Empire Investing Strategy Review - Part 2

In the first part of this review, I looked at the first two components of the investing strategy outlined at the Empire Investing website.  These were the 1. Filter and 2. Value steps.  I'd now like to take a look at the next few:

• 3. Assign Risk - utilise a margin of safety.
• 4. Observe - Concentrate and watch the select few closely - like a hawk.
• 5. Act on Buy Signals - Purchase on every buy signal.

I've leave "6. Assign Capital" for another post, as I think that that is complex enough to warrant it's own post.

Assign Risk - ustilise a margin of safefy

I've never quite got the concept of "margin of safety".  I understand that estimations and predictions have a margin of error, and that by creating a margin of safety, one hopes to eliminate, or at least minimize, the risk of a negative outcome.  However, what I can't grasp is how this is any different to the concept of maximizing expectation value, or in layman's terms "trying to make as much money as possible", and hence why it's referred to as "margin of safety" rather than "maximizing profits".

Is there a little book that beats "The little book that beats the market"?

Recently, I looked at the little book that (still) beats the market.

Being a revised edition of the orignal (hence the "still" in the title), towards the end of the book, Greenblatt responds to suggestions for improvements to his magic formula.  Interestingly, he tried a number of these suggested improvements using his simulation tool, and despite sounding like good ideas, none of the suggestions actually improved the portfolio performance.

This reminded me of the classic iterated prisoner's dilemma competition, where the simple winner (tit-for-tat) of the first competition also won the second competition, despite all the new entrants in the second competition knowing exactly how it worked to win the first competition, and being written to specifically beat tit-for-tat.  Each of the so-called "improvements" on tit-for-tat could beat tit-for-tat, but couldn't outperform tit-for-tat on average against all of the other strategies.

So, I pose the question - can the magic formula be improved, or does it's elegant simplicity outperform any variation?

In case you missed it...

This blog is now three months old, so I thought that it might be time for a checkpoint review.

I started off by trying to talk about some tax effective investment structures, in the hope that some real and useful information would give me some online credibility.  Perhaps I waited too long between the actual setup of those structures and the documentation thereof, and so the accuracy, and hence usefulness was not quite as high as I had hoped.  I'll know better for next time.

I tried a couple of thought experiments, which I personally found very useful in drawing me to a couple of my key investment beliefs, but they were not well received - in terms of readership and participation.  Nevertheless, I will persist with these, as I have a number more to go through, and they are central to the theme of this blog - delusional investing: "These are the thoughts going through my head.  Am I delusional?"

There were a few other random posts, that don't directly relate to the theme of this blog, but that I needed to write about to understand myself.  There will be many more these, that one day, I hope to string together into a reasonably cohesive story.

The most popular post to date has been on the little book that beats the market.  I'm not sure that this is a great thing, because I haven't been able to determine if the people that search for that book are after the "quick win" investing answer, or whether they are genuinely interesting in investing strategies.  Hopefully the latter, because I'll continue to review investing strategies as I find them.

Ideally, I like to have more comments on my posts than I have been receiving so far.  I don't measure the success of this blog on the number of views, but instead, on the number of "insightful comments".  Having only received a handful of comments, I have to count this as a failure of this blog to date.  Thanks to those that have commented though.

I think that I need to get more involved with other value investing blogs, and to participate in the existing communities, to be able to get the feedback that I am looking for.  To that end, I hope to review a bunch of blogs to determine which ones are of value to me, in the hope of reciprocity.

Anyway, thanks for reading, and please give feedback.

The reality of models

Models are useful abstractions of reality.  The "correctness" of a model is simply is usefulness for a particular purpose.

Instrinsic Value and Target Prices

When I was recently reviewing Empire Investing, I luckily stopped at the "value" step of their investment strategy, as this gave me time to reflect on a couple of things.

The first is the concept of intrinsic value, which most value investors will know well, as the traditional texts of Benjamin Graham and Warren Buffett refer to it often.  I, however, don't subscribe to it.  I simply don't believe that anything has an "intrinsic value" - the only "value" that can be placed upon something is someone's desire to have it.

A long term investor will value certain properties of a company very differently than a short term investor would value those properties.

Consider the example of a house.  I could describe a house as "2 bedrooms, 1 bathroom, modern and in a nice suburb" to a room full of people, and ask each of them to create a baseline valuation of this house.  It doesn't matter what valuation they come up with.  I could then ask "and what is the change in value if I add a double-car lock-up garage on".  To some people, this might de-value the house, (if for example they didn't have a car, didn't want one, and didn't need the storage space) and to others, like myself, it would add value to the house.  So, what is the "intrinsic value" of the garage?  It doesn't make sense.

So, what Buffett et al are referring to when they refer to intrinsic-value is actually value-to-them, as long term investors.

Empire Investing Strategy Review - Part 1

This blog is supposed to be about investing strategies, and to date, I haven't spent too much time talking about them (other than the magic formula).  Luckily for us, there is an investment company called Empire Investing that publishes their investing strategy, and so today I'd like to review it. 

Let me start by saying that I have no affiliation with Empire or any of it's staff, other than that The Prince has chanced across this blog before.  Not that it matters though, as it seems that they are not currently accepting any new clients or funds.

So, to start off, I'd say that one of the reasons that I'm looking forward to this review is that their investing strategy is quite similar to my own, but with some interesting differences.  Let's look at their strategy in a nut shell:

The stock market side pot

Here's another thought experiment for you.

Suppose the government (or the stock exchange) changed the rules on investing to ban short-term trading.  The mechanism for how they do this is not important, but it could be implemented, for example, by changing the capital-gains tax rules to tax short term trades at 100%, making them pointless.  Let's say that they effectively prevented anyone from owning stocks for less than 3 years.

What would happen to the market?

Friday on my mind - continued

I hope that you've had some time to think about the original thought experiment.  Please read it if you haven't, or else the rest of this post will make no sense whatsoever.

Friday on my mind

Here's a thought experiment for you.

Suppose that you own a regular house in a regular suburb.  One Sunday, you wake up, and you think to yourself - "I like this house, I think it's worth $500,000.  Yes, I wouldn't sell it for any less than that."

On Monday morning, for whatever reason - it doesn't actually matter why - your next door neighbour, who's house is practically identically to yours, comes over to your house and says "Today I am leaving, and I'm giving you my house. Here's the title.  It's yours".

On Tuesday morning, a man appears at you door, and offers you $500,000 for your house.  You seriously consider it, and tell him that you'll think about it, and get back to him.  You also point out that you own the house next door.  He leaves you with his offer.