Tuesday, 27 January 2009

Book Review: Stock Market Superstars by Bob Thompson

Imagine sitting down one afternoon with a dozen hockey greats, a few beers on the table, chicken wings and peanuts at hand and letting the tape run. Stock Market Superstars is the equivalent for the investor. I never thought a book could be so fun, fascinating, educational and thought-provoking all in one.

Bob Thompson has managed a coup in getting these twelve guys (they are all men) first to sit down and talk. Likely it's because he's one of them himself as a portfolio manager at Canaccord and can speak their jargon. Thompson also obviously boned up a lot before talking to them - he seems to know all their big winners and prompts them, at which point, they gab away revealing all the insider stuff. So much so that Thompson in the transcribed interviews is shown to ask such questions as "yeah" or "laughs". Sounds stupid but it works. Of the twelve superstars, only the interview of Rohit Seghal somehow doesn't come off. However, the others - my favorite is Wayne Deans - just roll along and I was laughing along too.

They spill the beans on what they have done, how they do it and even where they think things are heading ... thus the subtitle Secrets of Canada's Top Stock Pickers (which should actually be principles, not secrets, as several of the Superstars tried to point out not much of it really is so secret).

They tell it like it is and the book is stuffed with great quotes - "there's a difference between patience and delusion" (Tim McElvaine), "don't believe what you read in a prospectus, it could be bullshit", or "assume the board is incompetent until proven otherwise". (Wayne Deans), "I think the U.S. is bankrupt" (Eric Sprott), "He (Greg Maffei, of eventually bankrupt 360 Networks) couldn't read a balance sheet because he came from Microsoft. He was the CFO of a company with no debt, and he didn't realize the situation changes." and "We all have our own personal views, but we don't want them to get in the way of us making money" (reference to oil and gas supply situation not to any moral dilemma) (John Thiessen).

There is lots of positive advice, easy and logical to understand, though hard to put in practice, which is really where the superstars set themselves apart. Perhaps a surprise, every one of them says a key to success is to remain humble, not to think they are smarter than everyone else. As several say and as Thompson himself says in his handy summary of their principles, they combine confidence in their judgment and in their approach with the humility to know they can and will be wrong at times. Tim McElvaine, a self-professed value manager says "value managers are much dumber than growth managers, but at least they know they're dumb".

There are a number of opinions thrown out by the superstars about future trends that are worth a thought or two: inflation is likely to return with a vengeance; the USD is over-valued and will fall; gold will rise since it is a store of value; diamonds are getting very scarce; alternative energy is a future good investing area since that is where capital spending is heading.

One subject seems to be completely irrelevant to the investing approach of the Superstars - taxes. The word almost doesn't appear in the text. It's as if they make so much on the capital gains of price appreciation of their successes that interest or dividends don't matter.

Anti-Theory
It is quite shocking to investors who subscribe to financial theory and asset allocation principles to see how much the superstars' opinions and methods diverge from orthodoxy:
  • they have mostly small, concentrated portfolios even with hundreds of millions of dollars at stake
  • risk reduction from deep knowledge and their own judgement rather than diversification and number of holdings
  • few international non-US holdings or maybe even only Canadian investments
  • little or no reference to the market, the focus is on companies and especially management (an insider edge difficult for individual investors to match)
  • all believe that markets are grossly inefficient
They do make it work however, by dint of focus, unrelenting hard work (constant insatiable reading to check and recheck their assumptions), judgement honed over years of mistakes (such mistakes being far more valuable for learning than successes apparently). I was asking myself, could I really do the same as them? A couple mention that the average investor is better off in index funds.

The fact that the superstar managers all run funds that diverge substantially from indices such as the TSX raises a couple of points:
  • first it proves the point in my rant about the infamous Brinson, Singer Beebower paper on asset allocation - if a fund chooses to mimic the index then the variability of its results will be "explained" by the index; the fact that most mutual and pension funds are "index huggers" as one of them put it means it is no surprise that studies will find such funds very similar to the index. If, on the other hand as in the case of these managers, they completely ignore the index in their choice of investments, there will be very low correlation with the index
  • second, maybe one or more of these funds can fit into an asset-allocated portfolio as another separate asset class; certainly they are offered to the public, though some have a very high minimum investment; author Thompson is apparently even proposing to create a "fund of funds" of the superstars, e.g. see the book's own website at http://www.stockmarketsuperstars.com/.
How the Superstars fared in 2008 ... not well
It seems that even the highly successful get caught in financial earthquakes. The table below (hat tip to Stokblog for the list of weblinks to the Superstars' funds) shows returns much worse than TSX and S&P500 markets average for 2008.

A few questions pose themselves. Was this a case of an event whose nature and amplitude surpassed the knowledge and risk management capability of even the Superstars? After all, the stock-picking skill of the Superstars is only in the context of certain rules, mostly valuing companies and identifying cheap ones. Did the financial game switch from chess to checkers somehow and if so, will that continue? If things are starting to return to "chess rules" should we expect the Superstars to continue such poor performance? Or might this be the perfect moment to buy into their funds as undervalued assets? After all, in the book, they all emphasize that the most important factor in the success of the undervalued companies they select is management. And the Superstars are the managers in this case. Are they still good or not?

The websites of the Superstars have a lot of interesting market commentary and are worth a scan. Most are pretty upbeat for the future despite the horrors of 2008, except for Eric Sprott who seems to think gold is the investment of choice because a depression has started. For those who like investing in individual stocks, Irwin Michaels even publishes his list of value pick companies at a separate website called Value Investigator.

My rating for this book: 11 out of 12 (1 boring interview out of a dozen). It's a Strong Buy!

1 comment:

Patrick Ritchie said...

On the topic of the superstars under performing in '08:

I think there are several factors at work here. The first thing to remember is that even the best stock picker will have to deal with very large quotational losses.

In a recent interview Warren Buffet stated that the largest permanent loss that he has ever taken to his net worth is 2%. But he has suffered up to 50% in quotational losses.

Here is a link to the article:

http://undergroundvalue.blogspot.com/2008/02/notes-from-buffett-meeting-2152008_23.html

One of the big problems with actively managed funds is that their very structure works to make some of these quotational loses permanent.

I'm not familiar with the specific funds you listed in your post, but here are a couple of the issues a typical fund manager has to deal with.

1. Most funds require a certain portion of the portfolio to be kept in equities. In many cases this forces managers to buy at higher valuations than they would like.

2. When things go bad in the market and money is withdrawn from the fund some positions need to be sold. In many cases this forces the fund manager to turn a quotational loss into a permanent one.

When you combine 1 & 2 it's easy to see how even the best manager can have really horrid down years.

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