Author Archives: amateurinvestor

Microsoft: leveraging and extending its competitive advantage into the future

My approach to investing in individual companies starts with identifying the rare companies with a sustainable competitive advantage.  While the existence of a durable competitive advantage is manifested in quantifiable features of the financial statement, the ultimate judgment of whether the current competitive advantage will last for the foreseeable future is qualitative, relying on an understanding of the nature, competitive environment and history of the business.

To adapt to an ever changing future, vigilant companies make trial investments in new related markets. The longest lasting companies are those who finally invest only in those areas in which they can maintain a competitive advantage, and hence continue to earn better than average returns on investment for the foreseeable future.   Many companies watch their once impregnable advantage decline as events shape history’s final judgment.  For example, Kodak was dominant in photographic film and in the 1970s had a 90% market share.  It then participated in the invention of digital photography and had the opportunity to integrate its own digital photo technology into PCs in the 1980s.  But Kodak did not pro-actively build a new basis for market dominance in the new markets.  Competitors caught up and passed, Kodak faded and finally filed for Chapter 11 Bankruptcy in 2012. It turns out that rare companies do the work to create bridges to future franchises, using their current market dominance to shape and outcompete in new markets.  Microsoft (MSFT) is such a company.

For the past 10 or 12 years, Microsoft has frankly been unloved by the fashionable tech media, and increasingly by the professional investing crowd.  Under this surface air of decayed greatness is an irrepressible, tenacious organism that adapts by thrusting into new territories, taking root only in areas in which it may extend its competitive advantage, and then proceeding to compete as if its life depended on it.

Recently, MSFT has put in motion a few approaches to increase its competitiveness, and these are now beginning to bear fruit.  These include low balling the price of its Windows OS;  developing its applications for cross platform markets;  partnering with 3rd party software/platform providers that may be competitors; and transitioning its market dominance to the cloud.

MSFT has used these strategies before. For example, in the early 1980’s Multiplan, the predecessor of Excel, was coded for a software emulator that would be interpreted for different OEM PCs. Thus it was sold to more than a hundred different OEMs selling to businesses, in an ultimately successful end run around Visicalc, which had locked up the retail market.  When MS-DOS was released in 1981, it was virtually given away to OEMs building IBM PC clones for a flat fee.  Clearly, MSFT viewed this as a race to sell applications (also including the programming languages that comprised its main business) as opposed to the OS.

For a vivid account of early Microsoft history and the tale of how a couple of intelligent, determined youngsters, who thought out of the box and had the courage to act on their convictions, created what would become one of the most formidable companies in history, read the splendid Hard Drive: Bill Gates and the Making of the Microsoft Empire
by James Wallace and Jim Erickson.

As announced in April at Build 2014 conference, Windows is now free to OEMs for smartphones and devices of screen size 9 inches or less, and windows now has lower processor and storage requirements. While Windows still has roughly 90% market share in PCs, the overall variegated market of computing devices has vastly increased in the last 10 years, so that Windows has less than 20% market share of that wider universe.  There are large markets for MSFT software.

OEMs have responded vigorously to this overture. For example, more than 11 (up from 3) signed up for Windows phone in the first quarter of this year.  It is important to note that since android OEMS must still pay license fees to MSFT, a $0 Windows Phone license costs them less than Android.

A lower cost Windows opens up markets on devices, as in the past, to Microsoft apps. These include both consumer oriented apps such as Xbox music, video and games, productivity apps including office 365, and services to manage devices for businesses. Over 2 years ago MSFT began writing a version of Office for iOS. When finally released in late March, it was  downloaded almost 30 million times in less than two months.  CEO Satya Nadella has articulated the vision of “Cloud First, Mobile First”, and that Microsoft will focus on “platforms and services”.  From the vantage point of BYOD, this means that businesses will use MSFT productivity applications on popular devices, on the respective different platforms, and manage mobile devices with MSFT Cloud based subscription services such as Microsoft Intune.

A third way MSFT is increasing competitiveness is by partnering with competing software service and platform providers. For the past 2 years, because there is demand for services from other providers in the public cloud, Windows Azure has increasingly accommodated services on 3rd party platforms running on Linux or from other providers such as Salesforce, SAP, Oracle and many, many others. This has produced a hockey stick upshift in Azure revenue growth.  See here for more on how Microsoft is levering its market dominance in productivity applications and services to gain market share in the Cloud, from which it wields the Cloud First, Mobile First strategy.

basis and disclosure for book reviews

A close sighted view of allocating my time for maximal profit would be to spend my time learning about investing solely for my benefit.

But I have also benefitted immensely by the careful study that is sharpened by a need to articulate and teach, even while simply discussing with others. So attempting to share my knowledge with others, hopefully in a lucid, vivid way, should continue to help my own investing efforts. And in truth, all that I learned, was aided by the material that others created in their efforts to teach.

There is also the ethical aspect, that just as I helped myself and my family by investing, I may perhaps touch others, who might discover the opportunities and gratification of the investing approach to life. Particularly, young people, may benefit so immensely from understanding that investment is fundamentally, the allocation of resources, your resources, so as to preserve your capabilities, add to them, and maximize your potential. And your truly maximal potential will be as directed by your talents and intentions, none others.

As I noted elsewhere, my learning has benefitted from reading. The writings of accomplished investors are a crucial starting place and continuing education and it is natural and important that I point my readers to this material. I have read every book I review. My reviews are my personal take on the book, not taken from elsewhere.

But this blog is at root an investment, with a watchful shareholder. As a sincere effort to earn money from this blog, I link the book reviews to a purchasing site on amazon.com (where I buy virtually all of my books). If you buy them after traversing the link provided, I do receive a small commission, which does not raise the price for you.

How we invest: distinguish fear and opportunity, insist on great companies, ignore wall street.

latest twitter pic7-9-14
Amateur Investor blog describes an approach to investing which can be executed on a part time basis, but hopes to beat average market returns.

Without question, Amateur Investor stands on the shoulders of giants. I came to investing relatively late in life, awakened by the cataclysmic power of the markets in the tech bubble of 2000. I embarked on a period of study and discovery of investing. I found that the greats of value investing possessed the antidote for the carnage that was the bursting of the tech bubble. Beginning with the greats of value inviting, including Warren Buffet, his teacher Benjamin Graham, and many other investors and writers, I iteratively honed my own approach.

I will take Benjamin Graham’s definition of investing as a minimal definition of investing as opposed to speculation:

“An investment operation is one which upon thorough analysis promises safety of principle and an adequate return. Operations not meeting this are speculative. ”
The fact is, successful Amateur investment requires more considerable studying, reading than the complete novice might desire. The possible exception to this is investment by the formula of Volume Cost Averaging.

And yet in my own experience various things have become apparent:

First, the investor who is prepared to spend a few pleasantly enlightening hours per week learning how to invest, and who has the requisite psychological approach, can obtain better than average results.

Second, he or she can obtain these much more efficiently by focusing on common stocks of companies which have certain attributes which allow them to earn better than average earnings for a prolonged period of time. Moreover, they progressively increase the ratio of their gross margin over time. I call these Eternal Companies, because they perpetually put their growing earnings to use strengthening the Company in a self-reinforcing virtual cycle, alongside growing benefits to shareholders

Eternal Companies are wonderful, but they are no mystery, and can be identified by a due examination of available financial statements, consideration of the economics of their business, industry and the company’s position in it, and other FACTS.

A key advantage over those will not beat the market, is the Amateur Investor learns to distinguish economic FACTS form wishful thinking. Coming to terms with the compelling reality of actual costs has the effect of drastically thinning the universe of investing opportunities , allowing one to focus on the rare Eternal Companies. The Amateur Investor finds that professional analysts often say “YES”, when they mean “I DON’T ACTUALLY KNOW, NO ONE DOES, but I will say yes because it sounds much better”.

Accepting the need to be emotionally comfortable with the investment is crucial. Because only with confidence in the Company can the Amateur Investor himself endure the vicious downturns in the market which are a central reality of investing. Indeed, particularly for Eternal Companies, it is these otherwise anxiety provoking market fluctuations which make possible the purchase at a relatively low price. This is one crucial key to above average returns in the long run.

By focusing exclusively on these rare companies, the Amateur is able to much more efficiently and contentedly concentrate and deepen his knowledge of his beloved eternal companies. A deep knowledge reinforces confidence, contributes to peace of mind.

Confidence and peace of mind in the Eternal Company investment enables the Amateur to hold the investment for a long time. Eternal Companies earn better than average earnings over a prolonged period of time. In order to realize the benefit of this economic power, compounding returns must be allowed to operate for as long as this economic power continues. Thus, psychological comfort with the investment unlocks the final step to realizing the potential of Eternal Company investing.

Truly,

Amateur Investor.

Header picture: view of Manhattan from Hudson River across George Washington Bridge and Upper New York Bay.

Manhattan was originally home to the Lenape Native Americans. In 1524 the Florentine Giovanni da Verrazano became the first European to sail as far as Upper New York Bay, and named it after his patron – the King of France’s – Sister. But it was almost a hundred years later that Manhattan’s destiny began to take shape, when corporate raiders of The Dutch West India Company arrived far afar to map the area, with more tangible goals in mind. In 1624 the New Netherlands was established, based on fur trading, and the island of Manhattan was purchased from the natives for approximately $1000 in 2014 USD. The Manhattan enterprise was founded by the Dutch West India Company in order to serve shareholder interests (“tend to the benefit of subscribers”). This focused people’s efforts in productive directions. For instance, when the colony political leader Peter Stuyvesant tried to ban Jewish financiers in the 1650’s, he was corrected by the corporate leadership. Shareholders, including some important Jewish shareholders, demanded the earnings that increased economic activity would bring. The right thing was what would secure long term growth in earning power. Growing the financial industry in Manhattan would grow its competitive advantage.

Manhattan’s competitive advantage was its geographic location with excellent harbor, which attracted the most dynamic elements of the growing Colonies, United States, and a continuous stream of immigrants. This quality strengthened as trade volume and diversity vastly increased with the development of Canal transport to the growing Midwest, later rail and increased shipping. From the beginning, its status as a trade center translated into bleeding edge financial innovation. While becoming a financial center, a large diversity of occupations were attracted to the island.

In 1975 accelerated overspending led NYC to the literally violently teetering brink of bankruptcy. But it was saved, by temporarily chastened unions, bond holding banking interests, and pressure by a nervous US government and foreign financial and government interests, who feared a wider banking crisis. Simply put, New York had to be saved in order to preserve its financial advantages: it was indispensable.

With a renewed devotion to the pursuit of the free market, New York City boomed in the 1980s, 1990s, and 2000s, as Wall Street ascended to new heights of paramountcy, financial wizardry and notoriety, with the customary subsequent tumbles from sun drenched elevations, and temporary regrets.

Today, Manhattan continues as a financial center, as well as a center in many other areas. The reason it endures goes beyond tangible volumes of transactions. The quality that emerges from the interaction humans in a wide range of socioeconomic, cultural, ethnic, national, aesthetic, and many other types of diversity, is propinquity. Propinquity, closeness to each other of distinct entities, or people. If you want to access the potential and the fruits of the entire planet’s resilient, resourceful, dynamic individuals, you can come to New York.

book review for required reading

This is a brief review of The Intelligent Investor, Rev. EdProfessor Graham was a highly intelligent, educated and erudite gentleman who writes lucidly with a gentle humour. Warren Buffet thinks this is “the best book about investing ever written”.

It is mandatory reading for amateurinvestors because it explores three key insights. One is that market prices for potential investments are not predictable, at times tending to sink below the worth of the investment as a going concern (or even the company assets in liquidation), at other times greatly overstating the value of the company. Second, to achieve an adequate return on investment, one must buy at a price that is relatively low, in the sense that it is not a product of the market’s over optimistic view of the company’s prospects. And while particularly true for poor quality companies, this is even true for good quality, promising companies. Third, the investor must beware of his own emotions as a source of erroneous transactions; both in purchasing out of misplaced eagerness, or selling out of misplaced regret or fear.

Finding the listing for the hardcopy, 4th revised edition of this book on Amazon, I was surprised to encounter the notice that “You bought this book on May 1st, 2002”. I remembered that time of my first foray into the world of investing as one marked by trepidation. It was a difficult time for my family in NYC in the economic contraction following 911.

As a very late starter in investing, my first participation in the excitement offered by the market was guided by the breathless optimism of the internet/biotech/large cap growth bubbles that formed the landscape of the euphoric peak of the bull market at the climax of the 1990s.

Until the spring of 2000, there was still a magical energy which propelled seemingly all stocks worth talking about upward. In March this vaporized amongst earnings disappointments and surprise indebtedness on the part of the market darlings. The media conversation began turning to more prosaic matters such as, the requirement for actual earnings. But matters did not rest there, by any means. The market plunged at unpredictable intervals, repeatedly bludgeoning the remaining hope in the power of the market to heal all financial ills. Subsequent years were marked by the record breaking, wholescale corporate fraud and subsequent bankruptcies of Enron, then Worldcom among others, capped by the attacks of 911 and accompanying recession.

The online media pundits which had been so glibly confident were plainly wrong. But I had no alternative basis for a sound policy to guide investment, that is, until I found this book.

Warren Buffet, who did not invest in tech stocks, had been derided as an out of date bumpkin by the investing media during the halcyon days of the tech market bubble. The stock price of Berkshire Hathaway bottomed as the NASDAQ peaked, and surged as the tech stocks plunged, dashing media expectations. Now these same pundits held him up as a clairvoyant. I researched the name of the investor who was now held up as an oracle, began with reading his letters to shareholders, made my way to his mentor, Benjamin Graham.

A subsequent edition, contains commentary on each chapter by Jason Zweig Reading the original text gives an authentic sense of Mr. Graham’s pearls of wisdom. The commentary, while useful at times, also injects some scarcely relevant, unnecessary additional points which can detract from the uniqueness of Mr. Graham’s message. Once you have read the original, it might be useful to reread, this time adding the commentary. I mean no disrespect to Mr. Zweig. I own both editions and periodically reread parts of them. But Martin Zweig is not Benjamin Graham.

The content in the 1986 edition (which also forms the basis for the later 2005 edition with Zweig commentary) dates from 1971. A superficial reading results in the impression that the book is dull, because out of date. Rest assured, dear amateurinvestor, in this book you will find among many other nuggets: that there is nothing truly new under the sun in the recent history of wall street speculation and investor foibles; and that the fruitful search for worthwhile investments will take you in a quite different direction from wall street/media stock market forecasters, analysts and other pundits. These revelations are made even more clearly in Mr. Graham’s other masterpiece, Security Analysis: Sixth Edition, Foreword by Warren Buffett (Security Analysis Prior Editions) which I read following Intelligent Investor.

Some of the important points Mr. Graham makes:

The definition of investment: “an investment operation is one which, upon thorough analysis promises safety of principal and an adequate return. Operations not meeting these requirements are speculative.” This is a definition which I have adopted for my own “investment operations”.

Reviewing the implications to the investor of Market Fluctuations, he reiterates that “the future of security prices is never predictable”. That is, one can never predict precisely when or in what direction they will fluctuate. He illustrates this with innumerable examples of fluctuations in both bond and stock markets which were unexpected to the professional financial traders. “The investor can scarcely take seriously the innumerable predictions which appear almost daily and are his for the asking”.

He elaborates on the distinction of market price of a stock and its value, describing innumerable examples of “discrepancies between price and value” that he found for a specific companies. He addresses the effect of prices on the hopes and fears of the individual investor. He also notes that the attitudes of the population of investors drive market prices separately from the value of the underlying companies. Investors (including financial professionals) make decisions or rather follow each other as a crowd. The market therefore consistently exaggerates both over and undervaluation. Which brings me to one my favorite Benjamin Graham quotations:

“To enjoy a reasonable chance for continued better than average results, the investor must follow policies which are inherently sound and promising, and not popular on wall street”.

Mr. Graham emphasizes the work needed to achieve outstanding results. Reasonably reliable results can be obtained by choosing investments conservatively and making sure to purchase at a relatively low price relative to historical prices for comparable investments (defensive investor). To attempt to beat the market consistently by choosing companies liable to grow at a more rapid rate or investigating the finances of companies to make purchases at more notable discounts from asset value (enterprising investor), requires considerable learning and effort.

“…The art of investment has one characteristic that is not generally appreciated. A creditable, if unspectacular, result can be achieved by the lay investor with a minimum of effort and capability; but to improve this easily attainable standard requires much application and more than a trace of wisdom. If you merely try to bring just a little extra knowledge and cleverness to bear upon your investment program, instead of realizing a little better than normal results, you may well find that you have done worse.”

The rate of return to be expected does not dependent on the degree of risk the investor is willing to take on. Rather, it depends on the amount of intelligent effort he is able to bring to bear on his task. Moreover the enterprising investor’s efforts must be based on facts and reason.

“You are neither right nor wrong because the crowd disagrees with you. You are right because your data and reasoning are right”.

I note that he hinted at the role of an emotional commitment, for this assertion was preceded by the following:

“Have the courage of your knowledge and experience. If you have formed a conclusion from the facts and if you know your judgment is sound, act on it, even though others may hesitate or differ”

The most efficient and simple formula investing method for the lay investor is cost averaging into a broad market index, carrying on regardless of market fluctuations. This approach is mathematically guaranteed to beat the market over time. In fact, this would also beat the vast majority of career investors in the financial industry. “Even the majority of the investment funds, with all their experienced personnel, have not performed so well over the years as has the general market” Why is this? Mr. Graham addresses the root cause. He recognizes the influence of emotions on buy/sell decisions. The greatest danger to the investor lies in taking emotional cues from the marketplace, confidently buying when the price is climbing, and anxiously selling as the price falls.

For the cost averaging investor, the only barrier remaining between the investor and his/her modestly market beating returns is the challenge of carrying on while ignoring market fluctuations. Mr. Graham recommends not starting a cost averaging program if the market is high relative to recent history, because if/when it falls, the investor is liable to fearfully stop the program. This shows that Mr. Graham did not consider that the average (defensive) investor attained the emotional discipline to ignore market fluctuations.

Margin of safety

As investors’ mood changes, the market will offer a price which does allow some margin of safety, or at least is more reasonable in relation to the past p/e ratio for the specific company.

Growth stocks are those representing companies whom are recognized as promising better than average income growth, and the stock price spends much time in an overvalued relative to the company assets. Its price is predicated on the expectation of a rate continued earnings growth. This growth is predicted by the same analysts who, as mentioned above, are unable to make long or short term market predictions accurately.

To avoid prolonged or permanent loss of capital, one must buy with a margin of safety, at a price which is relatively low. With growth stocks, this means one should wait until their price has experienced one of the dips which invariably occur and recur, although seemingly not when expected. Which brings me to the second of my favorite Graham quotations, and one the wisdom of which I have repeatedly had to relearn:

“while enthusiasm may be necessary for great accomplishments elsewhere, on Wall Street it almost invariably leads to disaster.”

And yet perhaps disaster is too vivid a characterization of the suboptimal price obtained for an investment, when patience would have allowed the appearance of a much better one. The limitations of Professor Grahams’ approach, lie in the fundamentally fearful or defensive approach to market fluctuations. His approach to avoiding losses hinges on making purchases at relatively low prices, so as to avoid having to endure the fear created by market downturns.

In my view, he did not go beyond this defensive posture, to attempt to identify companies which would provide above average investment returns over time, in spite of market fluctuations. This apprehensiveness extended to the cost average, whom he advised not to begin a cost averaging program when the market seems high, although mathematically speaking, continuing the program through “thick and thin” is the source of success in this formula investing.

He noted that some investments that he had sold, or that others held, continued to produce superior returns, and did appear overvalued by the market, nevertheless continuing to grow in value. He attributed the ability to hold investments through vigorous market fluctuations to emotional investment by the holder, but did not make a concerted attempt to understand how investments with these long term superior results are produced.

The amateurinvestor blog results from an attempt to address both of these issues. By learning to ignore market fluctuations, we can buy in the face of market fear and derision, or hold fast in the same. By insisting on only companies with a clearly sustainable competitive advantage, we can outperform the market. As Prof. Graham intimated, an emotional component of ownership is important. In my view, familiarity, resulting from fact based research on the company, gives the investor the fortitude to buy in the face of market fear, and continue to hold in the face market fluctuations based on an understanding of the company’s destiny as a going concern.

It is important to note the Prof. Graham’s cautious approach is likely attributable to his personal history. His family emigrated from England to the United States in 1895 and settled in New York City when he was one year old. His father Isaac was a workaholic who owned and operated a thriving business importing, distributing and selling European gifts and artifacts to the United States. While young Benjamin’s family lived in luxury initially, his father died of pancreatic cancer when he was 9 years old, and the family quickly and unexpectedly descended into poverty. Driven by need, Benjamin became as assiduous worker. He was extremely gifted in intelligence, and was offered full professorship in separate disciplines upon graduating from Columbia University at age 20, but instead went to work on Wall Street and became a partner through merit of his skills in an investment firm. The Crash of 1929 almost wiped out the firm, and this lesson is another source of Prof. Graham’s defensive approach to investing. The biography of Benjamin Graham is readable in the enjoyable book: The Einstein of Money: The Life and Timeless Financial Wisdom of Benjamin Graham

In my view, this story shows again, that personal emotions cannot be separated from investment. Investment means placing part of yourself into a vehicle from which you hope to gain. The fate of the investment will be shaped by economic and financial realities. But it will also be shaped by the human nature of the investor, with his or her hopes or fears determining the price of the final sale, as well as the unpredictably changing attitudes of the market of investors at large.

Professor Graham’s defensive approach may have been shaped by the fears of his childhood and early professional career. It was very successful, and he found greater fulfilment in intellectual pursuits including such as classical literature, writing, and social and romantic interests. Perhaps he did not have the emotional need or hunger to identify investments which would create riches vaster than any other’s. In this he contrasts with Warren Buffet, who has seemingly dedicated his life, from early childhood, to creating the strongest “financial fortress” on the planet, and who has recognized the power of the sustainable competitive advantage. Mr. Buffet’s efforts are have an important emotional component too, whether admitted or not.