industry than foreign competitors.

Chandler is a proponent of the turn-of-the-century Open Door Policy, which led the US to be more free market capitalist than the rest of the world, gaining influence through trade.? Together with military victories, this led the US to be the world’s dominant economic power post-WWII.? Given the change in currency regimes, this made the US Dollar the leading reserve currency in the world.

Aside from military superiority, and political calm,? labor market flexibility and a culture of innovation have made the US dominant in global economic affairs.? As I have sometimes said, if the world did not have America, it would have to invest one.? Where else would all of the spare labor, capital and goods go?

There are advantages to being the world’s reserve currency.? The US runs current account deficits, and other nations buy our debts.? Such a deal; every nation should want this (but, as we learn, it is likely only one nation can have this at a time).

Capital flows are much larger than trade flows; it should be no surprise that the US Dollar does not react to the current account deficit.

(An aside: when I was in Grad School, the idea that interest rates drove currencies through arbitrage was new, and gaining favor.? Since then, a blend of the interest rate markets and goods markets driving currencies is the dominant paradigm, with momentum thrown in.)

Chandler deals with these issues, and other myths that plague the discussions around international economics and the currency markets.? In general, I agree with his views, but with a few quibbles/additions:

It is not costless for countries to run current account deficits.? Countries that run current account deficits have to offer attractive opportunities for foreigners to invest in their country, or suffer declines in the value of the currency.
The country taking the non-economic action will eventually pay the price.? Whether hoarding gold in mercantilism, or neo-mercantilism, hoarding US debt assets, whether Japan in the late ’80s or China today, the nation forcing the issue gets hurt more.? China will suffer for over-promoting growth of exports.
It would be reasonable to have a gold standard once more — the trick is setting the initial price level, so that it would not be inflationary or deflationary.
It would have been nice to offer retail investors some theory to explain how currencies move, rather than just dispel myths.? That said, there probably is no such theory, and if it exists, ordinary people probably could not understand it.

Absent my quibbles, on foreign currency Marc Chandler knows far more than me.? If foreign exchange and trade is of interest to you, you will benefit from this book. One more note: this is not a technical book with lots of math, and there is no technical analysis on its pages.

If you want to buy the book, you can buy it here: Making Sense of the Dollar: Exposing Dangerous Myths about Trade and Foreign Exchange

Full disclosure 1: I actually read the books that I review.? Many reviewers don’t.? They read the stuff the PR flack sends along, and read a chapter or two, and write the review.? I throw away what the PR flack sends before I read the book.? I give you my own opinion on the matter, nothing more, nothing less.? Finally, if you enter Amazon through my site and buy anything, I get a small commission.

Full disclosure 2: long NUE

Book Review: Mr. Market Miscalculates

Posted on 29 July 200920 June 2017 by David Merkel

Since the first time I read him, I have been a fan of James Grant.? He helped to sharpen my focus on how money and credit work in the long run, and how they affect the economy as a whole.? Reading one of his early books, Minding Mr. Market: Ten Years on Wall Street With Grant’s Interest Rate Observer, I gained perspective on the increasingly complex financial world that we were moving into.

But not all have shared the opinion of Mr. Grant’s wisdom.? When I worked for Provident Mutual, the Chief Portfolio Manager (at that time new to me, but eventually a dear colleague) said to me, “feel free to borrow any of the publications we receive.”? For a guy who likes to read, and learn about investments, I was jazzed. But, when I came back and asked whether we subscribed to Grant’s Interest Rate Observer, I got the look that said, “You poor fool; what next, conspiracy theories?” while she said, “Uh, noooo. We don’t have any interest in that.”

Now the next two firms I worked for did subscribe, and I enjoyed reading it from 1998 to 2007. But now the question: why buy a book that repeats articles written over the last fifteen years?

I once reviewed the book Just What I Said: Bloomberg Economics Columnist Takes on Bonds, Banks, Budgets, and Bubbles, by another acquaintance of mine, the equally bright (compared to James Grant) Caroline Baum.? This book followed the same format, reprinting the best of old columns, with modest commentary.? In my review, I cited Grant’s earlier book as a comparison, Minding Mr. Market.

As an investor, why read books that will not give an immediate idea of where to invest now?? Isn’t that a waste of time? That depends.? Are we looking to become discoverers of investment/economic ideas, or recipients of those ideas?? Books like those of Grant and Baum will help you learn to think, which is more valuable than a hot tip.

Here are topics that the book will help one to understand:

How does monetary policy affect the financial economy?
Why throwing liquidity at every financial crisis eventually creates a bigger crisis.
Why do value (and other) investors need to be extra careful when investing in leveraged firms?
What is risk?? Variation of total return or likelihood of loss and its severity?
Why financial systems eventually fail at compounding returns at rates of growth significantly above the growth rate of GDP.
Why great technologies may make lousy investments.
Why does neoclassical economics fail us when trying to understand the financial economy?
How does one recognize a speculative mania?
And more…

The largest criticism that can be leveled at James Grant was that he saw that he would happen in this crisis far sooner than most others.? Being too early means you eventually get disregarded.? The error that the “earlies” made, and I knew quite a few of them, was not recognizing how much debt could be crammed into the financial economy in order to juice returns on fixed income assets with yields lower than likely default losses.? That’s a mouthful, but the financial economy had not enough good loans to make relative to the amount of loans needed to maintain the earnings growth expectations of the shareholders of financial companies. Thus, the credit bubble, facilitated by the Fed and the banking regulators.? You can read all about it in its many facets in James Grant’s book.

You can buy the book here: Mr. Market Miscalculates: The Bubble Years and Beyond.

Who would benefit from the book?

Those that have assumed that neoclassical economics adequately explains the way our economy works.
Those that want to understand how monetary policy really works, or doesn’t.
Those that want to learn about equity or fixed income value investing from a quirky but accurate viewpoint.
Those that want to be entertained by intelligent commentary that proved right in the past.

As with other James Grant books, this does not so much deal with current problems, as much as educate us on how to view the problems that face us, through the prism of how past problems developed.

Full disclosure: If you buy anything through the links to Amazon at my blog, I get a small commission,? but your costs don’t go up.?? Also, thanks to Axios Press for the free review copy.? I read the whole thing, and enjoyed it all.

Book Review: The Myth of the Rational Market

Posted on 14 July 200914 July 2009 by David Merkel

There are few books that I read that leave me feeling as if I have taken a trip down memory lane.? The Myth of the Rational Market was that for me.

In my junior year at Johns Hopkins, I wrote my senior thesis on predicting splits in the stock market.? I had to do it in my junior year because I had applied to do a combined BA/MA in political economy in my senior year.

My thesis, springing from what I had learned in Dr. Carl Christ’s class on financial economics (which in itself was an anomaly in the political economy department), forced me to analyze the then-fresh literature on event studies on efficient markets, including the famous paper by Fama, Fisher, Jensen, and Roll on how it was impossible to make money off of stock market splits.

That paper was important, because prior research was not agreed on the topic, and it was an example of something not all that significant that could be a signal of greater things — that managements would only split the stock when they had confidence.

Young David, having been raised in a home where his self-trained mother had regularly beaten the market, found the efficient markets hypothesis less than compelling.? Like his mother, he felt that superior analysis of fundamentals should outperform.

But here was a situation where it was obvious that stocks that split outperformed before they split.? My thesis asked, “Could splits be predicted?”

Going through the literature, I came up with some variables that could be useful — some were valuation-based, some were technical (price, volume), and some were anomalies (insider trading).? I ended up finding that stock splits could be predicted more often than not, but more importantly, that the variables that correlated with stock splits were more generally correlated with outperformance (in the 7%/yr region).? Those variables included valuation, momentum, and insider trading — which for a paper written in 1982 was notable.? I concluded that the Efficient Markets Hypothesis was flawed, also notable for its time.

Wait — this is a book review.? As I read Justin Fox’s work, I admired its ambition.? This attempts to cover financial markets efficiency, with some efforts toward economic efficiency generally.? It covers a lot of ground — all of the major players in the efficiency of financial markets debate are featured, and written about in simple language — there are no equations to wade through as I once did.? This book is comprehensive, and touches on many of the more obscure critics of the Efficient Markets Hypothesis.? Bright men who are tangential to the Financial Economics profession get their play — Kahneman, Tversky, Minsky, Mandelbrot, and more

Many of these men that questioned market efficiency went down the same trail that I did; they were led by the data, which conflicted with neoclassical economic theory.? Many of them came to my view that the market is pretty efficient, but not perfectly so.? Efforts at finding inefficiency promote market efficiency.? Efficient markets make people lazy, which leads to inefficiencies that can be profited from.

I liked this book a great deal.? It gets a bit thin at the end when it tries to incorporate the current crisis into its framework.? More broadly, it is at its weakest where it merely touches on a significant contribution, but does not dig deeper.? That said, a book of 500 pages would be far less readable than one of 300+.

Who would benefit from this book:

Those who are too certain about their positions on market efficiency.
Those that assume that the market is always or rarely right.
Those that select asset managers, because there is a lot of volatility around investment returns.? What is luck? What is skill?? We know less here than we imagine.
Academics in economics that are not familiar with the finance literature, because this would give an outline of the questions involved.

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When I do book reviews, I actually read the books.? In the few cases where I scan a book, I reveal that in the review.? I also offer the easy ability to buy books through Amazon.com, and if you want to buy this book click here:? The Myth of the Rational Market: A History of Risk, Reward, and Delusion on Wall Street

Full disclosure: if you buy anything through Amazon after entering through my site, I get a small commission, but your costs do not go up.

Book Review: The Guru Investor

Posted on 17 June 200917 June 2009 by David Merkel

John Reese and I share something in common: we both once wrote for RealMoney.com.? Occasionally I would question him in? the CC about what he wrote, but I never got an answer back.? He was probably a busy man.

Well, now I get to review his book, and I have to say that I like it.? It won’t be one of my favorite investment books, but it embeds many good ideas that will be useful to average investors.? Here are some of the main advantages:

1) It points people toward strategies that are valuation-conscious.? Whether investing for growth or value, the best investors pay attention to valuation.

2) Valuation is not everything.? Earnings growth and price momentum also are valuable to follow.

3)? Quality of the balance sheet matters.

One of the things that I like to say to investors is find something that fits your character, your free time, and your time horizon.?? This book simplifies the strategies of ten clever investors.? Some require more time and effort, some less.? With ten good strategies to choose from, perhaps one will fit your situation well.

For the ten gurus, it describes them, their strategies, and how to implement them in a simplified way.? I knew a little about all of the gurus before reading the book, but I learned a little bit new about each one, except Buffett.? They made life choices that led them to their investment theories, and the book makes that connection.

Sell Discipline

The sell disciplines in the book are similar to mine — rebalancing, and adding stocks that the model likes better, and removing those that rank lower.? For fundamental investors, that’s a reasonable way of limiting risk, assuming that you review your thesis before adding new money.

Quibbles

1)? Earnings quality: leaving aside Piotorski, the rest of the gurus spend little time on earnings quality.? Particularly for value investors this component is critical for avoiding mistakes.

2)? What Reese puts forth is a simplified version of what most of these great investors do.? The actual process is more complex, and requires business judgment.? That said, his simplifed versions have done better than the market, in general.

3)? Performance calculations cut off in July 2008.? Now, he had to cut off somewhere, or he couldn’t publish.? Still, it would be interesting to know how the strategies did July 2008 through February 2009 — how did they do at risk control?

4) To be able to use this book effectively, you would need to have access to some reasonably sophisticated stock screening software.? The cheapest one that I know of would come from AAII, but you would also have to be an AAII member to buy it.? (If anyone knows a better one at a cheaper price, let me know.)

Who Would Benefit From this Book

This book would work best for people who want to follow valuation-conscious strategies, and not spend a ton of time at it, if they are willing to put in some time at the beginning setting up stock screens.

Summary

If after you have read this, you want to buy the book, you can buy it here — The Guru Investor: How to Beat the Market Using History’s Best Investment Strategies.

Full disclosure: I get a small commission from Amazon on anything that gets bought after entering Amazon through my site.? Your price doesn’t go up, and Amazon is always happy to have additional sales, even at a lower gross margin.

Book Review: Financial Shock

Posted on 22 May 2009 by David Merkel

Note to readers: for this review, I read the first chapter, and skimmed the rest of the book. (full disclosure)? I usually read the entirety of every book I review, but I did not this time.? Why?? Chapter 1 is the backbone of the book, and tells the whole story in a nutshell.? The remaining chapters flesh out Chapter 1.? Most of my writings over the past five years shadow what Mr. Zandi has written, and he has created an integrated description that covers every major area of the crisis, with particular attention to mortgages, and the huge effect that the speculative mania in real estate had on the financial economy.

This is a serious book, one that explains the roots of our crisis.? If you haven’t understood it in a systematic way from reading my blog, or those that I recommend, this book will give you a coherent explanation of how we got here.

I do have some quibbles with the book.? When he describes residential mortgage securitization on page 117, the mezzanine and subordinated tranches are too large, even for subprime.? Also, his recommendations in the last chapter — I can agree with most of them, but not with mark-to-market, and the uptick rule.

This edition of the book takes us up to the first quarter of 2009, allowing Zandi to comment on the initial actions of the Obama administration.

All in all a very good book.? If you have a relative that doesn’t understand the crisis, this will explain it to him in a simple way.? If you want to buy it, you can buy it here:

Financial Shock (Updated Edition), (Paperback): Global Panic and Government Bailouts–How We Got Here and What Must Be Done to Fix It

As with all of my reviews, if you buy something through Amazon after entering through my site, I get a small commission, and you don’t pay anything more.? Don’t buy anything that you don’t want to buy on my account, though.