Buffett’s Best: Microcap Cigar Butts

February 18, 2024

Warren Buffett, the world’s greatest investor, earned the highest returns of his career from microcap cigar butts.  Buffett wrote in the 2014 Berkshire Letter:

My cigar-butt strategy worked very well while I was managing small sums.  Indeed, the many dozens of free puffs I obtained in the 1950’s made the decade by far the best of my life for both relative and absolute performance.

Even then, however, I made a few exceptions to cigar butts, the most important being GEICO.  Thanks to a 1951 conversation I had with Lorimer Davidson, a wonderful man who later became CEO of the company, I learned that GEICO was a terrific business and promptly put 65% of my $9,800 net worth into its shares.  Most of my gains in those early years, though, came from investments in mediocre companies that traded at bargain prices.  Ben Graham had taught me that technique, and it worked.

But a major weakness in this approach gradually became apparent:  Cigar-butt investing was scalable only to a point.  With large sums, it would never work well…

Before Buffett led Berkshire Hathaway, he managed an investment partnership from 1957 to 1970 called Buffett Partnership Ltd. (BPL).  While running BPL, Buffett wrote letters to limited partners filled with insights (and humor) about investing and business.  Jeremy C. Miller has written a great book— Warren Buffett’s Ground Rules (Harper, 2016)—summarizing the lessons from Buffett’s partnership letters.

This blog post considers a few topics related to microcap cigar butts:

  • Net Nets
  • Dempster: The Asset Conversion Play
  • Liquidation Value or Earnings Power?
  • Mean Reversion for Cigar Butts
  • Focused vs. Statistical
  • The Rewards of Psychological Discomfort
  • Conclusion



Here Miller quotes the November 1966 letter, in which Buffett writes about valuing the partnership’s controlling ownership position in a cigar-butt stock:

…Wide changes in the market valuations accorded stocks at some point obviously find reflection in the valuation of businesses, although this factor is of much less importance when asset factors (particularly when current assets are significant) overshadow earnings power considerations in the valuation process…

Ben Graham’s primary cigar-butt method was net nets.  Take net current asset value minus ALL liabilities, and then only buy the stock at 2/3 (or less) of that level.  If you buy a basket (at least 20-30) of such stocks, then given enough time (at least a few years), you’re virtually certain to get good investment results, predominantly far in excess of the broad market.

A typical net-net stock might have $30 million in cash, with no debt, but have a market capitalization of $20 million.  Assume there are 10 million shares outstanding.  That means the company has $3/share in net cash, with no debt.  But you can buy part ownership of this business by paying only $2/share.  That’s ridiculously cheap.  If the price remained near those levels, you could effectively buy $1 million in cash for $667,000—and repeat the exercise many times.

Of course, a company that cheap almost certainly has problems and may be losing money.  But every business on the planet, at any given time, is in either one of two states:  it is having problems, or it will be having problems.  When problems come—whether company-specific, industry-driven, or macro-related—that often causes a stock to get very cheap.

The key question is whether the problems are temporary or permanent.  Statistically speaking, many of the problems are temporary when viewed over the subsequent 3 to 5 years.  The typical net-net stock is so extremely cheap relative to net tangible assets that usually something changes for the better—whether it’s a change by management, or a change from the outside (or both).  Most net nets are not liquidated, and even those that are still bring a profit in many cases.

The net-net approach is one of the highest-returning investment strategies ever devised.  That’s not a surprise because net nets, by definition, are absurdly cheap on the whole, often trading below net cash—cash in the bank minus ALL liabilities.

Buffett called Graham’s net-net method the cigar-butt approach:

…I call it the cigar-butt approach to investing.  You walk down the street and you look around for a cigar butt someplace.  Finally you see one and it is soggy and kind of repulsive, but there is one puff left in it.  So you pick it up and the puff is free – it is a cigar butt stock.  You get one free puff on it and then you throw it away and try another one.  It is not elegant.  But it works.  Those are low return businesses.

Link: http://intelligentinvestorclub.com/downloads/Warren-Buffett-Florida-Speech.pdf

(Photo by Sky Sirasitwattana)

When running BPL, Buffett would go through thousands of pages of Moody’s Manuals (and other such sources) to locate just one or a handful of microcap stocks trading at less than liquidation value.  Other leading value investors have also used this technique.  This includes Charlie Munger (early in his career), Walter Schloss, John Neff, Peter Cundill, and Marty Whitman, to name a few.

The cigar-butt approach is also called deep value investing.  This normally means finding a stock that is available below liquidation value, or at least below net tangible book value.

When applying the cigar-butt method, you can either do it as a statistical group approach, or you can do it in a focused manner.  Walter Schloss achieved one of the best long-term track records of all time—near 21% annually (gross) for 47 years—using a statistical group approach to cigar butts.  Schloss typically had a hundred stocks in his portfolio, most of which were trading below tangible book value.

At the other extreme, Warren Buffett—when running BPL—used a focused approach to cigar butts.  Dempster is a good example, which Miller explores in detail in his book.



Dempster was a tiny micro cap, a family-owned company in Beatrice, Nebraska, that manufactured windmills and farm equipment.  Buffett slowly bought shares in the company over the course of five years.

(Photo by Digikhmer)

Dempster had a market cap of $1.6 million, about $13.3 million in today’s dollars, says Miller.

  • Note:  A market cap of $13.3 million is in the $10 to $25 million range—among the tiniest micro caps—which is avoided by nearly all investors, including professional microcap investors.

Buffett’s average price paid for Dempster was $28/share.  Buffett’s estimate of liquidation value early on was near $35/share, which is intentionally conservative.  Miller quotes one of Buffett’s letters:

The estimated value should not be what we hope it would be worth, or what it might be worth to an eager buyer, etc., but what I would estimate our interest would bring if sold under current conditions in a reasonably short period of time.

To estimate liquidation value, Buffett followed Graham’s method, as Miller explains:

  • cash, being liquid, doesn’t need a haircut
  • accounts receivable are valued at 85 cents on the dollar
  • inventory, carried on the books at cost, is marked down to 65 cents on the dollar
  • prepaid expenses and “other” are valued at 25 cents on the dollar
  • long-term assets, generally less liquid, are valued using estimated auction values

Buffett’s conservative estimate of liquidation value for Dempster was $35/share, or $2.2 million for the whole company.  Recall that Buffett paid an average price of $28/share—quite a cheap price.

Even though the assets were clearly there, Dempster had problems.  Stocks generally don’t get that cheap unless there are major problems.  In Dempster’s case, inventories were far too high and rising fast.  Buffett tried to get existing management to make needed improvements.  But eventually Buffett had to throw them out.  Then the company’s bank was threatening to seize the collateral on the loan.  Fortunately, Charlie Munger—who later became Buffett’s business partner—recommended a turnaround specialist, Harry Bottle.  Miller:

Harry did such an outstanding job whipping the company into shape that Buffett, in the next year’s letter, named him “man of the year.”  Not only did he reduce inventories from $4 million to $1 million, alleviating the concerns of the bank (whose loan was quickly repaid), he also cut administrative and selling expenses in half and closed five unprofitable branches.  With the help of Buffett and Munger, Dempster also raised prices on their used equipment up to 500% with little impact to sales volume or resistance from customers, all of which worked in combination to restore a healthy economic return in the business.

Miller explains that Buffett rationally focused on maximizing the return on capital:

Buffett was wired differently, and he achieves better results in part because he invests using an absolute scale.  With Dempster he wasn’t at all bogged down with all the emotional baggage of being a veteran of the windmill business.  He was in it to produce the highest rate of return on the capital he had tied up in the assets of the business.  This absolute scale allowed him to see that the fix for Dempster would come by not reinvesting back into windmills.  He immediately stopped the company from putting more capital in and started taking the capital out.

With profits and proceeds raised from converting inventory and other assets to cash, Buffett started buying stocks he liked.  In essence, he was converting capital that was previously utilized in a bad (low-return) business, windmills, to capital that could be utilized in a good (high-return) business, securities.

Bottle, Buffett, and Munger maximized the value of Dempster’s assets.  Buffett took the further step of not reinvesting cash in a low-return business, but instead investing in high-return stocks.  In the end, on its investment of $28/share, BPL realized a net gain of $45 per share.  This is a gain of a bit more than 160% on what was a very large position for BPL—one-fifth of the portfolio.  Had the company been shut down by the bank, or simply burned through its assets, the return after paying $28/share could have been nothing or even negative.

Miller nicely summarizes the lessons of Buffett’s asset conversion play:

Buffett teaches investors to think of stocks as a conduit through which they can own their share of the assets that make up a business.  The value of that business will be determined by one of two methods: (1) what the assets are worth if sold, or (2) the level of profits in relation to the value of assets required in producing them.  This is true for each and every business and they are interrelated…

Operationally, a business can be improved in only three ways: (1) increase the level of sales; (2) reduce costs as a percent of sales; (3) reduce assets as a percentage of sales.  The other factors, (4) increase leverage or (5) lower the tax rate, are the financial drivers of business value.  These are the only ways a business can make itself more valuable.

Buffett “pulled all the levers” at Dempster…



For most of the cigar butts that Buffett bought for BPL, he used Graham’s net-net method of buying at a discount to liquidation value, conservatively estimated.  However, you can find deep value stocks—cigar butts—on the basis of other low “price-to-a-fundamental” ratio’s, such as low P/E or low EV/EBITDA.  Even Buffett, when he was managing BPL, used a low P/E in some cases to identify cigar butts.  (See an example below: Western Insurance Securities.)

Tobias Carlisle and Wes Gray tested various measures of cheapness from 1964 to 2011.  Quantitative Value (Wiley, 2012)—an excellent book—summarizes their results.  James P. O’Shaughnessy has conducted one of the broadest arrays of statistical backtests.  See his results in What Works on Wall Street (McGraw-Hill, 4th edition, 2012), a terrific book.

(Illustration by Maxim Popov)

  • Carlisle and Gray found that low EV/EBIT was the best-performing measure of cheapness from 1964 to 2011.  It even outperformed composite measures.
  • O’Shaughnessy learned that low EV/EBITDA was the best-performing individual measure of cheapness from 1964 to 2009.
  • But O’Shaughnessy also discovered that a composite measure—combining low P/B, P/E, P/S, P/CF, and EV/EBITDA—outperformed low EV/EBITDA.

Assuming relatively similar levels of performance, a composite measure is arguably better because it tends to be more consistent over time.  There are periods when a given individual metric might not work well.  The composite measure will tend to smooth over such periods.  Besides, O’Shaughnessy found that a composite measure led to the best performance from 1964 to 2009.

Carlisle and Gray, as well as O’Shaughnessy, didn’t include Graham’s net-net method in their reported results.  Carlisle wrote another book, Deep Value (Wiley, 2014)—which is fascinating—in which he summarizes several tests of net nets:

  • Henry Oppenheimer found that net nets returned 29.4% per year versus 11.5% per year for the market from 1970 to 1983.
  • Carlisle—with Jeffrey Oxman and Sunil Mohanty—tested net nets from 1983 to 2008.  They discovered that the annual returns for net nets averaged 35.3% versus 12.9% for the market and 18.4% for a Small Firm Index.
  • A study of the Japanese market from 1975 to 1988 uncovered that net nets outperformed the market by about 13% per year.
  • An examination of the London Stock Exchange from 1981 to 2005 established that net nets outperformed the market by 19.7% per year.
  • Finally, James Montier analyzed all developed markets globally from 1985 to 2007.  He learned that net nets averaged 35% per year versus 17% for the developed markets on the whole.

Given these outstanding returns, why didn’t Carlisle and Gray, as well as O’Shaughnessy, consider net nets?  Primarily because many net nets are especially tiny microcap stocks.  For example, in his study, Montier found that the median market capitalization for net nets was $21 million.  Even the majority of professionally managed microcap funds do not consider stocks this tiny.

  • Recall that Dempster had a market cap of $1.6 million, or about $13.3 million in today’s dollars.
  • Unlike the majority of microcap funds, the Boole Microcap Fund does consider microcap stocks in the $10 to $25 million market cap range.

In 1999, Buffett commented that he could get 50% per year by investing in microcap cigar butts.  He was later asked about this comment in 2005, and he replied:

Yes, I would still say the same thing today.  In fact, we are still earning those types of returns on some of our smaller investments.  The best decade was the 1950s;  I was earning 50% plus returns with small amounts of capital.  I would do the same thing today with smaller amounts.  It would perhaps even be easier to make that much money in today’s environment because information is easier to access.  You have to turn over a lot of rocks to find those little anomalies.  You have to find the companies that are off the map—way off the map.  You may find local companies that have nothing wrong with them at all.  A company that I found, Western Insurance Securities, was trading for $3/share when it was earning $20/share!!  I tried to buy up as much of it as possible.  No one will tell you about these businesses.  You have to find them.

Although the majority of microcap cigar butts Buffett invested in were cheap relative to liquidation value—cheap on the basis of net tangible assets—Buffett clearly found some cigar butts on the basis of a low P/E.  Western Insurance Securities is a good example.  It had a P/E of 0.15.



Warren Buffett commented on high quality companies versus statistically cheap companies in his October 1967 letter to partners:

The evaluation of securities and businesses for investment purposes has always involved a mixture of qualitative and quantitative factors.  At the one extreme, the analyst exclusively oriented to qualitative factors would say, “Buy the right company (with the right prospects, inherent industry conditions, management, etc.) and the price will take care of itself.”  On the other hand, the quantitative spokesman would say, “Buy at the right price and the company (and stock) will take care of itself.”  As is so often the pleasant result in the securities world, money can be made with either approach.  And, of course, any analyst combines the two to some extent—his classification in either school would depend on the relative weight he assigns to the various factors and not to his consideration of one group of factors to the exclusion of the other group.

Interestingly enough, although I consider myself to be primarily in the quantitative school… the really sensational ideas I have had over the years have been heavily weighted toward the qualitative side where I have had a “high-probability insight”.  This is what causes the cash register to really sing.  However, it is an infrequent occurrence, as insights usually are, and, of course, no insight is required on the quantitative side—the figures should hit you over the head with a baseball bat.  So the really big money tends to be made by investors who are right on qualitative decisions but, at least in my opinion, the more sure money tends to be made on the obvious quantitative decisions.

Buffett and Munger acquired See’s Candies for Berkshire Hathaway in 1972.  See’s Candies is the quintessential high quality company because of its sustainably high ROIC (return on invested capital) of over 100%.

Truly high quality companies—like See’s—are very rare and difficult to find.  Cigar butts are much easier to find by comparison.

Furthermore, it’s important to understand that Buffett got around 50% annual returns from cigar butts because he took a focused approach, like BPL’s 20% position in Dempster.

The vast majority of investors, if using a cigar-butt approach like net nets, should implement a group—or statistical—approach, and regularly buy and hold a basket of cigar butts (at least 20-30).  This typically won’t produce 50% annual returns.  But net nets, as a group, clearly have produced very high returns, often 30%+ annually.  To do this today, you’d have to look globally.

As an alternative to net nets, you could implement a group approach using one of O’Shaughnessy’s composite measures—such as low P/B, P/E, P/S, P/CF, EV/EBITDA.  Applying this to micro caps can produce 15-20% annual returns.  Still excellent results.  And much easier to apply consistently.

You may think that you can find some high quality companies.  But that’s not enough.  You have to find a high quality company that can maintain its competitive position and high ROIC.  And it has to be available at a reasonable price.

Most high quality companies are trading at very high prices, to the extent that you can’t do better than the market by investing in them.  In fact, often the prices are so high that you’ll probably do worse than the market.

Consider this observation by Charlie Munger:

The model I like to sort of simplify the notion of what goes o­n in a market for common stocks is the pari-mutuel system at the racetrack.  If you stop to think about it, a pari-mutuel system is a market.  Everybody goes there and bets and the odds change based o­n what’s bet.  That’s what happens in the stock market.

Any damn fool can see that a horse carrying a light weight with a wonderful win rate and a good post position etc., etc. is way more likely to win than a horse with a terrible record and extra weight and so o­n and so on.  But if you look at the odds, the bad horse pays 100 to 1, whereas the good horse pays 3 to 2.  Then it’s not clear which is statistically the best bet using the mathematics of Fermat and Pascal.  The prices have changed in such a way that it’s very hard to beat the system.

(Illustration by Nadoelopisat)

A horse with a great record (etc.) is much more likely to win than a horse with a terrible record.  But—whether betting on horses or betting on stocks—you don’t get paid for identifying winners.  You get paid for identifying mispricings.

The statistical evidence is overwhelming that if you systematically buy stocks at low multiples—P/B, P/E, P/S, P/CF, EV/EBITDA, etc.—you’ll almost certainly do better than the market over the long haul.

A deep value (cigar-butt) approach has always worked, given enough time.  Betting on “the losers” has always worked eventually, whereas betting on “the winners” hardly ever works.

Classic academic studies showing “the losers” doing far better than “the winners” over subsequent 3- to 5-year periods:

That’s not to say deep value investing is easy.  When you put together a basket of statistically cheap companies, you’re buying stocks that are widely hated or neglected.  You have to endure loneliness and looking foolish.  Some people can do it, but it’s important to know yourself before using a deep value strategy.

In general, we extrapolate the poor performance of cheap stocks and the good performance of expensive stocks too far into the future.  This is the mistake of ignoring mean reversion.

When you find a group of companies that have been doing poorly for at least several years, those conditions typically do not persist.  Instead, there tends to be mean reversion, or a return to “more normal” levels of revenues, earnings, or cash flows.

Similarly for a group of companies that have been doing exceedingly well.  Those conditions also do not continue in general.  There tends to be mean reversion, but in this case the mean—the average or “normal” conditions—is below recent activity levels.

Here’s Ben Graham explaining mean reversion:

It is natural to assume that industries which have fared worse than the average are “unfavorably situated” and therefore to be avoided.  The converse would be assumed, of course, for those with superior records.  But this conclusion may often prove quite erroneous.  Abnormally good or abnormally bad conditions do not last forever.  This is true of general business but of particular industries as well.  Corrective forces are usually set in motion which tend to restore profits where they have disappeared or to reduce them where they are excessive in relation to capital.

With his taste for literature, Graham put the following quote from Horace’s Ars Poetica at the beginning of Security Analysis—the bible for value investors:

Many shall be restored that now are fallen and many shall fall than now are in honor.

Tobias Carlisle, while discussing mean reversion in Deep Value, smartly (and humorously) included this image of Albrecht Durer’s Wheel of Fortune:

(Albrecht Durer’s Wheel of Fortune from Sebastien Brant’s Ship of Fools (1494) via Wikimedia Commons)



We’ve already seen that there are two basic ways to do cigar-butt investing: focused vs. statistical (group).

Ben Graham usually preferred the statistical (group) approach.  Near the beginning of the Great Depression, Graham’s managed accounts lost more than 80 percent.  Furthermore, the economy and the stock market took a long time to recover.  As a result, Graham had a strong tendency towards conservatism in investing.  This is likely part of why he preferred the statistical approach to net nets.  By buying a basket of net nets (at least 20-30), the investor is virtually certain to get the statistical results of the group over time, which are broadly excellent.

Graham also was a polymath of sorts.  He had wide-ranging intellectual interests.  Because he knew net nets as a group would do quite well over the long term, he wasn’t inclined to spend much time analyzing individual net nets.  Instead, he spent time on his other interests.

Warren Buffett was Graham’s best student.  Buffett was the only student ever to be awarded an A+ in Graham’s class at Columbia University.  Unlike Graham, Buffett has always had an extraordinary focus on business and investing.  After spending many years learning everything about virtually every public company, Buffett took a focused approach to net nets.  He found the ones that were the cheapest and that seemed the surest.

Buffett has asserted that returns can be improved—and risk lowered—if you focus your investments only on those companies that are within your circle of competence—those companies that you can truly understand.  Buffett also maintains, however, that the vast majority of investors should simply invest in index funds: https://boolefund.com/warren-buffett-jack-bogle/

Regarding individual net nets, Graham admitted a danger:

Corporate gold dollars are now available in quantity at 50 cents and less—but they do have strings attached.  Although they belong to the stockholder, he doesn’t control them.  He may have to sit back and watch them dwindle and disappear as operating losses take their toll.  For that reason the public refuses to accept even the cash holdings of corporations at their face value.

Graham explained that net nets are cheap because they “almost always have an unsatisfactory trend in earnings.”  Graham:

If the profits had been increasing steadily it is obvious that the shares would not sell at so low a price.  The objection to buying these issues lies in the probability, or at least the possibility, that earnings will decline or losses continue, and that the resources will be dissipated and the intrinsic value ultimately become less than the price paid.

(Image by Preecha Israphiwat)

Value investor Seth Klarman warns:

As long as working capital is not overstated and operations are not rapidly consuming cash, a company could liquidate its assets, extinguish all liabilities, and still distribute proceeds in excess of the market price to investors.  Ongoing business losses can, however, quickly erode net-net working capital.  Investors must therefore always consider the state of a company’s current operations before buying.

Even Buffett—nearly two decades after closing BPL—wrote the following in his 1989 letter to Berkshire shareholders:

If you buy a stock at a sufficiently low price, there will usually be some hiccup in the fortunes of the business that gives you a chance to unload at a decent profit, even though the long-term performance of the business may be terrible.  I call this the “cigar butt” approach to investing.  A cigar butt found on the street that has only one puff left in it may not offer much of a smoke, but the “bargain purchase” will make that puff all profit.

Unless you are a liquidator, that kind of approach to buying businesses is foolish.  First, the original “bargain” price probably will not turn out to be such a steal after all.  In a difficult business, no sooner is one problem solved than another surfaces—never is there just one cockroach in the kitchen.  Second, any initial advantage you secure will be quickly eroded by the low return that the business earns.  For example, if you buy a business for $8 million that can be sold or liquidated for $10 million and promptly take either course, you can realize a high return.  But the investment will disappoint if the business is sold for $10 million in ten years and in the interim has annually earned and distributed only a few percent on cost…

Based on these objections, you might think that Buffett’s focused approach is better than the statistical (group) method.  That way, the investor can figure out which net nets are more likely to recover instead of burn through their assets and leave the investor with a low or negative return.

However, Graham’s response was that the statistical or group approach to net nets is highly profitable over time.  There is a wide range of potential outcomes for net nets, and many of those scenarios are good for the investor.  Therefore, while there are always some individual net nets that don’t work out, a group or basket of net nets is nearly certain to work well eventually.

Indeed, Graham’s application of a statistical net-net approach produced 20% annual returns over many decades.  Most backtests of net nets have tended to show annual returns of close to 30%.  In practice, while around 5 percent of net nets may suffer a terminal decline in stock price, a statistical group of net nets has done far better than the market and has experienced fewer down years.  Moreover, as Carlisle notes in Deep Value, very few net nets are actually liquidated or merged.  In the vast majority of cases, there is a change by management, a change from the outside, or both, in order to restore earnings to a level more in line with net asset value.  Mean reversion.



We noted earlier that it’s far more difficult to find a company like See’s Candies, at a reasonable price, than it is to find statistically cheap stocks.  Moreover, if you buy a basket of statistically cheap stocks, you don’t have to possess an ability to analyze individual businesses in great depth.

That said, in order to use a deep value strategy, you do have to be able to handle the psychological discomfort of being lonely and looking foolish.

(Illustration by Sangoiri)

John Mihaljevic, author of The Manual of Ideas (Wiley, 2013), writes:

Comfort can be expensive in investing.  Put differently, acceptance of discomfort can be rewarding, as equities that cause their owners discomfort frequently trade at exceptionally low valuations….

…Misery loves company, so it makes sense that rewards may await those willing to be miserable in solitude…

Mihaljevic explains:

If we owned nothing but a portfolio of Ben Graham-style bargain equities, we may become quite uncomfortable at times, especially if the market value of the portfolio declined precipitously.  We might look at the portfolio and conclude that every investment could be worth zero.  After all, we could have a mediocre business run by mediocre management, with assets that could be squandered.  Investing in deep value equities therefore requires faith in the law of large numbers—that historical experience of market-beating returns in deep value stocks and the fact that we own a diversified portfolio will combine to yield a satisfactory result over time.  This conceptually sound view becomes seriously challenged in times of distress…

Playing into the psychological discomfort of Graham-style equities is the tendency of such investments to exhibit strong asset value but inferior earnings or cash flows.  In a stressed situation, investors may doubt their investment theses to such an extent that they disregard the objectively appraised asset values.  After all—the reasoning of a scared investor might go—what is an asset really worth if it produces no cash flow?

Deep value investors often find some of the best investments in cyclical areas.  A company at a cyclical low may have multi-bagger potential—the prospect of returning 300-500% (or more) to the investor.

Mihaljevic comments on a central challenge of deep value investing in cyclical companies:

The question of whether a company has entered permanent decline is anything but easy to answer, as virtually all companies appear to be in permanent decline when they hit a rock-bottom market quotation.  Even if a business has been cyclical in the past, analysts generally adopt a “this time is different” attitude.  As a pessimistic stock price inevitably influences the appraisal objectivity of most investors, it becomes exceedingly difficult to form a view strongly opposed to the prevailing consensus.

Consider the following industries that have been pronounced permanently impaired in the past, only to rebound strongly in subsequent years:  Following the financial crisis of 2008-2009, many analysts argued that the banking industry would be permanently negatively affected, as higher capital requirements and regulatory oversight would compress returns on equity.  The credit rating agencies were seen as impaired because the regulators would surely alter the business model of the industry for the worse following the failings of the rating agencies during the subprime mortgage bubble.  The homebuilding industry would fail to rebound as strongly as in the past, as overcapacity became chronic and home prices remained tethered to building costs.  The refining industry would suffer permanently lower margins, as those businesses were capital-intensive and driven by volatile commodity prices.



Buffett has made it clear, including in his 2014 letter to shareholders, that the best returns of his career came from investing in microcap cigar butts.  Most of these were mediocre businesses (or worse).  But they were ridiculously cheap.  And, in some cases like Dempster, Buffett was able to bring about needed improvements when required.

When Buffett wrote about buying wonderful businesses in his 1989 letter, that’s chiefly because investable assets at Berkshire Hathaway had grown far too large for microcap cigar butts.

Even in recent years, Buffett invested part of his personal portfolio in a group of cigar butts he found in South Korea.  So he’s never changed his view that an investor can get the highest returns from microcap cigar butts, either by using a statistical group approach or by using a more focused method.



An equal weighted group of micro caps generally far outperforms an equal weighted (or cap-weighted) group of larger stocks over time.  See the historical chart here:  https://boolefund.com/best-performers-microcap-stocks/

This outperformance increases significantly by focusing on cheap micro caps.  Performance can be further boosted by isolating cheap microcap companies that show improving fundamentals.  We rank microcap stocks based on these and similar criteria.

There are roughly 10-20 positions in the portfolio.  The size of each position is determined by its rank.  Typically the largest position is 15-20% (at cost), while the average position is 8-10% (at cost).  Positions are held for 3 to 5 years unless a stock approaches intrinsic value sooner or an error has been discovered.

The mission of the Boole Fund is to outperform the S&P 500 Index by at least 5% per year (net of fees) over 5-year periods.  We also aim to outpace the Russell Microcap Index by at least 2% per year (net).  The Boole Fund has low fees.


If you are interested in finding out more, please e-mail me or leave a comment.

My e-mail: jb@boolefund.com




Disclosures: Past performance is not a guarantee or a reliable indicator of future results. All investments contain risk and may lose value. This material is distributed for informational purposes only. Forecasts, estimates, and certain information contained herein should not be considered as investment advice or a recommendation of any particular security, strategy or investment product. Information contained herein has been obtained from sources believed to be reliable, but not guaranteed. No part of this article may be reproduced in any form, or referred to in any other publication, without express written permission of Boole Capital, LLC.

Invest Like Sherlock Holmes

November 26, 2023

Robert G. Hagstrom has written a number of excellent books on investing.  One of his best is The Detective and the Investor  (Texere, 2002).

Many investors are too focused on the short term, are overwhelmed with information, take shortcuts, or fall prey to cognitive biases.  Hagstrom argues that investors can learn from the Great Detectives as well as from top investigative journalists.

Great detectives very patiently gather information from a wide variety of sources.  They discard facts that turn out to be irrelevant and keep looking for new facts that are relevant.  They painstakingly use logic to analyze the given information and reach the correct conclusion.  They’re quite willing to discard a hypothesis, no matter how well-supported, if new facts lead in a different direction.

(Illustration of Sherlock Holmes by Sidney Paget (1891), via Wikimedia Commons)

Top investigative journalists follow a similar method.

Outline for this blog post:

  • The Detective and the Investor
  • Auguste Dupin
  • Jonathan Laing and Sunbeam
  • Top Investigative Journalists
  • Edna Buchanan—Pulitzer Prize Winner
  • Sherlock Holmes
  • Arthur Conan Doyle
  • Holmes on Wall Street
  • Father Brown
  • How to Become a Great Detective

The first Great Detective is Auguste Dupin, an invention of Edgar Allan Poe.  The financial journalist Jonathan Laing’s patient and logical analysis of the Sunbeam Corporation bears similarity to Dupin’s methods.

Top investigative journalists are great detectives.  The Pulitzer Prize-winning journalist Edna Buchanan is an excellent example.

Sherlock Holmes is the most famous Great Detective.  Holmes was invented by Dr. Arthur Conan Doyle.

Last but not least, Father Brown is the third Great Detective discussed by Hagstrom.  Father Brown was invented by G. K. Chesterton.

The last section—How To Become a Great Detective—sums up what you as an investor can learn from the three Great Detectives.



Hagstrom writes that many investors, both professional and amateur, have fallen into bad habits, including the following:

  • Short-term thinking: Many professional investors advertise their short-term track records, and many clients sign up on this basis.  But short-term performance is largely random, and usually cannot be maintained.  What matters (at a minimum) is performance over rolling five-year periods.
  • Infatuation with speculation: Speculation is guessing what other investors will do in the short term.  Investing, on the other hand, is figuring out the value of a given business and only buying when the price is well below that value.
  • Overload of information: The internet has led to an overabundance of information.  This makes it crucial that you, as an investor, know how to interpret and analyze the information.
  • Mental shortcuts: We know from Daniel Kahneman (see Thinking, Fast and Slow) that most people rely on System 1 (intuition) rather than System 2 (logic and math) when making decisions under uncertainty.  Most investors jump to conclusions based on easy explanations, and then—due to confirmation bias—only see evidence that supports their conclusions.
  • Emotional potholes: In addition to confirmation bias, investors suffer from overconfidence, hindsight bias, loss aversion, and several other cognitive biases.  These cognitive biases regularly cause investors to make mistakes in their investment decisions.  I wrote about cognitive biases here: https://boolefund.com/cognitive-biases/

How can investors develop better habits?  Hagstrom:

The core premise of this book is that the same mental skills that characterize a good detective also characterize a good investor… To say this another way, the analytical methods displayed by the best fictional detectives are in fact high-level decision-making tools that can be learned and applied to the investment world.

(Illustration of Sherlock Holmes by Sidney Paget, via Wikimedia Commons)

Hagstrom asks if it is possible to combine the methods of the three Great Detectives.  If so, what would the ideal detective’s approach to investing be?

First, our investor-detective would have to keep an open mind, be prepared to analyze each new opportunity without any preset opinions.  He or she would be well versed in the basic methods of inquiry, and so would avoid making any premature and possibly inaccurate assumptions.  Of course, our investor-detective would presume that the truth might be hidden below the surface and so would distrust the obvious.  The investor-detective would operate with cool calculation and not allow emotions to distract clear thinking.  The investor-detective would also be able to deconstruct the complex situation into its analyzable parts.  And perhaps most important, our investor-detective would have a passion for truth, and, driven by a nagging premonition that things are not what they seem to be, would keep digging away until all the evidence had been uncovered.



(Illustration—by Frédéric Théodore Lix—to The Purloined Letter, via Wikimedia Commons)

The Murders in the Rue Morgue exemplifies Dupin’s skill as a detective.  The case involves Madame L’Espanaye and her daughter.  Madame L’Espanaye was found behind the house in the yard with multiple broken bones and her head almost severed.  The daughter was found strangled to death and stuffed upside down into a chimney.  The murders occurred in a fourth-floor room that was locked from the inside.  On the floor were a bloody straight razor, several bloody tufts of grey hair, and two bags of gold coins.

Several witnesses heard voices, but no one could say for sure which language it was.  After deliberation, Dupin concludes that they must not have been hearing a human voice at all.  He also dismisses the possibility of robbery, since the gold coins weren’t taken.  Moreover, the murderer would have to possess superhuman strength to stuff the daughter’s body up the chimney.  As for getting into a locked room, the murderer could have gotten in through a window.  Finally, Dupin demonstrates that the daughter could not have been strangled by a human hand.  Dupin concludes that Madame L’Espanaye and her daughter were killed by an orangutan.

Dupin places an advertisement in the local newspaper asking if anyone had lost an orangutan.  A sailor arrives looking for it.  The sailor explains that he had seen the orangutan with a razor, imitating the sailor shaving.  The orangutan had then fled.  Once it got into the room with Madame L’Espanaye and her daughter, the orangutan probably grabbed Madame’s hair and was waving the razor, imitating a barber.  When the woman screamed in fear, the orangutan grew furious and killed her and her daughter.

Thus Dupin solves what at first seemed like an impossible case.  The solution is completely unexpected but is the only logical possibility, given all the facts.

Hagstrom writes that investors can learn important lessons from the Great Detective Auguste Dupin:

First, look in all directions, observe carefully and thoughtfully everything you see, and do not make assumptions from inadequate information.  On the other hand, do not blindly accept what you find.  Whatever you read, hear, or overhear about a certain stock or company may not necessarily be true.  Keep on with your research;  give yourself time to dig beneath the surface.

If you’re a small investor, it’s often best to invest in microcap stocks.  (This presumes that you have access to a proven investment process.)  There are hundreds of tiny companies much too small for most professional investors even to consider.  Thus, there is much more mispricing among micro caps.  Moreover, many microcap companies are relatively easy to analyze and understand.  (The Boole Microcap Fund invests in microcap companies.)



(Sunbeam logo, via Wikimedia Commons)

Hagstrom writes that, in the spring of 1997, Wall Street was in love with the self-proclaimed ‘turnaround genius’ Al Dunlap.  Dunlap was asked to take over the troubled Sunbeam Corporation, a maker of electric home appliances.  Dunlap would repeat the strategy he used on previous turnarounds:

[Drive] up the stock price by any means necessary, sell the company, and cash in his stock options at the inflated price.

Although Dunlap made massive cost cuts, some journalists were skeptical, viewing Sunbeam as being in a weak competitive position in a harsh industry.  Jonathan Laing of Barron’s, in particular, took a close look at Sunbeam.  Laing focused on accounting practices:

First, Laing pointed out that Sunbeam took a huge restructuring charge ($337 million) in the last quarter of 1996, resulting in a net loss for the year of $228.3 million.  The charges included moving reserves from 1996 to 1997 (where they could later be recharacterized as income);  prepaying advertising expenses to make the new year’s numbers look better;  a suspiciously high charge for bad-debt allowance;  a $90 million write-off for inventory that, if sold at a later date, could turn up in future profits;  and write-offs for plants, equipment, and trademarks used by business lines that were still operating.

To Laing, it looked very much like Sunbeam was trying to find every possible way to transfer 1997 projected losses to 1996 (and write 1996 off as a lost year, claiming it was ruined by previous management) while at the same time switching 1996 income into 1997…

(Photo by Evgeny Ivanov)

Hagstrom continues:

Even though Sunbeam’s first-quarter 1997 numbers did indeed show a strong increase in sales volume, Laing had collected evidence that the company was engaging in the practice known as ‘inventory stuffing’—getting retailers to place abnormally large orders either through high-pressure sales tactics or by offering them deep discounts (using the written-off inventory from 1996).  Looking closely at Sunbeam’s financial reports, Laing also found a hodgepodge of other maneuvers designed to boost sales numbers, such as delaying delivery of sales made in 1996 so they could go on the books as 1997 sales, shipping more units than the customer had actually ordered, and counting as sales orders that had already been canceled.

The bottom line was simply that much of 1997’s results would be artificial.  Hagstrom summarizes the lesson from Dupin and Laing:

The core lesson for investors here can be expressed simply:  Take nothing for granted, whether it comes from the prefect of police or the CEO of a major corporation.  This is, in fact, a key theme of this chapter.  If something doesn’t make sense to you—no matter who says it—that’s your cue to start digging.

By July 1998, Sunbeam stock had lost 80 percent of its value and was lower than when Dunlap took over.  The board of directors fired Dunlap and admitted that its 1997 financial statements were unreliable and were being audited by a new accounting firm.  In February 2001, Sunbeam filed for Chapter 11 bankruptcy protection.  On May 15, 2001, the Securities and Exchange Commission filed suit against Dunlap and four senior Sunbeam executives, along with their accounting firm, Arthur Andersen.  The SEC charged them with a fraudulent scheme to create the illusion of a successful restructuring.

Hagstrom points out what made Laing successful as an investigative journalist:

He read more background material, dissected more financial statements, talked to more people, and painstakingly pieced together what many others failed to see.



Hagstrom mentions Professor Linn B. Washington, Jr., a talented teacher and experienced investigative reporter.  (Washington was awarded the Robert F. Kennedy Prize for his series of articles on drug wars in the Richard Allen housing project.)  Hagstrom quotes Washington:

Investigative journalism is not a nine-to-five job.  All good investigative journalists are first and foremost hard workers.  They are diggers.  They don’t stop at the first thing they come to but rather they feel a need to persist.  They are often passionate about the story they are working on and this passion helps fuel the relentless pursuit of information.  You can’t teach that.  They either have it or they don’t.

…I think most reporters have a sense of morality.  They are outraged by corruption and they believe their investigations have a real purpose, an almost sacred duty to fulfill.  Good investigative reporters want to right the wrong, to fight for the underdog.  And they believe there is a real responsibility attached to the First Amendment.

(Photo by Robyn Mackenzie)

Hagstrom then refers to The Reporter’s Handbook, written by Steve Weinberg for investigative journalists.  Weinberg maintains that gathering information involves two categories: documents and people.  Hagstrom:

Weinberg asks readers to imagine three concentric circles.  The outmost one is ‘secondary sources,’ the middle one ‘primary sources.’  Both are composed primarily of documents.  The inner circle, ‘human sources,’ is made up of people—a wide range of individuals who hold some tidbit of information to add to the picture the reporter is building.

Ideally, the reporter starts with secondary sources and then primary sources:

At these two levels of the investigation, the best reporters rely on what has been called a ‘documents state of mind.’  This way of looking at the world has been articulated by James Steele and Donald Bartlett, an investigative team from the Philadephia Inquirer.  It means that the reporter starts from day one with the belief that a good record exists somewhere, just waiting to be found.

Once good background knowledge is accumulated from all the primary and secondary documents, the reporter is ready to turn to the human sources…

Photo by intheskies

Time equals truth:

As they start down this research track, reporters also need to remember another vital concept from the handbook:  ‘Time equals truth.’  Doing a complete job of research takes time, whether the researcher is a reporter following a story or an investor following a company—or for that matter, a detective following the evidence at a crime scene.  Journalists, investors, and detectives must always keep in mind that the degree of truth one finds is directly proportional to the amount of time one spends in the search.  The road to truth permits no shortcuts.

The Reporter’s Handbook also urges reporters to question conventional wisdom, to remember that whatever they learn in their investigation may be biased, superficial, self-serving for the source, or just plain wrong.  It’s another way of saying ‘Take nothing for granted.’  It is the journalist’s responsibility—and the investor’s—to penetrate the conventional wisdom and find what is on the other side.

The three concepts discussed above—‘adopt a documents state of mind,’ ‘time equals truth,’ and ‘question conventional wisdom;  take nothing for granted’—may be key operating principles for journalists, but I see them also as new watchwords for investors.



Edna Buchanan, working for the Miami Herald and covering the police beat, won a Pulitzer Prize in 1986.  Hagstrom lists some of Buchanan’s principles:

  • Do a complete background check on all the key players.  Find out how a person treats employees, women, the environment, animals, and strangers who can do nothing for them.  Discover if they have a history of unethical and/or illegal behavior.
  • Cast a wide net.  Talk to as many people as you possibly can.  There is always more information.  You just have to find it.  Often that requires being creative.
  • Take the time.  Learning the truth is proportional to the time and effort you invest.  There is always more that you can do.  And you may uncover something crucial.  Never take shortcuts.
  • Use common sense.  Often official promises and pronouncements simply don’t fit the evidence.  Often people lie, whether due to conformity to the crowd, peer pressure, loyalty (like those trying to protect Nixon et al. during Watergate), trying to protect themselves, fear, or any number of reasons.  As for investing, some stories take a long time to figure out, while other stories (especially for tiny companies) are relatively simple.
  • Take no one’s word.  Find out for yourself.  Always be skeptical and read between the lines.  Very often official press releases have been vetted by lawyers and leave out critical information.  Take nothing for granted.
  • Double-check your facts, and then check them again.  For a good reporter, double-checking facts is like breathing.  Find multiples sources of information.  Again, there are no shortcuts.  If you’re an investor, you usually need the full range of good information in order to make a good decision.

In most situations, to get it right requires a great deal of work.  You must look for information from a broad range of sources.  Typically you will find differing opinions.  Not all information has the same value.  Always be skeptical of conventional wisdom, or what ‘everybody knows.’



Image by snaptitude

Sherlock Holmes approaches every problem by following three steps:

  • First, he makes a calm, meticulous examination of the situation, taking care to remain objective and avoid the undue influence of emotion.  Nothing, not even the tiniest detail, escapes his keen eye.
  • Next, he takes what he observes and puts it in context by incorporating elements from his existing store of knowledge.  From his encyclopedic mind, he extracts information about the thing observed that enables him to understand its significance.
  • Finally, he evaluates what he observed in the light of this context and, using sound deductive reasoning, analyzes what it means to come up with the answer.

These steps occur and re-occur in an iterative search for all the facts and for the best hypothesis.

There was a case involving a young doctor, Percy Trevelyan.  Some time ago, an older gentleman named Blessington offered to set up a medical practice for Trevelyan in return for a share of the profits.  Trevelyan agreed.

A patient suffering from catalepsy—a specialty of the doctor—came to the doctor’s office one day.  The patient also had his son with him.  During the examination, the patient suffered a cataleptic attack.  The doctor ran from the room to grab the treatment medicine.  But when he got back, the patient and his son were gone.  The two men returned the following day, giving a reasonable explanation for the mix-up, and the exam continued.  (On both visits, the son had stayed in the waiting room.)

Shortly after the second visit, Blessington burst into the exam room, demanding to know who had been in his private rooms.  The doctor tried to assure him that no one had.  But upon going to Blessington’s room, he saw a strange set of footprints.  Only after Trevelyan promises to bring Sherlock Holmes to the case does Blessington calm down.

Holmes talks with Blessington.  Blessington claims not to know who is after him, but Holmes can tell that he is lying.  Holmes later tells his assistant Watson that the patient and his son were fakes and had some sinister reason for wanting to get Blessington.

Holmes is right.  The next morning, Holmes and Watson are called to the house again.  This time, Blessington is dead, apparently having hung himself.

But Holmes deduces that it wasn’t a suicide but a murder.  For one thing, there were four cigar butts found in the fireplace, which led the policeman to conclude that Blessington had stayed up late agonizing over his decision.  But Holmes recognizes that Blessington’s cigar is a Havana, but the other three cigars had been imported by the Dutch from East India.  Furthermore, two had been smoked from a holder and two without.  So there were at least two other people in the room with Blessington.

Holmes does his usual very methodical examination of the room and the house.  He finds three sets of footprints on the stairs, clearly showing that three men had crept up the stairs.  The men had forced the lock, as Holmes deduced from scratches on it.

Holmes also realized the three men had come to commit murder.  There was a screwdriver left behind.  And he could further deduce (by the ashes dropped) where each man sat as the three men deliberated over how to kill Blessington.  Eventually, they hung Blessington.  Two killers left the house and the third barred the door, implying that the third murderer must be a part of the doctor’s household.

All these signs were visible:  the three sets of footprints, the scratches on the lock, the cigars that were not Blessington’s type, the screwdriver, the fact that the front door was barred when the police arrived.  But it took Holmes to put them all together and deduce their meaning:  murder, not suicide.  As Holmes himself remarked in another context, ‘The world is full of obvious things which nobody by any chance ever observes.’

…He knows Blessington was killed by people well known to him.  He also knows, from Trevelyan’s description, what the fake patient and his son look like.  And he has found a photograph of Blessington in the apartment.  A quick stop at policy headquarters is all Holmes needs to pinpoint their identity.  The killers, no strangers to the police, were a gang of bank robbers who had gone to prison after being betrayed by their partner, who then took off with all the money—the very money he used to set Dr. Trevelyan up in practice.  Recently released from prison, the gang tracked Blessington down and finally executed him.

Spelled out thus, one logical point after another, it seems a simple solution.  Indeed, that is Holmes’s genius:  Everything IS simple, once he explains it.

Hagstrom then adds:

Holmes operates from the presumption that all things are explainable;  that the clues are always present, awaiting discovery. 

The first step—gathering all the facts—usually requires a great deal of careful effort and attention.  One single fact can be the key to deducing the true hypothesis.  The current hypothesis is revisable if there may be relevant facts not yet known.  Therefore, a heightened degree of awareness is always essential.  With practice, a heightened state of alertness becomes natural for the detective (or the investor).

“Details contain the vital essence of the whole matter.” — Sherlock Holmes

Moreover, it’s essential to keep emotion out of the process of discovery:

One reason Holmes is able to see fully what others miss is that he maintains a level of detached objectivity toward the people involved.  He is careful not to be unduly influenced by emotion, but to look at the facts with calm, dispassionate regard.  He sees everything that is there—and nothing that is not.  For Holmes knows that when emotion seeps in, one’s vision of what is true can become compromised.  As he once remarked to Dr. Watson, ‘Emotional qualities are antagonistic to clear reasoning… Detection is, or ought to be, an exact science and should be treated in the same cold and unemotional manner.  You have attempted to tinge it with romanticism, which produces much the same effect as if you worked a love story or an elopement into the fifth proposition of Euclid.’

Image by snaptitude

Holmes himself is rather aloof and even antisocial, which helps him to maintain objectivity when collecting and analyzing data.

‘I make a point of never having any prejudices and of following docilely wherever fact may lead me.’  He starts, that is, with no preformed idea, and merely collects data.  But it is part of Holmes’s brilliance that he does not settle for the easy answer.  Even when he has gathered together enough facts to suggest one logical possibility, he always knows that this answer may not be the correct one.  He keeps searching until he has found everything, even if subsequent facts point in another direction.  He does not reject the new facts simply because they’re antithetical to what he’s already found, as so many others might.

Hagstrom observes that many investors are susceptible to confirmation bias:

…Ironically, it is the investors eager to do their homework who may be the most susceptible.  At a certain point in their research, they have collected enough information that a pattern becomes clear, and they assume they have found the answer.  If subsequent information then contradicts that pattern, they cannot bring themselves to abandon the theory they worked so hard to develop, so they reject the new facts.

Gathering information about an investment you are considering means gather all the information, no matter where it ultimately leads you.  If you find something that does not fit your original thesis, don’t discard the new information—change the thesis.



Arthur Conan Doyle was a Scottish doctor.  One of his professors, Dr. Bell, challenged his students to hone their skills of observation.  Bell believed that a correct diagnosis required alert attention to all aspects of the patient, not just the stated problem.  Doyle later worked for Dr. Bell.  Doyle’s job was to note the patients’ problem along with all possibly relevant details.

Doyle had a very slow start as a doctor.  He had virtually no patients.  He spent his spare time writing, which he had loved doing since boarding school.  Doyle’s main interest was historical fiction.  But he didn’t get much money from what he wrote.

One day he wrote a short novel, A Study in Scarlet, which introduced a private detective, Sherlock Holmes.  Hagstrom quotes Doyle:

I thought I would try my hand at writing a story where the hero would treat crime as Dr. Bell treated disease, and where science would take the place of chance.

Doyle soon realized that he might be able to sell short stories about Sherlock Holmes as a way to get some extra income.  Doyle preferred historical novels, but his short stories about Sherlock Holmes started selling surprisingly well.  Because Doyle continued to emphasize historical novels and the practice of medicine, he demanded higher and higher fees for his short stories about Sherlock Holmes.  But the stories were so popular that magazine editors kept agreeing to the fee increases.

Photo by davehanlon

Soon thereafter, Doyle, having hardly a single patient, decided to abandon medicine and focus on writing.  Doyle still wanted to do other types of writing besides the short stories.  He asked for a very large sum for the Sherlock Holmes stories so that the editors would stop bothering him.  Instead, the editors immediately agreed to the huge fee.

Many years later, Doyle was quite tired of Holmes and Watson after having written fifty-six short stories and four novels about them.  But readers never could get enough.  And the stories are still highly popular to this day, which attests to Doyle’s genius.  Doyle has always been credited with launching the tradition of the scientific sleuth.



Sherlock Holmes is the most famous Great Detective for good reason.  He is exceptionally thorough, unemotional, and logical.

Holmes knows a great deal about many different things, which is essential in order for him to arrange and analyze all the facts:

The list of things Holmes knows about is staggering:  the typefaces used by different newspapers, what the shape of a skull reveals about race, the geography of London, the configuration of railway lines in cities versus suburbs, and the types of knots used by sailors, for a few examples.  He has authored numerous scientific monographs on such topics as tattoos, ciphers, tobacco ash, variations in human ears, what can be learned from typewriter keys, preserving footprints with plaster of Paris, how a man’s trade affects the shape of his hands, and what a dog’s manner can reveal about the character of its owner.

(Illustration of Sherlock Holmes with various tools, by Elena Kreys)

Consider what Holmes says about his monograph on the subject of tobacco:

“In it I enumerate 140 forms of cigar, cigarette, and pipe tobacco… It is sometimes of supreme importance as a clue.  If you can say definitely, for example, that some murder has been done by a man who was smoking an Indian lunkah, it obviously narrows your field of search.”

It’s very important to keep gathering and re-gathering facts to ensure that you haven’t missed anything.  Holmes:

“It is a capital mistake to theorize before you have all the evidence.  It biases the judgment.”

“The temptation to form premature theories upon insufficient data is the bane of our profession.”

Although gathering all facts is essential, at the same time, you must be organizing those facts since not all facts are relevant to the case at hand.  Of course, this is an iterative process. You may discard a fact as irrelevant and realize later that it is relevant.

Part of the sorting process involves a logical analysis of various combinations of facts.  You reject combinations that are logically impossible.  As Holmes famously said:

“When you have eliminated the impossible, whatever remains, however improbable, must be the truth.”

Often there is more than one logical possibility that is consistent with the known facts.  Be careful not to be deceived by obvious hypotheses.  Often what is ‘obvious’ is completely wrong.

Sometimes finding the solution requires additional research.  Entertaining several possible hypotheses may also be required.  Holmes:

“When you follow two separate chains of thought you will find some point of intersection which should approximate to the truth.”

But be careful to keep facts and hypotheses separate, as Holmes asserts:

“The difficulty is to detach the frame of absolute undeniable facts from the embellishments of theorists.  Then, having established ourselves upon this sound basis, it is our duty to see what inferences may be drawn and what are the special points upon which the whole mystery turns.”

For example, there was a case involving the disappearance of a valuable racehorse.  The chief undeniable fact was that the dog did not bark, which meant that the intruder had to be familiar to the dog.

Sherlock Holmes As Investor

How would Holmes approach investing?  Hagstrom:

Here’s what we know of his methods:  He begins an examination with an objective mind, untainted by prejudice.  He observes acutely and catalogues all the information, down to the tiniest detail, and draws on his broad knowledge to put those details into context.  Then, armed with the facts, he walks logically, rationally, thoughtfully toward a conclusion, always on the lookout for new, sometimes contrary information that might alter the outcome.

It’s worth repeating that much of the process of gathering facts can be tedious and boring.  This is the price you must pay to ensure you get all the facts.  Similarly, analyzing all the facts often requires patience and can take a long time.  No shortcuts.



Hagstrom opens the chapter with a scene in which Aristide Valentin—head of Paris police and the most famous investigator in Europe—is chasing Hercule Flambeau, a wealthy and famous French jewel thief.  Both Valentin and Flambeau are on the same train.  But Valentin gets distracted by the behavior of a very short Catholic priest with a round face.  The priest is carrying several brown paper parcels, and he keeps dropping one or the other, or dropping his umbrella.

When the train reaches London, Valentin isn’t exactly sure where Flambeau went.  So Valentin decides to go systematically to the ‘wrong places.’  Valentin ends up at a certain restaurant that caught his attention.  A sugar bowl has salt in it, while the saltcellar contains sugar.  He learns from a waiter that two clergymen had been there earlier, and that one had thrown a half-empty cup of soup against the wall.  Valentin inquires which way the priests went.

Valentin goes to Carstairs Street.  He passes a greengrocer’s stand where the signs for oranges and nuts have been switched.  The owner is still upset about a recent incident in which a parson knocked over his bin of apples.

Valentin keeps looking and notices a restaurant that has a broken window.  He questions the waiter, who explains to him that two foreign parsons had been there.  Apparently, they overpaid.  The waiter told the two parsons of their mistake, at which point one parson said, ‘Sorry for the confusion.  But the extra amount will pay for the window I’m about to break.’  Then the parson broke the window.

Valentin finally ends up in a public park, where he sees two men, one short and one tall, both wearing clerical garb.  Valentin approaches and recognizes that the short man is the same clumsy priest from the train.  The short priest suspected all along that the tall man was not a priest but a criminal.  The short priest, Father Brown, had left the trail of hints for the police.  At that moment, even without turning around, Father Brown knew the police were nearby ready to arrest Flambeau.

Father Brown was invented by G. K. Chesterton.  Father Brown is very compassionate and has deep insight into human psychology, which often helps him to solve crimes.

He knows, from hearing confessions and ministering in times of trouble, how people act when they have done something wrong.  From observing a person’s behavior—facial expressions, ways of walking and talking, general demeanor—he can tell much about that person.  In a word, he can see inside someone’s heart and mind, and form a clear impression about character…

His feats of detection have their roots in this knowledge of human nature, which comes from two sources:  his years in the confessional, and his own self-awareness.  What makes Father Brown truly exceptional is that he acknowledges the capacity for evildoing in himself.  In ‘The Hammer of God’ he says, ‘I am a man and therefore have all devils in my heart.’

Because of this compassionate understanding of human weakness, from both within and without, he can see into the darkest corners of the human heart.  The ability to identify with the criminal, to feel what he is feeling, is what leads him to find the identity of the criminal—even, sometimes, to predict the crime, for he knows the point at which human emotions such as fear or jealousy tip over from acceptable expression into crime.  Even then, he believes in the inherent goodness of mankind, and sets the redemption of the wrongdoer as his main goal.

While Father Brown excels in understanding human psychology, he also excels at logical analysis of the facts.  He is always open to alternative explanations.

(Frontispiece to G. K. Chesterton’s The Wisdom of Father Brown, Illustration by Sydney Semour Lucas, via Wikimedia Commons)

Later the great thief Flambeau is persuaded by Father Brown to give up a life of crime and become a private investigator.  Meanwhile, Valentin, the famous detective, turns to crime and nearly gets away with murder.  Chesterton loves such ironic twists.

Chesterton was a brilliant writer who wrote in an amazing number of different fields.  Chesterton was very compassionate, with a highly developed sense of social justice, notes Hagstrom.  The Father Brown stories are undoubtedly entertaining, but they also deal with questions of justice and morality.  Hagstrom quotes an admirer of Chesterton, who said:  ‘Sherlock Holmes fights criminals;  Father Brown fights the devil.’  Whenever possible, Father Brown wants the criminal to find redemption.

Hagstrom lists what could be Father Brown’s investment guidelines:

  • Look carefully at the circumstances;  do whatever it takes to gather all the clues.
  • Cultivate the understanding of intangibles.
  • Using both tangible and intangible evidence, develop such a full knowledge of potential investments that you can honestly say you know them inside out.
  • Trust your instincts.  Intuition is invaluable.
  • Remain open to the possibility that something else may be happening, something different from that which first appears; remember that the full truth may be hidden beneath the surface.

Hagstrom mentions that psychology can be useful for investing:

Just as Father Brown’s skill as an analytical detective was greatly improved by incorporating the study of psychology with the method of observations, so too can individuals improve their investment performance by combining the study of psychology with the physical evidence of financial statement analysis.



Hagstrom lists the habits of mind of the Great Detectives:

Auguste Dupin

  • Develop a skeptic’s mindset;  don’t automatically accept conventional wisdom.
  • Conduct a thorough investigation.

Sherlock Holmes

  • Begin an investigation with an objective and unemotional viewpoint.
  • Pay attention to the tiniest details.
  • Remain open-minded to new, even contrary, information.
  • Apply a process of logical reasoning to all you learn.

Father Brown

  • Become a student of psychology.
  • Have faith in your intuition.
  • Seek alternative explanations and re-descriptions.

Hagstrom argues that these habits of mind, if diligently and consistently applied, can help you to do better as an investor over time.

Furthermore, the true hero is reason, a lesson directly applicable to investing:

As I think back over all the mystery stories I have read, I realize there were many detectives but only one hero.  That hero is reason.  No matter who the detective was—Dupin, Holmes, Father Brown, Nero Wolfe, or any number of modern counterparts—it was reason that solved the crime and captured the criminal.  For the Great Detectives, reason is everything.  It controls their thinking, illuminates their investigation, and helps them solve the mystery.

Illustration by yadali

Hagstrom continues:

Now think of yourself as an investor.  Do you want greater insight about a perplexing market?  Reason will clarify your investment approach.

Do you want to escape the trap of irrational, emotion-based action and instead make decisions with calm deliberation?  Reason will steady your thinking.

Do you want to be in possession of all the relevant investment facts before making a purchase?  Reason will help you uncover the truth.

Do you want to improve your investment results by purchasing profitable stocks?  Reason will help you capture the market’s mispricing.

In sum, conduct a thorough investigation.  Painstakingly gather all the facts and keep your emotions entirely out of it.  Skeptically question conventional wisdom and ‘what is obvious.’  Carefully use logic to reason through possible hypotheses.  Eliminate hypotheses that cannot explain all the facts.  Stay open to new information and be willing to discard the best current hypothesis if new facts lead in a different direction.  Finally, be a student of psychology.



An equal weighted group of micro caps generally far outperforms an equal weighted (or cap-weighted) group of larger stocks over time.  See the historical chart here:  https://boolefund.com/best-performers-microcap-stocks/

This outperformance increases significantly by focusing on cheap micro caps.  Performance can be further boosted by isolating cheap microcap companies that show improving fundamentals.  We rank microcap stocks based on these and similar criteria.

There are roughly 10-20 positions in the portfolio.  The size of each position is determined by its rank.  Typically the largest position is 15-20% (at cost), while the average position is 8-10% (at cost).  Positions are held for 3 to 5 years unless a stock approaches intrinsic value sooner or an error has been discovered.

The mission of the Boole Fund is to outperform the S&P 500 Index by at least 5% per year (net of fees) over 5-year periods.  We also aim to outpace the Russell Microcap Index by at least 2% per year (net).  The Boole Fund has low fees.


If you are interested in finding out more, please e-mail me or leave a comment.

My e-mail: jb@boolefund.com




Disclosures: Past performance is not a guarantee or a reliable indicator of future results. All investments contain risk and may lose value. This material is distributed for informational purposes only. Forecasts, estimates, and certain information contained herein should not be considered as investment advice or a recommendation of any particular security, strategy or investment product. Information contained herein has been obtained from sources believed to be reliable, but not guaranteed. No part of this article may be reproduced in any form, or referred to in any other publication, without express written permission of Boole Capital, LLC.

Business Adventures

November 12, 2023

In 1991, when Bill Gates met Warren Buffett, Gates asked him to recommend his favorite business book.  Buffett immediately replied, “It’s Business Adventures, by John Brooks.  I’ll send you my copy.”  Gates wrote in 2014:

Today, more than two decades after Warren lent it to me—and more than four decades after it was first published—Business Adventures remains the best business book I’ve ever read.  John Brooks is still my favorite business writer.

It’s certainly true that many of the particulars of business have changed.  But the fundamentals have not.  Brooks’s deeper insights about business are just as relevant today as they were back then.  In terms of its longevity, Business Adventures stands alongside Benjamin Graham’s The Intelligent Investor, the 1949 book that Warren says is the best book on investing that he has ever read.

See:  https://www.gatesnotes.com/Books/Business-Adventures

I’ve had the enormous pleasure of reading Business Adventures twice.  John Brooks is quite simply a terrific business writer.

Each chapter of the book is a separate business adventure.  Outline:

  • The Fluctuation
  • The Fate of the Edsel
  • A Reasonable Amount of Time
  • Xerox Xerox Xerox Xerox
  • Making the Customers Whole
  • The Impacted Philosophers
  • The Last Great Corner
  • A Second Sort of Life
  • Stockholder Season
  • One Free Bite



Brooks recounts J.P. Morgan’s famous answer when an acquaintance asked him what the stock market would do:  “It will fluctuate.”  Brooks then writes:

Apart from the economic advantages and disadvantages of stock exchanges – the advantage that they provide a free flow of capital to finance industrial expansion, for instance, and the disadvantage that they provide an all too convenient way for the unlucky, the imprudent, and the gullible to lose their money – their development has created a whole pattern of social behavior, complete with customs, language, and predictable responses to given events.

Brooks explains that the pattern emerged fully at the first important stock exchange in 1611 in Amsterdam.  Brooks mentions that Joseph de la Vega published, in 1688, a book about the first Dutch stock traders.  The book was aptly titled, Confusion of Confusions.

And the pattern persists on the New York Stock Exchange.  (Brooks was writing in the 1960’s, but many of his descriptions still apply.)  Brooks adds that a few Dutchmen haggling in the rain might seem to be rather far from the millions of participants in the 1960’s.  However:

The first stock exchange was, inadvertently, a laboratory in which new human reactions were revealed.  By the same token, the New York Stock Exchange is also a sociological test tube, forever contributing to the human species’ self-understanding.

On Monday, May 28, 1962, the Dow Jones Average dropped 34.95 points, or more than it had dropped on any day since October 28, 1929.  The volume was the seventh-largest ever.  Then on Tuesday, May 29, after most stocks opened down, the market reversed itself and surged upward with a large gain of 27.03.  The trading volume on Tuesday was the highest ever except for October 29, 1929.  Then on Thursday, May 31, after a holiday on Wednesday, the Dow rose 9.40 points on the fifth-greatest volume ever.


The crisis ran its course in three days, but needless to say, the post-mortems took longer.  One of de la Vega’s observations about the Amsterdam traders was that they were ‘very clever in inventing reasons’ for a sudden rise or fall in stock prices, and the Wall Street pundits certainly needed all the cleverness they could muster to explain why, in the middle of an excellent business year, the market had suddenly taken its second-worst nose dive ever up to that moment.

Many rated President Kennedy’s April crackdown on the steel industry’s planned price increase as one of the most likely causes.  Beyond that, there were comparisons to 1929.  However, there were more differences than similarities, writes Brooks.  For one thing, margin requirements were far higher in 1962 than in 1929.  Nonetheless, the weekend before the May 1962 crash, many securities dealers were occupied sending out margin calls.

In 1929, it was not uncommon for people to have only 10% equity, with 90% of the stock position based on borrowed money.  (The early Amsterdam exchange was similar.)  Since the crash in 1929, margin requirements had been raised to 50% equity (leaving 50% borrowed).

Brooks says the stock market had been falling for most of 1962 up until crash.  But apparently the news before the May crash was good.  Not that news has any necessary relationship with stock movements, although most financial reporting services seem to assume otherwise.  After a mixed opening – some stocks up, some down – on Monday, May 28, volume spiked as selling became predominant.  Volume kept going up thereafter as the selling continued.  Brooks:

Evidence that people are selling stocks at a time when they ought to be eating lunch is always regarded as a serious matter.

One problem in this crash was that the tape – which records the prices of stock trades – got delayed by 55 minutes due to the huge volume.  Some brokerage firms tried to devise their own systems to deal with this issue.  For instance, Merrill Lynch floor brokers – if they had time – would shout the results of trades into a floorside telephone connected to a “squawk box” in the firm’s head office.

Brooks remarks:

All that summer, and even into the following year, security analysts and other experts cranked out their explanations of what had happened, and so great were the logic, solemnity, and detail of these diagnoses that they lost only a little of their force through the fact that hardly any of the authors had had the slightest idea what was going to happen before the crisis occurred.

Brooks then points out that an unprecedented 56.8 percent of the total volume in the crash had been individual investors.  Somewhat surprisingly, mutual funds were a stabilizing factor.  During the Monday sell-off, mutual funds bought more than they sold.  And as stocks surged on Thursday, mutual funds sold more than they bought.  Brooks concludes:

In the last analysis, the cause of the 1962 crisis remains unfathomable;  what is known is that it occurred, and that something like it could occur again.



1955 was the year of the automobile, writes Brooks.  American auto makers sold over 7 million cars, a million more than in any previous year.  Ford Motor Company decided that year to make a new car in the medium-price range of $2,400 to $4,000.  Brooks continues:

[Ford] went ahead and designed it more or less in comformity with the fashion of the day, which was for cars that were long, wide, low, lavishly decorated with chrome, liberally supplied with gadgets… Two years later, in September, 1957, Ford put its new car, the Edsel, on the market, to the accompaniment of more fanfare than had attended the arrival of any new car since the same company’s Model A, brought out thirty years earlier.  The total amount spent on the Edsel before the first specimen went on sale was announced as a quarter of a billion dollars;  its launching… was more costly than any other consumer product in history.  As a starter toward getting its investment back, Ford counted on selling at least 200,000 Edsels the first year.

There may be an aborigine somewhere in a remote rainforest who hasn’t yet heard that things failed to turn out that way… on November 19, 1959, having lost, according to some outside estimates, around $350 million on the Edsel, the Ford Company permanently discontinued its production.

Brooks asks:

How could this have happened?  How could a company so mightily endowed with money, experience, and, presumably, brains have been guilty of such a monumental mistake?

Many claimed that Ford had paid too much attention to public-opinion polls and the motivational research it conducted.  But Brooks adds that some non-scientific elements also played a roll.  In particular, after a massive effort to come up with possible names for the car, science was ignored at the last minute and the Edsel was named for the father of the company’s president.  Brooks:

As for the design, it was arrived at without even a pretense of consulting the polls, and by the method that has been standard for years in the designing of automobiles – that of simply pooling the hunches of sundry company committees.

The idea for the Edsel started years earlier.  The company noticed that owners of cars would trade up to the medium-priced car as soon as they could.  The problem was that Ford owners were not trading up to the Mercury, Ford’s medium-priced car, but to the medium-priced cars of its rivals, General Motors and Chrysler.

Late in 1952, a group called the Forward Product Planning Committee gave much of the detailed work to the Lincoln-Mercury Division, run by Richard Krafve (pronounced “Kraffy”).  In 1954, after two years’ work, the Forward Product Planning Committee submitted to the executive committee a six-volume report.  In brief, the report predicted that there would be seventy million cars in the U.S. by 1965, and more than 40 percent of all cars sold would be in the medium-price range.  Brooks:

On the other hand, the Ford bosses were well aware of the enormous risks connected with putting a new car on the market.  They knew, for example, that of the 2,900 American makes that had been introduced since the beginning of the automobile age… only about twenty were still around.

But Ford executives felt optimistic.  They set up another agency, the Special Products Division, again with Krafve in charge.  The new car was referred to as the “E”-Car among Ford designers and workers.  “E” for Experimental.  Roy A. Brown was in charge of the E-car’s design.  Brown stated that they sought to make a car that was unique as compared to the other nineteen cars on the road at the time.

Brooks observes that Krafve later calculated that he and his associates would make at least four thousand decisions in designing the E-Car.  He thought that if they got every decision right, they could create the perfectly designed car.  Krafve admitted later, however, that there wasn’t really enough time for perfection.  They would make modifications, and then modifications of those modifications.  Then time would run out and they had to settle on the most recent modifications.

Brooks comments:

One of the most persuasive and frequently cited explanations of the Edsel’s failure is that it was a victim of the time lag between the decision to produce it and the act of putting it on the market.  It was easy to see a few years later, when smaller and less powerful cars, euphemistically called “compacts,” had become so popular as to turn the old automobile status-ladder upside down, that the Edsel was a giant step in the wrong direction, but it far from easy to see that in fat, tail-finny 1955.

As part of the marketing effort, the Special Products Division tapped David Wallace, director of planning for market research.  Wallace:

‘We concluded that cars are a means to a sort of dream fulfillment.  There’s some irrational factor in people that makes them want one kind of car rather than another – something that has nothing to do with the mechanism at all but with the car’s personality, as the customer imagines it.  What we wanted to do, naturally, was to give the E-Car the personality that would make the greatest number of people want it.’

Wallace’s group decided to get interviews of 1,600 car buyers.  The conclusion, in a nutshell, was that the E-Car could be “the smart car for the younger executive or professional family on its way up.”

As for the name of the car, Krafve had suggested to the members of the Ford family that the new car be named the Edsel Ford – the name of their father.  The three Ford brothers replied that their father probably wouldn’t want the car named after him.  Therefore, they suggested that the Special Products Division look for another name.

The Special Products Division conducted a large research project regarding the best name for the E-Car.  At one point, Wallace interviewed the poet Marianne Moore about a possible name.  A bit later, the Special Products Division contacted Foote, Cone & Belding, an advertising agency, to help with finding a name.

The advertising agency produced 18,000 names, which they then carefully pruned to 6,000.  Wallace told them that was still way too many names from which to pick.  So Foote, Cone & Belding did an all-out three-day session to cut the list down to 10 names.  They divided into two groups for this task.  By chance, when each group produced its list of 10 names, 4 of the names were the same:  Corsair, Citation, Pacer, and Ranger.

Wallace thought that Corsair was clearly the best name.  However, the Ford executive committee had a meeting at a time when all three Ford brothers were away.  Executive vice-president Ernest R. Breech, chairman of the board, led the meeting.  When Breech saw the final list of 10 names, he said he didn’t like any of them.

So Breech and the others were shown another list of names that hadn’t quite made the top 10.  The Edsel had been kept on this second list – despite the three Ford brothers being against it – for some reason, perhaps because it was the originally suggested name.  When the group came to the name “Edsel,” Breech firmly said, “Let’s call it that.”  Breech added that since there were going to be four models of the E-Car, the four favorite names – Corsair, Citation, Pacer, and Ranger – could still be used as sub-names.

Brooks writes that Foote, Cone & Belding presumably didn’t react well to the chosen name, “Edsel,” after their exhaustive research to come up with the best possible names.  But the Special Products Division had an even worse reaction.  However, there were a few, including Krafve, would didn’t object to the name.

Krafve was named Vice-President of the Ford Motor Company and General Manager, Edsel Division.  Meanwhile, Edsels were being road-tested.  Brown and other designers were already working on the subsequent year’s model.  A new set of retail dealers was already being put together.  Foote, Cone & Belding was hard at work on strategies for advertising and selling Edsels.  In fact, Fairfax M. Cone himself was leading this effort.

Cone decided to use Wallace’s idea of “the smart car for the younger executive or professional family on its way up.”  But Cone amended it to: “the smart car for the younger middle-income family or professional family on its way up.”  Cone was apparently quite confident, since he described his advertising ideas for the Edsel to some reporters.  Brooks notes with amusement:

Like a chess master that has no doubt that he will win, he could afford to explicate the brilliance of his moves even as he made them.

Normally, a large manufacturer launches a new car through dealers already handling some of its other makes.  But Krafve got permission to go all-out on the Edsel.  He could contact dealers for other car manufacturers and even dealers for other divisions of Ford.  Krafve set a goal of signing up 1,200 dealers – who had good sales records – by September 4, 1957.

Brooks remarks that Krafve had set a high goal, since a dealer’s decision to sell a new car is major.  Dealers typically have one hundred thousand dollars – more than 8x that in 2019 dollars – invested in their dealerships.

J. C. (Larry) Doyle, second to Krafve, led the Edsel sales effort.  Doyle had been with Ford for 40 years.  Brooks records that Doyle was somewhat of a maverick in his field.  He was kind and considerate, and he didn’t put much stock in the psychological studies of car buyers.  But he knew how to sell cars, which is why he was called on for the Edsel campaign.

Doyle put Edsels into a few dealerships, but kept them hidden from view.  Then he went about recruiting top dealers.  Many dealers were curious about what the Edsel looked like.  But Doyle’s group would only show dealers the car if they listened to a one-hour pitch.  This approach worked.  It seems that quite a few dealers were so convinced by the pitch that they signed up without even looking at the car in any detail.

C. Gayle Warnock, director of public relations at Ford, was in charge of keeping public interest in the Edsel – which was already high – as strong as possible.  Warnock told Krafve that public interest might be too strong, to the extent that people would be disappointed when they discovered that the Edsel was a car.  Brooks:

It was agreed that the safest way to tread the tightrope between overplaying and underplaying the Edsel would be to say nothing about the car as a whole but to reveal its individual charms a little at a time – a sort of automotive strip tease…

Brooks continues:

That summer, too, was a time of speechmaking by an Edsel foursome consisting of Krafve, Doyle, J. Emmet Judge, who was Edsel’s director of merchandise and product planning, and Robert F. G. Copeland, its assistant general sales manager for advertising, sales promotion, and training.  Ranging separately up and down and across the nation, the four orators moved around so fast and so tirelessly, that Warnock, lest he lost track of them, took to indicating their whereabouts with colored pins on a map in his office.  ‘Let’s see, Krafve goes from Atlanta to New Orleans, Doyle from Council Bluffs to Salt Lake City,’ Warnock would muse of a morning in Dearborn, sipping his second cup of coffee and then getting up to yank the pins out and jab them in again.

Needless to say, this was by far the largest advertising campaign ever conducted by Ford.  This included a three-day press preview, with 250 reporters from all over the country.  On one afternoon, the press were taken to the track to see stunt drivers in Edsels doing all kinds of tricks.  Brooks quotes the Foote, Cone man:

‘You looked over this green Michigan hill, and there were those glorious Edsels, performing gloriously in unison.  It was beautiful.  It was like the Rockettes.  It was exciting.  Morale was high.’

Brooks then writes about the advertising on September 3 – “E-Day-minus-one”:

The tone for Edsel Day’s blizzard of publicity was set by an ad, published in newspapers all over the country, in which the Edsel shared the spotlight with the Ford Company’s President Ford and Chairman Breech.  In the ad, Ford looked like a dignified young father, Breech like a dignified gentleman holding a full house against a possible straight, the Edsel just looked like an Edsel.  The accompanying text declared that the decision to produce the car had been ‘based on what we knew, guessed, felt, believed, suspected – about you,’ and added, ‘YOU are the reason behind the Edsel.’  The tone was calm and confident.  There did not seem to be much room for doubt about the reality of that full house.

The interior of the Edsel, as predicted by Krafve, had an almost absurd number of push-buttons.

The two larger models – the Corsair and the Citation – were 219 inches long, two inches longer than the biggest of the Oldsmobiles.  And they were 80 inches wide, “or about as wide as passenger cars ever get,” notes Brooks.  Each had 345 horsepower, making it more powerful than any other American car at the time of launching.

Brooks records that the car received mixed press after it was launched.  In January, 1958, Consumer Reports wrote:

The Edsel has no important basic advantage over other brands.  The car is almost entirely conventional in construction…

Three months later, Consumer Reports wrote:

[The Edsel] is more uselessly overpowered… more gadget bedecked, more hung with expensive accessories than any other car in its price class.

This report gave the Corsair and the Citation the bottom position in its competitive ratings.

Brooks says there were several factors in the downfall of the Edsel.  It wasn’t just that the design fell short, nor was it simply that the company relied too much on psychological research.  For one, many of the early Edsels suffered from a surprising variety of imperfections.  It turned out that only about half the early Edsels functioned properly.

Brooks recounts:

For the first ten days of October, nine of which were business days, there were only 2,751 deliveries – an average of just over three hundred cars a day.  In order to sell the 200,000 cars per year that would make the Edsel operation profitable the Ford Motor Company would have to move an average of between six and seven hundred each business day – a good many more than three hundred a day.  On the night of Sunday, October 13th, Ford put on a mammoth television spectacular for Edsel, pre-empting the time ordinarily allotted to the Ed Sullivan show, but though the program cost $400,000 and starred Bing Crosby and Frank Sinatra, it failed to cause any sharp spurt in sales.  Now it was obvious that things were not going well at all.

Among the former executives of the Edsel Division, opinions differ as to the exact moment when the portents of doom became unmistakable… The obvious sacrificial victim was Brown, whose stock had gone through the roof at the time of the regally accoladed debut of his design, in August, 1955.  Now, without having done anything further, for either better or worse, the poor fellow became the company scapegoat…

Ford re-committed to selling the Edsel in virtually every way that it could.  Sales eventually increased, but not nearly enough.  Ultimately, the company had to stop production.  The net loss for Ford was roughly $350 million.

Krafve rejects that the Edsel failed due to a poor choice of the name.  He maintains that it was a mistake of timing.  Had they produced the car two years earlier, when medium-sized cars were still highly popular, the Edsel would have been a success.  Brown agrees with Krafve that it was a mistake of timing.

Doyle says it was a buyers’ strike.  He claims not to understand at all why the American public suddenly switched its taste from medium-sized cars to smaller-sized cars.

Wallace argued that the Russian launch of the sputnik had caused many Americans to start viewing Detroit products as bad, especially medium-priced cars.

Brooks concludes by noting that Ford did not get hurt by this setback, nor did the majority of people associated with the Edsel.  In 1958, net income per share dropped from $5.40 to $2.12, and Ford stock dropped from a 1957 high of $60 to a low of $40.  However, by 1959, net income per-share jumped to $8.24 and the stock hit $90.

The Ford executives associated with the Edsel advanced in their careers, for the most part.  Moreover, writes Brooks:

The subsequent euphoria of these former Edsel men did not stem entirely from the fact of their economic survival;  they appear to have been enriched spiritually.  They are inclined to speak of their Edsel experience – except for those still with Ford, who are inclined to speak of it as little as possible – with the verve and garrulity of old comrades-in-arms hashing over their most thrilling campaign.




Most nineteenth-century American fortunes were enlarged by, if they were not actually founded on, the practice of insider trading…

Not until 1934 did Congress pass the Securities Exchange Act, which forbids insider trading.  Later, a 1942 rule 10B-5 held that no stock trader could “make any untrue statement of a material fact or… omit to state a material fact.”  However, observes Brooks, this rule had basically been overlooked for the subsequent couple of decades.  It was argued that insiders needed the incentive of being able to profit in order to bring forth their best efforts.  Further, some authorities said that insider trading helped the markets function more smoothly.  Finally, it was held that most stock traders “possess and conceal information of one sort or another.”

In short, the S.E.C. seemed to be refraining from doing anything regarding insider trading.  But this changed when a civil complaint was made against Texas Gulf Sulphur Company.  The case was tried in the United States District Court in Foley Square May 9 to June 21, 1966.  The presiding judge was Dudley J. Bonsal, says Brooks, who remarked at one point, “I guess we all agree that we are plowing new ground here to some extent.”

In March 1959, Texas Gulf, a New York-based company and the world’s leader producer of sulphur, began conducting aerial surveys over a vast area of eastern Canada.  They weren’t looking for sulphur or gold, but for sulphides – sulphur in combination with other useful minerals such as zinc and copper.  Texas Gulf wanted to diversify its production.

These surveys took place over two years.  Many areas of interest were noted.  The company concluded that several hundred areas were most promising, including a segment called Kidd-55, which was fifteen miles north of Timmins, Ontario, an old gold-mining town several hundred miles northwest of Toronto.

The first challenge was to get title to do exploratory drilling on Kidd-55.  It wasn’t until June, 1963, that Texas Gulf was able to begin exploring on the northeast quarter of Kidd-55.  After Texas Gulf engineer, Richard H. Clayton, completed a ground electromagnetic survey and was convinced the area had potential, the company decided to drill.  Drilling began on November 8.  Brooks writes:

The man in charge of the drilling crew was a young Texas Gulf geologist named Kenneth Darke, a cigar smoker with a rakish gleam in his eye, who looked a good deal more like the traditional notion of a mining prospector than that of the organization man that he was.

A cylindrical sample an inch and a quarter in diameter was brought out of the earth.  Darke studied it critically inch by inch using only his eyes and his knowledge.  On November 10, Darke telephoned his immediate superior, Walter Holyk, chief geologist of Texas Gulf, to report the findings at that point.

The same night, Holyk called his superior, Richard D. Mollison, a vice president of Texas Gulf.  Mollison then called his superior, Charles F. Fogarty, executive vice president and the No. 2 man at the company.  Further reports were made the next day.  Soon Holyk, Mollison, and Fogarty decided to travel to Kidd-55 to take a look for themselves.

By November 12, Holyk was on site helping Darke examine samples.  Holyk was a Canadian in his forties with a doctorate in geology from MIT.  The weather had turned bad.  Also, much of the stuff came up covered in dirt and grease, and had to be washed with gasoline.  Nonetheless, Holyk arrived at an initial estimate of the core’s content.  There seemed to be average copper content of 1.15% and average zinc content of 8.64%.  If true and if it was not just in one narrow area, this appeared to be a huge discovery.  Brooks:

Getting title would take time if it were possible at all, but meanwhile there were several steps that the company could and did take.  The drill rig was moved away from the site of the test hole.  Cut saplings were stuck in the ground around the hole, to restore the appearance of the place to a semblance of its natural state.  A second test hole was drilled, as ostentatiously as possible, some distance away, at a place where a barren core was expected – and found.  All of these camouflage measures, which were in conformity with long-established practice among miners who suspect that they have made a strike, were supplemented by an order from Texas Gulf’s president, Claude O. Stephens, that no one outside the actual exploration group, even within the company, should be told what had been found.  Late in November, the core was shipped off, in sections, to the Union Assay Office in Salt Lake City for scientific analysis of its contents.  And meanwhile, of course, Texas Gulf began discreetly putting out feelers for the purchase of the rest of Kidd-55.

Brooks adds:

And meanwhile other measures, which may or may not have been related to the events of north of Timmins, were being taken.  On November 12th, Fogarty bought three hundred shares of Texas Gulf stock;  on the 15th he added seven hundred more shares, on November 19th five hundred more, and on November 26th two hundred more.  Clayton bought two hundred on the 15th, Mollison one hundred on the same day; and Mrs. Holyk bought fifty on the 29th and one hundred more on December 10th.  But these purchases, as things turned out, were only the harbingers of a period of apparently intense affection for Texas Gulf stock among certain of its officers and employees, and even some of their friends.

The results of the sample test confirmed Holyk’s estimates.  Also found were 3.94 ounces of silver per ton.  In late December, while in the Washington, D.C. area, Darke recommended Texas Gulf stock to a girl he knew there and her mother.  They later became known as “tippees,” while a few people they later told naturally became “sub-tippees.”  Between December 30 and February 17, Darke’s tippees and sub-tippees purchased 2,100 shares of Texas Gulf stock and also bought calls on another 1,500 shares.

In the first three months of 1964, Darke bought 300 shares of Texas Gulf stock, purchased calls on 3,000 more shares, and added several more persons to his burgeoning list of tippees.  Holyk and his wife bought a large number of calls on Texas Gulf stock.  They’d hardly heard of calls before, but calls “were getting to be quite the rage in Texas Gulf circles.”

Finally in the spring, Texas Gulf had the drilling rights it needed and was ready to proceed.  Brooks:

After a final burst of purchases by Darke, his tippees, and his sub-tippees on March 30th and 31st (among them all, six hundred shares and calls on 5,100 more shares for the two days), drilling was resumed in the still-frozen muskeg at Kidd-55, with Holyk and Darke both on the site this time.

While the crew stayed on site, the geologists almost daily made the fifteen-mile trek to Simmins.  With seven-foot snowdrifts, the trip took three and a half to four hours.

At some stage – later a matter of dispute – Texas Gulf realized that it had a workable mine of large proportions.  Vice President Mollison arrived on site for a day.  Brooks:

But before going he issued instructions for the drilling of a mill test hole, which would produce a relatively large core that could be used to determine the amenability of the mineral material to routine mill processing.  Normally, a mill test hole is not drilled until a workable mine is believed to exist.  And so it may have been in this case;  two S.E.C. mining experts were to insist later, against contrary opinions of experts for the defense, that by the time Mollison gave his order, Texas Gulf had information on the basis of which it could have calculated that the ore reserves at Kidd-55 had a gross assay value of at least two hundred million dollars.

Brooks notes:

The famous Canadian mining grapevine was humming by now, and in retrospect the wonder is that it had been relatively quiet for so long.

On April 10, President Stephens had become concerned enough to ask a senior member of the board – Thomas S. Lamont of Morgan fame – whether Texas Gulf should issue a statement.  Lamont told him he could wait until the reports were published in U.S. papers, but then he should issue a statement.

The following day, April 11, the reports poured forth in the U.S. papers.  The Herald Tribune called it “the biggest ore strike since gold was discovered more than 60 years ago in Canada.”  Stephens instructed Fogarty to begin preparing a statement to be issued on Monday, April 13.  Meanwhile, the estimated value of the mine seemed to be increasing by the hour as more and more copper and zinc ore was brought to the surface.  Brooks writes:

However, Fogarty did not communicate with Timmins after Friday night, so the statement that he and his colleagues issued to the press on Sunday afternoon was not based on the most up-to-the-minute information.  Whether because of that or for some other reason, the statement did not convey the idea that Texas Gulf thought it had a new Comstock Lode.  Characterizing the published reports as exaggerated and unreliable, it admitted that recent drilling on ‘one property near Timmins’ had led to ‘preliminary indications that more drilling would be required for proper evaluation of the prospect;’  went on to say that ‘the drilling done to date has not been conclusive;’  and then, putting the same thought in what can hardly be called another way, added that ‘the work done to date has not been sufficient to reach definitive conclusions.’

The wording of this press release was sufficient to put a damper on any expectations that may have arisen due to the newspaper stories the previous Friday.  Texas Gulf stock had gone from around $17 the previous November to around $30 just before the stories.  On Monday, the stock went to $32, but then came back down and even dipped below $29 in the subsequent two days.

Meanwhile, at Kidd-55, Mollison, Holyk, and Darke talked with a visiting reporter who had been shown around the place.  Brooks:

The things they told the reporter make it clear, in retrospect, that whatever the drafters of the release may have believed on Sunday, the men at Kidd-55 knew on Monday that they had a mine and a big one.  However, the world was not to know it, or at least not from that source, until Thursday morning, when the next issue of the Miner would appear in subscribers’ mail and on newstands.

Mollison and Holyk flew to Montreal Tuesday evening for the annual convention of the Canadian Institute of Mining and Metallurgy.  They had arranged for that Wednesday, in the company of the Minister of Mines of the Province of Ontario and his deputy, to attend the convention.  En route, they briefed the minister on Kidd-55.  The minister decided he wanted to make an announcement as soon as possible.  Mollison helped the minister draft the statement.

According to the copy Mollison kept, the announcement stated that “the information now in hand… gives the company confidence to allow me to announce that Texas Gulf Sulphur has a mineable body of zinc, copper, and silver ore of substantial dimensions that will be developed and brought to production as soon as possible.”  Mollison and Holyk believed that the minister would make the announcement that evening.  But for some reason, the minister didn’t.

Texas Gulf was to have a board of directors meeting that Thursday.  Since better and better news had been coming in from Kidd-55, the company officers decided they should write a new press release, to be issued after the Thursday morning board meeting.  This statement was based on the very latest information and it read, in part, “Texas Gulf Sulphur Company has made a major strike of zinc, copper, and silver in the Timmins area… Seven drill holes are now essentially complete and indicate an ore body of at least 800 feet in length, 300 feet in width, and having a vertical depth of more than 800 feet.  This is a major discovery.  The preliminary data indicate a reserve of more than 25 million tons of ore.”

The statement also noted that “considerably more data has been accumulated,” in order to explain the difference between this statement and the previous one.  Indeed, the value of the ore was not the two hundred million dollars alleged to have been estimable a week earlier, but many times that.

The same day, engineer Clayton and company secretary Crawford bought 200 and 300 shares, respectively.  The next morning, Crawford doubled his order.

The directors’ meeting ended at ten o’clock.  Then 22 reporters entered the room.  President Stephens read the new press release.  Most reporters rushed out before he was finished to report the news.

The actions of two Texas Gulf directors, Coates and Lamont, during the next half hour were later to lead to the most controversial part of the S.E.C.’s complaint.  As Brooks writes, the essence of the controversy was timing.  The Texas Gulf news was released by the Dow Jones News Service, the well-known spot-news for investors.  In fact, a piece of news is considered to be public the moment it crosses “the broad tape.”

The morning of April 16, 1964, a Dow Jones reporter was among those who attended the Texas Gulf press conference.  He left early and called in the news around 10:10 or 10:15, according to his recollection.  Normally, a news item this important would be printed on the Dow Jones machines two or three minutes after being phoned in.  But for reasons unknown, the Texas Gulf story did not appear on the tape until 10:54.  This delay was left unexplained during the trial based on irrelevance, says Brooks.

Coates, the Texan, around the end of the press conference, called his son-in-law, H. Fred Haemisegger, a stockbroker in Houston.  Coates told Haemisegger about the Texas Gulf discovery, also saying that he waited to call until “after the public announcement” because he was “too old to get in trouble with the S.E.C.”  Coates next placed an order for 2,000 shares of Texas Gulf stock for four family trusts.  He was a trustee, but not a beneficiary.  The stock had opened at $30.  Haemisegger, by acting quickly, was able to buy a bit over $31.

Lamont hung around the press conference area for 20 minutes or so.  He recounts that he “listened to chatter” and “slapped people on the back.”  Then at 10:39 or 10:40, he called a friend at Morgan Guaranty Trust Company – Longstreet Hinton, the bank’s executive vice president and head of its trust department.  Hinton had asked Lamont earlier in the week if he knew anything about the rumors of an ore discovery made by Texas Gulf.  Lamont had said no then.

But during this phone call, Lamont told Hinton that he had some news now.  Hinton asked whether it was good.  Lamont replied either “pretty good” or “very good.”  (Brooks notes that they mean the same thing in this context.)  Hinton immediately called the bank’s trading department, got a quote on Texas Gulf, and placed an order for 3,000 shares for the account of the Nassau Hospital, of which he was treasurer.  Hinton never bothered to look at the tape – despite being advised to do so by Lamont – because Hinton felt he already had the information he needed.  (Lamont didn’t know about the inexplicable forty minute delay before the Texas Gulf news appeared on the tape.)

Then Hinton went to the office of the Morgan Guaranty officer in charge of pension trusts.  Hinton recommended buying Texas Gulf.  In less than half an hour, the bank had ordered 7,000 shares for its pension fund and profit-sharing account.

An hour after that – at 12:33 – Lamont purchased 3,000 shares for himself and his family, paying $34 1/2 for them.  The stock closed above $36.  It hit a high of over $58 later that month.  Brooks:

…and by the end of 1966, when commercial production of ore was at last underway at Kidd-55 and the enormous new mine was expected to account for one-tenth of Canada’s total annual production of copper and one-quarter of its total annual production of zinc, the stock was selling at over 100.  Anyone who had bought Texas Gulf between November 12th, 1963 and the morning (or even the lunch hour) of April 16th, 1964 had therefore at least tripled his money.

Brooks then introduces the trial:

Perhaps the most arresting aspect of the Texas Gulf trial – apart from the fact that a trial was taking place at all – was the vividness and variety of the defendants who came before Judge Bonsal, ranging as they did from a hot-eyed mining prospector like Clayton (a genuine Welchman with a degree in mining from the University of Cardiff) through vigorous and harried corporate nabobs like Fogarty and Stephens to a Texas wheeler-dealer like Coates and a polished Brahmin of finance like Lamont.

Darke did not appear at the trial, claiming his Canadian nationality.  Brooks continues:

The S.E.C., after its counsel, Frank E. Kennamer Jr. had announced his intention to “drag to light and pillory the misconduct of these defendants,” asked the court to issue a permanent injunction forbidding Fogarty, Mollison, Clayton, Holyk, Darke, Crawford, and several other corporate insiders who had bought stock or calls between November 8th, 1963 and April 15th, 1964, from ever again “engaging in any act… which operates or would operate as a fraud or deceit upon any person in connection with purchase or sale of securities”;  further – and here it was breaking entirely new ground – it prayed that the court order the defendants to make restitution to the persons they had allegedly defrauded by buying stock or calls from them on the basis of inside information.  The S.E.C. also charged that the pessimistic April 12th press release was deliberately deceptive, and asked that because of it Texas Gulf be enjoined from “making any untrue statement of material fact or omitting to state a material fact.”  Apart from any question of loss of corporate face, the nub of the matter here lay in the fact that such a judgment, if granted, might well open the way for legal action against the company by any stockholder who had sold his Texas Gulf stock to anybody in the interim between the first press release and the second one, and since the shares that had changed hands during that period had run into the millions, it was a nub indeed.

Regarding the November purchases, the defense argued that a workable mine was far from a sure thing based only on the first drill hole.  Some even argued that the hole could have turned out to be a liability rather than an asset for Texas Gulf, based on what was known then.  The people who bought stock or calls during the winter claimed that the hole had little or nothing to do with their decision.  They stated that they thought Texas Gulf was a good investment in general.  Clayton said his sudden appearance as a large investor was because he had just married a well-to-do wife.  Brooks:

The S.E.C. countered with its own parade of experts, maintaining that the nature of the first core had been such as to make the existence of a rich mine an overwhelming probability, and that therefore those privy to the facts about it had possessed a material fact.

The S.E.C. also made much of the fact that Fogarty based the initial press release on information that was two days old.  The defense countered that the company had been in a sensitive position.  If it had issued an optimistic report that later turned out to be false, it could well be accused of fraud for that.

Judge Bonsal concluded that the definition of materiality must be conservative.  He therefore decided that up until April 9th, when three converging drill holes positively established the three-dimensionality of the ore deposit, material information had not been in hand.  Therefore, the decisions of insiders to buy stock before that date, even if based on initial drilling results, were legal “educated guesses.”

Case was thus dismissed against all educated guessers who had bought stock or calls, or recommended others do so, before the evening of April 9th.  Brooks:

With Clayton and Crawford, who had been so injudicious as to buy or order stock on April 15th, it was another matter.  The judge found no evidence that they had intended to deceive or defraud anyone, but they had made their purchases with the full knowledge that a great mine had been found and that it would be announced the next day – in short, with material private information in hand.  Therefore they were found to have violated Rule 10B-5, and in due time would presumably be enjoined from doing such a thing again and made to offer restitution to the persons they bought their April 15th shares from – assuming, of course, that such persons can be found…

On the matter of the April 12th press release, the judge found that it was not false or misleading.

Still to be settled was the matter of Coates and Lamont making their purchases.  The question was when it can be said that the information has officially been made public.  This was the most important issue and would likely set a legal precedent.

The S.E.C. argued that the actions of Coates and Lamont were illegal because they occurred before the ore strike news had crossed the Dow Jones broad tape.  The S.E.C. argued, furthermore, that even if Coates and Lamont had acted after the “official” announcement, it still would be illegal unless enough time had passed so that those who hadn’t attended the press conference, or even those who hadn’t seen the initial news cross the broad tape, had enough time to absorb the information.

Defense argued first that Coates and Lamont had every reason to believe that the news was already out, since Stephens said it had been released by the Ontario Minister of Mines the previous evening.  So Coates and Lamont acted in good faith.  Second, counsel argued that for all practical purposes, the news was out, via osmosis and The Northern Miner.  Brokerage offices and the Stock Exchange had been buzzing all morning.  Lamont’s lawyers also argued that Lamont had merely told Hinton to look at the tape, not to buy any stock.  Defense argued that the S.E.C. was asking the court to write new rules and then apply them retroactively, while the plaintiff was merely asking that an old rule 10B-5, be applied broadly.

As for Lamont’s waiting for two hours, until 12:33, before buying stock for himself, the S.E.C. took issue, as Brooks records:

‘It is the Commission’s position that even after corporate information has been published in the news media, insiders, are still under a duty to refrain from securities transactions until there had elapsed a reasonable amount of time in which the securities industry, the shareholders, and the investing public can evaluate the development and make informed investment decisions… Insiders must wait at least until the information is likely to have reached the average investor who follows the market and he has had some opportunity to consider it.’

In the Texas Gulf case, the S.E.C. argued that one hour and thirty-nine minutes was not “a reasonable amount of time.”  What, then, is “a reasonable amount of time,” the S.E.C. was asked?  The S.E.C.’s counsel, Kennamer, said it “would vary from case to case.”  Kennamer added that it would be “a nearly impossible task to formulate a rigid set of rules that would apply in all situations of this sort.”

Brooks sums it up with a hint of irony:

Therefore, in the S.E.C.’s canon, the only way an insider could find out whether he had waited long enough before buying his company’s stock was by being hauled into court and seeing what the judge would decide.

Judge Bonsal rejected this argument by the S.E.C.  Moreover, he took a narrower view that, based on legal precedent, the key moment was when the press release was read.  The judge admitted that a better rule might be formulated according to which insiders had to wait at least some amount time after the initial press release so that other investors could absorb it.  However, he didn’t think he should write such a rule.  Nor should this matter be left up to the judge on a case-by-base basis.  Thus, the complaints against Coates and Lamont were dismissed.

The S.E.C. appealed all the dismissals.  Brooks concludes:

…in August, 1968, the U.S. Court of Appeals for the Second Circuit handed down a decision which flatly reversed Judge Bonsal’s findings on just about every score except the findings against Crawford and Clayton, which were affirmed.  The Appeals Court found that the original November drill hole had provided material evidence of a valuable ore deposit, and that therefore Fogarty, Mollison, Darke, Holyk, and all other insiders who had bought Texas Gulf stock or calls on it during the winter were guilty of violations of the law;  that the gloomy April 12th press release had been ambiguous and perhaps misleading;  and that Coates had improperly and illegally jumped the gun in placing his orders right after the April 16th press conference.  Only Lamont – the charges against whom had been dropped following his death shortly after the lower court decision – and a Texas Gulf office manager, John Murray, remained exonerated.



There was no economical and practical way of making copies until after 1950.  Brooks writes that the 1950’s were the pioneering years for mechanized office copying.  Although people were starting to show a compulsion to make copies, the early copying machines suffered from a number of problems.  Brooks:

…What was needed for the compulsion to flower into a mania was a technological breakthrough, and the breakthrough came at the turn of the decade with the advent of a machine that worked on a new principle, known as xerography, and was able to make dry, good-quality, permanent copies on ordinary paper with a minimum of trouble.  The effect was immediate.  Largely as a result of xerography, the estimated number of copies (as opposed to duplicates) made annually in the United States sprang from some twenty million in the mid-fifties to nine and a half billion in 1964, and to fourteen billion in 1966 – not to mention billions more in Europe, Asia, and Latin America.  More than that, the attitude of educators towards printed textbooks and of business people toward written communication underwent a discernable change;  avant-garde philosophers took to hailing xerography as a revolution comparable in importance to the invention of the wheel;  and coin-operated copy machines began turning up in candy stores and beauty parlors…

The company responsible for the great breakthrough and the one on whose machines the majority of these billions of copies were made was of course, the Xerox Corporation, of Rochester, New York.  As a result, it became the most spectacular big-business success of the nineteen-sixties.  In 1959, the year the company – then called Haloid Xerox, Inc. – introduced its first automatic xerographic office copier, its sales were thirty-three million dollars.  In 1961, they were sixty-six million, in 1963 a hundred and seventy-six million, and in 1966 over half a billion.

The company was extremely profitable.  It ranked two hundred and seventy-first in Fortune’s ranking in 1967.  However, in 1966 the company ranked sixty-third in net profits and probably ninth in the ratio of profits to sales and fifteenth in terms of market value.  Brooks continues:

…Indeed, the enthusiasm the investing public showed for Xerox made its shares the stock market Golconda of the sixties.  Anyone who bought its stock toward the end of 1959 and held on to it until early 1967 would have found his holding worth about sixty-six times its original price, and anyone who was really fore-sighted and bought Haloid in 1955 would have seen his original investment grow – one might almost say miraculously – a hundred and eighty times.  Not surprisingly, a covey of “Xerox millionaires” sprang up – several hundred of them all told, most of whom either lived in the Rochester area or had come from there.

The Haloid company was started in Rochester in 1906.  It manufactured photographic papers.  It survived OK.  But after the Second World War, due to an increase in competition and labor costs, the company was looking for new products.

More than a decade earlier, in 1938, an obscure thirty-two year-old inventor, Chester F. Carlson, was spending his spare time trying to invent an office copying machine.  Carlson had a degree in physics from the California Institute of Technology.  Carlson had hired Otto Kornei, a German refugee physicist, to help him.  Their initial copying machine was unwieldy and produced much smoke and stench.  Brooks:

The process, which Carlson called electrophotography, had – and has – five basic steps:  sensitizing a photoconductive surface to light by giving it an electrostatic charge (for example, by rubbing it with fur);  exposing this surface to a written page to form an electrostatic image;  developing the latest image by dusting the surface with a powder that will adhere only to the charged areas;  transferring the image to some sort of paper;  and fixing the image by the application of heat.

Although each individual step was already used in other technologies, this particular combination of steps was new.  Carlson carefully patented the process and began trying to sell it.  Over the ensuing five years, Carlson tried to sell the rights to every important office-equipment company in the country.  He was turned down every time.  In 1944, Carlson finally convinced Battelle Memorial Institute to conduct further development work on the process in exchange for three-quarters of any future royalties.

In 1946, various people at Haloid, including Joseph C. Wilson – who was about to become president – had noticed the work that Battelle was doing.  Wilson asked a friend of his, Sol M. Linowitz, a smart, public-spirited lawyer just back from service in the Navy, to research the work at Battelle as a “one-shot” job.  The result was an agreement giving Haloid the rights to the Carlson process in exchange for royalties for Battelle and Carlson.

At one point in the research and development process, the Haloid people got so discouraged that they considered selling most of their xerography rights to International Business Machines.  The research process became quite costly.  But Haloid committed itself to seeing it through.  It took full title of the Carlson process and assumed the full cost of development in exchange for shares in Haloid (for Battelle and Carlson).  Brooks:

…The cost was staggering.  Between 1947 and 1960, Haloid spent about seventy-five million dollars [over $800 million in 2019 dollars] on research in xerography, or about twice what it earned from its regular operations during that period;  the balance was raised through borrowing and through the wholesale issuance of common stock to anyone who was kind, reckless, or prescient enough to take it.  The University of Rochester, partly out of interest in a struggling local industry, bought an enormous quantity for its endowment fund at a price that subsequently, because of stock splits, amounted to fifty cents a share.  ‘Please don’t be mad at us if we have to sell our Haloid stock in a couple of years to cut our losses on it,’ a university official nervously warned Wilson.  Wilson promised not to be mad.  Meanwhile, he and other executives of the company took most of their pay in the form of stock, and some of them went as far as to put up their savings and the mortgages on their houses to help the cause along.

In 1961, the company changed its name to Xerox Corporation.  One unusual aspect to the story is that Xerox became rather public-minded.  Brooks quotes Wilson:

‘To set high goals, to have almost unattainable aspirations, to imbue people with the belief that they can be achieved – these are as important as the balance sheet, perhaps more so.’

This rhetoric is not uncommon.  But Xerox followed through by donating one and a half percent of its profits to educational and charitable institutions in 1965-1966.  In 1966, Xerox committed itself to the “one-per-cent program,” also called the Cleveland Plan, according to which the company gives one percent of its pre-tax income annually to educational institutions, apart from any other charitable activities.

Furthermore, President Wilson said in 1964, “The corporation cannot refuse to take a stand on public issues of major concern.”  As Brooks observes, this is “heresy” for a business because it could alienate customers or potential customers.  Xerox’s chief stand was in favor of the United Nations.  Brooks:

Early in 1964, the company decided to spend four million dollars – a year’s advertising budget – on underwriting a series of network-television programs dealing with the U.N., the programs to be unaccompanied by commercials or any other identification of Xerox apart from a statement at the beginning and end of each that Xerox had paid for it.

Xerox was inundated with letters opposing the company’s support of the U.N.  Many said that the U.N. charter had been written by American Communists and that the U.N. was an instrument for depriving Americans of their Constitutional rights.  Although only a few of these letters came from the John Birch Society, it turned out later that most of the letters were part of a meticulously planned Birch campaign.  Xerox officers and directors were not intimidated.  The U.N. series appeared in 1965 and was widely praised.

Furthermore, Xerox consistently committed itself to informing the users of its copiers of their legal responsibilities.  It took this stand despite their commercial interest.

Brooks visited Xerox in order to talk with some of its people.  First he spoke with Dr. Dessauer, a German-born engineer who had been in charge of the company’s research and engineering since 1938.  It was Dessauer who first brought Carlson’s invention to the attention of Joseph Wilson.  Brooks noticed a greeting card from fellow employees calling Dessauer the “Wizard.”

Dr. Dessauer told Brooks about the old days.  Dessauer said money was the main problem.  Many team members gambled heavily on the xerox project.  Dessauer himself mortgaged his house.  Early on, team members would often say the damn thing would never work.  Even if it did work, the marketing people said there was only a market for a few thousand of the machines.

Next Brooks spoke with Dr. Harold E. Clark, who had been a professor of physics before coming to Haloid in 1949.  Dr. Clark was in charge of the xerography-development program under Dr. Dessauer.  Dr. Clark told Brooks that Chet Carlson’s invention was amazing.  Also, no one else invented something similar at the same time, unlike the many simultaneous discoveries in scientific history.  The only problem, said Dr. Clark, was that it wasn’t a good product.

The main trouble was that Carlson’s photoconductive surface, which was coated with sulphur, lost its qualities after it had made a few copies and became useless.  Acting on a hunch unsupported by scientific theory, the Battelle researchers tried adding to the sulphur a small quantity of selenium, a non-metallic element previously used chiefly in electrical resistors and as a coloring material to redden glass.  The selenium-and-sulphur surface worked a little better than the all-sulphur one, so the Battelle men tried adding a little more selenium.  More improvement.  They gradually kept increasing the percentage until they had a surface consisting entirely of selenium – no sulphur.  That one worked best of all, and thus it was found, backhandedly, that selenium and selenium alone could make xerography practical.

Dr. Clark went on to tell Brooks that they basically patented one of the elements, of which there are not many more than one hundred.  What is more, they still don’t understand how it works.  There are no memory effects – no traces of previous copies are left on the selenium drum.  A selenium-coated drum in the lab can last a million processes, or theoretically an infinite number.  They don’t understand why.  Dr. Clark concluded that they combined “Yankee tinkering and scientific inquiry.”

Brooks spoke with Linowitz, who only had a few minutes because he had just been appointed U.S. Ambassador to the Organization of American States.  Linowitz told him:

…the qualities that made for the company’s success were idealism, tenacity, the courage to take risks, and enthusiasm.

Joseph Wilson told Brooks that his second major had been English literature.  He thought he would be a teacher or work in administration at a university.  Somehow he ended up at Harvard Business School, where he was a top student.  After that, he joined Haloid, the family business, something he’d never planned on doing.

Regarding the company’s support of the U.N., Wilson explained that world cooperation was the company’s business, because without it there would be no world and thus no business.  He went on to explain that elections were not the company’s business.  But university education, civil rights, and employment of African-Americans were their business, to name just a few examples.  So far, at least, Wilson said there hadn’t been a conflict between their civic duties and good business.  But if such a conflict arose, he hoped that the company would honor its civic responsibilities.



On November 19th, 1963, the Stock Exchange became aware that two of its member firms – J. R. Williston & Beane, Inc., and Ira Haupt & Co. – were in serious financial trouble.  This later became a crisis that was made worse by the assassination of JFK on November 22, 1963.  Brooks:

It was the sudden souring of a speculation that these two firms (along with various brokers not members of the Stock Exchange) had become involved in on behalf of a single customer – the Allied Crude Vegetable Oil & Refining Co., of Bayonne, New Jersey.  The speculation was in contracts to buy vast quantities of cotton-seed oil and soybean oil for future delivery.

Brooks then writes:

On the two previous business days – Friday the fifteenth and Monday the eighteenth – the prices had dropped an average of a little less than a cent and a half per pound, and as a result Haupt had demanded that Allied put up about fifteen million dollars in cash to keep the account seaworthy.  Allied had declined to do this, so Haupt – like any broker when a customer operating on credit has defaulted – was faced with the necessity of selling out the Allied contracts to get back what it could of its advances.  The suicidal extent of the risk that Haupt had undertaken is further indicated by the fact that while the firm’s capital in early November had amounted to only about eight million dollars, it had borrowed enough money to supply a single customer – Allied – with some thirty-seven million dollars to finance the oil speculations.  Worse still, as things turned out it had accepted as collateral for some of these advances enormous amounts of actual cottonseed oil and soybean oil from Allied’s inventory, the presence of which in tanks at Bayonne was attested to by warehouse receipts stating the precise amount and kind of oil on hand.  Haupt had borrowed the money it supplied Allied from various banks, passing along most of the warehouse receipts to the banks as collateral.  All this would have been well and good if it had not developed later that many of the warehouse receipts were forged, that much of the oil they attested to was not, and probably never had been, in Bayonne, and that Allied’s President, Anthony De Angelis (who was later sent to jail on a whole parcel of charges), had apparently pulled off the biggest commercial fraud since that of Ivar Kreuger, the match king.

What began to emerge as the main issue was that Haupt had about twenty thousand individual stock-market customers, who had never heard of Allied or commodity trading.  Williston & Beane had nine thousand individual customers.  All these accounts were frozen when the two firms were suspended by the Stock Exchange.  (Fortunately, the customers of Williston & Beane were made whole fairly rapidly.)

The Stock Exchange met with its member firms.  They decided to make the customers of Haupt whole.  G. Keith Funston, President of the Stock Exchange, urged the member firms to take over the matter.  The firms replied that the Stock Exchange should do it.  Funston replied, “If we do, you’ll have to repay us the amount we pay out.”  So it was agreed that the payment would come out of the Exchange’s treasury, to be repaid later by the member firms.

Funston next led the negotiations with Haupt’s creditor banks.  Their unanimous support was essential.  Chief among the creditors were four local banks – Chase Manhattan, Morgan Guaranty Trust, First National City, and Manufacturers Hanover Trust.  Funston proposed that the Exchange would put up the money to make the Haupt customers whole – about seven and a half million dollars.  In return, for every dollar the Exchange put up, the banks would agree to defer collection on two dollars.  So the banks would defer collection on about fifteen million.

The banks agreed to this on the condition that the Exchange’s claim to get back any of its contribution would come after the banks’ claims for their loans.  Funston and his associates at the Exchange agreed to that.  After more negotiating, there was a broad agreement on the general plan.

Early on Saturday, the Exchange’s board met and learned from Funston what was proposed.  Almost immediately, several governors rose to state that it was a matter of principle.  And so the board agreed with the plan.  Later, Funston and his associates decided to put the Exchange’s chief examiner in charge of the liquidation of Haupt in order to ensure that its twenty thousand individual customers were made whole as soon as the Exchange had put up the cash.  (The amount of cash would be at least seven and a half million, but possibly as high as twelve million.)

Fortunately, the American banks eventually all agreed to the final plan put forth by the Exchange.  Brooks notes that the banks were “marvels of cooperation.”  But agreement was still needed from the British banks.  Initially, Funston was going to make the trip to England, but he couldn’t be spared.

Several other governors quickly volunteered to go, and one of them, Gustave L. Levy, was eventually selected, on the ground that his firm, Goldman, Sachs & Co., had had a long and close association with Kleinwort, Benson, one of the British banks, and that Levy himself was on excellent terms with some of the Kleinwort, Benson partners.

The British banks were very unhappy.  But since their loans to Allied were unsecured, they didn’t have any room to negotiate.  Still, they asked for time to think the matter over.  This gave Levy an opportunity to meet with this Kleinwort, Benson friends.  Brooks:

The circumstances of the reunion were obviously less than happy, but Levy says that his friends took a realistic view of their situation and, with heroic objectivity, actually helped their fellow-Britons to see the American side of the question.

The market was closed Monday for JFK’s funeral.  Funston was still waiting for the call from Levy.  After finally getting agreement from all the British banks, Levy placed the call to Funston.

Funston felt at this point that the final agreement had been wrapped up, since all he needed was the signatures of the fifteen Haupt general partners.  The meeting with the Haupt partners ended up taking far longer than expected.  Brooks:

One startling event broke the even tenor of this gloomy meeting… someone noticed an unfamiliar and strikingly youthful face in the crowd and asked its owner to identify himself.  The unhesitating reply was, ‘I’m Russell Watson, a reporter for the Wall Street Journal.’  There was a short, stunned silence, in recognition of the fact that an untimely leak might still disturb the delicate balance of money and emotion that made up the agreement.  Watson himself, who was twenty-four and had been on the Journal for a year, has since explained how he got into the meeting, and under what circumstances he left it.  ‘I was new on the Stock Exchange beat then,’ he said afterward.  ‘Earlier in the day, there had been word that Funston would probably hold a press conference sometime that evening, so I went over to the Exchange.  At the main entrance, I asked a guard where Mr. Funston’s conference was.  The guard said it was on the sixth floor, and ushered me into an elevator.  I suppose he thought I was a banker, a Haupt partner, or a lawyer.  On the sixth floor, people were milling around everywhere.  I just walked off the elevator and into the office where the meeting was – nobody stopped me.  I didn’t understand much of what was going on.  I got the feeling that whatever was at stake, there was general agreement but still a lot of haggling over details to be done.  I didn’t recognize anybody there but Funston.  I stood around quietly for about five minutes before anybody noticed me, and then everybody said, pretty much at once, “Good God, get out of here!”  They didn’t exactly kick me out, but I saw it was time to go.’

At fifteen minutes past midnight, finally all the parties signed an agreement.

As soon as the banks opened on Tuesday, the Exchange deposited seven and a half million dollars in an account on which the Haupt liquidator – James P. Mahony – could draw.  The stock market had its greatest one-day rise in history.  A week later, by December 2, $1,750,000 had been paid out to Haupt customers.  By December 12, it was $5,400,000.  And by Christmas, it was $6,700,000.  By March 11, the pay-out had reached nine and a half million dollars and all the Haupt customers had been made whole.

  • Note:  $9.5 million in 1963 would be approximately $76 million dollars today (in 2018), due to inflation.

Brooks describes the reaction:

In Washington, President Johnson interrupted his first business day in office to telephone Funston and congratulate him.  The chairman of the S.E.C., William L. Cary, who was not ordinarily given to throwing bouquets at the Stock Exchange, said in December that it had furnished ‘a dramatic, impressive demonstration of its strength and concern for the public interest.’

Brooks later records:

Oddly, almost no one seems to have expressed gratitude to the British and American banks, which recouped something like half of their losses.  It may be that people simply don’t thank banks, except in television commercials.



Brooks opens this chapter by observing that communication is one of the biggest problems in American industry.  (Remember he was writing in the 1960’s).  Brooks:

This preoccupation with the difficulty of getting a thought out of one head and into another is something the industrialists share with a substantial number of intellectuals and creative writers, more and more of whom seemed inclined to regard communication, or the lack of it, as one of the greatest problems not just of industry, but of humanity.

Brooks then adds:

What has puzzled me is how and why, when foundations sponsor one study of communication after another, individuals and organizations fail so consistently to express themselves understandably, or how and why their listeners fail to grasp what they hear.

A few years ago, I acquired a two-volume publication of the United States Government Printing Office entitled Hearings Before the Subcommittee on Antitrust and Monopoly of the Committee on the Judiciary, United States Senate, Eighty-Seventh Congress, First Session, Pursuant to S. Res. 52, and after a fairly diligent perusal of its 1,459 pages I thought I could begin to see what the industrialists are talking about.

The hearings were conducted in April, May, and June of 1961 under the chairmanship of Senator Estes Kefauver of Tennessee.  They concerned price-fixing and bid-rigging in conspiracies in the electrical-manufacturing industry.  Brooks:

…Senator Kefauver felt that the whole matter needed a good airing.  The transcript shows that it got one, and what the airing revealed – at least within the biggest company involved – was a breakdown in intramural communication so drastic as to make the building of the tower of Babel seem a triumph of organizational rapport.

Brooks explains a bit later:

The violations, the government alleged, were committed in connection with the sale of large and expensive pieces of apparatus of a variety that is required chiefly by public and private electric-utility companies (power transformers, switchgear assemblies, and turbine-generator units, among many others), and were the outcome of a series of meetings attended by executives of the supposedly competing companies – beginning at least as early as 1956 and continuing into 1959 – at which noncompetitive price levels were agreed upon, nominally sealed bids on individual contracts were rigged in advance, and each company was allocated a certain percentage of the available business.

Brooks explains that in an average year at the time of the conspiracies, about $1.75 billion – $14 billion in 2019 dollars – was spent on the sorts of machines in question, with nearly a quarter of that local, state, and federal government spending.  Brooks gives a specific example, a 500,000-kilowatt turbine-generator, which sold for about $16 million (nearly $130 million in 2019 dollars), but was often discounted by 25 percent.  If the companies wanted to, they could effectively charge $4 million extra (nearly $32 million extra in 2019 dollars).  Any such additional costs as a result of price-fixing would, in the case of government purchases, ultimately fall on the taxpayer.

Brooks again:

To top it all off, there was a prevalent suspicion of hypocrisy in the very highest places.  Neither the chairman of the board nor the president of General Electric, the largest of the corporate defendants, had been caught on the government’s dragnet, and the same was true of Westinghouse Electric, the second-largest;  these four ultimate bosses let it be known that they had been entirely ignorant of what had been going on within their commands right up to the time the first testimony on the subject was given to the Justice Department.  Many people, however, were not satisfied by these disclaimers, and, instead, took the position that the defendant executives were men in the middle, who had broken the law only in response either to actual orders or to a corporate climate favoring price-fixing, and who were now being allowed to suffer for the sins of their superiors.  Among the unsatisfied was Judge Ganey himself, who said at the time of the sentencing, ‘One would be most naive indeed to believe that these violations of the law, so long persisted in, affecting so large a segment of the industry, and, finally, involving so many millions upon millions of dollars, were facts unknown to those responsible for the conduct of the corporation… I am convinced that in the great number of these defendants’ cases, they were torn between conscience and approved corporate policy, with the rewarding objectives of promotion, comfortable security, and large salaries.’

General Electric got most of the attention.  It was, after all, by far the largest of those companies involved.  General Electric penalized employees who admitted participation in the conspiracy.  Some saw this as good behavior, while others thought it was G.E. trying to save higher-ups by making a few sacrifices.

G.E. maintained that top executives didn’t know.  Judge Ganey thought otherwise.  But Brooks realized it couldn’t be determined:

…For, as the testimony shows, the clear waters of moral responsibility at G.E. became hopelessly muddied by a struggle to communicate – a struggle so confused that in some cases, it would appear, if one of the big bosses at G.E. had ordered a subordinate to break the law, the message would somehow have been garbled in its reception, and if the subordinate had informed the boss that he was holding conspiratorial meetings with competitors, the boss might well have been under the impression that the subordinate was gossiping idly about lawn parties or pinochle lessons.

G.E., for at least eight years, has had a rule, Directive Policy 20.5, which explicitly forbids price-fixing, bid-rigging, and similar anticompetitive practices.  The company regularly reissued 20.5 to new executives and asked them to sign their names to it.

The problem was that many, including those who signed, didn’t take 20.5 seriously.  They thought it was just a legal device.  They believed that meeting illegally with competitors was the accepted and standard practice.  They concluded that if a superior told them to comply with 20.5, he was actually ordering him to violate it.  Brooks:

Illogical as it might seem, this last assumption becomes comprehensible in light of the fact that, for a time, when some executives orally conveyed, or reconveyed, the order, they were apparently in the habit of accompanying it with an unmistakable wink.

Brooks gives an example of just such a meeting of sales managers in May 1948.  Robert Paxton, an upper-level G.E. executive who later became the company’s president, addressed the group and gave the usual warnings about antitrust violations.  William S. Ginn, a salesman under Paxton, interjected, “We didn’t see you wink.”  Paxton replied, “There was no wink.  We mean it, and these are the orders.”

Senator Kefauver asked Paxton how long he had known about such winks.  Paxton said that in 1935, he saw his boss do it following an order.  Paxton recounts that he became incensed.  Since then, he had earned a reputation as an antiwink man.

In any case, Paxton’s seemingly unambiguous order in 1948 failed to get through to Ginn, who promptly began pricing-fixing with competitors.  When asked about it thirteen years later, Ginn – having recently gotten out of jail and having lost his $135,000 a year job at G.E. – said he had gotten a contrary order from two other superiors, Henry V. B. Erben and Francis Fairman.  Brooks:

Erben and Fairman, Ginn said, had been more articulate, persuasive, and forceful in issuing their order than Paxton had been in issuing his;  Fairman, especially, Ginn stressed, had proved to be ‘a great communicator, a great philosopher, and, frankly, a great believer in stability of prices.’  Both Erben and Fairman had dismissed Paxton as naive, Ginn testified, and, in further summary of how he had been led astray, he said that ‘the people who were advocating the Devil were able to sell me better than the philosophers that were selling me the Lord.’

Unfortunately, Erben and Fairman had passed away before the hearing.  So we don’t have their testimonies.  Ginn consistently described Paxton as a philosopher-salesman on the side of the Lord.

In November, 1954, Ginn was made general manager of the transformer division.  Ralph J. Cordiner, chairman of the board at G.E. since 1949, called Ginn down to New York to order him to comply strictly with Directive 20.5.  Brooks:

Cordiner communicated this idea so successfully that it was clear enough to Ginn at the moment, but it remained so only as long as it took him, after leaving the chairman, to walk to Erben’s office.

Erben, Ginn’s direct superior, countermanded Cordiner’s order.

Erben’s extraordinary communicative prowess carried the day, and Ginn continued to meet with competitors.

At the end of 1954, Paxton took over Erben’s job and was thus Ginn’s direct superior.  Ginn kept meeting with competitors, but he didn’t tell Paxton about it, knowing his opposition to the practice.

In January 1957, Ginn became general manager of G.E.’s turbine-generator division.  Cordiner called him down again to instruct him to follow 20.5.  This time, however, Ginn got the message.  Why?  “Because my air cover was gone,” Ginn explained to the Subcommittee.  Brooks:

If Erben, who had not been Ginn’s boss since late in 1954, had been the source of his air cover, Ginn must have been without its protection for over two years, but, presumably, in the excitement of the price war he had failed to notice its absence.

In any case, Ginn apparently had reformed.  Ginn circulated copies of 20.5 among all his division managers.  He then instructed them not to even socialize with competitors.

It appears that Ginn had not been able to impart much of his shining new philosophy to others, and that at the root of his difficulty lay that old jinx, the problem of communicating.

Brooks quotes Ginn:

‘I have got to admit that I made a communication error.  I didn’t sell this thing to the boys well enough… The price is so important in the complete running of a business that, philosophically, we have got to sell people not only just the fact that it is against the law, but… that it shouldn’t be done for many, many reasons.  But it has got to be a philosophical approach and a communication approach…’

Frank E. Stehlik was general manager of the low-voltage-switchgear department from May, 1956 to February, 1960.  Stehlik not only heard 20.5 directly from his superiors in oral and written communications.  But, in addition, Stehlik was open to a more visceral type of communication he called “impacts.”  Brooks explains:

Apparently, when something happened within the company that made an impression on him, he would consult an internal sort of metaphysical voltmeter to ascertain the force of the jolt he had received, and, from the reading he got, would attempt to gauge the true drift of company policy.

In 1956, 1957, and for most of 1958, Stehlik believed that company policy clearly required compliance with 20.5.  But in the fall of 1958, Stehlik’s immediate superior, George E. Burens, told him that Paxton had told him (Burens) to have lunch with a competitor.  Paxton later testified that he categorically told Burens not to discuss prices.  But Stehlik got a different impression.

In Stehlik’s mind, this fact made an “impact.”  He felt that company policy was now in favor of disobeying 20.5.  So, late in 1958, when Burens told him to begin having price meetings with a competitor, he was not at all surprised.  Stehlik complied.

Brooks next describes the communication problem from the point of view of superiors.  Raymond W. Smith was general manager of G.E.’s transformer division, while Arthur F. Vinson was vice-president in charge G.E.’s apparatus group.  Vinson ended up becoming Smith’s immediate boss.

Smith testified that Cordiner gave him the usual order on 20.5.  But late in 1957, price competition for transformers was so intense that Smith decided on his own to start meeting with competitors to see if prices could be stabilized.  Smith thought company policy and industry practice both supported his actions.

When Vinson became Smith’s boss, Smith felt he should let him know what he was doing.  So on several occasions, Smith told Vinson, “I had a meeting with the clan this morning.”

Vinson, in his testimony, said he didn’t even recall Smith use the phrase, “meeting of the clan.”  Vinson only recalled that Smith would say things like, “Well, I am going to take this new plan on transformers and show it to the boys.”  Vinson testified that he thought Smith meant the G.E. district salespeople and the company’s customers.  Vinson claimed to be shocked when he learned that Smith was referring to price-fixing meetings with competitors.

But Smith was sure that his communication had gotten through to Vinson.  “I never got the impression that he misunderstood me,” Smith testified.

Senator Kefauver asked Vinson if he was so naive as to not know to whom “the boys” referred.  Vinson replied, “I don’t think it is too naive.   We have a lot of boys… I may be naive, but I am certainly telling the truth, and in this kind of thing I am sure I am naive.”

Kefauver pressed Vinson, asking how he could have become vice-president at $200,000 a year if he were naive.  Vinson:  “I think I could well get there by being naive in this area.  It might help.”

Brooks asks:

Was Vinson really saying to Kefauver what he seemed to be saying – that naivete about antitrust violations might be a help to a man in getting and holding a $200,000-a-year job at General Electric?  It seems unlikely.  And yet what else could he have meant?

Vinson was also implicated in another part of the case.  Four switchgear executives – Burens, Stehlik, Clarence E. Burke, and H. Frank Hentschel – testified before the grand jury (and later before the Subcommittee) that in mid-1958, Vinson had lunch with them in Dining Room B of G.E.’s switchgear works in Philadelphia, and that Vinson told them to hold price meetings with competitors.

This led the four switchgear executives to hold a series of meetings with competitors.  But Vinson told prosecutors that the lunch never took place and that he had had no knowledge at all of the conspiracy until the case broke.  Regarding the lunch, Burens, Stehlik, Burke, and Hentschel all had lie-detector tests, given by the F.B.I., and passed them.

Brooks writes:

Vinson refused to take a lie-detector test, at first explaining that he was acting on advice of counsel and against his personal inclination, and later, after hearing how the four other men had fared, arguing that if the machine had not pronounced them liars, it couldn’t be any good.

It was shown that there were only eight days in mid-1958 when Burens, Stehlik, Burke, and Hentschel all had been together at the Philadelphia plant and could have had lunch together.  Vinson produced expense accounts showing that he had been elsewhere on each of those eight days.  So the Justice Department dropped the case against Vinson.

The upper level of G.E. “came through unscathed.”  Chairman Cordiner and President Paxton did seem to be clearly against price-fixing, and unaware of all the price-fixing that had been occurring.  Paxton, during his testimony, said that he learned from his boss, Gerard Swope, that the ultimate goal of business was to produce more goods for people at lower cost.  Paxton claimed to be deeply impacted by this philosophy, explaining why he was always strongly against price-fixing.

Brooks concludes:

Philosophy seems to have reached a high point at G.E., and communication a low one.  If executives could just learn to understand one another, most of the witnesses said or implied, the problem of antitrust violations would be solved.  But perhaps the problem is cultural as well as technical, and has something to do with a loss of personal identity that comes with working in a huge organization.  The cartoonist Jules Feiffer, contemplating the communication problem in a nonindustrial context, has said, ‘Actually, the breakdown is between the person and himself.  If you’re not able to communicate successfully between yourself and yourself, how are you supposed to make it with the strangers outside?’  Suppose, purely as a hypothesis, that the owner of a company who orders his subordinates to obey the antitrust laws has such poor communication with himself that he does not really know whether he wants the order to be complied with or not.  If his order is disobeyed, the resulting price-fixing may benefit his company’s coffers;  if it is obeyed, then he has done the right thing.  In the first instance, he is not personally implicated in any wrongdoing, while in the second he is positively involved in right doing.  What, after all, can he lose?  It is perhaps reasonable to suppose that such an executive will communicate his uncertainty more forcefully than his order.



Piggly Wiggly Stores – a chain of retail self-service markets mostly in the South and West, and headquartered in Memphis – was first listed on the New York Stock Exchange in June, 1922.  Clarence Saunders was the head of Piggly Wiggly.  Brooks describes Saunders:

…a plump, neat, handsome man of forty-one who was already something of a legend in his home town, chiefly because of a house he was putting up there for himself.  Called the Pink Palace, it was an enormous structure faced with pink Georgia marble and built around an awe-inspiring white-marble Roman atrium, and, according to Saunders, it would stand for a thousand years.  Unfinished though it was, the Pink Palace was like nothing Memphis had ever seen before.  Its grounds were to include a private golf course, since Saunders liked to do his golfing in seclusion.

Brooks continues:

The game of Corner – for in its heyday it was a game, a high-stakes gambling game, pure and simple, embodying a good many of the characteristics of poker – was one phase of the endless Wall Street contest between bulls, who want the price of a stock to go up, and bears, who want it to go down.  When a game of Corner was underway, the bulls’ basic method of operation was, of course, to buy stock, and the bears’ was to sell it.

Since most bears didn’t own the stock, they would have to conduct a short sale.  This means they borrow stock from a broker and sell it.  But they must buy the stock back later in order to return it to the broker.  If they buy the stock back at a lower price, then the difference between where they initially sold the stock short, and where they later buy it back, represents their profit.  If, however, they buy the stock back at a higher price, then they suffer a loss.

There are two related risks that the short seller (the bear) faces.  First, the short seller initially borrows the stock from the broker in order to sell it.  If the broker is forced to demand the stock back from the short seller – either because the “floating supply” needs to be replenished, or because the short seller has insufficient equity (due to the stock price moving to high) – then the short seller can be forced to take a loss.  Second, technically there is no limit to how much the short seller can lose because there is no limit to how high a stock can go.

The danger of potentially unlimited losses for a short seller can be exacerbated in a Corner.  That’s because the bulls in a Corner can buy up so much of the stock that there is very little supply of it left.  As the stock price skyrockets and the supply of stock shrinks, the short seller can be forced to buy the stock back – most likely from the bulls – at an extremely high price.  This is precisely what the bulls are trying to accomplish in a Corner.

On the other hand, if the bulls end up owning most of the publicly available stock, and if the bears can ride out the Corner, then to whom can the bulls sell their stock?  If there are virtually no buyers, then the bulls have no chance of selling most of their holding.  In this case, the bulls can get stuck with a mountain of stock they can’t sell.  The achievable value of this mountain can even approach zero in some extreme cases.

Brooks explains that true Corners could not happen after the new securities legislation in the 1930’s.  Thus, Saunders was the last intentional player of the game.

Saunders was born to a poor family in Amherst County, Virginia, in 1881.  He started out working for practically nothing for a local grocer.  He then worked for a wholesale grocer in Clarksville, Tennessee, and then for another one in Memphis.  Next, he organized a retail food chain, which he sold.  Then he was a wholesale grocer before launching the retail self-service food chain he named Piggly Wiggly Stores.

By the fall of 1922, there were over 1,200 Piggly Wiggly Stores.  650 of these were owned outright by Saunders’ Piggly Wiggly Stores, Inc.  The rest were owned independently, but still paid royalties to the parent company.  For the first time, customers were allowed to go down any aisle and pick out whatever they wanted to buy.  Then they paid on their way out of the store.  Saunders didn’t know it, but he had invented the supermarket.

In November, 1922, several small companies operating Piggly Wiggly Stores in New York, New Jersey, and Connecticut went bankrupt.  These were independently owned, having nothing to do with Piggly Wiggly Stores, Inc.  Nonetheless, several stock-market operators saw what they believed was a golden opportunity for a bear raid.  Brooks:

If individual Piggly Wiggly stores were failing, they reasoned, then rumors could be spread that would lead the uninformed public to believe that the parent firm was failing, too.  To further this belief, they began briskly selling Piggly Wiggly short, in order to force the price down.  The stock yielded readily to their pressure, and within a few weeks its price, which earlier in the year had hovered around fifty dollars a share, dropped to below forty.

Saunders promptly announced to the press that he was going to “beat the Wall Street professionals at their own game” through a buying campaign.  At that point, Saunders had no experience at all with owning stock, Piggly Wiggly being the only stock he had ever owned.  Moreover, there is no reason to think Saunders was going for a Corner at this juncture.  He merely wanted to support his stock on behalf of himself and other stockholders.

Saunders borrowed $10 million dollars – about $140 million in 2019 dollars – from bankers in Memphis, Nashville, New Orleans, Chattanooga, and St. Louis.  Brooks:

Legend has it that he stuffed his ten million-plus, in bills of large denomination, into a suitcase, boarded a train for New York, and, his pockets bulging with currency that wouldn’t fit in the suitcase, marched on Wall Street, ready to do battle.

Saunders later denied this, saying he conducted his campaign from Memphis.  Brooks continues:

Wherever he was at the time, he did round up a corp of some twenty brokers, among them Jesse L. Livermore, who served as his chief of staff.  Livermore, one of the most celebrated American speculators of this century, was then forty-five years old but was still occasionally, and derisively, referred to by the nickname he had earned a couple of decades earlier – the Boy Plunger of Wall Street.  Since Saunders regarded Wall Streeters in general and speculators in particular as parasitic scoundrels intent only on battering down his stock, it seemed likely that his decision to make an ally of Livermore was a reluctant one, arrived at simply with the idea of getting the enemy chieftain into his own camp.

Within a week, Saunders had bought 105,000 shares – more than half of the 200,000 shares outstanding.  By January 1923, the stock hit $60 a share, its highest level ever.  Reports came from Chicago that the stock was cornered.  The bears couldn’t find any available supply in order to cover their short positions by buying the stock back.  The New York Stock Exchange immediately denied the rumor, saying ample amounts of Piggly Wiggly stock were still available.

Saunders then made a surprising but exceedingly crafty move.  The stock was pushing $70, but Saunders ran advertisements offering to sell it for $55.  Brooks explains:

One of the great hazards in Corner was always that even though a player might defeat his opponents, he would discover that he had won a Pyrrhic victory.  Once the short sellers had been squeezed dry, that is, the cornerer might find that the reams of stock he had accumulated in the process were a dead weight around his neck;  by pushing it all back into the market in one shove, he would drive its price down close to zero.  And if, like Saunders, he had had to borrow heavily to get into the game in the first place, his creditors could be expected to close in on him and perhaps not only divest him of his gains but drive him into bankruptcy.  Saunders apparently anticipated this hazard almost as soon as a corner was in sight, and accordingly made plans to unload some of his stock before winning instead of afterward.  His problem was to keep the stock he sold from going right back into the floating supply, thus breaking his corner;  and his solution was to sell his fifty-five-dollar shares on the installment plan.

Crucially, the buyers on the installment plan wouldn’t receive the certificates of ownership until they had paid their final installment.  This meant they couldn’t sell their shares back into the floating supply until they had finished making all their installment payments.

By Monday, March 19, Saunders owned nearly all of the 200,000 shares of Piggly Wiggly stock.  Livermore had already bowed out of the affair on March 12 because he was concerned about Saunders’ financial position.  Nonetheless, Saunders asked Livermore to spring the bear trap.  Livermore wouldn’t do it.  So Saunders himself had to do it.

On Tuesday, March 20, Saunders called for delivery all of his Piggly Wiggly stock.  By the rules of the Exchange, stock so called for had to be delivered by 2:15 the following afternoon.  There were a few shares around owned in small amounts by private investors.  Short sellers were frantically trying to find these folks.  But on the whole, there were basically no shares available outside of what Saunders himself owned.

This meant that Piggly Wiggly shares had become very illiquid – there were hardly any shares trading.  A nightmare, it seemed, for short sellers.  Some short sellers bought at $90, some at $100, some at $110.  Eventually the stock reached $124.  But then a rumor reached the floor that the governors of the Exchange were considering a suspension of trading in Piggly Wiggly, as well as an extension of the deadline for short sellers.  Piggly Wiggly stock fell to $82.

The Governing Committee of the Exchange did, in fact, made such an announcement.  They claimed that they didn’t want to see a repeat of the Northern Pacific panic.  However, many wondered whether the Exchange was just helping the short sellers, among whom were some members of the Exchange.

Saunders still hadn’t grasped the fundamental problem he now faced.  He still seemed to have several million in profits.  But only if he could actually sell his shares.

Next, the Stock Exchange announced a permanent suspension of trading in Piggly Wiggly stock and a full five day extension for short sellers to return their borrowed shares.  Short sellers had until 2:15 the following Monday.

Meanwhile, Piggly Wiggly Stores, Inc., released its annual financial statement, which revealed that sales, profits, and assets had all sharply increased from the previous year.  But everyone ignored the real value of the company.  All that mattered at this point was the game.

The extension allowed short sellers the time to find shareholders in a variety of locations around the country.  These shareholders were of course happy to dig out their stock certificates and sell them for $100 a share.  In this way, the short sellers were able to completely cover their short positions by Friday evening.  And instead of paying Saunders cash for some of his shares, the short sellers gave him more shares to settle their debt, which is the last thing Saunders wanted just then.  (A few short sellers had to pay Saunders directly.)

The upshot was that all the short sellers were in the clear, whereas Saunders was stuck owning nearly every single share of Piggly Wiggly stock.  Saunders, who had already started complaining loudly, repeated his charge that Wall Street had changed its own rule in order to let “a bunch of welchers” off the hook.

In response, the Stock Exchange issued a statement explaining its actions:

‘The enforcement simultaneously of all contracts for the return of stock would have forced the stock to any price that might be fixed by Mr. Saunders, and competitive bidding for the insufficient supply might have brought about conditions illustrated by other corners, notably the Northern Pacific corner in 1901.’

Furthermore, the Stock Exchange pointed out that its own rules allowed it to suspend trading in a stock, as well as to extend the deadline for the return of borrowed shares.

It is true that the Exchange had the right to suspend trading in a stock.  But it is unclear, to say the least, about whether the Exchange had any right to postpone the deadline for the delivery of borrowed shares.  In fact, two years after Saunders’ corner, in June, 1925, the Exchange felt bound to amend its constitution with an article stating that “whenever in the opinion of the Governing Committee a corner has been created in a security listed on the Exchange… the Governing Committee may postpone the time for deliveries on Exchange contracts therein.”



According to Brooks, other than FDR himself, perhaps no one typified the New Deal better than David Eli Lilienthal.  On a personal level, Wall Streeters found Lilienthal a reasonable fellow.  But through his association with Tennessee Valley Authority from 1933 to 1946, Lilienthal “wore horns.”  T.V.A. was a government-owned electric-power concern that was far larger than any private power corporation.  As such, T.V.A. was widely viewed on Wall Street as the embodiment of “galloping Socialism.”

In 1946, Lilienthal became the first chairman of the United States Atomic Energy Commission, which he held until February, 1950.

Brooks was curious what Lilienthal had been up to since 1950, so he did some investigating.  He found that Lilienthal was co-founder and chairman of Development & Resources Corporation.  D. & R. helps governments set up programs similar to the T.V.A.  Brooks also found that as of June, 1960, Lilienthal was a director and major shareholder of Minerals & Chemicals Corporation of America.

Lastly, Brooks discovered Lilienthal had published his third book in 1953, “Big Business: A New Era.”  In the book, he argues that:

  • the productive superiority of the United States depends on big business;
  • we have adequate safeguards against abuses by big business;
  • big businesses tend to promote small businesses, not destroy them;
  • and big business promotes individualism, rather than harms it, by reducing poverty, disease, and physical insecurity.

Lilienthal later agreed with his family that he hadn’t spent enough time on the book, although its main points were correct.  Also, he stressed that he had conceived of the book before he ever decided to transition from government to business.

In 1957, Lilienthal and his wife Helen Lamb Lilienthal had settled in a house in Princeton.  It was a few years later, at this house, that Brooks went to interview Lilienthal.  Brooks was curious to hear about how Lilienthal thought about his civic career as compared to his business career.

Lilienthal had started out as a lawyer in Chicago and he done quite well.  But he didn’t want to practice the law.  Then – in 1950 – his public career over, he was offered various professorship positions at Harvard.  He didn’t want to be a professor.  Then various law firms and businesses approached Lilienthal.  He still had no interest in practicing law.  He also rejected the business offers he received.

In May, 1950, Lilienthal took a job as a part-time consultant for Lazard Freres & Co., whose senior partner, Andre Meyer, he had met through Albert Lasker, a mutual friend.  Through Lazard Freres and Meyer, Lilienthal became a consultant and then an executive of a small company, the Minerals Separation North American Corporation.  Lazard Freres had a large interest in the concern.

The company was in trouble, and Meyer thought Lilienthal was the man to solve the case.  Through a series of mergers, acquisitions, etc., the firm went through several name changes ending, in 1960, with the name, Minerals & Chemicals Philipp Corporation.  Meanwhile, annual sales for the company went from $750,000 in 1952 to more than $274,000,000 in 1960.  (In 2019 dollars, this would be a move from $6,750,000 to $2,466,000,000.)  Brooks writes:

For Lilienthal, the acceptance of Meyer’s commission to look into the company’s affairs was the beginning of a four-year immersion in the day-to-day problems of managing a business;  the experience, he said decisively, turned out to be one of his life’s richest, and by no means only in the literal sense of that word.

Minerals Separation North American, founded in 1916 as an offshoot from a British company, was a patent firm.  It held patents on processes used to refine copper ore and other nonferrous minerals.  In 1952, Lilienthal became the president of the company.  In order to gain another source of revenue, Lilienthal arranged a merger between Minerals Separation and Attapulgus Clay Company, a producer of a rare clay used in purifying petroleum products and also a manufacturer of various household products.

The merger took place in December, 1952, thanks in part to Lilienthal’s work to gain agreement from the Attapulgus people.  The profits and stock price of the new company went up from there.  Lilienthal managed some of the day-to-day business.  And he helped with new mergers.  One in 1954, with Edgar Brothers, a leading producer of kaolin for paper coating.  Two more in 1955, with limestone firms in Ohio and Virginia.  Brooks notes that the company’s net profits quintupled between 1952 and 1955.

Lilienthal received stock options along the way.  Because the stock went up a great deal, he exercised his options and by August, 1955, Lilienthal had 40,000 shares.  Soon the stock hit $40 and was paying a $0.50 annual dividend.  Lilienthal’s financial worries were over.

Brooks asked Lilienthal how all of this felt.  Lilienthal:

‘I wanted an entrepreneurial experience.  I found a great appeal in the idea of taking a small and quite crippled company and trying to make something of it.  Building.  That kind of building, I thought, is the central thing in American free enterprise, and something I’d missed in all my government work.  I wanted to try my hand at it.  Now, about how it felt.  Well, it felt plenty exciting.  It was full of intellectual stimulation, and a lot of my old ideas changed.  I conceived a great new respect for financiers – men like Andre Meyer.  There’s a correctness about them, a certain high sense of honor, that I’d never had any conception of.  I found that business life is full of creative, original minds – along with the usual number of second-guessers, of course.  Furthermore, I found it seductive.  In fact, I was in danger of becoming a slave… I found that the things you read – for instance, that acquiring money for its own sake can become an addiction if you’re not careful – are literally true.  Certain good friends helped keep me on track… Oh, I had my problems.  I questioned myself at every step.  It was exhausting.’

A friend of Lilienthal’s told Brooks that Lilienthal had a marvelous ability to immerse himself totally in the work.  The work may not always be important.  But Lilienthal becomes so immersed, it’s as if the work becomes important simply because he’s doing it.

On the matter of money, Lilienthal said it doesn’t make much difference as long as you have enough.  Money was something he never really thought about.

Next Brooks describes Lilienthal’s experience at Development & Resources Corporation.  The situation became ideal for Lilienthal because it combined helping the world directly with the possibility of also earning a profit.

In the spring of 1955, Lilienthal and Meyer had several conversations.  Lilienthal told Meyer that he knew dozens of foreign dignitaries and technical personnel who had visited T.V.A. and shown strong interest.  Many of them told Lilienthal that at least some of their own countries would be interested in starting similar programs.

The idea for D. & R. was to accomplish very specific projects and, incidentally, to make a profit.  Meyer liked the idea – although he expected no profit – so they went forward, with Lazard Freres owning half the firm.  The executive appointments for D.& R. included important alumni from T.V.A., people with deep experience and knowledge in management, engineering, dams, electric power, and related areas.

In September, 1955, Lilienthal was at a World Bank meeting in Istanbul and he ended up speaking with Abolhassan Ebtehaj, head of a 7-year development plan in Iran.  Iran had considerable capital with which to pay for development projects, thanks to royalties from its nationalized oil industry.  Moreover, what Iran badly needed was technical and professional guidance.  Lilienthal and a colleague later visited Iran as guests of the Shah to see what could be done about Khuzistan.

Lilienthal didn’t know anything about the region at first.  But he learned that Khuzistan was in the middle of the Old Testament Elamite kingdom and later of the Persian Empire.  The ruins of Persepolis are close by.  The ruins of Susa, where King Darius had a winter palace, are at the center of Khuzistan.  Brooks quotes Lilienthal (in the 1960’s):

Nowadays, Khuzistan is one of the world’s richest oil fields  – the famous Abadan refinery is at its southern tip – but the inhabitants, two and a half million of them, haven’t benefited from that.  The rivers have flowed unused, the fabulously rich soil has lain fallow, and all but a tiny fraction of the people have continued to live in desperate poverty.

D. & R. signed a 5-year agreement with the Iranian government.  Once the project got going, there were 700 people working on it – 100 Americans, 300 Iranians, and 300 others (mostly Europeans).  In addition, 4,700 Iranian-laborers were on the various sites.  The entire project called for 14 dams on 5 different rivers.  After D. & R. completed its first 5-year contract, they signed a year-and-a-half extension including an option for an additional 5 years.

Brooks records:

While the Iranian project was proceeding, D. & R. was also busy lining up and carrying out its programs for Italy, Colombia, Ghana, the Ivory Coast, and Puerto Rico, as well as programs for private business groups in Chile and the Philippines.  A job that D. & R. had just taken on from the United States Army Corps of Engineers excited Lilienthal enormously – an investigation of the economic impact of power from a proposed dam on the Alaskan sector of the Yukon, which he described as ‘the river with the greatest hydroelectric potential remaining on this continent.’  Meanwhile, Lazard Freres maintained its financial interest in the firm and now very happily collected its share of a substantial annual profit, and Lilienthal happily took to teasing Meyer about his former skepticism as to D. & R. financial prospects.

Lilienthal wrote in his journal about the extreme poverty in Ahwaz, Khuzistan:

…visiting villages and going into mud ‘homes’ quite unbelievable – and unforgettable forever and ever.  As the Biblical oath has it:  Let my right hand wither if I ever forget how some of the most attractive of my fellow human beings live – are living tonight, only a few kilometres from here, where we visited them this afternoon…

And yet I am as sure as I am writing these notes that the Ghebli area, of only 45,000 acres, swallowed in the vastness of Khuzistan, will become as well known as, say, the community of Tupelo… became, or New Harmony or Salt Lake City when it was founded by a handful of dedicated men in a pass of the great Rockies.



The owners of public businesses in the United States are the stockholders.  But many stockholders don’t pay much attention to company affairs when things are going well.  Also, many stockholders own small numbers of shares, making it not seem worthwhile to exercise their rights as owners of the corporations.  Furthermore, many stockholders don’t understand or follow business, notes Brooks.

Brooks decided to attend several annual meetings in the spring of 1966.

What particularly commended the 1966 season to me was that it promised to be a particularly lively one.  Various reports of a new “hard-line approach” by company managements to stockholders had appeared in the press.  (I was charmed by the notion of a candidate for office announcing his new hard-line approach to voters right before an election.)

Brooks first attended the A. T. & T. annual meeting in Detroit.  Chairman Kappel came on stage, followed by eighteen directors who sat behind him, and he called the meeting to order.  Brooks:

From my reading and from annual meetings that I’d attended in past years, I knew that the meetings of the biggest companies are usually marked by the presence of so-called professional stockholders… and that the most celebrated members of this breed were Mrs. Wilma Soss, of New York, who heads an organization of women stockholders and votes the proxies of its members as well as her own shares, and Lewis D. Gilbert, also of New York, who represents his own holdings and those of his family – a considerable total.

Brooks learned that, apart from prepared comments by management, many big-company meetings are actually a dialogue between the chairman and a few professional stockholders.  So professional stockholders can come to represent, in a way, many other shareholders who might otherwise not be represented, whether because they own few shares, don’t follow business, or other reasons.

Brooks notes that occasionally some professional stockholders get boorish, silly, on insulting.  But not Mrs. Soss or Mr. Gilbert:

Mrs. Soss, a former public-relations woman who has been a tireless professional stockholder since 1947, is usually a good many cuts above this level.  True, she is not beyond playing to the gallery by wearing bizarre costumes to meetings;  she tries, with occasional success, to taunt recalcitrant chairmen into throwing her out;  she is often scolding and occasionally abusive;  and nobody could accuse her of being unduly concise.  I confess that her customary tone and manner set my teeth on edge, but I can’t help recognizing that, because she does her homework, she usually has a point.  Mr. Gilbert, who has been at it since 1933 and is the dean of them all, almost invariably has a point, and by comparison with his colleagues he is the soul of brevity and punctilio as well as of dedication and diligence.

At the A. T. & T. meeting, after the management-sponsored slate of directors had been duly nominated, Mrs. Soss got up to make a nomination of her own, Dr. Frances Arkin, a psychoanalyst.  Mrs. Soss said A. T. & T. ought to have a woman on its board and, moreover, she thought some of the company’s executives would have benefited from periodic psychiatric examinations.  (Brooks comments that things were put back into balance at another annual meeting when the chairman suggested that some of the firm’s stockholders should see a psychiatrist.)  The nomination of Dr. Arkin was seconded by Mr. Gilbert, but only after Mrs. Soss nudged him forcefully in the ribs.

A professional stockholder named Evelyn Y. Davis complained about the meeting not being in New York, as it usually is.  Brooks observed that Davis was the youngest and perhaps the best-looking, but “not the best-informed or the most temperate, serious-minded, or worldly-wise.”  Davis’ complaint was met with boos from the largely local crowd in Detroit.

After a couple of hours, Mr. Kappel was getting testy.  Soon thereafter, Mrs. Soss was complaining that while the business affiliations of the nominees for director were listed in the pamphlet handed out at the meeting, this information hadn’t been included in the material mailed to stockholders, contrary to custom.  Mrs. Soss wanted to know why.  Mrs. Soss adopted a scolding tone and Mr. Kappel an icy one, says Brooks.  “I can’t hear you,” Mrs. Soss said at one point.  “Well, if you’d just listen instead of talking…”, Mr. Kappel replied.  Then Mrs. Soss said something (Brooks couldn’t hear it precisely) that successfully baited the chairman, who got upset and had the microphone in front of Mrs. Soss turned off.  Mrs. Soss marched towards the platform and was directly facing Mr. Kappel.  Mr. Kappel said he wasn’t going to throw her out of the meeting as she wanted.  Mrs. Soss later returned to her seat and a measure of calm was restored.

Later, Brooks attended the annual meeting of Chas. Pfizer & Co., which was run by the chairman, John E. McKeen.  After the company announced record highs on all of its operational metrics, and predicted more of the same going forward, “the most intransigent professional stockholder would have been hard put to it to mount much of a rebellion at this particular meeting,” observes Brooks.

John Gilbert, brother of Lewis Gilbert, may have been the only professional stockholder present.  (Lewis Gilbert and Mrs. Davis were at the U.S. Steel meeting in Cleveland that day.)

John Gilbert is the sort of professional stockholder the Pfizer management deserves, or would like to think it does.  With an easygoing manner and a habit of punctuating his words with self-deprecating little laughs, he is the most ingratiating gadly imaginable (or was on this occasion; I’m told he isn’t always), and as he ran through what seemed to be the standard Gilbert-family repertoire of questions – on the reliability of the firms’s auditors, the salaries of its officers, the fees of its directors – he seemed almost apologetic that duty called on him to commit the indelicacy of asking such things.

The annual meeting of Communications Satellite Corporation had elements of farce, recounts Brooks.  (Brooks refers to Comsat as a “glamorous space-age communications company.”)  Mrs. Davis, Mrs. Soss, and Lewis Gilbert were in attendance.  The chairman of Comsat, who ran the meeting, was James McCormack, a West Point graduate, former Rhodes Scholar, and retired Air Force General.

Mrs. Soss made a speech which was inaudible because her microphone wasn’t working.  Next, Mrs. Davis rose to complain that there was a special door to the meeting for “distinguished guests.”  Mrs. Davis viewed this as undemocratic.  Mr. McCormack responded, “We apologize, and when you go out, please go by any door you want.”  But Mrs. Davis went on speaking.  Brooks:

And now the mood of farce was heightened when it became clear that the Soss-Gilbert faction had decided to abandon all efforts to keep ranks closed with Mrs. Davis.  Near the height of her oration, Mr. Gilbert, looking as outraged as a boy whose ball game is being spoiled by a player who doesn’t know the rules or care about the game, got up and began shouting, ‘Point of order!  Point of order!’  But Mr. McCormack spurned this offer of parliamentary help;  he ruled Mr. Gilbert’s point of order out of order, and bade Mrs. Davis proceed.  I had no trouble deducing why he did this.  There were unmistakable signs that he, unlike any other corporate chairman I had seen in action, was enjoying every minute of the goings on.  Through most of the meeting, and especially when the professional stockholders had the floor, Mr. McCormack wore the dreamy smile of a wholly bemused spectator.

Mrs. Davis’ speech increased in volume and content, and she started making specific accusations against individual Comsat directors.  Three security guards appeared on the scene and marched to a location near Mrs. Davis, who then suddenly ended her speech and sat down.

Brooks comments:

Once, when Mr. Gilbert said something that Mrs. Davis didn’t like and Mrs. Davis, without waiting to be recognized, began shouting her objection across the room, Mr. McCormack gave a short irrepressible giggle.  That single falsetto syllable, magnificently amplified by the chairman’s microphone, was the motif of the Comsat meeting.



Brooks writes about Donald W. Wohlgemuth, a scientist for B. F. Goodrich Company in Akron, Ohio.

…he was the manager of Goodrich’s department of space-suit engineering, and over the past years, in the process of working his way up to that position, he had had a considerable part in the designing and construction of the suits worn by our Mercury astronauts on their orbital and suborbital flights.

Some time later, the International Latex Corporation, one of Goodrich’s three main competitors in the space-suit field, contacted Wohlgemuth.

…Latex had recently been awarded a subcontract, amounting to some three-quarters of a million dollars, to do research and development on space suits for the Apollo, or man-on-the-moon, project.  As a matter of fact, Latex had won this contract in competition with Goodrich, among others, and was thus for the moment the hottest company in the space-suit field.

Moreover, Wohlgemuth was not particularly happy at Goodrich for a number of reasons.  His salary was below average.  His request for air-conditioning had been turned down.

Latex was located in Dover, Delaware.  Wohlgemuth went there to meet with company representatives.  He was given a tour of the company’s space-suit-development facilities.  Overall, he was given “a real red-carpet treatment,” as he later desribed.  Eventually he was offered the position of manager of engineering for the Industrial Products Division, which included space-suit development, at an annual salary of $13,700 (over $109,000 in 2019 dollars) – solidly above his current salary.  Wohlgemuth accepted the offer.

The next morning, Wohlgemuth informed his boss at Goodrich, Carl Effler, who was not happy.  The morning after that, Wohlgemuth told Wayne Galloway – with whom he had worked closely – of his decision.

Galloway replied that in making the move Wohlgemuth would be taking to Latex certain things that did not belong to him – specifically, knowledge of the processes that Goodrich used in making space suits.

Galloway got upset with Wohlgemuth.  Later Effler called Wohlgemuth to his office and told him he should leave the Goodrich offices as soon as possible.  Then Galloway called him and told him the legal department wanted to see him.

While he was not bound to Goodrich by the kind of contract, common in American industry, in which an employee agrees not to do similar work for any competing company for a stated period of time, he had, on his return from the Army, signed a routine paper agreeing ‘to keep confidential all information, records, and documents of the company of which I may have knowledge because of my employment’ – something Wohlgemuth had entirely forgotten until the Goodrich lawyer reminded him.  Even if he had not made that agreement, the lawyer told him now, he would be prevented from going to work on space suits for Latex by established principles of trade-secrets law.  Moreover, if he persisted in his plan, Goodrich might sue him.

To make matters worse, Effler told Wohlgemuth that if he stayed at Goodrich, this incident could not be forgotten and might well impact his future.  Wohlgemuth then informed Latex that he would be unable to accept their offer.

That evening, Wohlgemuth’s dentist put him in touch with a lawyer.  Wohlgemuth talked with the lawyer, who consulted another lawyer.  They told Wohlgemuth that Goodrich was probably bluffing and wouldn’t sue him if he went to work for Latex.

The next morning – Thursday – officials of Latex called him back to assure him that their firm would bear his legal expenses in the event of a lawsuit, and, furthermore, would indemnify him against any salary losses.

Wohlgemuth decided to work for Latex, after all, and left the offices of Goodrich late that day, taking with him no documents.

The next day, R. G. Jeter, general counsel of Goodrich, called Emerson P. Barrett, director of industrial relations for Latex.  Jeter outlined Goodrich’s concern for its trade secrets.  Barrett replied that Latex was not interested in Goodrich trade secrets, but was only interested in Wohlgemuth’s “general professional abilities.”

That evening, at a farewell dinner given by forty or so friends, Wohlgemuth was called outside.  The deputy sheriff of Summit County handed him two papers.

One was a summons to appear in the Court of Common Pleas on a date a week or so off.  The other was a copy of a petition that had been filed in the same court that day by Goodrich, praying that Wohlgemuth be permanently enjoined from, among other things, disclosing to any unauthorized person any trade secrets belonging to Goodrich, and ‘performing any work for any corporation… other than plaintiff, relating to the design, manufacture and/or sale of high-altitude pressure suits, space suits and/or similar protective garments.’

For a variety of reasons, says Brooks, the trial attracted much attention.

On one side was the danger that discoveries made in the course of corporate research might become unprotectable – a situation that would eventually lead to the drying up of private research funds.  On the other side was the danger that thousands of scientists might, through their very ability and ingenuity, find themselves permanently locked in a deplorable, and possibly unconstitutional, kind of intellectual servitude – they would be barred from changing jobs because they knew too much.

Judge Frank H. Harvey presided over the trial, which took place in Akron from November 26 to December 12.  The seriousness with which Goodrich took this case is illustrated by the fact that Jeter himself, who hadn’t tried a case in 10 years, headed Goodrich’s legal team.  The chief defense counsel was Richard A. Chenoweth, of Buckingham, Doolittle & Burroughs – an Akron law firm retained by Latex.

From the outset, the two sides recognized that if Goodrich was to prevail, it had to prove, first, that it possessed trade secrets;  second, that Wohlgemuth also possessed them, and that a substantial peril of disclosure existed;  and, third, that it would suffer irreparable injury if injunctive relief was not granted.

Goodrich attorneys tried to establish that Goodrich had a good number of space-suit secrets.  Wohlgemuth, upon cross-examination from his counsel, sought to show that none of these processes were secrets at all.  Both companies brought their space suits into the courtroom.  Goodrich wanted to show what it had achieved through research.  The Latex space suit was meant to show that Latex was already far ahead of Goodrich in space-suit development, and so wouldn’t have any interest in Goodrich secrets.

On the second point, that Wohlgemuth possessed Goodrich secrets, there wasn’t much debate.  But Wohlgemuth’s lawyers did argue that he had taken no papers with him and that he was unlikely to remember the details of complex scientific processes, even if he wanted to.

On the third point, seeking injunctive relief to prevent irreparable injury, Jeter argued that Goodrich was the clear pioneer in space suits.  It made the first full-pressure flying suit in 1934.  Since then, it has invested huge amounts in space suit research and development.  Jeter characterized Latex as a newcomer intent on profiting from Goodrich’s years of research by hiring Wohlgemuth.

Furthermore, even if Wohlgemuth and Latex had the best of intentions, Wohlgemuth would inevitably give away trade secrets.  But good intentions hadn’t been demonstrated, since Latex deliberately sought Wohlgemuth, who in turn justified his decision in part on the increase in salary.  The defense disagreed that trade secrets would be revealed or that anyone had bad intentions.  The defense also got a statement in court from Wohlgemuth in which he pledged not to reveal any trade secrets of B. F. Goodrich Company.

Judge Harvey reserved the decision for a later date.  Meanwhile, the lawyers for each side fought one another in briefs intended to sway Judge Harvey.  Brooks:

…it became increasingly clear that the essence of the case was quite simple.  For all practical purposes, there was no controversy over facts.  What remained in controversy was the answer to two questions:  First, should a man be formally restrained from revealing trade secrets when he has not yet committed any such act, and when it is not clear that he intends to?  And, secondly, should a man be prevented from taking a job simply because the job presents him with unique temptations to break the law?

The defense referred to “Trade Secrets,” written by Ridsdale Ellis and published in 1953, which stated that usually it is not until there is evidence that the employee has not lived up to the contract, written or implied, that the former employer can take action.  “Every dog has one free bite.”

On February 20, 1963, Judge Harvey delivered his decision in a 9-page essay.  Goodrich did have trade secrets.  And Wohlgemuth could give these secrets to Latex.  Furthermore, there’s no doubt Latex was seeking to get Wohlgemuth for his specialized knowledge in space suits, which would be valuable for the Apollo contract.  There’s no doubt, wrote the judge, that Wohlgemuth would be able to disclose confidential information.

However, the judge said, in keeping with the one-free-bite principle, an injunction against disclosure of trade secrets cannot be issued before such disclosure has occurred unless there is clear and substantial evidence of evil intent on the part of the defendant.  In the view of the court, Wohlgemuth did not have evil intent in this case, therefore the injunction was denied.

On appeal, Judge Arthur W. Doyle partially reversed the decision.  Judge Doyle granted an injunction against Wohlgemuth from disclosing to Latex any trade secrets of Goodrich.  On the other hand, Wohlgemuth had the right to take a job in a competitive industry, and he could use his knowledge and experience – other than trade secrets – for the benefit of his employer.  Wohlgemuth was therefore free to work on space suits for Latex, provided he didn’t reveal any trade secrets of Goodrich.



An equal weighted group of micro caps generally far outperforms an equal weighted (or cap-weighted) group of larger stocks over time.  See the historical chart here:  https://boolefund.com/best-performers-microcap-stocks/

This outperformance increases significantly by focusing on cheap micro caps.  Performance can be further boosted by isolating cheap microcap companies that show improving fundamentals.  We rank microcap stocks based on these and similar criteria.

There are roughly 10-20 positions in the portfolio.  The size of each position is determined by its rank.  Typically the largest position is 15-20% (at cost), while the average position is 8-10% (at cost).  Positions are held for 3 to 5 years unless a stock approaches intrinsic value sooner or an error has been discovered.

The mission of the Boole Fund is to outperform the S&P 500 Index by at least 5% per year (net of fees) over 5-year periods.  We also aim to outpace the Russell Microcap Index by at least 2% per year (net).  The Boole Fund has low fees.


If you are interested in finding out more, please e-mail me or leave a comment.

My e-mail: jb@boolefund.com


Disclosures: Past performance is not a guarantee or a reliable indicator of future results. All investments contain risk and may lose value. This material is distributed for informational purposes only. Forecasts, estimates, and certain information contained herein should not be considered as investment advice or a recommendation of any particular security, strategy or investment product. Information contained herein has been obtained from sources believed to be reliable, but not guaranteed. No part of this article may be reproduced in any form, or referred to in any other publication, without express written permission of Boole Capital, LLC.

Common Stocks and Common Sense

November 5, 2023

It’s crucial in investing to have the proper balance of confidence and humility.  Overconfidence is very deep-seated in human nature.  Nearly all of us tend to believe that we’re above average across a variety of dimensions, such as looks, smarts, academic ability, business aptitude, driving skill, and even luck (!).

Overconfidence is often harmless and it even helps in some areas.  But when it comes to investing, if we’re overconfident about what we know and can do, eventually our results will suffer.

(Image by Wilma64)

The simple truth is that the vast majority of us should invest in broad market low-cost index funds.  Buffett has maintained this argument for a long time: https://boolefund.com/warren-buffett-jack-bogle/

The great thing about investing in index funds is that you can outperform most investors, net of costs, over the course of several decades.  This is purely a function of costs.  A Vanguard S&P 500 index fund costs 2-3% less per year than the average actively managed fund.  This means that, after a few decades, you’ll be ahead at least 80% (or more) of all active investors.

You can do better than a broad market index fund if you invest in a solid quantitative value fund.  Such a fund can do at least 1-2% better per year, on average and net of costs, than a broad market index fund.

But you can do even better—at least 8% better per year than the S&P 500 index—by investing in a quantitative value fund focused on microcap stocks.

  • At the Boole Microcap Fund, our mission is to help you do at least 8% better per year, on average, than an S&P 500 index fund.  We achieve this by implementing a quantitative deep value approach focused on cheap micro caps with improving fundamentals.  See: https://boolefund.com/best-performers-microcap-stocks/


I recently re-read Common Stocks and Common Sense (Wiley, 2016), by Edgar Wachenheim III.  It’s a wonderful book.  Wachenheim is one of the best value investors.  He and his team at Greenhaven Associates have produced 19% annual returns for over 25 years.

Wachenheim emphasizes that, due to certain behavioral attributes, he has outperformed many other investors who are as smart or smarter.  As Warren Buffett has said:

Success in investing doesn’t correlate with IQ once you’re above the level of 125.  Once you have ordinary intelligence, what you need is the temperament to control the urges that get other people into trouble in investing.

That’s not to say IQ isn’t important.  Most of the finest investors are extremely smart.  Wachenheim was a Baker Scholar at Harvard Business School, meaning that he was in the top 5% of his class.

The point is that—due to behavioral factors such as patience, discipline, and rationality—top investors outperform many other investors who are as smart or smarter.  Buffett again:

We don’t have to be smarter than the rest; we have to be more disciplined than the rest.

Buffett himself has always been extraordinarily patient and disciplined.  There have been several times in Buffett’s career when he went for years on end without making a single investment.

Wachenheim highlights three behavioral factors that have helped him outperform others of equal or greater talent.

The bulk of Wachenheim’s book—chapters 3 through 13—is case studies of specific investments.  Wachenheim includes a good amount of fascinating business history, some of which is mentioned here.

Outline for this blog post:

  • Approach to Investing
  • Being a Contrarian
  • Probable Scenarios
  • Controlling Emotions
  • IBM
  • Interstate Bakeries
  • U.S. Home Corporation
  • Centex
  • Union Pacific
  • American International Group
  • Lowe’s
  • Whirlpool
  • Boeing
  • Southwest Airlines
  • Goldman Sachs

(Photo by Lsaloni)



From 1960 through 2009 in the United States, common stocks have returned about 9 to 10 percent annually (on average).

The U.S. economy grew at roughly a 6 percent annual rate—3 percent from real growth (unit growth) and 3 percent from inflation (price increases).  Corporate revenues—and earnings—have increased at approximately the same 6 percent annual rate.  Share repurchases and acquisitions have added 1 percent a year, while dividends have averaged 2.5 percent a year.  That’s how, on the whole, U.S. stocks have returned 9 to 10 percent annually, notes Wachenheim.

Even if the economy grows more slowly in the future, Wachenheim argues that U.S. investors should still expect 9 to 10 percent per year.  In the case of slower growth, corporations will not need to reinvest as much of their cash flows.  That extra cash can be used for dividends, acquisitions, and share repurchases.

Following Warren Buffett and Charlie Munger, Wachenheim defines risk as the potential for permanent loss.  Risk is not volatility.

Stocks do fluctuate up and down.  But every time the market has declined, it has ultimately recovered and gone on to new highs.  The financial crisis in 2008-2009 is an excellent example of large—but temporary—downward volatility:

The financial crisis during the fall of 2008 and the winter of 2009 is an extreme (and outlier) example of volatility.  During the six months between the end of August 2008 and end of February 2009, the [S&P] 500 Index fell by 42 percent from 1,282.83 to 735.09.  Yet by early 2011 the S&P 500 had recovered to the 1,280 level, and by August 2014 it had appreciated to the 2000 level.  An investor who purchased the S&P 500 Index on August 31, 2008, and then sold the Index six years later, lived through the worst financial crisis and recession since the Great Depression, but still earned a 56 percent profit on his investment before including dividends—and 69 percent including the dividends that he would have received during the six-year period.  Earlier, I mentioned that over a 50-year period, the stock market provided an average annual return of 9 to 10 percent.  During the six-year period August 2008 through August 2014, the stock market provided an average annual return of 11.1 percent—above the range of normalcy in spite of the abnormal horrors and consequences of the financial crisis and resulting deep recession.

(Photo by Terry Mason)

Wachenheim notes that volatility is the friend of the long-term investor.  The more volatility there is, the more opportunity to buy at low prices and sell at high prices.

Because the stock market increases on average 9 to 10 percent per year and always recovers from declines, hedging is a waste of money over the long term:

While many investors believe that they should continually reduce their risks to a possible decline in the stock market, I disagree.  Every time the stock market has declined, it eventually has more than fully recovered.  Hedging the stock market by shorting stocks, or by buying puts on the S&P 500 Index, or any other method usually is expensive, and, in the long run, is a waste of money.

Wachenheim describes his investment strategy as buying deeply undervalued stocks of strong and growing companies that are likely to appreciate significantly due to positive developments not yet discounted by stock prices.

Positive developments can include:

  • a cyclical upturn in an industry
  • an exciting new product or service
  • the sale of a company to another company
  • the replacement of a poor management with a good one
  • a major cost reduction program
  • a substantial share repurchase program

If the positive developments do not occur, Wachenheim still expects the investment to earn a reasonable return, perhaps close to the average market return of 9 to 10 percent annually.  Also, Wachenheim and his associates view undervaluation, growth, and strength as providing a margin of safety—protection against permanent loss.

Wachenheim emphasizes that at Greenhaven, they are value investors not growth investors.  A growth stock investor focuses on the growth rate of a company.  If a company is growing at 15 percent a year and can maintain that rate for many years, then most of the returns for a growth stock investor will come from future growth.  Thus, a growth stock investor can pay a high P/E ratio today if growth persists long enough.

Wachenheim disagrees with growth investing as a strategy:

…I have a problem with growth-stock investing.  Companies tend not to grow at high rates forever.  Businesses change with time.  Markets mature.  Competition can increase.  Good managements can retire and be replaced with poor ones.  Indeed, the market is littered with once highly profitable growth stocks that have become less profitable cyclic stocks as a result of losing their competitive edge.  Kodak is one example.  Xerox is another.  IBM is a third.  And there are hundreds of others.  When growth stocks permanently falter, the price of their shares can fall sharply as their P/E ratios contract and, sometimes, as their earnings fall—and investors in the shares can suffer serious permanent loss.

Many investors claim that they will be able to sell before a growth stock seriously declines.  But very often it’s difficult to determine whether a company is suffering from a temporary or permanent decline.

Wachenheim observes that he’s known many highly intelligent investors—who have similar experiences to him and sensible strategies—but who, nonetheless, haven’t been able to generate results much in excess of the S&P 500 Index.  Wachenheim says that a key point of his book is that there are three behavioral attributes that a successful investor needs:

In particular, I believe that a successful investor must be adept at making contrarian decisions that are counter to the conventional wisdom, must be confident enough to reach conclusions based on probabilistic future developments as opposed to extrapolations of recent trends, and must be able to control his emotions during periods of stress and difficulties.  These three behavioral attributes are so important that they merit further analysis.



(Photo by Marijus Auruskevicius)

Most investors are not contrarians because they nearly always follow the crowd:

Because at any one time the price of a stock is determined by the opinion of the majority of investors, a stock that appears undervalued to us appears appropriately valued to most other investors.  Therefore, by taking the position that the stock is undervalued, we are taking a contrarian position—a position that is unpopular and often is very lonely.  Our experience is that while many investors claim they are contrarians, in practice most find it difficult to buck the conventional wisdom and invest counter to the prevailing opinions and sentiments of other investors, Wall Street analysts, and the media.  Most individuals and most investors simply end up being followers, not leaders.

In fact, I believe that the inability of most individuals to invest counter to prevailing sentiments is habitual and, most likely, a genetic trait.  I cannot prove this scientifically, but I have witnessed many intelligent and experienced investors who shunned undervalued stocks that were under clouds, favored fully valued stocks that were in vogue, and repeated this pattern year after year even though it must have become apparent to them that the pattern led to mediocre results at best.

Wachenheim mentions a fellow investor he knows—Danny.  He notes that Danny has a high IQ, attended an Ivy League university, and has 40 years of experience in the investment business.  Wachenheim often describes to Danny a particular stock that is depressed for reasons that are likely temporary.  Danny will express his agreement, but he never ends up buying before the problem is fixed.

In follow-up conversations, Danny frequently states that he’s waiting for the uncertainty to be resolved.  Value investor Seth Klarman explains why it’s usually better to invest before the uncertainty is resolved:

Most investors strive fruitlessly for certainty and precision, avoiding situations in which information is difficult to obtain.  Yet high uncertainty is frequently accompanied by low prices.  By the time the uncertainty is resolved, prices are likely to have risen.  Investors frequently benefit from making investment decisions with less than perfect knowledge and are well rewarded for bearing the risk of uncertainty.  The time other investors spend delving into the last unanswered detail may cost them the chance to buy in at prices so low that they offer a margin of safety despite the incomplete information.



(Image by Alain Lacroix)

Many (if not most) investors tend to extrapolate recent trends into the future.  This usually leads to underperforming the market.  See:

The successful investor, by contrast, is a contrarian who can reasonably estimate future scenarios and their probabilities of occurrence:

Investment decisions seldom are clear.  The information an investor receives about the fundamentals of a company usually is incomplete and often is conflicting.  Every company has present or potential problems as well as present or future strengths.  One cannot be sure about the future demand for a company’s products or services, about the success of any new products or services introduced by competitors, about future inflationary cost increases, or about dozens of other relevant variables.  So investment outcomes are uncertain.  However, when making decisions, an investor often can assess the probabilities of certain outcomes occurring and then make his decisions based on the probabilities.  Investing is probabilistic.

Because investing is probabilitistic, mistakes are unavoidable.  A good value investor typically will have at least 33% of his or her ideas not work, whether due to an error, bad luck, or an unforeseeable event.  You have to maintain equanimity despite inevitable mistakes:

If I carefully analyze a security and if my analysis is based on sufficiently large quantities of accurate information, I always will be making a correct decision.  Granted, the outcome of the decision might not be as I had wanted, but I know that decisions always are probabilistic and that subsequent unpredictable changes or events can alter outcomes.  Thus, I do my best to make decisions that make sense given everything I know, and I do not worry about the outcomes.  An analogy might be my putting game in golf.  Before putting, I carefully try to assess the contours and speed of the green.  I take a few practice strokes.  I aim the putter to the desired line.  I then putt and hope for the best.  Sometimes the ball goes in the hole…



(Photo by Jacek Dudzinski)


I have observed that when the stock market or an individual stock is weak, there is a tendency for many investors to have an emotional response to the poor performance and to lose perspective and patience.  The loss of perspective and patience often is reinforced by negative reports from Wall Street and from the media, who tend to overemphasize the significance of the cause of the weakness.  We have an expression that aiplanes take off and land every day by the tens of thousands, but the only ones you read about in the newspapers are the ones that crash.  Bad news sells.  To the extent that negative news triggers further selling pressures on stocks and further emotional responses, the negativism tends to feed on itself.  Surrounded by negative news, investors tend to make irrational and expensive decisions that are based more on emotions than on fundamentals. This leads to the frequent sale of stocks when the news is bad and vice versa.  Of course, the investor usually sells stocks after they already have materially decreased in price.  Thus, trading the market based on emotional reactions to short-term news usually is expensive—and sometimes very expensive.

Wachenheim agrees with Seth Klarman that, to a large extent, many investors simply cannot help making emotional investment decisions.  It’s part of human nature.  People overreact to recent news.

I have continually seen intelligent and experienced investors repeatedly lose control of their emotions and repeatedly make ill-advised decisions during periods of stress.

That said, it’s possible (for some, at least) to learn to control your emotions.  Whenever there is news, you can learn to step back and look at your investment thesis.  Usually the investment thesis remains intact.



(IBM Watson by Clockready, Wikimedia Commons)

When Greenhaven purchases a stock, it focuses on what the company will be worth in two or three years.  The market is more inefficient over that time frame due to the shorter term focus of many investors.

In 1993, Wachenheim estimated that IBM would earn $1.65 in 1995.  Any estimate of earnings two or three years out is just a best guess based on incomplete information:

…having projections to work with was better than not having any projections at all, and my experience is that a surprisingly large percentage of our earnings and valuation projections eventually are achieved, although often we are far off on the timing.

The positive development Wachenheim expected was that IBM would announce a concrete plan to significantly reduce its costs.  On July 28, 1993, the CEO Lou Gerstner announced such a plan.  When IBM’s shares moved up from $11½ to $16, Wachenheim sold his firm’s shares since he thought the market price was now incorporating the expected positive development.

Selling IBM at $16 was a big mistake based on subsequent developments.  The company generated large amounts of cash, part of which it used to buy back shares.  By 1996, IBM was on track to earn $2.50 per share.  So Wachenheim decided to repurchase shares in IBM at $24½.  Although he was wrong to sell at $16, he was right to see his error and rebuy at $24½.  When IBM ended up doing better than expected, the shares moved to $48 in late 1997, at which point Wachenheim sold.

Over the years, I have learned that we can do well in the stock market if we do enough things right and if we avoid large permanent losses, but that it is impossible to do nearly everything right.  To err is human—and I make plenty of errors.  My judgment to sell IBM’s shares in 1993 at $16 was an expensive mistake.  I try not to fret over mistakes.  If I did fret, the investment process would be less enjoyable and more stressful.  In my opinion, investors do best when they are relaxed and are having fun.

Finding good ideas takes time.  Greenhaven rejects the vast majority of its potential ideas.  Good ideas are rare.



(Photo of a bakery by Mohylek, Wikimedia Commons)

Wachenheim discovered that Howard Berkowitz bought 12 percent of the outstanding shares of Interstate Bakeries, became chairman of the board, and named a new CEO.  Wachenheim believed that Howard Berkowitz was an experienced and astute investor.  In 1967, Berkowitz was a founding partner of Steinhardt, Fine, Berkowitz & Co., one of the earliest and most successful hedge funds.  Wachenheim started analyzing Interstate in 1985 when the stock was at about $15:

Because of my keen desire to survive by minimizing risks of permanent loss, the balance sheet then becomes a good place to start efforts to understand a company.  When studying a balance sheet, I look for signs of financial and accounting strengths.  Debt-to-equity ratios, liquidity, depreciation rates, accounting practices, pension and health care liabilities, and ‘hidden’ assets and liabilities all are among common considerations, with their relative importance depending on the situation.  If I find fault with a company’s balance sheet, especially with the level of debt relative to the assets or cash flows, I will abort our analysis, unless there is a compelling reason to do otherwise.  

Wachenheim looks at management after he is done analyzing the balance sheet.  He admits that he is humble about his ability to assess management.  Also, good or bad results are sometimes due in part to chance.

Next Wachenheim examines the business fundamentals:

We try to understand the key forces at work, including (but not limited to) quality of products and services, reputation, competition and protection from future competition, technological and other possible changes, cost structure, growth opportunities, pricing power, dependence on the economy, degree of governmental regulation, capital intensity, and return on capital.  Because we believe that information reduces uncertainty, we try to gather as much information as possible.  We read and think—and we sometimes speak to customers, competitors, and suppliers.  While we do interview the managements of the companies we analyze, we are wary that their opinions and projections will be biased.

Wachenheim reveals that the actual process of analyzing a company is far messier than you might think based on the above descriptions:

We constantly are faced with incomplete information, conflicting information, negatives that have to be weighed against positives, and important variables (such as technological change or economic growth) that are difficult to assess and predict.  While some of our analysis is quantitative (such as a company’s debt-to-equity ratio or a product’s share of market), much of it is judgmental.  And we need to decide when to cease our analysis and make decisions.  In addition, we constantly need to be open to new information that may cause us to alter previous opinions or decisions.

Wachenheim indicates a couple of lessons learned.  First, it can often pay off when you follow a capable and highly incentivized business person into a situation.  Wachenheim made his bet on Interstate based on his confidence in Howard Berkowitz.  Interstate’s shares were not particularly cheap.

Years later, Interstate went bankrupt because they took on too much debt.  This is a very important lesson.  For any business, there will be problems.  Working through difficulties often takes much longer than expected.  Thus, having low or no debt is essential.



(Photo by Dwight Burdette, Wikimedia Commons)

Wachenheim describes his use of screens:

I frequently use Bloomberg’s data banks to run screens.  I screen for companies that are selling for low price-to-earnings (PE) ratios, low prices to revenues, low price-to-book values, or low prices relative to other relevant metrics.  Usually the screens produce a number of stocks that merit additional analyses, but almost always the additional analyses conclude that there are valid reasons for the apparent undervaluations. 

Wachenheim came across U.S. Home in mid-1994 based on a discount to book value screen.  The shares appeared cheap at 0.63 times book and 6.8 times earnings:

Very low multiples of book and earnings are adrenaline flows for value investors.  I eagerly decided to investigate further.

Later, although U.S. Home was cheap and produced good earnings, the stock price remained depressed.  But there was a bright side because U.S. Home led to another homebuilder idea…



(Photo by Steven Pavlov, Wikimedia Commons)

After doing research and constructing a financial model of Centex Corporation, Wachenheim had a startling realization:  the shares would be worth about $63 a few years in the future, and the current price was $12.  Finally, a good investment idea:

…my research efforts usually are tedious and frustrating.  I have hundreds of thoughts and I study hundreds of companies, but good investment ideas are few and far between.  Maybe only 1 percent or so of the companies we study ends up being part of our portfolios—making it much harder for a stock to enter our portfolio than for a student to enter Harvard.  However, when I do find an exciting idea, excitement fills the air—a blaze of light that more than compensates for the hours and hours of tedium and frustration.

Greenhaven typically aims for 30 percent annual returns on each investment:

Because we make mistakes, to achieve 15 to 20 percent average returns, we usually do not purchase a security unless we believe that it has the potential to provide a 30 percent or so annual return.  Thus, we have very high expectations for each investment.

In late 2005, Wachenheim grew concerned that home prices had gotten very high and might decline.  Many experts, including Ben Bernanke, argued that because home prices had never declined in U.S. history, they were unlikely to decline.  Wachenheim disagreed:

It is dangerous to project past trends into the future.  It is akin to steering a car by looking through the rearview mirror…



(Photo by Slambo, Wikimedia Commons)

After World War II, the construction of the interstate highway system gave trucks a competitive advantage over railroads for many types of cargo.  Furthermore, fewer passengers took trains, partly due to the interstate highway system and partly due to the commercialization of the jet airplane.  Excessive regulation of the railroadsin an effort to help farmersalso caused problems.  In the 1960s and 1970s, many railroads went bankrupt.  Finally, the government realized something had to be done and it passed the Staggers Act in 1980, deregulating the railroads:

The Staggers Act was a breath of fresh air.  Railroads immediately started adjusting their rates to make economic sense.  Unprofitable routes were dropped.  With increased profits and with confidence in their future, railroads started spending more to modernize.  New locomotives, freight cars, tracks, automated control systems, and computers reduced costs and increased reliability.  The efficiencies allowed the railroads to reduce their rates and become more competitive with trucks and barges….

In the 1980s and 1990s, the railroad industry also enjoyed increased efficiencies through consolidating mergers.  In the west, the Burlington Northern merged with the Santa Fe, and the Union Pacific merged with the Southern Pacific.  

Union Pacific reduced costs during the 2001-2002 recession, but later this led to congestion on many of its routes and to the need to hire and train new employees once the economy had picked up again.  Union Pacific experienced an earnings shortfall, leading the shares to decline to $14.86.

Wachenheim thought that Union Pacific’s problems were temporary, and that the company would earn about $1.55 in 2006.  With a conservative multiple of 14 times earnings, the shares would be worth over $22 in 2006.  Also, the company was paying a $0.30 annual dividend.  So the total return over a two-year period from buying the shares at $14½ would be 55 percent.

Wachenheim also thought Union Pacific stock had good downside protection because the book value was $12 a share.

Furthermore, even if Union Pacific stock just matched the expected return from the S&P 500 Index of 9½ percent a year, that would still be much better than cash.

The fact that the S&P 500 Index increases about 9½ percent a year is an important reason why shorting stocks is generally a bad business.  To do better than the market, the short seller has to find stocks that underperform the market by 19 percent a year.  Also, short sellers have limited potential gains and unlimited potential losses.  On the whole, shorting stocks is a terrible business and often even the smartest short sellers struggle.

Greenhaven sold its shares in Union Pacific at $31 in mid-2007, since other investors had recognized the stock’s value.  Including dividends, Greenhaven earned close to a 24 percent annualized return.

Wachenheim asks why most stock analysts are not good investors.  For one, most analysts specialize in one industry or in a few industries.  Moreover, analysts tend to extrapolate known information, rather than define future scenarios and their probabilities of occurrence:

…in my opinion, most individuals, including securities analysts, feel more comfortable projecting current fundamentals into the future than projecting changes that will occur in the future.  Current fundamentals are based on known information.  Future fundamentals are based on unknowns.  Predicting the future from unknowns requires the efforts of thinking, assigning probabilities, and sticking one’s neck out—all efforts that human beings too often prefer to avoid.

Also, I believe it is difficult for securities analysts to embrace companies and industries that currently are suffering from poor results and impaired reputations.  Often, securities analysts want to see tangible proof of better results before recommending a stock.  My philosophy is that life is not about waiting for the storm to pass.  It is about dancing in the rain.  One usually can read a weather map and reasonably project when a storm will pass.  If one waits for the moment when the sun breaks out, there is a high probability others already will have reacted to the improved prospects and already will have driven up the price of the stock—and thus the opportunity to earn large profits will have been missed.

Wachenheim then quotes from a New York Times op-ed piece written on October 17, 2008, by Warren Buffett:

A simple rule dictates my buying:  Be fearful when others are greedy, and be greedy when others are fearful.  And most certainly, fear is now widespread, gripping even seasoned investors.  To be sure, investors are right to be wary of highly leveraged entities or businesses in weak competitive positions.  But fears regarding the long-term prosperity of the nation’s many sound companies make no sense.  These businesses will indeed suffer earnings hiccups, as they always have.  But most major companies will be setting new profit records 5, 10, and 20 years from now.  Let me be clear on one point:  I can’t predict the short-term movements of the stock market.  I haven’t the faintest idea as to whether stocks will be higher or lower a month—or a year—from now.  What is likely, however, is that the market will move higher, perhaps substantially so, well before either sentiment or the economy turns up.  So if you wait for the robins, spring will be over.



(AIG Corporate, Photo by AIG, Wikimedia Commons)

Wachenheim is forthright in discussing Greenhaven’s investment in AIG, which turned out to be a huge mistake.  In late 2005, Wachenheim estimated that the intrinsic value of AIG would be about $105 per share in 2008, nearly twice the current price of $55.  Wachenheim also liked the first-class reputation of the company, so he bought shares.

In late April 2007, AIG’s shares had fallen materially below Greenhaven’s cost basis:

When shares of one of our holdings are weak, we usually revisit the company’s longer-term fundamentals.  If the longer-term fundamentals have not changed, we normally will continue to hold the shares, if not purchase more.  In the case of AIG, it appeared to us that the longer-term fundamentals remained intact.

When Lehman filed for Chapter 11 bankruptcy protection on September 15, 2008, all hell broke loose:

The decline in asset values caused financial institutions to mark down the carrying value of their assets, which, in turn, caused sharp reductions in their credit ratings.  Sharp reductions in credit ratings required financial institutions to raise capital and, in the case of AIG, to post collateral on its derivative contracts.  But the near freezing of the financial markets prevented the requisite raising of capital and cash and thus caused a further deterioration in creditworthiness, which further increased the need for new capital and cash, and so on… On Tuesday night, September 16, the U.S. government agreed to provide the requisite cash in return for a lion’s share of the ownership of AIG.  As soon as I read the agreement, it was clear to me that we had a large permanent loss in our holdings of AIG.

Wachenheim defends the U.S. government bailouts.  Much of the problem was liquidity, not solvency.  Also, the bailouts helped restore confidence in the financial system.

Wachenheim asked himself if he would make the same decision today to invest in AIG:

My answer was ‘yes’—and my conclusion was that, in the investment business, relatively unpredictable outlier developments sometimes can quickly derail otherwise attractive investments.  It comes with the territory.  So while we work hard to reduce the risks of large permanent loss, we cannot completely eliminate large risks.  However, we can draw a line on how much risk we are willing to accept—a line that provides sufficient apparent protection and yet prevents us from being so risk averse that we turn down too many attractive opportunities.  One should not invest with the precept that the next 100-year storm is around the corner.

Wachenheim also points out that when Greenhaven learns of a flaw in its investment thesis, usually the firm is able to exit the position with only a modest loss.  If you’re right 2/3 of the time and if you limit losses as much as possible, the results should be good over time.



(Photo by Miosotis Jade, Wikimedia Commons)

In 2011, Wachenheim carefully analyzed the housing market and reached an interesting conclusion:

I was excited that we had a concept about a probable strong upturn in the housing market that was not shared by most others.  I believed that the existing negativism about housing was due to the proclivity of human beings to uncritically project recent trends into the future and to overly dwell on existing problems.  When analyzing companies and industries, I tend to be an optimist by nature and a pragmatist through effort.  In terms of the proverbial glass of water, it is never half empty, but always half full—and, as a pragmatist, it is twice as large as it needs to be.

Next Wachenheim built a model to estimate normalized earnings for Lowe’s three years in the future (in 2014).  He came up with normal earnings of $3 per share.  He thought the appropriate price-to-earnings ratio was 16.  So the stock would be worth $48 in 2014 versus its current price (in 2011) of $24.  It looked like a bargain.

After gathering more information, Wachenheim revised his earnings model:

…I revise models frequently because my initial models rarely are close to being accurate.  Usually, they are no better than directional.  But they usually do lead me in the right direction, and, importantly, the process of constructing a model forces me to consider and weigh the central fundamentals of a company that will determine the company’s future value.

Wachenheim now thought that Lowe’s could earn close to $4.10 in 2015, which would make the shares worth even more than $48.  In August 2013, the shares hit $45.

In late September 2013, after playing tennis, another money manager asked Wachenheim if he was worried that the stock market might decline sharply if the budget impasse in Congress led to a government shutdown:

I answered that I had no idea what the stock market would do in the near term.  I virtually never do.  I strongly believe in Warren Buffett’s dictum that he never has an opinion on the stock market because, if he did, it would not be any good, and it might interfere with opinions that are good.  I have monitored the short-term market predictions of many intelligent and knowledgeable investors and have found that they were correct about half the time.  Thus, one would do just as well by flipping a coin.

I feel the same way about predicting the short-term direction of the economy, interest rates, commodities, or currencies.  There are too many variables that need to be identified and weighed.

As for Lowe’s, the stock hit $67.50 at the end of 2014, up 160 percent from what Greenhaven paid.



(Photo by Steven Pavlov, Wikimedia Commons)

Wachenheim does not believe in the Efficient Market Hypothesis:

It seems to me that the boom-bust of growth stocks in 1968-1974 and the subsequent boom-bust of Internet technology stocks in 1998-2002 serve to disprove the efficient market hypothesis, which states that it is impossible for an investor to beat the stock market because stocks always are efficiently priced based on all the relevant and known information on the fundamentals of the stocks.  I believe that the efficient market hypothesis fails because it ignores human nature, particularly the nature of most individuals to be followers, not leaders.  As followers, humans are prone to embrace that which already has been faring well and to shun that which recently has been faring poorly.  Of course, the act of buying into what already is doing well and shunning what is doing poorly serves to perpetuate a trend.  Other trend followers then uncritically join the trend, causing the trend to feed on itself and causing excesses.

Many investors focus on the shorter term, which generally harms their long-term performance:

…so many investors are too focused on short-term fundamentals and investment returns at the expense of longer-term fundamentals and returns.  Hunter-gatherers needed to be greatly concerned about their immediate survival—about a pride of lions that might be lurking behind the next rock… They did not have the luxury of thinking about longer-term planning… Then and today, humans often flinch when they come upon a sudden apparent danger—and, by definition, a flinch is instinctive as opposed to cognitive.  Thus, over years, the selection process resulted in a subconscious proclivity for humans to be more concerned about the short term than the longer term.

By far the best thing for long-term investors is to do is absolutely nothing.  The investors who end up performing the best over the course of several decades are nearly always those investors who did virtually nothing.  They almost never checked prices.  They never reacted to bad news.

Regarding Whirlpool:

In the spring of 2011, Greenhaven studied Whirlpool’s fundamentals.  We immediately were impressed by management’s ability and willingness to slash costs.  In spite of a materially subnormal demand for appliances in 2010, the company was able to earn operating margins of 5.9 percent.  Often, when a company is suffering from particularly adverse industry conditions, it is unable to earn any profit at all.  But Whirlpool remained moderately profitable.  If the company could earn 5.9 percent margins under adverse circumstances, what could the company earn once the U.S. housing market and the appliance market returned to normal?

Not surprisingly, Wall Street analysts were focused on the short term:

…A report by J. P. Morgan dated April 27, 2011, stated that Whirlpool’s current share price properly reflected the company’s increased costs for raw materials, the company’s inability to increase its prices, and the current soft demand for appliances…

The J. P. Morgan report might have been correct about the near-term outlook for Whirlpool and its shares.  But Greenhaven invests with a two- to four-year time horizon and cares little about the near-term outlook for its holdings.

The bulk of Greenhaven’s returns has been generated by relatively few of its holdings:

If one in five of our holdings triples in value over a three-year period, then the other four holdings only have to achieve 12 percent average annual returns in order for our entire portfolio to achieve its stretch goal of 20 percent.  For this reason, Greenhaven works extra hard trying to identify potential multibaggers.  Whirlpool had the potential to be a multibagger because it was selling at a particularly low multiple of its potential earnings power.  Of course, most of our potential multibaggers do not turn out to be multibaggers.  But one cannot hit a multibagger unless one tries, and sometimes our holdings that initially appear to be less exciting eventually benefit from positive unforeseen events (handsome black swans) and unexpectedly turn out to be a complete winner.  For this reason, we like to remain fully invested as long as our holdings remain reasonably priced and free from large risks of permanent loss.



(Photo by José A. Montes, Wikimedia Commons)

Wachenheim likes to read about the history of each company that he studies.

On July 4, 1914, a flight took place in Seattle, Washington, that had a major effect on the history of aviation.  On that day, a barnstormer named Terah Maroney was hired to perform a flying demonstration as part of Seattle’s Independence Day celebrations.  After displaying aerobatics in his Curtis floatplane, Maroney landed and offered to give free rides to spectators.  One spectator, William Edward Boeing, a wealthy owner of a lumber company, quickly accepted Maroney’s offer.  Boeing was so exhilarated by the flight that he completely caught the aviation bug—a bug that was to be with him for the rest of his life.

Boeing launched Pacific Aero Products (renamed the Boeing Airplane Company in 1917).  In late 1916, Boeing designed an improved floatplane, the Model C.  The Model C was ready by April 1917, the same month the United States entered the war.  Boeing thought the Navy might need training aircraft.  The Navy bought two.  They performed well, so the Navy ordered 50 more.

Boeing’s business naturally slowed down after the war.  Boeing sold a couple of small floatplanes (B-1’s), then 13 more after Charles Lindberg’s 1927 transatlantic flight.  Still, sales of commercial planes were virtually nonexistent until 1933, when the company started marketing its model 247.

The twin-engine 247 was revolutionary and generally is recognized as the world’s first modern airplane.  It had a capacity to carry 10 passengers and a crew of 3.  It had a cruising speed of 189 mph and could fly about 745 miles before needing to be refueled.

Boeing sold seventy-five 247’s before making the much larger 307 Stratoliner, which would have sold well were it not for the start of World War II.

Boeing helped the Allies defeat Germany.  The Boeing B-17 Flying Fortress bomber and the B-29 Superfortress bomber became legendary.  More than 12,500 B-17s and more than 3,500 B-29s were built (some by Boeing itself and some by other companies that had spare capacity).

Boeing prospered during the war, but business slowed down again after the war.  In mid-1949, the de Havilland Aircraft Company started testing its Comet jetliner, the first use of a jet engine.  The Comet started carrying passengers in 1952.  In response, Boeing started developing its 707 jet.  Commercial flights for the 707 began in 1958.

The 707 was a hit and soon became the leading commercial plane in the world.

Over the next 30 years, Boeing grew into a large and highly successful company.  It introduced many models of popular commercial planes that covered a wide range of capacities, and it became a leader in the production of high-technology military aircraft and systems.  Moreover, in 1996 and 1997, the company materially increased its size and capabilities by acquiring North American Aviation and McDonnell Douglas.

In late 2012, after several years of delays on its new, more fuel-efficient plane—the 787—Wall Street and the media were highly critical of Boeing.  Wachenheim thought that the company could earn at least $7 per share in 2015.  The stock in late 2012 was at $75, or 11 times the $7.  Wachenheim believed that this was way too low for such a strong company.

Wachenheim estimated that two-thirds of Boeing’s business in 2015 would come from commercial aviation.  He figured that this was an excellent business worth 20 times earnings (he used 19 times to be conservative).  He reckoned that defense, one-third of Boeing’s business, was worth 15 times earnings.  Therefore, Wachenheim used 17.7 as the multiple for the whole company, which meant that Boeing would be worth $145 by 2015.

Greenhaven established a position in Boeing at about $75 a share in late 2012 and early 2013.  By the end of 2013, Boeing was at $136.  Because Wall Street now had confidence that the 787 would be a commercial success and that Boeing’s earnings would rise, Wachenheim and his associates concluded that most of the company’s intermediate-term potential was now reflected in the stock price.  So Greenhaven started selling its position.



(Photo by Eddie Maloney, Wikimedia Commons)

The airline industry has had terrible fundamentals for a long time.  But Wachenheim was able to be open-minded when, in August 2012, one of his fellow analysts suggested Southwest Airlines as a possible investment.  Over the years, Southwest had developed a low-cost strategy that gave the company a clear competitive advantage.

Greenhaven determined that the stock of Southwest was undervalued, so they took a position.

The price of Southwest’s shares started appreciating sharply soon after we started establishing our position.  Sometimes it takes years before one of our holdings starts to appreciate sharply—and sometimes we are lucky with our timing.

After the shares tripled, Greenhaven sold half its holdings since the expected return from that point forward was not great.  Also, other investors now recognized the positive fundamentals Greenhaven had expected.  Greenhaven sold the rest of its position as the shares continued to increase.



(Photo of Marcus Goldman, Wikimedia Commons)

Wachenheim echoes Warren Buffett when it comes to recognizing how much progress the United States has made:

My experience is that analysts and historians often dwell too much on a company’s recent problems and underplay its strengths, progress, and promise.  An analogy might be the progress of the United States during the twentieth century.  At the end of the century, U.S. citizens generally were far wealthier, healthier, safer, and better educated than at the start of the century.  In fact, the century was one of extraordinary progress.  Yet most history books tend to focus on the two tragic world wars, the highly unpopular Vietnam War, the Great Depression, the civil unrest during the Civil Rights movement, and the often poor leadership in Washington.  The century was littered with severe problems and mistakes.  If you only had read the newspapers and the history books, you likely would have concluded that the United States had suffered a century of relative and absolute decline.  But the United States actually exited the century strong and prosperous.  So did Goldman exit 2013 strong and prosperous.

In 2013, Wachenheim learned that Goldman had an opportunity to gain market share in investment banking because some competitors were scaling back in light of new regulations and higher capital requirements.  Moreover, Goldman had recently completed a $1.9 billion cost reduction program.  Compensation as a percentage of sales had declined significantly in the past few years.

Wachenheim discovered that Goldman is a technology company to a large extent, with a quarter of employees working in the technology division.  Furthermore, the company had strong competitive positions in its businesses, and had sold or shut down sub-par business lines.  Wachenheim checked his investment thesis with competitors and former employees.  They confirmed that Goldman is a powerhouse.

Wachenheim points out that it’s crucial for investors to avoid confirmation bias:

I believe that it is important for investors to avoid seeking out information that reinforces their original analyses.  Instead, investors must be prepared and willing to change their analyses and minds when presented with new developments that adversely alter the fundamentals of an industry or company.  Good investors should have open minds and be flexible.

Wachenheim also writes that it’s very important not to invent a new thesis when the original thesis has been invalidated:

We have a straightforward approach.  When we are wrong or when fundamentals turn against us, we readily admit we are wrong and we reverse our course.  We do not seek new theories that will justify our original decision.  We do not let errors fester and consume our attention.  We sell and move on.

Wachenheim loves his job:

I am almost always happy when working as an investment manager.  What a perfect job, spending my days studying the world, economies, industries, and companies;  thinking creatively;  interviewing CEOs of companies… How lucky I am.  How very, very lucky.



An equal weighted group of micro caps generally far outperforms an equal weighted (or cap-weighted) group of larger stocks over time.  See the historical chart here:  https://boolefund.com/best-performers-microcap-stocks/

This outperformance increases significantly by focusing on cheap micro caps.  Performance can be further boosted by isolating cheap microcap companies that show improving fundamentals.  We rank microcap stocks based on these and similar criteria.

There are roughly 10-20 positions in the portfolio.  The size of each position is determined by its rank.  Typically the largest position is 15-20% (at cost), while the average position is 8-10% (at cost).  Positions are held for 3 to 5 years unless a stock approaches intrinsic value sooner or an error has been discovered.

The mission of the Boole Fund is to outperform the S&P 500 Index by at least 5% per year (net of fees) over 5-year periods.  We also aim to outpace the Russell Microcap Index by at least 2% per year (net).  The Boole Fund has low fees.


If you are interested in finding out more, please e-mail me or leave a comment.

My e-mail: jb@boolefund.com




Disclosures: Past performance is not a guarantee or a reliable indicator of future results. All investments contain risk and may lose value. This material is distributed for informational purposes only. Forecasts, estimates, and certain information contained herein should not be considered as investment advice or a recommendation of any particular security, strategy or investment product. Information contained herein has been obtained from sources believed to be reliable, but not guaranteed. No part of this article may be reproduced in any form, or referred to in any other publication, without express written permission of Boole Capital, LLC.

Walter Schloss: Cigar-Butt Specialist

October 29, 2023

Walter Schloss generated one of the best investment track records of all time—close to 21% (gross) annually over 47 years—by investing exclusively in cigar butts (deep value stocks).  Cigar-butt investing usually means buying stock at a discount to book value, i.e., a P/B < 1 (price-to-book ratio below 1).

The highest returning cigar butt strategy comes from Ben Graham, the father of value investing.  It’s called the net-net strategy whereby you take current assets minus all liabilities, and then invest at 2/3 of that level or less.

  • The main trouble with net nets today is that many of them are tiny microcap stocks—below $50 million in market cap—that are too small even for most microcap funds.
  • Also, many net nets exist in markets outside the United States.  Some of these markets have had problems periodically related to the rule of law.

Schloss used net nets in the early part of his career (1955 to 1960).  When net nets became too scarce (1960), Schloss started buying stocks at half of book value.  When those became too scarce, he went to buying stocks at two-thirds of book value.  Eventually he had to adjust again and buy stocks at book value.  Though his cigar-butt method evolved, Schloss was always using a low P/B to find cheap stocks.

(Photo by Sky Sirasitwattana)

One extraordinary aspect to Schloss’s track record is that he invested in roughly 1,000 stocks over the course of his career.  (At any given time, his portfolio had about 100 stocks.)  Warren Buffett commented:

Following a strategy that involved no real risk—defined as permanent loss of capital—Walter produced results over his 47 partnership years that dramatically surpassed those of the S&P 500.  It’s particularly noteworthy that he built this record by investing in about 1,000 securities, mostly of a lackluster type.  A few big winners did not account for his success.  It’s safe to say that had millions of investment managers made trades by a) drawing stock names from a hat; b) purchasing these stocks in comparable amounts when Walter made a purchase; and then c) selling when Walter sold his pick, the luckiest of them would not have come close to equaling his record. There is simply no possibility that what Walter achieved over 47 years was due to chance.

Schloss was aware that a concentrated portfolio—e.g., 10 to 20 stocks—could generate better long-term returns.  However, this requires unusual insight on a repeated basis, which Schloss humbly admitted he didn’t have.

Most investors are best off investing in low-cost index funds or in quantitative value funds.  For investors who truly enjoy looking for undervalued stocks, Schloss offered this advice:

It is important to know what you like and what you are good at and not worry that someone else can do it better.  If you are honest, hardworking, reasonably intelligent and have good common sense, you can do well in the investment field as long as you are not too greedy and don’t get too emotional when things go against you.

I found a few articles I hadn’t seen before on The Walter Schloss Archive, a great resource page created by Elevation Capital: https://www.walterschloss.com/

Here’s the outline for this blog post:

  • Stock is Part Ownership;  Keep It Simple
  • Have Patience;  Don’t Sell on Bad News
  • Have Courage
  • Buy Assets Not Earnings
  • Buy Based on Cheapness Now, Not Cheapness Later
  • Boeing:  Asset Play
  • Less Downside Means More Upside
  • Multiple Ways to Win
  • History;  Honesty;  Insider Ownership
  • You Must Be Willing to Make Mistakes
  • Don’t Try to Time the Market
  • When to Sell
  • The First 10 Years Are Probably the Worst
  • Stay Informed About Current Events
  • Control Your Emotions;  Be Careful of Leverage
  • Ride Coattails;  Diversify



A share of stock represents part ownership of a business and is not just a piece of paper or a blip on the computer screen.

Try to establish the value of the company.  Use book value as a starting point.  There are many businesses, both public and private, for which book value is a reasonable estimate of intrinsic value.  Intrinsic value is what a company is worth—i.e., what a private buyer would pay for it.  Book value—assets minus liabilities—is also called “net worth.”

Follow Buffett’s advice: keep it simple and don’t use higher mathematics.

(Illustration by Ileezhun)

Some kinds of stocks are easier to analyze than others.  As Buffett has said, usually you don’t get paid for degree of difficulty in investing.  Therefore, stay focused on businesses that you can fully understand.

  • There are thousands of microcap companies that are completely neglected by most professional investors.  Many of these small businesses are simple and easy to understand.



Hold for 3 to 5 years.  Schloss:

Have patience.  Stocks don’t go up immediately.

Schloss again:

Things usually take longer to work out but they work out better than you expect.

(Illustration by Marek)

Don’t sell on bad news unless intrinsic value has dropped materially.  When the stock drops significantly, buy more as long as the investment thesis is intact.

Schloss’s average holding period was 4 years.  It was less than 4 years in good markets when stocks went up more than usual.  It was greater than 4 years in bad markets when stocks stayed flat or went down more than usual.



Have the courage of your convictions once you have made a decision.

(Courage concept by Travelling-light)

Investors shun companies with depressed earnings and cash flows.  It’s painful to own stocks that are widely hated.  It can also be frightening.  As John Mihaljevic explains in The Manual of Ideas (Wiley, 2013):

Playing into the psychological discomfort of Graham-style equities is the tendency of such investments to exhibit strong asset value but inferior earnings or cash flows.  In a stressed situation, investors may doubt their investment theses to such an extent that they disregard the objectively appraised asset values.  After all—the reasoning of a scared investor might go—what is an asset really worth if it produces no cash flow?

A related worry is that if a company is burning through its cash, it will gradually destroy net asset value.  Ben Graham:

If the profits had been increasing steadily it is obvious that the shares would not sell at so low a price.  The objection to buying these issues lies in the probability, or at least the possibility, that earnings will decline or losses continue, and that the resources will be dissipated and the intrinsic value ultimately become less than the price paid.

It’s true that an individual cigar butt (deep value stock) is more likely to underperform than an average stock.  But because the potential upside for a typical cigar butt is greater than the potential downside, a basket of cigar butts (portfolio of at least 30) does better than the market over time and also has less downside during bad states of the world—such as bear markets and recessions.

Schloss discussed an example: Cleveland Cliffs, an iron ore producer.  Buffett owned the stock at $18 but then sold at about that level.  The steel industry went into decline.  The largest shareholder sold out because he thought the industry wouldn’t recover.

Schloss bought a lot of stock at $6.  Nobody wanted it.  There was talk of bankruptcy.  Schloss noted that if he had lived in Cleveland, he probably wouldn’t have been able to buy the stock because all the bad news would have been too close.

Soon thereafter, the company sold some assets and bought back some stock.  After the stock increased a great deal from the lows, then it started getting attention from analysts.

In sum, often when an industry is doing terribly, that’s the best time to find cheap stocks.  Investors avoid stocks when they’re having problems, which is why they get so cheap.  Investors overreact to negative news.



(Illustration by Teguh Jati Prasetyo)


Try to buy assets at a discount [rather] than to buy earnings.  Earnings can change dramatically in a short time.  Usually assets change slowly.  One has to know much more about a company if one buys earnings.

Not only can earnings change dramatically; earnings can easily be manipulated—often legally.  Schloss:

Ben made the point in one of his articles that if U.S. Steel wrote down their plants to a dollar, they would show very large earnings because they would not have to depreciate them anymore.



Buy things based on cheapness now.  Don’t buy based on cheapness relative to future earnings, which are hard to predict.

Graham developed two ways of estimating intrinsic value that don’t depend on predicting the future:

  • Net asset value
  • Current and past earnings

Professor Bruce Greenwald, in Value Investing (Wiley, 2004), has expanded on these two approaches.

  • As Greenwald explains, book value is a good estimate of intrinsic value if book value is close to the replacement cost of the assets.  The true economic value of the assets is the cost of reproducing them at current prices.
  • Another way to determine intrinsic value is to figure out earnings power—also called normalized earnings—or how much the company should earn on average over the business cycle.  Earnings power typically corresponds to a market level return on the reproduction value of the assets.  In this case, your intrinsic value estimate based on normalized earnings should equal your intrinsic value estimate based on the reproduction value of the assets.

In some cases, earnings power may exceed a market level return on the reproduction value of the assets.  This means that the ROIC (return on invested capital) exceeds the cost of capital.  It can be exceedingly difficult, however, to determine by how much and for how long earnings power will exceed a market level return.  Often it’s a question of how long some competitive advantage can be maintained.  How long can a high ROIC be sustained?

As Buffett remarked:

The key to investing is not assessing how much an industry is going to affect society, or how much it will grow, but rather determining the competitive advantage of any given company and, above all, the durability of that advantage.  The products or services that have wide, sustainable moats around them are the ones that deliver rewards to investors.

A moat is a sustainable competitive advantage.  Schloss readily admits he can’t determine which competitive advantages are sustainable.  That requires unusual insight.  Buffett can do it, but very few investors can.

As far as franchises or good businesses—companies worth more than adjusted book value—Schloss says he likes these companies, but rarely considers buying them unless the stock is close to book value.  As a result, Schloss usually buys mediocre and bad businesses at book value or below.  Schloss buys “difficult businesses” at clearly cheap prices.

Buying a high-growing company on the expectation that growth will continue can be quite dangerous.  First, growth only creates value if the ROIC exceeds the cost of capital.  Second, expectations for the typical growth stock are so high that even a small slowdown can cause the stock to drop noticeably.  Schloss:

If observers are expecting the earnings to grow from $1.00 to $1.50 to $2.00 and then $2.50, an earnings disappointment can knock a $40 stock down to $20.  You can lose half your money just because the earnings fell out of bed.

If you buy a debt-free stock with a $15 book selling at $10, it can go down to $8.  It’s not great, but it’s not terrible either.  On the other hand, if things turn around, that stock can sell at $25 if it develops its earnings.

Basically, we like protection on the downside.  A $10 stock with a $15 book can offer pretty good protection.  By using book value as a parameter, we can protect ourselves on the downside and not get hurt too badly.

Also, I think the person who buys earnings has got to follow it all the darn time.  They’re constantly driven by earnings, they’re driven by timing.  I’m amazed.



(Boeing 377 Stratocruiser, San Diego Air & Space Museum Archives, via Wikimedia Commons)

Cigar butts—deep value stocks—are characterized by two things:

  • Poor past performance;
  • Low expectations for future performance, i.e., low multiples (low P/B, low P/E, etc.)

Schloss has pointed out that Graham would often compare two companies.  Here’s an example:

One was a very popular company with a book value of $10 selling at $45.  The second was exactly the reverse—it had a book value of $40 and was selling for $25.

In fact, it was exactly the same company, Boeing, in two very different periods of time.  In 1939, Boeing was selling at $45 with a book of $10 and earning very little.  But the outlook was great.  In 1947, after World War II, investors saw no future for Boeing, thinking no one was going to buy all these airplanes.

If you’d bought Boeing in 1939 at $45, you would have done rather badly.  But if you’d bought Boeing in 1947 when the outlook was bad, you would have done very well.

Because a cigar butt is defined by poor recent performance and low expectations, there can be a great deal of upside if performance improves.  For instance, if a stock is at a P/E (price-to-earnings ratio) of 5 and if earnings are 33% of normal, then if earnings return to normal and if the P/E moves to 15, you’ll make 900% on your investment.  If the initial purchase is below true book value—based on the replacement cost of the assets—then you have downside protection in case earnings don’t recover.



If you buy stocks that are protected on the downside, the upside takes care of itself.

The main way to get protection on the downside is by paying a low price relative to book value.  If in addition to quantitative cheapness you focus on companies with low debt, that adds additional downside protection.

If the stock is well below probable intrinsic value, then you should buy more on the way down.  The lower the price relative to intrinsic value, the less downside and the more upside.  As risk decreases, potential return increases.  This is the opposite of what modern finance theory teaches.  According to theory, your expected return only increases if your risk also increases.

In The Superinvestors of Graham-and-Doddsville, Warren Buffett discusses the relationship between risk and reward.  Sometimes risk and reward are positively correlated.  Buffett gives the example of Russian roulette.  Suppose a gun contains one cartridge and someone offers to pay you $1 million if you pull the trigger once and survive.  Say you decline the bet as too risky, but then the person offers to pay you $5 million if you pull the trigger twice and survive.  Clearly that would be a positive correlation between risk and reward.  Buffett continues:

The exact opposite is true with value investing.  If you buy a dollar bill for 60 cents, it’s riskier than if you buy a dollar bill for 40 cents, but the expectation of reward is greater in the latter case.  The greater the potential for reward in the value portfolio, the less risk there is.

One quick example:  The Washington Post Company in 1973 was selling for $80 million in the market.  At the time, that day, you could have sold the assets to any one of ten buyers for not less than $400 million, probably appreciably more.  The company owned the Post, Newsweek, plus several television stations in major markets.  Those same properties are worth $2 billion now, so the person who would have paid $400 million would not have been crazy.

Now, if the stock had declined even further to a price that made the valuation $40 million instead of $80 million, its beta would have been greater.  And to people that think beta measures risk, the cheaper price would have made it look riskier.  This is truly Alice in Wonderland.  I have never been able to figure out why it’s riskier to buy $400 million worth of properties for $40 million than $80 million.

Link: https://bit.ly/2jBezdv

Most brokers don’t recommend buying more on the way down because most people (including brokers’ clients) don’t like to buy when the price keeps falling.  In other words, most investors focus on price instead of intrinsic value.



A stock trading at a low price relative to book value—a low P/B stock—is usually distressed and is experiencing problems.  But there are several ways for a cigar-butt investor to win, as Schloss explains:

The thing about buying depressed stocks is that you really have three strings to your bow:  1) Earnings will improve and the stocks will go up;  2) somebody will come in and buy control of the company;  or 3) the company will start buying its own stock and ask for tenders.

Schloss again:

But lots of times when you buy a cheap stock for one reason, that reason doesn’t pan out but another reason does—because it’s cheap.



Look at the history of the company.  Value line is helpful for looking at history 10-15 years back.  Also, read the annual reports.  Learn about the ownership, what the company has done, when business they’re in, and what’s happened with dividends, sales, earnings, etc.

It’s usually better not to talk with management because it’s easy to be blinded by their charisma or sales skill:

When we buy into a company that has problems, we find it difficult talking to management as they tend to be optimistic.

That said, try to ensure that management is honest.  Honesty is more important than brilliance, says Schloss:

…we try to get in with people we feel are honest.  That doesn’t mean they’re necessarily smart—they may be dumb.

But in a choice between a smart guy with a bad reputation or a dumb guy, I think I’d go with the dumb guy who’s honest.

Finally, insider ownership is important.  Management should own a fair amount of stock, which helps to align their incentives with the interests of the stockholders.

Speaking of insider ownership, Walter and Edwin Schloss had a good chunk of their own money invested in the fund they managed.  You should prefer investment managers who, like the Schlosses, eat their own cooking.



(Illustration by Lkeskinen0)

You have to be willing to make mistakes if you want to succeed as an investor.  Even the best value investors tend to be right about 60% of the time and wrong 40% of the time.  That’s the nature of the game.

You can’t do well unless you accept that you’ll make plenty of mistakes.  The key, again, is to try to limit your downside by buying well below probable intrinsic value.  The lower the price you pay (relative to estimated intrinsic value), the less you can lose when you’re wrong and the more you can make when you’re right.



No one can predict the stock market.  Ben Graham observed:

If I have noticed anything over these sixty years on Wall Street, it is that people do not succeed in forecasting what’s going to happen to the stock market.

(Illustration by Maxim Popov)

Or as value investor Seth Klarman has put it:

In reality, no one knows what the market will do; trying to predict it is a waste of time, and investing based upon that prediction is a speculative undertaking.

Perhaps the best quote comes from Henry Singleton, a business genius (100 points from being a chess grandmaster) who was easily one of the best capital allocators in American business history:

I don’t believe all this nonsense about market timing.  Just buy very good value and when the market is ready that value will be recognized.

Singleton built Teledyne using extraordinary capital allocation skills over the course of more than three decades, from 1960 to the early 1990’s.  Fourteen of these years—1968 to 1982—were a secular bear market during which stocks were relatively flat and also experienced a few large downward moves (especially 1973-1974).  But this long flat period punctuated by bear markets didn’t slow down or change Singleton’s approach.  Because he consistently bought very good value, on the whole his acquisitions grew significantly in worth over time regardless of whether the broader market was down, flat, or up.

Of course, it’s true that if you buy an undervalued stock and then there’s a bear market, it may take longer for your investment to work.  However, bear markets create many bargains.  As long as you maintain a focus on the next 3 to 5 years, bear markets are wonderful times to buy cheap stocks (including more of what you already own).

In 1955, Buffett was advised by his two heroes, his father and Ben Graham, not to start a career in investing because the market was too high.  Similarly, Graham told Schloss in 1955 that it wasn’t a good time to start.

Both Buffett and Schloss ignored the advice.  In hindsight, both Buffett and Schloss made great decisions.  Of course, Singleton would have made the same decision as Buffett and Schloss.  Even if the market is high, there are invariably individual stocks hidden somewhere that are cheap.

Schloss always remained fully invested because he knew that virtually no one can time the market except by luck.



Don’t be in too much of a hurry to sell… Before selling try to reevaluate the company again and see where the stock sells in relation to its book value.

Selling is hard.  Schloss readily admits that many stocks he sold later increased a great deal.  But he doesn’t dwell on that.

The basic criterion for selling is whether the stock price is close to estimated intrinsic value.  For a cigar butt investor like Schloss, if he paid a price that was half book, then if the stock price approaches book value, it’s probably time to start selling.  (Unless it’s a rare stock that is clearly worth more than book value, assuming the investor was able to buy it low in the first place.)

If stock A is cheaper than stock B, some value investors will sell A and buy B.  Schloss doesn’t do that.  It often takes four years for one of Schloss’s investments to work.  If he already has been waiting for 1-3 years with stock A, he is not inclined to switch out of it because he might have to wait another 1-3 years before stock B starts to move.  Also, it’s very difficult to compare the relative cheapness of stocks in different industries.

Instead, Schloss makes an independent buy or sell decision for every stock.  If B is cheap, Schloss simply buys B without selling anything else.  If A is no longer cheap, Schloss sells A without buying anything else.



John Templeton’s worst ten years as an investor were his first ten years.  The same was true for Schloss, who commented that it takes about ten years to get the hang of value investing.



(Photo by Juan Moyano)

Walter Schloss and his son Edwin sometimes would spend a whole day discussing current events, social trends, etc.  Edwin Schloss said:

If you’re not in touch with what’s going on or you don’t see what’s going on around you, you can miss out on a lot of investment opportunities. So we try to be aware of everything around us—like John Templeton says in his book about being open to new ideas and new experiences.



Try not to let your emotions affect your judgment.  Fear and greed are probably the worst emotions to have in connection with the purchase and sale of stocks.

Quantitative investing is a good way to control emotion.  This is what Graham suggested and practiced.  Graham just looked at the numbers to make sure they were below some threshold—like 2/3 of current assets minus all liabilities (the net-net method).  Graham typically was not interested in what the business did.

On the topic of discipline and controlling your emotions, Schloss told a great story about when Warren Buffett was playing golf with some buddies:

One of them proposed, “Warren, if you shoot a hole-in-one on this 18-hole course, we’ll give you $10,000 bucks.  If you don’t shoot a hole-in-one, you owe us $10.”

Warren thought about it and said, “I’m not taking the bet.”

The others said, “Why don’t you?  The most you can lose is $10. You can make $10,000.”

Warren replied, If you’re not disciplined in the little things, you won’t be disciplined in the big things.”

Be careful of leverage.  It can go against you.  Schloss acknowledges that sometimes he has gotten too greedy by buying highly leveraged stocks because they seemed really cheap.  Companies with high leverage can occasionally become especially cheap compared to book value.  But often the risk of bankruptcy is too high.

Still, as conservative value investor Seth Klarman has remarked, there’s room in the portfolio occasionally for a super cheap, highly indebted company.  If the probability of success is high enough and if the upside is great enough, it may not be a difficult decision.  Often the upside can be 10x or 20x your investment, which implies a positive expected return even when the odds of success are 10%.



Sometimes you can get good ideas from other investors you know or respect.  Even Buffett did this.  Buffett called it “coattail riding.”

Schloss, like Graham and Buffett, recommends a diversified approach if you’re doing cigar butt (deep value) investing.  Have at least 15-20 stocks in your portfolio.  A few investors can do better by being more concentrated.  But most investors will do better over time by using a quantitative, diversified approach.

Schloss tended to have about 100 stocks in his portfolio:

…And my argument was, and I made it to Warren, we can’t project the earnings of these companies, they’re secondary companies, but somewhere along the line some of them will work out.  Now I can’t tell you which ones, so I buy a hundred of them.  Of course, it doesn’t mean you own the same amount of each stock.  If we like a stock we put more money in it.  Positions we are less sure about we put less in… We then buy the stock on the way down and try to sell it on the way up.

Even though Schloss was quite diversified, he still took larger positions in the stocks he liked best and smaller positions in the stocks about which he was less sure.

Schloss emphasized that it’s important to know what you know and what you don’t know.  Warren Buffett and Charlie Munger call this a circle of competence.  Even if a value investor is far from being the smartest, there are hundreds of microcap companies that are easy to understand with enough work.

(Image by Wilma64)

The main trouble in investing is overconfidence: having more confidence than is warranted by the evidence.  Overconfidence is arguably the most widespread cognitive bias suffered by humans, as Nobel Laureate Daniel Kahneman details in Thinking, Fast and Slow.  By humbly defining your circle of competence, you can limit the impact of overconfidence.  Part of this humility comes from making mistakes.

The best choice for most investors is either an index fund or a quantitative value fund.  It’s the best bet for getting solid long-term returns, while minimizing or removing entirely the negative influence of overconfidence.



An equal weighted group of micro caps generally far outperforms an equal weighted (or cap-weighted) group of larger stocks over time.  See the historical chart here:  https://boolefund.com/best-performers-microcap-stocks/

This outperformance increases significantly by focusing on cheap micro caps.  Performance can be further boosted by isolating cheap microcap companies that show improving fundamentals.  We rank microcap stocks based on these and similar criteria.

There are roughly 10-20 positions in the portfolio.  The size of each position is determined by its rank.  Typically the largest position is 15-20% (at cost), while the average position is 8-10% (at cost).  Positions are held for 3 to 5 years unless a stock approaches intrinsic value sooner or an error has been discovered.

The mission of the Boole Fund is to outperform the S&P 500 Index by at least 5% per year (net of fees) over 5-year periods.  We also aim to outpace the Russell Microcap Index by at least 2% per year (net).  The Boole Fund has low fees.


If you are interested in finding out more, please e-mail me or leave a comment.

My e-mail: jb@boolefund.com


Disclosures: Past performance is not a guarantee or a reliable indicator of future results. All investments contain risk and may lose value. This material is distributed for informational purposes only. Forecasts, estimates, and certain information contained herein should not be considered as investment advice or a recommendation of any particular security, strategy or investment product. Information contained herein has been obtained from sources believed to be reliable, but not guaranteed. No part of this article may be reproduced in any form, or referred to in any other publication, without express written permission of Boole Capital, LLC.

Fooled by Randomness

October 22, 2023

Nassim Nicholas Taleb’s Fooled by Randomness: The Hidden Role of Chance in the Markets and in Life, is an excellent book.  Below I summarize the main points.

Here’s the outline:

    • Prologue

Part I: Solon’s Warning—Skewness, Asymmetry, and Induction

    • One: If You’re So Rich, Why Aren’t You So Smart?
    • Two: A Bizarre Accounting Method
    • Three: A Mathematical Meditation on History
    • Four: Randomness, Nonsense, and the Scientific Intellectual
    • Five: Survival of the Least Fit—Can Evolution Be Fooled By Randomness?
    • Six: Skewness and Asymmetry
    • Seven: The Problem of Induction

Part II: Monkeys on Typewriters—Survivorship and Other Biases

    • Eight: Too Many Millionaires Next Door
    • Nine: It Is Easier to Buy and Sell Than Fry an Egg
    • Ten: Loser Takes All—On the Nonlinearities of Life
    • Eleven: Randomness and Our Brain—We Are Probability Blind

Part III: Wax in my Ears—Living With Randomitis

    • Twelve: Gamblers’ Ticks and Pigeons in a Box
    • Thirteen: Carneades Comes to Rome—On Probability and Skepticism
    • Fourteen: Bacchus Abandons Antony

(Albrecht Durer’s Wheel of Fortune from Sebastien Brant’s Ship of Fools (1494) via Wikimedia Commons)



Taleb presents Table P.1 Table of Confusion, listing the central distinctions used in the book.


Luck Skills
Randomness Determinism
Probability Certainty
Belief, conjecture Knowledge, certitude
Theory Reality
Anecdote, coincidence Causality, law
Forecast Prophecy


Lucky idiot Skilled investor
Survivorship bias Market outperformance


Volatility Return (or drift)
Stochastic variable Deterministic variable


Noise Signal


None Symbol


Epistemic probability Physical probability
Induction Deduction
Synthetic proposition Analytic proposition



Taleb introduces an options trader Nero Tulip.  He became convinced that being an options trader was even more interesting that being a pirate would be.

Nero is highly educated (like Taleb himself), with an undergraduate degree in ancient literature and mathematics from Cambridge University, a PhD. in philosophy from the University of Chicago, and a PhD. in mathematical statistics.  His thesis for the PhD. in philosophy had to do with the methodology of statistical inference in its application to the social sciences.  Taleb comments:

In fact, his thesis was indistinguishable from a thesis in mathematical statistics—it was just a bit more thoughtful (and twice as long).

Nero left philosophy because he became bored with academic debates, particularly over minor points.  Nero wanted action.

(Photo by Neil Lockhart)

Nero became a proprietary trader.  The firm provided the capital.  As long as Nero generated good results, he was free to work whenever he wanted.  Generally he was allowed to keep between 7% and 12% of his profits.

It is paradise for an intellectual like Nero who dislikes manual work and values unscheduled meditation.

Nero was an extremely conservative options trader.  Over his first decade, he had almost no bad years and his after-tax income averaged $500,000.  Due to his extreme risk aversion, Nero’s goal is not to maximize profits as much as it is to avoid having such a bad year that his “entertaining money machine called trading” would be taken away from him.  In other words, Nero’s goal was to avoid blowing up, or having such a bad year that he would have to leave the business.

Nero likes taking small losses as long as his profits are large.  Whereas most traders make money most of the time during a bull market and lose money during market panics or crashes, Nero would lose small amounts most of the time during a bull market and then make large profits during a market panic or crash.

Nero does not do as well as some other traders.  One reason is that his extreme risk aversion leads him to invest his own money in treasury bonds.  So he missed most of the bull market from 1982 to 2000.

Note: From a value investing point of view, Nero should at least have invested in undervalued stocks, since such a strategy will almost certainly do well after 10+ years.  But Nero wasn’t trained in value investing, and he was acutely aware of what can happen during market panics or crashes.

Also Note:  For a value investor, a market panic or crash is an opportunity to buy more stock at very cheap prices.  Thus bear markets benefit the value investor who can add to his or her positions.

Nero and his wife live across the street from John the High-Yield Trader and his wife.  John was doing much better than Nero.  John’s strategy was to maximize profits for as long as the bull market lasted.  Nero’s wife and even Nero himself would occasionally feel jealous when looking at the much larger house in which John and his wife lived.  However, one day there was a market panic and John blew up, losing virtually everything including his house.

Taleb writes:

…Nero’s merriment did not come from the fact that John went back to his place in life, so much as it was from the fact that Nero’s methods, beliefs, and track record had suddenly gained in credibility.  Nero would be able to raise public money on his track record precisely because such a thing could not possibly happen to him.  A repetition of such an event would pay off massively for him.  Part of Nero’s elation also came from the fact that he felt proud of his sticking to his strategy for so long, in spite of the pressure to be the alpha male.  It was also because he would no longer question his trading style when others were getting rich because they misunderstood the structure of randomness and market cycles.

Taleb then comments that lucky fools never have the slightest suspicion that they are lucky fools.  As long as they’re winning, they get puffed up from the release of the neurotransmitter serotonin into their systems.  Taleb notes that our hormonal system can’t distinguish between winning based on luck and winning based on skill.

(A lucky seven.  Photo by Eagleflying)

Furthermore, when serotonin is released into our system based on some success, we act like we deserve the success, regardless of whether it was based on luck or skill.  Our new behavior will often lead to a virtuous cycle during which, if we continue to win, we will rise in the pecking order.  Similarly, when we lose, whether that loss is due to bad luck or poor skill, our resulting behavior will often lead to a vicious cycle during which, if we continue to lose, we will fall in the pecking order.  Taleb points out that these virtuous and vicious cycles are exactly what happens with monkeys who have been injected with serotonin.

Taleb adds that you can always tell whether some trader has had a winning day or a losing day.  You just have to observe his or her gesture or gait.  It’s easy to tell whether the trader is full of serotonin or not.

Photo by Antoniodiaz



Taleb introduces the concept of alternative histories.  This concept applies to many areas of human life, including many different professions (war, politics, medicine, investments).  The main idea is that you cannot judge the quality of a decision based only on its outcome.  Rather, the quality of a decision can only be judged by considering all possible scenarios (outcomes) and their associated probabilities.

Once again, our brains deceive us unless we develop the habit of thinking probabilistically, in terms of alternative histories.  Without this habit, if a decision is successful, we get puffed up with serotonin and believe that the successful outcome is based on our skill.  By nature, we cannot account for luck or randomness.

Taleb offers Russian roulette as an analogy.  If you are offered $10 million to play Russian roulette, and if you play and you survive, then you were lucky even though you will get puffed up with serotonin.

Photo by Banjong Khanyai

Taleb argues that many (if not most) business successes have a large component of luck or randomness.  Again, though, successful businesspeople in general will be puffed up with serotonin and they will attribute their success primarily to skill.  Taleb:

…the public observes the external signs of wealth without even having a glimpse at the source (we call such source the generator).

Now, if the lucky Russian roulette player continues to play the game, eventually the bad histories will catch up with him or her.  Here’s an important point:  If you start out with thousands of people playing Russian roulette, then after the first round roughly 83.3% will be successful.  After the second round, roughly 83.3% of the survivors of round one will be successful.  After the third round, roughly 83.3% of the survivors of round two will be successful.  And on it goes…  After twenty rounds, there will be a small handful of extremely successful and wealthy Russian roulette players.  However, these cases of extreme success are due entirely to luck.

In the business world, of course, there are many cases where skill plays a large role.  The point is that our brains by nature are unable to see when luck has played a role in some successful outcome.  And luck almost always plays an important role in most areas of life.

Taleb points out that there are some areas where success is due mostly to skill and not luck.  Taleb likes to give the example of dentistry.  The success of a dentist will typically be due mostly to skill.

Taleb attributes some of his attitude towards risk to the fact that at one point he had a boss who forced him to consider every possible scenario, no matter how remote.

Interestingly, Taleb understands Homer’s The Iliad as presenting the following idea: heroes are heroes based on heroic behavior and not based on whether they won or lost.  Homer seems to have understood the role of chance (luck).



A Monte Carlo generator creates many alternative random sample paths.  Note that a sample path can be deterministic, but our concern here is with random sample paths.  Also note that some random sample paths can have higher probabilities than other random sample paths.  Each sample path represents just one sequence of events out of many possible sequences, ergo the word “sample”.

Taleb offers a few examples of random sample paths.  Consider the price of your favorite technology stock, he says.  It may start at $100, hit $220 along the way, and end up at $20.  Or it may start at $100 and reach $145, but only after touching $10.  Another example might be your wealth during at a night at the casino.  Say you begin with $1,000 in your pocket.  One possibility is that you end up with $2,200, while another possibility is that you end up with only $20.

Photo by Emily2k

Taleb says:

My Monta Carlo engine took me on a few interesting adventures.  While my colleagues were immersed in news stories, central bank announcements, earnings reports, economic forecasts, sports results and, not least, office politics, I started toying with it in fields bordering my home base of financial probability.  A natural field of expansion for the amateur is evolutionary biology… I started simulating populations of fast mutating animals called Zorglubs under climactic changes and witnessing the most unexpected of conclusions… My aim, as a pure amateur fleeing the boredom of business life, was merely to develop intuitions for these events… I also toyed with molecular biology, generating randomly occurring cancer cells and witnessing some surprising aspects to their evolution.

Taleb continues:

Naturally the analogue to fabricating populations of Zorglubs was to simulate a population of “idiotic bull”, “impetuous bear”, and “cautious” traders under different market regimes, say booms and busts, and to examine their short-term and long-term survival… My models showed almost nobody to really ultimately make money; bears dropped out like flies in the rally and bulls got ultimately slaughtered, as paper profits vanished when the music stopped.  But there was one exception; some of those who traded options (I called them option buyers) had remarkable staying power and I wanted to be one of those.  How?  Because they could buy insurance against the blowup; they could get anxiety-free sleep at night, thanks to the knowledge that if their careers were threatened, it would not be owing to the outcome of a single day.

Note from a value investing point of view

A value investor seeks to pay low prices for stock in individual businesses.  Stock prices can jump around in the short term.  But over time, if the business you invest in succeeds, then the stock will follow, assuming you bought the stock at relatively low prices.  Again, if there’s a bear market or a market crash, and if the stock prices of the businesses in which you’ve invested decline, then that presents a wonderful opportunity to buy more stock at attractively low prices.  Over time, the U.S. and global economy will grow, regardless of the occasional market panic or crash.  Because of this growth, one of the lowest risk ways to build wealth is to invest in businesses, either on an individual basis if you’re a value investor or via index funds.

Taleb’s methods of trying to make money during a market panic or crash will almost certainly do less well over the long term than simple index funds.

Taleb makes a further point: The vast majority of people learn only from their own mistakes, and rarely from the mistakes of others.  Children only learn that the stove is hot by getting burned.  Adults are largely the same way: We only learn from our own mistakes.  Rarely do we learn from the mistakes of others.  And rarely do we heed the warnings of others.  Taleb:

All of my colleagues whom I have known to denigrate history blew up spectacularly—and I have yet to encounter some such person who has not blown up.

Keep in mind that Taleb is talking about traders here.  For a regular investor who dollar cost averages into index funds and/or who uses value investing, Taleb’s warning does not apply.  As a long-term investor in index funds and/or in value investing techniques, you do have to be ready for a 50% decline at some point.  But if you buy more after such a decline, your long-term results will actually be helped, not hurt, by a 50% decline.

Taleb points out that aged traders and investors are likely better to use as role models precisely because they have been exposed to markets longer.  Taleb:

I toyed with Monte Carlo simulations of heterogeneous populations of traders under a variety of regimes (closely resembling historical ones), and found a significant advantage in selecting aged traders, using, as a selection criterion their cumulative years of experience rather than their absolute success (conditional on their having survived without blowing up).

Taleb also observes that there is a similar phenomenon in mate selection.  All else equal, women prefer to mate with healthy older men over healthy younger ones.  Healthy older men, by having survived longer, show some evidence of better genes.



Using a random generator of words, it’s possible to create rhetoric, but it’s not possible to generate genuine scientific knowledge.



Taleb writes about Carlos “the emerging markets wizard.”  After excelling as an undergraduate, Carlos went for a PhD. in economics from Harvard.  Unable to find a decent thesis topic for his dissertation, he settled for a master’s degree and a career on Wall Street.

Carlos did well investing in emerging markets bonds.  One important reason for his success, beyond the fact that he bought emerging markets bonds that later went up in value, was that he bought the dips.  Whenever there was a momentary panic and emerging markets bonds dropped in value, Carlos bought more.  This dip buying improved his performance.  Taleb:

It was the summer of 1998 that undid Carlos—that last dip did not translate into a rally.  His track record today includes just one bad quarter—but bad it was.  He had earned close to $80 million cumulatively in his previous years.  He lost $300 million in just one summer.

When the market first started dipping, Carlos learned that a New Jersey hedge fund was liquidating, including its position in Russian bonds.  So when Russian bonds dropped to $52, Carlos was buying.  To those who questioned his buying, he yelled: “Read my lips: it’s li-qui-da-tion!”

Taleb continues:

By the end of June, his trading revenues for 1998 had dropped from up $60 million to up $20 million.  That made him angry.  But he calculated that should the market rise back to the pre-New Jersey selloff, then he would be up $100 million.  That was unavoidable, he asserted.  These bonds, he said, would never, ever trade below $48.  He was risking so little, to possibly make so much.

Then came July.  The market dropped a bit more.  The benchmark Russian bond was now $43.  His positions were under water, but he increased his stakes.  By now he was down $30 million for the year.  His bosses were starting to become nervous, but he kept telling them that, after all, Russia would not go under.  He repeated the cliche that it was too big to fail.  He estimated that bailing them out would cost so little and would benefit the world economy so much that it did not make sense to liquidate his inventory now.

Carlos asserted that the Russian bonds were trading near default value.  If Russia were to default, then Russian bonds would stay at the same prices they were at currently.  Carlos took the further step of investing half of his net worth, then $5,000,000, into Russian bonds.

Russian bond prices then dropped into the 30s, and then into the 20s.  Since Carlos thought the bonds could not be less than the default values he had calculated, and were probably worth much more, he was not alarmed.  He maintained that anyone who invested in Russian bonds at these levels would realize wonderful returns.  He claimed that stop losses “are for schmucks!  I am not going to buy high and sell low!”  He pointed out that in October 1997 they were way down, but that buying the dip ended up yielding excellent profits for 1997.  Furthermore, Carlos pointed out that other banks were showing even larger losses on their Russian bond positions.  Taleb:

Towards the end of August, the bellwether Russian Principal Bonds were trading below $10.  Carlos’s net worth was reduced by almost half.  He was dismissed.  So was his boss, the head of trading.  The president of the bank was demoted to a “newly created position”.  Board members could not understand why the bank had so much exposure to a government that was not paying its own employees—which, disturbingly, included armed soldiers.  This was one of the small points that emerging market economists around the globe, from talking to each other so much, forgot to take into account.

Taleb adds:

Louie, a veteran trader on the neighboring desk who suffered much humiliation by these rich emerging market traders, was there, vindicated.  Louie was then a 52-year-old Brooklyn-born-and-raised trader who over three decades survived every single conceivable market cycle.

Taleb concludes that Carlos is a gentleman, but a bad trader:

He has all of the traits of a thoughtful gentleman, and would be an ideal son-in-law.  But he has most of the attributes of the bad trader.  And, at any point in time, the richest traders are often the worst traders.  This, I will call the cross-sectional problem: at a given time in the market, the most profitable traders are likely to be those that are best fit to the latest cycle.

Taleb discusses John the high-yield trader, who was mentioned near the beginning of the book, as another bad trader.  What traits do bad traders, who may be lucky idiots for awhile, share?  Taleb:

    • An overestimation of the accuracy of their beliefs in some measure, either economic (Carlos) or statistical (John).  They don’t consider that what they view as economic or statistical truth may have been fit to past events and may no longer be true.
    • A tendency to get married to positions.
    • The tendency to change their story.
    • No precise game plan ahead of time as to what to do in the event of losses.
    • Absence of critical thinking expressed in absence of revision of their stance with “stop losses”.
    • Denial.



Taleb presents the following Table:

Event Probability Outcome Expectation
A 999/1000 $1 $.999
B 1/1000 -$10,000 -$10.00
Total -$9.001

The point is that the frequency of losing cannot be considered apart from the magnitude of the outcome.  If you play the game, you’re extremely likely to make $1.  But it’s not a good idea to play.  If you play this game millions of times, you’re virtually guaranteed to lose money.

Taleb comments that even professional investors misunderstand this bet:

How could people miss such a point?  Why do they confuse probability and expectation, that is, probability and probability times the payoff?  Mainly because much of people’s schooling comes from examples in symmetric environments, like a coin-toss, where such a difference does not matter.  In fact the so-called “Bell Curve” that seems to have found universal use in society is entirely symmetric.

(Coin toss.  Photo by Christian Delbert)

Taleb gives an example where he is shorting the S&P 500 Index.  He thought the market had a 70% chance of going up and a 30% chance of going down.  But he thought that if the market went down, it could go down a lot.  Therefore, it was profitable over time (by repeating the bet) to be short the S&P 500.

Note: From a value investing point of view, no one can predict what the market will do.  But you can predict what some individual businesses are likely to do.  The key is to invest in businesses when the price (stock) is low.

Rare Events

Taleb explains his trading strategy:

The best description of my lifelong business in the market is “skewed bets”, that is, I try to benefit from rare events, events that do not tend to repeat themselves frequently, but, accordingly, present a large payoff when they occur.  I try to make money infrequently, as infrequently as possible, simply because I believe that rare events are not fairly valued, and that the rarer the event, the more undervalued it will be in price.

Illustration by lqoncept

Taleb gives an example where his strategy paid off:

One such rare event is the stock market crash of 1987, which made me as a trader and allowed me the luxury of becoming involved in all manner of scholarship.

Taleb notes that in most areas of science, it is common practice to discard outliers when computing the average.  For instance, a professor calculating the average grade in his or her class might discard the highest and the lowest values.  In finance, however, it is often wrong to discard the extreme outcomes because, as Taleb has shown, the magnitude of an extreme outcome can matter.

Taleb advises studying market history.  But then again, you have to be careful, as Taleb explains:

Sometimes market data becomes a simple trap; it shows you the opposite of its nature, simply to get you to invest in the security or mismanage your risks.  Currencies that exhibit the largest historical stability, for example, are the most prone to crashes…

Taleb notes the following:

In other words history teaches us that things that never happened before do happen.

History does not always repeat.  Sometimes things change.  For instance, today the U.S. stock market seems high.  The S&P 500 Index is over 3,000.  Based on history, one might expect a bear market and/or a recession.  There hasn’t been a recession in the U.S. since 2009.

However, with interest rates low, and with the profit margins on many technology companies high, it’s possible that stocks will not decline much, even if there’s a recession.  It’s also possible that any recession could be delayed, partly because the Fed and other central banks remain very accommodative.  It’s possible that the business cycle itself may be less volatile because the fiscal and monetary authorities have gotten better at delaying recessions or at making recessions shallower than before.

Ironically, to the extent that Taleb seeks to profit from a market panic or crash, for the reasons just mentioned, Taleb’s strategy may not work as well going forward.

Taleb introduces the problem of stationarity.  To illustrate the problem, think of an urn with red balls and black balls in it.  Taleb:

Think of an urn that is hollow at the bottom.  As I am sampling from it, and without my being aware of it, some mischievous child is adding balls of one color or another.  My inference thus becomes insignificant.  I may infer that the red balls represent 50% of the urn while the mischievous child, hearing me, would swiftly replace all the red balls with black ones.  This makes much of our knowledge derived through statistics quite shaky.

The very same effect takes place in the market.  We take past history as a single homogeneous sample and believe that we have considerably increased our knowledge of the future from the observation of the sample of the past.  What if vicious children were changing the composition of the urn?  In other words, what if things have changed?

Taleb notes that there are many techniques that use past history in order to measure risks going forward.  But to the extent that past data are not stationary, depending upon these risk measurement techniques can be a serious mistake.  All of this leads to a more fundamental issue: the problem of induction.



Taleb quotes the Scottish philosopher David Hume:

No amount of observations of white swans can allow the inference that all swans are white, but the observation of a single black swan is sufficient to refute that conclusion.

(Black swan.  Photo by Damithri)

Taleb came to believe that Sir Karl Popper had an important answer to the problem of induction.  According to Popper, there are only two types of scientific theories:

    • Theories that are known to be wrong, as they were tested and adequately rejected (i.e., falsified).
    • Theories that have not yet been known to be wrong, not falsified yet, but are exposed to be proved wrong.

It also follows that we should not always rely on statistics.  Taleb:

More practically to me, Popper had many problems with statistics and statisticians.  He refused to blindly accept the notion that knowledge can always increase with incremental information—which is the foundation for statistical inference.  It may in some instances, but we do not know which ones.  Many insightful people, such as John Maynard Keynes, independently reached the same conclusions.  Sir Karl’s detractors believe that favorably repeating the same experiment again and again should lead to an increased comfort with the notion that “it works”.

Taleb explains the concept of an open society:

Popper’s falsificationism is intimately connected to the notion of an open society.  An open society is one in which no permanent truth is held to exist; this would allow counterideas to emerge.

For Taleb, a successful trader or investor must have an open mind in which no permanent truth is held to exist.

Taleb concludes the chapter by applying the logic of Pascal’s wager to trading and investing:

…I will use statistics and inductive methods to make aggressive bets, but I will not use them to manage my risks and exposure.  Surprisingly, all the surviving traders I know seem to have done the same.  They trade on ideas based on some observation (that includes past history) but, like the Popperian scientists, they make sure that the costs of being wrong are limited (and their probability is not derived from past data).  Unlike Carlos and John, they know before getting involved in the trading strategy which events would prove their conjecture wrong and allow for it (recall the Carlos and John used past history both to make their bets and measure their risk).



If you put an infinite number of monkeys in front of typewriters, it is certain that one of them will type an exact version of Homer’s The Iliad.  Taleb asks:

Now that we have found that hero among monkeys, would any reader invest his life’s savings on a bet that the monkey would write The Odyssey next?

Infinite number of monkeys on typewriters.  Illustration by Robert Adrian Hillman.



Taleb begins the chapter by describing a lawyer named Marc.  Marc makes $500,000 a year.  He attended Harvard as an undergraduate and then Yale Law School.  The problem is that some of Marc’s neighbors are much wealthier.  Taleb discusses Marc’s wife, Janet:

Every month or so, Janet has a crisis… Why isn’t her husband so successful?  Isn’t he smart and hard working?  Didn’t he get close to 1600 on the SAT?  Why is Ronald Something whose wife never even nods to Janet worth hundred of millions when her husband went to Harvard and Yale and has such a high I.Q., and has hardly any substantial savings?

Note: Warren Buffett and Charlie Munger have long made the point that envy is a massively stupid sin because, unlike other sins (e.g., gluttony), you can’t have any fun with it.  Granted, envy is a very human emotion.  But we can and must train ourselves not to fall into it.

Daniel Kahneman and others have demonstrated that the average person would rather make $70,000 as long as his neighbor makes $60,000 than make $80,000 if his neighbor makes $90,000.  How stupid to compare ourselves to people who happen to be doing better!  There will always be someone doing better.

Taleb mentions the book, The Millionaire Next Door.  One idea from the book is that the wealthy often do not look wealthy because they’re focused on saving and investing, rather than on spending.  However, Taleb finds two problems with the book.  First, the book does not adjust for survivorship bias.  In other words, for at least some of the wealthy, there is some luck involved.  Second, there’s the problem of induction.  If you measure someone’s wealth in the year 2000 (Taleb was writing in 2001), at the end of one of the biggest bull markets in modern history (from 1982 to 2000), then in many cases a large degree of that wealth came as a result of the prolonged bull market.  By contrast, if you measure people’s wealth in 1982, there would be fewer people who are millionaires, even after adjusting for inflation.



Taleb writes about going to the dentist and being confident that his dentist knows something about teeth.  Later, Taleb goes to Carnegie Hall.  Before the pianist begins her performance, Taleb has zero doubt that she knows how to play the piano and is not about to produce cacophony.  Later still, Taleb is in London and ends up looking at some of his favorite marble statues.  Once again, he knows they weren’t produced by luck.

However, in many areas of business and even more so when it comes to investing, luck does tend to play a large role.  Taleb is supposed to meet with a fund manager who has a good track record and who is looking for investors.  Taleb comments that buying and selling, which is what the fund manager does, is easier than frying an egg.  The problem is that luck plays such a large role in almost any good investment track record.

Photo by Alhovik

In order to study the role luck plays for investors, Taleb suggests a hypothetical game.  There are 10,000 investors at the beginning.  In the first round, a fair coin is tossed for each investor.  Heads, and the investor makes $10,000, tails, and the investor loses $10,000.  (Any investor who has a losing year is not allowed to continue to play the game.)  After the first round, there will be about 5,000 successful investors.  In the second round, a fair coin is again tossed.  After the second round, there will be 2,500 successful investors.  Another round, and 1,250 will remain.  A fourth round, and 625 successful investors will remain.  A fifth round, and 313 successful investors will remain.  Based on luck alone, after five years there will be approximately 313 investors with winning track records.  No doubt these 313 winners will be puffed up with serotonin.

Taleb then observes that you can play the same hypothetical game with bad investors.  You assume each year that there’s a 45% chance of winning and a 55% chance of losing.  After one year, 4,500 successful (but bad) investors will remain.  After two years, 2,025.  After three years, 911.  After four years, 410.  After five years, there will be 184 bad investors who have successful track records.

Taleb makes two counterintuitive points:

    • First, even starting with only bad investors, you will end up with a small number of great track records.
    • Second, how many great track records you end up with depends more on the size of the initial sample—how many investors you started with—than it does on the individual odds per investor.  Applied to the real world, this means that if there are more investors who start in 1997 than in 1993, then you will see a greater number of successful track records in 2002 than you will see in 1998.

Taleb concludes:

Recall that the survivorship bias depends on the size of the initial population.  The information that a person made money in the past, just by itself, is neither meaningful nor relevant.  We need to know that size of the population from which he came.  In other words, without knowing how many managers out there have tried and failed, we will not be able to assess the validity of the track record.  If the initial population includes ten managers, then I would give the performer half my savings without a blink.  If the initial population is composed of 10,000 managers, I would ignore the results.

The mysterious letter

Taleb tells a story.  You get a letter on Jan. 2 informing you that the market will go up during the month.  It does.  Then you get a letter on Feb. 1 saying the market will go down during the month.  It does.  You get another letter on Mar. 1.  Same story.  Again for April and for May.  You’ve now gotten five letters in a row predicting what the market would do during the ensuing month, and all five letters were correct.  Next you are asked to invest in a special fund.  The fund blows up.  What happened?

The trick is as follows.  The con operator gets 10,000 random names.  On Jan. 2, he mails 5,000 letters predicting that the market will go up and 5,000 letters predicting that the market will go down.  The next month, he focuses only on the 5,000 names who were just mailed a correct prediction.  He sends 2,500 letters predicting that the market will go up and 2,500 letters predicting that the market will go down.  Of course, next he focuses on the 2,500 letters which gave correct predictions.  He mails 1,250 letters predicting a market rise and 1,250 predicting a market fall.  After five months of this, there will be approximately 200 people who received five straight correct predictions.

Taleb suggests the birthday paradox as an intuitive way to explain the data mining problem.  If you encounter a random person, there is a one in 365.25 chance that you have the same birthday.  But if you have 23 random people in a room, the odds are close to 50 percent that you can find two people who share a birthday.

Similarly, what are the odds that you’ll run into someone you know in a totally random place?  The odds are quite high because you are testing for any encounter, with any person you know, in any place you will visit.

Taleb continues:

What is your probability of winning the New Jersey lottery twice?  One in 17 trillion.  Yet it happened to Evelyn Adams, whom the reader might guess should feel particularly chosen by destiny.  Using the method we developed above, Harvard’s Percy Diaconis and Frederick Mosteller estimated at 30 to 1 the probability the someone, somewhere, in a totally unspecified way, gets so lucky!

What is data snooping?  It’s looking  at historical data to determine the hypothetical performance of a large number of trading rules.  The more trading rules you examine, the more likely you are to find trading rules that would have worked in the past and that one might expect to work in the future.  However, many such trading rules would have worked in the past based on luck alone.

Taleb next writes about companies that increase their earnings.  The same logic can be applied.  If you start out with 10,000 companies, then by luck 5,000 will increase their profits after the first year.  After three years, there will be 1,250 “stars” that increased their profits for three years in a row.  Analysts will rate these companies a “strong buy”.  The point is not that profit increases are entirely due to luck.  The poin, rather, is that luck often plays a significant role in business results, usually far more than is commonly supposed.



Taleb writes:

This chapter is about how a small advantage in life can translate into a highly disproportionate payoff, or, more viciously, how no advantage at all, but a very, very small help from randomness, can lead to a bonanza.

Nonlinearity is when a small input can lead to a disproportionate response.  Consider a sandpile.  You can add many grains of sand with nothing happening.  Then suddenly one grain of sand causes an avalanche.

(Photo by Maocheng)

Taleb mentions actors auditioning for parts.  A handful of actors get certain parts, and a few of them become famous.  The most famous actors are not always the best actors (although they often are).  Rather, there could have been random (lucky) reasons why a handful of actors got certain parts and why a few of them became famous.

The QWERTY keyboard is not optimal.  But so many people were trained on it, and so many QWERTY keyboards were manufactured, that it has come to dominate.  This is called a path dependent outcome.  Taleb comments:

Such ideas go against classical economic models, in which results either come from a precise reason (there is no account for uncertainty) or the good guy wins (the good guy is the one who is more skilled and has some technical superiority)… Brian Arthur, an economist concerned with nonlinearities at the Santa Fe Institute, wrote that chance events coupled with positive feedback rather than technological superiority will determine economic superiority—not some abstrusely defined edge in a given area of expertise.  While early economic models excluded randomness, Arthur explained how “unexpected orders, chance meetings with lawyers, managerial whims… would help determine which ones achieved early sales and, over time, which firms dominated”.

Taleb continues by noting that Arthur suggests a mathematical model called the Polya process:

The Polya process can be presented as follows: assume an urn initially containing equal quantities of black and red balls.  You are to guess each time which color you will pull out before you make the draw.  Here the game is rigged.  Unlike a conventional urn, the probability of guessing correctly depends on past success, as you get better or worse at guessing depending on past performance.  Thus the probability of winning increases after past wins, that of losing increases after past losses.  Simulating such a process, one can see a huge variance of outcomes, with astonishing successes and a large number of failures (what we called skewness).



Our genes have not yet evolved to the point where our brains can naturally compute probabilities.  Computing probabilities is not something we even needed to do until very recently.

Here’s a diagram of how to compute the probability of A, conditional on B having happened:

(Diagram by Oleg Alexandrov, via Wikimedia Commons)


We are capable of sending a spacecraft to Mars, but we are incapable of having criminal trials managed by the basic laws of probability—yet evidence is clearly a probabilistic notion…

People who are as close to being criminal as probability laws can allow us to infer (that is with a confidence that exceeds the shadow of a doubt) are walking free because of our misunderstanding of basic concepts of the odds… I was in a dealing room with a TV set turned on when I saw one of the lawyers arguing that there were at least four people in Los Angeles capable of carrying O.J. Simpson’s DNA characteristics (thus ignoring the joint set of events…).  I then switched off the television set in disgust, causing an uproar among the traders.  I was under the impression until then that sophistry had been eliminated from legal cases thanks to the high standards of republican Rome.  Worse, one Harvard lawyer used the specious argument that only 10% of men who brutalize their wives go on to murder them, which is a probability unconditional on the murder… Isn’t the law devoted to the truth?  The correct way to look at it is to determine the percentage of murder cases where women were killed by their husband and had previously been battered by him (that is, 50%)—for we are dealing with what is called conditional probabilities; the probability that O.J. killed his wife conditional on the information of her having been killed, rather than the unconditional probability of O.J. killing his wife.  How can we expect the untrained person to understand randomness when a Harvard professor who deals and teaches the concept of probabilistic evidence can make such an incorrect statement?

Speaking of people misunderstanding probabilities, Daniel Kahneman and Amos Tversky have asked groups to answer the following question:

Linda is 31 years old, single, outspoken, and very bright.  She majored in philosophy.  As a student, she was deeply concerned with issues of discrimination and social justice, and also participated in anti-nuclear demonstrations.

Which is more probable?

    1. Linda is a bank teller.
    2. Linda is a bank teller and is active in the feminist movement.

The majority of people believe that 2. is more probable the 1.  But that’s an obvious fallacy.  Bank tellers who are also feminists is a subset of all bank tellers, therefore 1. is more probable than 2.  To see why, consider the following diagram:

(By svjo, via Wikimedia Commons)

B represents ALL bank tellers.  Out of ALL bank tellers, some are feminists and some are not.  Those bank tellers that are also feminists is represented by A.

Here’s a probability question that was presented to doctors:

A test of a disease presents a rate of 5% false positives.  The disease strikes 1/1,000 of the population.  People are tested at random, regardless of whether they are suspected of having the disease.  A patient’s test is positive.  What is the probability of the patient being stricken with the disease?

Many doctors answer 95%, which is wildly incorrect.  The answer is close to 2%.  Less than one in five doctors get the question right.

To see the right answer, assume that there are no false negatives.  Out of 1,000 patients, one will have the disease.  Consider the remaining 999.  50 of them will test positive.  The probability of being afflicted with the disease for someone selected at random who tested positive is the following ratio:

Number of afflicted persons  /  Number of true and false positives

So the answer is 1/51, about 2%.

Another example where people misunderstand probabilities is when it comes to valuing options.  (Recall that Taleb is an options trader.)  Taleb gives an example.  Say that the stock price is $100 today.  You can buy a call option for $1 that gives you the right to buy the stock at $110 any time during the next month.  Note that the option is out-of-the-money because you would not gain if you exercised your right to buy now, given that the stock is $100, below the exercise price of $110.

Now, what is the expected value of the option?  About 90 percent of out-of-the-money options expire worthless, that is, they end up being worth $0.  But the expected value is not $0 because there is a 10 percent chance that the option could be worth, say $10, because the stock went to $120.  So even though it is 90 percent likely that the option will end up being worth $0, the expected value is not $0.  The actual expected value in this example is:

(90% x $0) + (10% x $10) = $0 + $1 = $1

The expected value of the option is $1, which means you would have paid a fair price if you had bought it for $1.  Taleb notes:

I discovered very few people who accepted losing $1 for most expirations and making $10 once in a while, even if the game were fair (i.e., they made the $10 more than 10% of the time).

“Fair” is not the right term here.  If you make $10 more than 10% of the time, then the game has a positive expected value.  That means if you play the game repeatedly, then eventually over time you will make money.  Taleb’s point is that even if the game has a positive expected value, very few people would like to play it because on your way to making money, you have to accept small losses most of the time.

Taleb distinguishes between premium sellers, who sell options, and premium buyers, who buy options.  Following the same logic as above, premium sellers make small amounts of money roughly 90% of the time, and then take a big loss roughly 10% of the time.  Premium buyers lose small amounts about 90% of the time, and then have a big gain about 10% of the time.

Is it better to be an option seller or an option buyer?  It depends on whether you can find favorable odds.  It also depends on your temperament.  Most people do not like taking small losses most of the time.  Taleb:

Alas, most option traders I encountered in my career are premium sellers—when they blow up it is generally other people’s money.



Taleb writes that when Odysseus and his crew encountered the sirens, Odysseus had his crew put wax in their ears.  He also instructed his crew to tie him to the mast.  With these steps, Odysseus and crew managed to survive the sirens’ songs.  Taleb notes that he would be not Odysseus, but one of the sailors who needed to have wax in his ears.

(Odysseus and crew at the sirens.  Illustration by Mr1805)

Taleb admits that he is dominated by his emotions:

The epiphany I had in my career in randomness came when I understood that I was not intelligent enough, nor strong enough, to even try to fight my emotions.  Besides, I believe that I need my emotions to formulate my ideas and get the energy to execute them.

I am just intelligent enough to understand that I have a predisposition to be fooled by randomness—and to accept the fact that I am rather emotional.  I am dominated by my emotions—but as an aesthete, I am happy about that fact.  I am just like every single character whom I ridiculed in this book… The difference between myself and those I ridicule is that I try to be aware of it.  No matter how long I study and try to understand probability, my emotions will respond to a different set of calculations, those that my unintelligent genes want me to handle.

Taleb says he has developed tricks in order to handle his emotions.  For instance, if he has financial news playing on the television, he keeps the volume off.  Without volume, a babbling person looks ridiculous.  This trick helps Taleb stay free of news that is not rationally presented.



Early in his career as a trader, Taleb says he had a particularly profitable day.  It just so happens that the morning of this day, Taleb’s cab driver dropped him off in the wrong location.  Taleb admits that he was superstitious.  So the next day, he not only wore the same tie, but he had his cab driver drop him off in the same wrong location.

(Skinner boxes.  Photo by Luis Dantas, via Wikimedia Commons)

B.F. Skinner did an experiment with famished pigeons.  There was a mechanism that would deliver food to the box in which the hungry pigeon was kept.  But Skinner programmed the mechanism to deliver the food randomly.  Taleb:

He saw quite astonishing behavior on the part of the birds; they developed an extremely sophisticated rain-dance type of behavior in response to their ingrained statistical machinery.  One bird swung its head rhythmically against a specific corner of the box, others spun their heads anti-clockwise; literally all of the birds developed a specific ritual that progressively became hard-wired into their mind as linked to their feeding.

Taleb observes that whenever we experience two events, A and B, our mind automatically looks for a causal link even though there often is none.  Note: Even if B always follows A, that doesn’t prove a causal link, as Hume pointed out.

Taleb again admits that after he has calculated the probabilities in some situation, he finds it hard to modify his own conduct accordingly.  He gives an example of trading.  Taleb says if he is up $100,000, there is a 98% chance that it’s just noise.  But if he is up $1,000,000, there is a 1% chance that it’s noise and a 99% chance that his strategy is profitable.  Taleb:

A rational person would act accordingly in the selection of strategies, and set his emotions in accordance with his results.  Yet I have experienced leaps of joy over results that I knew were mere noise, and bouts of unhappiness over results that did not carry the slightest degree of statistical significance.  I cannot help it…

Taleb uses another trick to deal with this.  He denies himself access to his performance report unless it hits a predetermined threshold.



Taleb writes:

Carneades was not merely a skeptic; he was a dialectician, someone who never committed himself to any of the premises from which he argued, or to any of the conclusions he drew from them.  He stood all his life against arrogant dogma and belief in one sole truth.  Few credible thinkers rival Carneades in their rigorous skepticism (a class that would include the medieval Arab philosopher Al Gazali, Hume, and Kant—but only Popper came to elevate his skepticism to an all-encompassing scientific methodology).  As the skeptics’ main teaching was that nothing could be accepted with certainty, conclusions of various degrees of probability could be formed, and these supplied a guide to conduct.

Taleb holds that Cicero engaged in probabilistic reasoning:

He preferred to be guided by probability than allege with certainty—very handy, some said, because it allowed him to contradict himself.  This may be a reason for us, who have learned from Popper how to remain self critical, to respect him more, as he did not hew stubbornly to an opinion for the mere fact that he had voiced it in the past.

Taleb asserts that the speculator George Soros has a wonderful ability to change his opinions rather quickly.  In fact, without this ability, Soros could not have become so successful as a speculator.  There are many stories about Soros holding one view strongly, only to abandon it very quickly and take the opposite view, leading to a large profit where there otherwise would have been a large loss.

Most of us tend to become married to our favorite ideas.  Most of us are not like George Soros.  Especially after we have invested time and energy into developing some idea.

At the extreme, just imagine a scientist who spent years developing some idea.  Many scientists in that situation have a hard time abandoning their idea, even after there is good evidence that they’re wrong.  That’s why it is said that science evolves from funeral to funeral.



Taleb refers to C.P. Cavafy’s poem, Apoleipein o Theos Antonion (The God Abandons Antony).  The poem addresses Antony after he has been defeated.  Taleb comments:

There is nothing wrong and undignified with emotions—we are cut to have them.  What is wrong is not following the heroic, or at least, the dignified path.  That is what stoicism means.  It is the attempt by man to get even with probability.

Seneca 4 BC-65 AD Roman stoic philosopher, statesman, and tutor to the future Emperor Nero.  Photo by Bashta.

Taleb concludes with some advice (stoicism):

Dress at your best on your execution day (shave carefully); try to leave a good impression on the death squad by standing erect and proud.  Try not to play victim when diagnosed with cancer (hide it from others and only share the information with the doctor—it will avert the platitudes and nobody will treat you like  a victim worthy of their pity; in addition the dignified attitude will make both defeat and victory feel equally heroic).  Be extremely courteous to your assistant when you lose money (instead of taking it out on him as many of the traders whom I scorn routinely do).  Try not to blame others for your fate, even if they deserve blame.  Never exhibit any self pity, even if your significant other bolts with the handsome ski instructor or the younger aspiring model.  Do not complain… The only article Lady Fortuna has no control over is your behavior.



An equal weighted group of micro caps generally far outperforms an equal weighted (or cap-weighted) group of larger stocks over time.  See the historical chart here:  https://boolefund.com/best-performers-microcap-stocks/

This outperformance increases significantly by focusing on cheap micro caps.  Performance can be further boosted by isolating cheap microcap companies that show improving fundamentals.  We rank microcap stocks based on these and similar criteria.

There are roughly 10-20 positions in the portfolio.  The size of each position is determined by its rank.  Typically the largest position is 15-20% (at cost), while the average position is 8-10% (at cost).  Positions are held for 3 to 5 years unless a stock approaches intrinsic value sooner or an error has been discovered.

The mission of the Boole Fund is to outperform the S&P 500 Index by at least 5% per year (net of fees) over 5-year periods.  We also aim to outpace the Russell Microcap Index by at least 2% per year (net).  The Boole Fund has low fees.


If you are interested in finding out more, please e-mail me or leave a comment.

My e-mail: jb@boolefund.com




Disclosures: Past performance is not a guarantee or a reliable indicator of future results. All investments contain risk and may lose value. This material is distributed for informational purposes only. Forecasts, estimates, and certain information contained herein should not be considered as investment advice or a recommendation of any particular security, strategy or investment product. Information contained herein has been obtained from sources believed to be reliable, but not guaranteed. No part of this article may be reproduced in any form, or referred to in any other publication, without express written permission of Boole Capital, LLC.

Investing the Templeton Way

October 8, 2023

John Templeton is one of the greatest value investors of all time as well as one of the greatest global investors of all time.  Thus, his methods are worth studying carefully.  The book, Investing the Templeton Way: The Market-Beating Strategies of Value Investing’s Legendary Bargain Hunter, is an excellent summary of Templeton’s methods.  It is written by John Templeton’s niece Lauren C. Templeton and her husband Scott Phillips, both of whom are professional investors.

In the Forward to the book, Templeton remarks:

We should be deeply grateful to have been born in this age of unbelievable prosperity…

Throughout history, people have focused too little on the opportunities that problems present in investing and in life in general.  The twenty-first century offers great hope and glorious promise, perhaps a new golden age of opportunity.

Templeton also notes that he is a value investor:

There are many investing methods available, but I have had the most success when purchasing stocks priced far too low in relation to their intrinsic worth.  Throughout my investment career, I have searched the world for the best bargain stocks available.

Templeton shares his motto:

To buy when others are despondently selling and to sell when others are avidly buying requires the greatest of fortitude and pays the greatest ultimate reward.

Finally, Templeton observes:

Bull markets are born on pessimism, grow on skepticism, mature on optimism, and die on euphoria.  The time of maximum pessimism is the best time to buy, and the time of maximum optimism is the best time to sell.

This is very similar to Warren Buffett’s advice:

I’ll tell you the secret to getting rich.  Close the doors.  Be greedy when others are fearful and fearful when others are greedy.

Here is an outline of this blog post:

    • The Birth of a Bargain Hunter
    • The First Trade in Maximum Pessimism
    • The Uncommon Common Sense of Global Investing
    • The First to Spot the Rising Sun
    • The Death of Equities or the Birth of a Bull Market?
    • No Trouble to Short the Bubble
    • Crisis Equals Opportunity
    • History Rhymes
    • When Bonds are Not Boring
    • The Sleeping Dragon Awakes



John Templeton learned early from his parents the virtues of thrift, industriousness, curiosity, and quiet self-assuredness.  The author Lauren Templeton says,

If I had to characterize his personality in one phrase, it would be ‘eternally optimistic.’

Authors Lauren Templeton and Scott Philips then write that John Templeton—whom they call “Uncle John”—was a value investor, which they define as follows:

We consider a value investor to be an individual who attempts to pay less than what he or she believes is the true value of a specific asset or object.  At the core of this definition is a simple but critical assumption: The price of an asset or object can differ from its true value or worth.

The authors mention that John Templeton probably got his first lesson in value investing from watching his father, Harvey Sr., a lawyer in Winchester, Tennessee.  Harvey Sr. tried many methods of making extra money, such as running a cotton gin, selling insurance, renting property, and buying farm land.  When it came to buying farmland, Harvey Sr. would only bid at auctions that failed to get any bids.  So he bought some cheap properties that ended up being worth much more decades later.

The authors note that a great irony of the stock market is that when prices drop significantly, there are few buyers even though it’s the best time to buy.

Another formative experience for Uncle John was when his father made a fortune in the cotton futures market.  He announced to John and John’s brother that neither they, their children, nor their grandchildren would have to work.  Only a few days later, Harvey Sr. came home and announced, “Boys, we’ve lost it all; we’re ruined.”  This likely caused John to learn not only about the importance of savings, but also about the ethereal nature of paper wealth and the importance of risk management.

The authors record that Uncle John and his wife, Judith, made saving money into a game.  For instance, they furnished their first apartment for $25 (less than $500 today).  One of Uncle John’s favorite purchases was paying $5 for a $200 sofa bed.  A few years later, after having their first child, they bought a house for $5,000 in cash, which they sold five years later for $17,000.  The compounded annual return on that investment was close to 28 percent.  Uncle John never used debt of any kind, including never having a mortgage.  The authors note:

Seeing the lengths to which Uncle John and Judith went to track down bargains is important because it is wholly analogous to the same intensive search process that Uncle John employed in searching for bargain stocks on a worldwide basis.  In a sense, when Uncle John was poring over Value Line stock reports, company filings, and other materials in search of a cheap stock, this practice was an extension of an innate desire to buy something selling for less than what he supposed was its true worth.  Whether it is furniture, a house, a meal, a stock, or a bond, it doesn’t matter: Look for a bargain.

The authors reveal that Uncle John often spoke of a bargain as something that sells for 20 cents on the dollar, an 80% discount.  It’s not easy to find this good of a bargain, but it’s a worthy goal.  Also, keep in mind that Templeton was saving up to launch his own investment counsel practice, which he later did with great success.

The authors continue:

Often in the world of business you will find that the most successful practitioners are driven to heights by a noble purpose.  Although some successful businesspeople are driven by money, many are successful because of altruistic intentions.  Although it often is misunderstood, Sam Walton’s vision at Wal-Mart was to lower the cost of goods for Americans.  He reasoned that this would put more discretionary money in their pockets and thus improve their lives.  Henry Ford wanted to bring an automobile to the masses rather than sell to the wealthy alone like all the other carmarkets at that time.  Rose Blumkin, the original proprietor of Nebraska Furniture Mart (probably the most successful furniture store to date, now owned by Berkshire Hathaway), always told people that her objective was to make nice furniture affordable to improve the lives of her customers.  This concept of “doing well by doing good” was popularized by Benjamin Franklin, and it has been a winning recipe for business ever since.

It is no wonder, then, that Uncle John’s early love affair with thrift and saving guided him to share his gift for compounding his investors’ money in the best bargain stocks he could discover.  Uncle John’s practice of thrift, his talent for bargain hunting, and his fascination with the compounding of interest was the exact formula necessary to make good on the advice of his mother, Vella: ‘Find a need and fill it.’  The need he identified was improving people’s lives by helping them create wealth, and his ability to fill that need was honed over the many years that led up to the launching of his own practice.  By the time Uncle John began his own practice, he had determined his contribution to his fellow men and women and was executing that strategy during every waking moment.

After completing Yale undergrad, Templeton went to Oxford on a Rhodes Scholarship.  During his breaks, he traveled widely.  He also read ahead of time about each place he visited.  The result was that Templeton gained knowledge about many different countries and cultures, which helped him later as an international investor.

Most U.S. investors only invested in U.S. stocks, largely because they believed the U.S. stock market was the only one that mattered.  Templeton, on the other hand, invested all over the world.  For Templeton, if a stock was a bargain, it was a bargain, regardless of where in the world it was.  Of course, finding such global bargains entailed avoiding specific countries where there was political turmoil such as Germany in the late 1930s.

The authors note:

The point is that even back in the first half of the twentieth century, when no one else bought foreign stocks, Uncle John was comfortable investing in other countries because he had taken the time to become knowledgeable rather than be guided by biases.

The authors add:

If there is one thread that stretches throughout Uncle John’s investing career, it is his ability to sit back and act with wisdom, not just smarts, although he has plenty of those too.  When Uncle John was a young child, friends and acquaintences of his mother always said the same thing about him, which was that he was ‘born old.’  The character trait that people saw in him as a young child was a unique blend of common sense and wisdom for someone with very little life experience.  Incidentally, that is what enables him to play a cool hand when it comes to the market.  It sounds so simple: Because he possesses innate wisdom and calmness, he is routinely able to see things that others cannot.  The fact is that it is simple but extremely uncommon.

Simple wisdom is often lacking for most investors:

Many investors say that they are anxious for a big sell-off in the stock market so that they can pick up bargains.  The facts state the case differently, though, when we see the Dow Jones fall 22.6 percent in a single day.  Where were all those enthusiastic buyers when the Dow carried a price/earnings (P/E) ratio of 6.8 in 1979 and stayed at those low levels for a few years?  What we find when we ask these questions is that buying stocks when no one else will is difficult for the majority of investors.  Incidentally, that is the best way to get a bargain, and getting a bargain leads to the best returns.

It is all a matter of perspective, and Uncle John’s perspective on the market is very unusual despite how simple it appears.  Consider this type of perspective in Uncle John’s own words: ‘People are always asking me where the outlook is good, but that’s the wrong question.  The right question is: Where is the outlook most miserable?’  The obvious application of this concept in practice is to avoid following the crowd.  The crowd in this case consists of the majority of buyers in the stock market who continuously flock to the stocks whose prospects look the best.  Avoiding situations in which the prospects look the best is counterintuitive to the way we conduct our normal day-to-day lives.

The authors continue with an observation about Templeton’s move from New York  to the Bahamas:

Uncle John always remarks that his results improved after he moved to Nassau because he was forced to think far differenly than the rest of Wall Street.

Warren Buffett, arguably the greatest investor of all time, lives in the quiet, small city of Omaha, Nebraska, rather than in New York.

Uncle John’s ability to take advantage of the market’s occasional folly or naive misconceptions was honed throughout his childhood and into this college years by sitting at, of all places, the poker table.  Uncle John in his earlier days was an expert poker player, or at the very least he was an expert compared to the boys in Winchester and, later, Yale and Oxford.

Templeton used poker winnings in order to pay for part of his education at Yale.  Templeton excelled at keeping track of cards and calculating probabilities, while simultaneously understanding the abilities and strategies of other players.  Roughly 25 percent of Templeton’s education funding can from poker winnings.  The remaining 75 percent came from working student jobs and winning academic scholarships.

The authors write:

Let’s say you are playing poker with the same group of friends as always and one player has a habit of bluffing under certain circumstances.  Since you have learned to spot this player’s bluffs, you usually can wait until he confidently raises the pot and then call when you are ready to take all of his money.  Well, you cannot exactly call someone’s hand in the stock market, but if a stock is trading at an exorbitant level in comparison to its measures of prospective earnings, cash flows, and the like, you can conclude that the market for that stock, like your friend, is a bit full of it.  In that case, you can be assured that your friend eventually will lose his shirt; and similarly, the market for that expensive stock will fall when investors figure out they are holding not a full house but a pair of threes.



The authors write:

One of the key features of an asset bubble is that the market prices associated with the assets get much too high when the buyers are swept away by optimism and then later, after the market crashes, get much too low compared with the value of the assets as the sellers become pessimistic.  This exaggerated rise and fall typified the years preceding and following the crash of 1929.  Most important, this misbehavior of a stock price relative to the value of the company is not relegated to periods of market bubbles but can be a normal characteristic of daily, weekly, monthly, or yearly stock prices… The notion that a company and the stock price that supposedly represents its value in the market can become divorced from each other has its popular roots in the work and writings of Benjamin Graham, the coauthor of Security Analysis.  Graham postulated, correctly in our opinion, that every company has an intrinsic value; in other words, every company can be assigned a reasonable estimate of what it is worth.  However, in spite of this, the market for a company’s stock can fluctuate independently of the company’s value.

The authors later add:

This relationship is at the core of value investing: buying things for less than they are worth.  That is the idea.  As you will come to see later, you can arrive at this conclusion from a number of different directions.  Most important, this strategy should permeate all your investing, whether you are dealing in stocks, real estate, or even art, baseball cards, or stamps.  Identifying a discrepancy between what an asset is worth and its market price is the name of the game in every case.  Just remember that in each case the price of something and the value of that thing can be far different.  From here on, we will refer to this practice of buying things for less than they are worth as finding a bargain.

Many investors, even smart investors, can forget the difference between a stock price and the value of the company.  People can fall for a story about a company and forget the calculate intrinsic value based on the data.  The authors write:

Bargain hunters should never adopt a one-stop investment strategy that is based on well-told stories whether the stories come from your neighbor, your barber, or the smartest analyst on Wall Street.  Bargain hunters must rely on their own assessment of whether the stock price is far enough below what they believe a company is worth.  This is the sole guiding light on the horizon, and skepticism is the compass.  Buying stocks solely on the basis of stories about companies is like letting the mythological sirens entice you onto the rocks of the shoreline.  That rocky shoreline is scattered with the bodies of investors who listen to stories.

With respect to identnifying overvalued stocks, the authors write:

A tremendous body of research conducted over the last 50 years empirically confirms that stocks carrying a high ratio of price to sales, price to earnings, or price to book value make bad investments over the long run.

Furthermore, the authors assert:

…if you scanned your list of stocks ranked from the highest to lowest ratios of price to sales, price to earnings, price to book, and price to cash flow, you might discover that at the bottom of the list are some of the most unattractive, unexciting companies in the market.  Perversely, these companies have been proven over time to have the most rewarding stocks you can purchase.  If you chose to focus only on the bottom 10 percent of that list for an investment, you would be increasing the probability of your success as an investor a great deal.  Careful bargain hunters find that the bottom of this barrel is a fertile hunting ground for successful stock investments.

Later, the authors write:

When investors overreact to bad news and sell their stocks off feverishly, they are increasing the inventory of bargains for you to choose from; this is the perspective of a bargain hunter.  As a successful bargain hunter, it is to your advantage to have emotional sellers in the market beecause they create opportunities.  Similarly, it is to your advantage to have sellers in the market who are guided solely by the news headlines, the charts they look at, superstition, ‘hot tips,’ or anything else that diverts them from investing on the basis of the stock price relative to a company’s fair value.  The point is that these misguided participants are in the market and should be thought of as your friends.  They will create bargain opportunities for you as well as the best returns after you purchase shares.  In Uncle John’s words (tongue in cheek), these are the very people you want to help.  Your role as a bargain hunter is to accomodate them by offering to buy the stocks they are desperate to sell and sell them the stocks they are desperate to buy.

Uncle John has the benefit of seven decades of experience in the market.  His accumulation of experiences has made spotting bargains in the stock market second nature for him.  We noticed throughout our time investing under him that he kept getting better with each year he continued to invest.

Often what causes stock prices to drop are business problems.  One of the keys to successful value investing is learning to distinguish between problems that are either minor or solvable and problems that are either major or unsolvable.  The authors write:

Understanding the history of the market is a huge asset for investing.  This is the case not because events repeat themselves exactly but because patterns of events and the way the people who make up the market react can be typical and predictable.  History shows that people overreact to surprises [especially negative surprises] in the stock market.  They always have and always will.  Grasping that fact sets the table for bargain hunters to scoop up cheap stocks when a surprise occurs, and anticipating and looking forward to these surprises provides bargain hunters with the mindset to act decisively when the opportunity arrives.  Salivating for a big surprise that sends stocks into a frenzied sell-off is a common daydream for bargain hunters.

At the beginning of World War II, the U.S. stock market declined 49 percent.  Templeton thought this was a massive overreaction because he believed the United States would enter the war and would therefore need a huge amount of commodities and other products, which would be a massive stimulus for many American businesses.  On this basis, Templeton borrowed money—he already had plenty of cash but wanted to capitalize on this opportunity—and bought shares of every stock trading below $1.  Over the course of the next four years, Templeton’s investment quadrupled.

Note that of the 104 companies that Templeton purchased, 37 were already in bankruptcy.  Templeton calculated that the stocks of marginal companies would perform particularly well once the U.S. started producing commodities and other items for the war.  In the end, only 4 out of 104 investments Templeton made didn’t work.  Had Templeton only purchased the better companies, his results would have been far less good.  This is a lesson that a value investor should remain flexible.

The authors compared the results of some typical marginal companies Templeton invested in with the results of some typical better companies Templeton invested in.  As a group, the stocks of some typical marginal companies produced a 1,085% return whereas the stocks of some typical better companies only returned 11%.

Although Templeton’s investments had performed exceedingly well, he still recognized that he had actually sold a bit too early for some of his investments, some of which subsequently increased significantly.  Templeton reviewed his process for selling and made some modifications, which the authors discuss in the coming chapters.



Although global investing is more accepted today, there were many decades—including when Templeton was doing most of his investing—when that was clearly not the case.  The authors write:

When Uncle John launched the Templeton Growth Fund in November 1954, he was on the cutting edge of global investing.  Often referred to as the “Dean of Global Investing” by Forbes magazine, Uncle John never had a problem looking past geographical borders to find a bargain stock to purchase.  There are two commonsense reasons for leaving the domestic market behind to find bargain stocks.  The first is to widen and deepen the pool of possible bargains.  If your goal as a bargain hunter is to purchase only the stocks that offer the largest differential between the stock market price and your calculation of what a business is worth, searching worldwide for these bargains makes sense.  For one thing, the bargain inventory from which to choose is exponentially larger.  For instance, your inventory for selection may jump from approximately 3,000 stocks in the United States to approximately 20,000 worldwide.  Therefore, your chances to succeed over the long-haul are much higher if you stay flexible and let the various stock markets around the world tell you where to invest.

In addition to obtaining a wider selection to choose from, it is common to find relatively better bargains in one country than in another.  If your mission is to exploit the opportunities created by pessimism, fear, or negativity, it is likely that one country will have a better outlook than another.  The differing outlooks and sentiment surrounding the various countries creates asymmetry in the pricing of the assets in one country versus another.  Put more simply, differing outlooks may make stocks a better bargain in one country than in another.

The authors also point out the by investing globally, you gain diversification.  No one can predict which global market will perform best and exactly when it will do so.  By spreading your investments across multiple countries, you can lower your risk without necessarily lowering your return.  Often it can take three to four years for a value investment to pay off, although sometimes it is sooner than that and sometimes later.   If, on the other hand, you were to wait for sentiment to change from negative to positive before investing, then you would be following the crowd and in many cases you would achieve lower investment returns than if you had invested ahead of the crowd.

To be clear: The crowd often achieves results that are average.  Net of fees, the crowd by definition will typically perform worse than a low-cost index fund.

Important Note: One thing that is not discussed in this book is investing in microcap stocks.  Very few professional investors ever even consider microcap stocks.  Therefore, if you focus there and you’re willing to do your homework thoroughly, it stands to reason that you could do well.  Warren Buffett famously commented in 1999 that if he were managing $1 million or $10 million, he would be fully invested.  Why would Buffett be fully invested during a bubble in U.S. stocks?  Because undervalued microcap stocks can sometimes perform well even as larger stocks experience a bubble and the inevitable bust.  In the same quote, Buffett guarantees that he could get 50% annual returns by investing in the most undervalued microcap stocks.

The authors comment:

What may be overlooked by some… is the strong performance of the Templeton Growth Fund during the 1970s.  By nearly all accounts, the 1970s was a difficult era to invest in as it was characterized by a number of treacherous factors.  There was the rise and fall of the famed story stocks known as the Nifty Fifty that grossly misled investors into heavy losses.  If that was not enough, investors also grappled with surging inflation, energy crises, and sluggish economic growth.  That decade provides a solid empirical argument for the benefits of bargain hunting combined with diversification.  In light of all the fluctuation in the economic environment and the lack of a discernably positive trend, the stock market of the 1970s was defined by the fact that the index ended at the same level at which it began the decade.  If you had invested in the Dow stocks at the beginning of the 1970s, chances are that you were invested for the entire 10 years with nothing to show for it.  Taking into account the rate of inflation, you would have lost wealth as purchasing power eroded heavily during that time.

The authors pose a question and then answer it:

Does the stock market have to go up for you to make money?  The simple answer is no.  If you are executing your strategy as a bargain hunter correctly—purchasing only the stocks that are lowest in relation to your estimation of their companies’ worth—you effectively are investing in only the best opportunities available.  In using this method, you are not necessarily tagging along with the performance of the market unless, coincidentally, the stocks that have the lowest price in relation to their worth happen to be in one of the popular market proxies, such as the Dow Jones Industrial Average, the S&P 500, or the NASDAQ.  This has happened before, for example, in the early 1980s, when Uncle John loaded up on the ‘famous name stocks’ in the United States as their P/E ratios had become thoroughly depressed to less than half their long-term averages.  More often than not, though, your collection of stocks will be unknown to most or avoided by most.  The broader idea at work here is to piece together on a stock-by-stock basis your most attractive collection of bargains available in the market.

One important related point is that, as a value investor, you never make a macroeconomic call about a particular country.  Templeton was known for seeming to pick the best countries to invest in.  But he always examined stocks on a case-by-case basis.  Templeton carefully picked the cheapest individual stocks he could find, wherever he could find them.  This strategy often led him to be highly exposed to one country or to a few countries.  But this resulted from bottom-up stock-picking, not from a top-down macroeconomic call.

The authors wisely point out:

The appropriate way to look at the ‘stock market’ is to view it as a collection of stocks rather than an index number.  When you view the market on a stock-by-stock basis, you will find that ay any particular time the stock market contains a number of individual bull markets and bear markets.  In fact, each stock is its own stock market; that is, each stock is composed of a number of buyers and sellers.  In applying this perspective, it is possible to locate a number of stocks that could perform well during a bear market for the indexes or poorly during a bull market for the indexes. (my emphasis)

While you may outperform during a bear market by investing in specific undervalued stocks, you are also likely to trail at times during a bull market.  The authors comment:

History shows that although your overall performance as an investor may be superior to the market averages, you can expect periods in which your performance falls short of the market.  Sometimes you may underperform by a wide margin.  Your edge as a bargain hunter is to have conviction that you did your homework up front and that time is on your side.  The market eventually will recognize what you already know  A few years of underperformance compared to the market should be expected.

If you accept this basic reality at the outset, you will have the psychological strength not to cut and run when the ball does not bounce your way in the short term.  The urge to switch out of your losing investments and into ‘better’ investments—usually meaning something that is rising in price—may be overwhelming.  It is important to resist these urges if your original analysis and research are sound.  No matter whose track record you are examining among the great mutual fund investors who have been at it for a decade or more, you will see that they went through periods of underperformance in spite of their long-term ability to outperform the market.

The authors explain that, during the 1970s, the Templeton Growth Fund produced 22 percent annual compound returns versus 4.6 percent for the Dow.  But the Templeton Growth Fund had lackluster results in 1970, 1971, and 1975 (minus 8.9 percent).  Had an investor abandoned the Templeton Growth Fund after a flat year or after a negative year, they would have missed out on some outstanding returns.  This also illustrates, again, that if you invest in undervalued stocks wherever in the world you can find them, you can produce excellent long-term returns even if there are bear markets in some or most of the global stock markets.

The authors quote advice from John Templeton:

‘The time to reflect on your investing methods is when you are most successful, not when you are making the most mistakes.’

Today, some investors complain about the lack of information when it comes to investing internationally.  The authors note:

To complicate the issue, the naysayers have this one right!  It is generally true that there is less information available on foreign companies, particularly if you are looking to invest in emerging markets.  However, your perspective on this reality can hep seal your fate as a global bargain hunter.  Do you see the glass half empty?  Are you scared off by the lack of information?  Or do you see the glass as half full?  Can you take advantage of this lack of information and seize it as an opportunity to make an investment ahead of the crowd?  Uncle John is the eternal optimist, and his practical response is to roll up his sleeves and do his homework.  Bargain hunters need to realize that finding stocks about which information is lacking is an effective way to find mispricings.

A good example of these information gaps and a working example of how Uncle John tackled them comes from his purchase of the Mexican telephone company Telefonos de Mexico in the mid-1980s.  At that time, the company’s reported numbers were unreliable in Uncle John’s opinion.  His solution was to count the number of telephones in that country and multiply that number by the rate the citizens were paying.  This required a great deal of work and research, but he then was able to determine that the stock price was far too low compared with what the company was worth, using his own projections.  This example may sound a bit extreme, but it is a good illustration of what a bargain hunter must be prepared to do in searching for the truth.

The authors say that the Mexican telephone company stock had gotten cheap because of the lack of information combined with the unwillingness of other investors to search for the information.  The authors write:

Often, the only hurdle is your unwillingness to work just a bit harder than the next guy or gal to get the answers.  Uncle John always considers this intense work ethic as a basic philosophy underlying success, whether in investing or in any other pursuit.  This belief in an exponential payoff to working harder than the next person is whta he refers to as the ‘doctrine of the extra ounce.’  This is akin to a famous piece of advice offered by Henry Ford: ‘Genius is 1 percent inspiration and 99 percent perspiration.’  Uncle John believes that in all walks of life, those who became moderately successful did almost as much work as those who were the most successful.  In other words, what separates the best from all the rest is a willingness to put in that one extra hour of reading, that one extra hour of conditioning, that one extra hour of training, that one extra hour of study.  Everyone has run across someone who was loaded with natural talent in his or her profession, sport, or classroom but never generated the amount of success that was there for the taking.  This reveals that sometimes being the brightest student or the most gifted athlete is a handicap.  This is true in every walk of life and every pursuit, not just investing.  The best bargain hunters realize that the one extra annual report they read, the one extra competing company they interview, or the one extra newspaper article they scan may be the tipping point for the best investment they ever make.

The authors note:

…we have found that the market is still teeming with stocks that have no research coverage or only a few analysts covering them.  These stocks should be considered prime hunting ground for bargain hunters who are willing to put in the work and do some original bottom-up analysis.  Stocks in the foreign markets with very little research coverage can carry major inefficiencies involving what is occurring in their businesses and how the market perceives those businesses.  Looking for and spotting these mismatches is a tried-and-true technique for successful global bargain hunting.

My Note: There are thousands of microcap stocks that have no research coverage at all.  A bargain hunter should not only look globally, but should also look at many of the smallest stocks globally.  I noted earlier Buffett’s assertion that he could get 50 percent per year returns by investing in microcap stocks, even as larger stocks were about to enter a bear market.

The authors next note that Templeton used a low P/E ratio as a way to identify potentially good investments.

This may strike some as very simplistic, but the truth is that the P/E ratio (price divided by earnings per share) is a good proxy or starting point for valuation.  Low P/Es led Uncle John into Japan in the 1960s, the United States in the 1980s, and South Korea in the late 1990s.

The idea is that you want to pay as little as possible for future earnings:

To tilt the probabilities of success in your favor, you should search for a stock priced exceptionally low relative to the earnings of a company that has better than average long-term growth prospects and better than average long-term earnings power…. To give you some idea of what his benchmarks of value were, Uncle John often looked for stocks that were trading at no more than five times the current share price divided by his estimate of earnings five years into the future… Likewise, he has remarked that occasionally he was able to pay only one to two times his estimate of earnings to be reported in the coming year.  That, of course, is dealing in an extreme situation of depressed value.  However, this is exactly what bargain hunters must be on the lookout for: extreme cases of mispricing.

Of course, it’s quite difficult to forecast the future earnings of a company, especially five years into the future.  But most analysts use historical figures to make such forecasts.  You have to assume average performance relative to a company’s history, which can include some great performance but also some lousy performance.  Of course, if there is a really compelling reason to expect stellar future performance, then if the price is right, you may have found an excellent investment.  The most important question is: what are the competitive advantages of the company?  As Warren Buffett has remarked,

‘The key to investing is determining the competitive advantage of any given company and, above all, the durability of the advantage.  The products or services that have wide, sustainable moats around them are the ones that deliver rewards to investors.’

If the company has a durable competitive advantage, it becomes easier to forecast future earnings and therefore easier to determine if today’s stock price represent a bargain relative to those future earnings.

When it comes to curriences, Templeton assumed that currency trends tend to last for years.  Also, less risky currencies exist in countries with modest borrowing and high savings rates.  One potential problem in democracies is the voters tend to prefer more spending rather than less.  When politicians give the voters more spending, this eventually leads to inflation if the country has to keep increasing its overall government debt levels.  The higher the inflation, the faster the currency in question is losing value.

Templeton had a way of measuring the riskiness of investing in a given country:

First, if you want to avoid companies operating in riskier currencies, focus on companies with over 25 percent of their business performed in countries that export more goods than they import.  From another perspective this means that the exporter is accumulating reserves, or savings, and the purchase of its goods from other nations also can create upward pressure on the exporter’s currency (which thus should stabilize or even increase in value).  The second thing to determine is that the country does not have government debts that exceed 25 percent of its annual gross national product.  This measure gives bargain hunters a benchmark for what a conservatively managed government balance sheet should look like.  The problem that heavily indebted countries run into occurs when creditors or investors fear that they will not be repaid or will be repaid with a currency that has been devalued.  When creditors and investors become worried for these reasons, the flight from debt or investments they hold in the heavily indebted nation creates selling in that country’s currency, and the selling causes it to lose value.

Another basket of risks for bargain hunters to consider relates to the political landscape of a country they are considering for investment.  As we mentioned above, Uncle John is a huge proponent of free enterprise and the freedom of individuals to pursue their interests.

China is a good example, the authors note, of a government that believes in capitalism and freer markets.  Although the government in China is communist, the amazing wealth created in that country is because of its capitalist and free market realities.  Venezuela, on the other hand, is supposedly a democracy, but its leader has nationalized assets and transferred ownership from private to public hands.  Venezuela should be competely avoided by global bargain hunters.  After all, what is a business worth to global investors if the government can simply nationalize its assets?  The authors write:

The consequences of nationalized assets are often chronic underinvestment of outside capital and public capital, followed by the eventual underutilization and underperformance of the nationalized assets.  As a bargain hunter, you should avoid these situations at all costs.

The bottom line:

…nationalizing assets not only represents a poor investment but also goes against a deep philosophical belief that Uncle John holds.  That belief is that free enterprise and the competition that results from it lead to progress.  Progress is a very good and necessary thing for businesses.  Progress is also a very good and necessary thing in all walks of life, whether technology, science, or any other discipline.  When competition is stifled, progress is too.

My Note: As Ray Dalio points out in Principles for Dealing with the Changing World Order, the most fundamental force in human life is the force of evolution.  Evolution and innovation are what cause the economy to keep growing—through improvements in productivity—making most people better off on a per capita basis.

Both the United States and China, although using different political systems, are set up to maximize the improvements in productivity that result from the force of evolution being unleashed in free market competition.  To varying extents, many other countries around the world are set up to unleash the force of evolution through free market competition.



The authors record:

There is no question that his heavy investment in Japan was led principally by the demonstrably low P/E ratios and high growth rates that the stocks and their companies carried in the 1950s and 1960s, but his intention to sit tight in the holdings and wait for their market values to rise no doubt was driven by viewing firsthand the same qualities that he held in such high esteem: thrift, focused determination, and hard work.  The people of Japan embodied those ideals, and the companies that employed them became economic manifestations of those characteristics.

Although Japan was viewed as a producer of inferior cheap products during the 1950s, the country was already transforming itself into an industrial power.  During the 1960s, Japan’s GDP grew at 10.5 percent per year, more than twice the GDP in the United States.

Templeton invested his personal savings into Japan in the 1950s.  But Japan had a policy of not allowing foreign investors to withdraw their investments.  As a result, Templeton waited before investing his clients’ money.  Templeton thought that eventually Japan would open its markets, and by the 1960s he was right.

The authors compare:

In the early 1960s, the Japanese economy was growing at an average rate of 10 percent and the U.S. economy was growing at an average rate of around 4 percent.  In other words, the Japanese economy was expanding 2.5 times faster than the U.S. economy, but many stocks in Japan cost 80 percent less than the average of stocks in the United States (4x P/E versus 19.5x P/E).  These are tremendous discrepancies, particularly when we consider investors’ long-standing love affair with high-growth companies.  How could such a discrepancy in the pricing of assets exist?  There are many cited reasons.  The reasons relate to the prevailing conventional wisdom at the time or simple misunderstandings.  The first reason is that investing overseas, particularly somewhere as exotic sa Japan in the 1960s, was basically too avant-garde for the time.

Moreover, the reasons given for not investing included the following:

‘Fluctuations in stock prices are too extreme.’

‘There is not enough information.’

The authors write:

Believe it or not, those are direct quotations.  As we can see, two of the main objections among active investors… were the exact things that Uncle John looked for in his search for bargains around the world.  Ironically, these two characteristics that kept investors away from Japan were the very things Uncle John found attractive in an investment environment.  Furthermore, these are just the reasons offered by professional investors.  There was another, broader layer of negative sentiment among the public in the developed markets.  That public sentiment was something along the lines of ‘Why would anyone invest in Japan?  After all, they lost the war.  They make trinkets in their low-wage factories and could never match the power and might of the United States in business.’  Those biases against the Japanese were inaccurate, unfair, and ignorant.  Most important to the bargain hunter, though, without their existence the prices of those stocks would not have been so low relative to the intrinsic worth of their companies.

The authors add:

Welcome to the world of neglected stocks.  This realm is one of your most cherished sanctuaries as a bargain hunter.  In many cases, when you are exploiting neglected stocks, you are not necessarily dealing with a large array of ‘problems’ at the company level or even the industry level.  Instead, you are tackling a heavy misconception or the mere obscurity of a stock in the broader market.  You might question how the market could overlook or ignore what was occurring in Japan at the time and chalk it up to the ‘unsophisticated’ nature of investors in the 1960s.  You might believe that these situations no longer occur in the modern market.

But this is not necessarily true.  These kinds of bargains continue to appear form time to time in various countries and regions around the world.  The authors say:

Sometimes the best opportunities are in plain view, but when investors see other investors passing them by or deriding them, they too pass.  Social proof is a powerful force, but work hard not to let it guide your investment decisions.  Often, what can happen—and what did happen in the case of Japan in the 1950s and 1960s—is that the entire economy can be transformed unnoticed by the crowd simply because they were unwilling to look in that direction.

Undervalued stocks may involve companies that are not expected to grow or they may involve companies that are expected to grow.  The authors write:

Uncle John’s main goal is to buy something for substantially less than its worth.  If that means purchasing somethingn with limited growth potential, that is okay; if it means buying something that should grow at a double-digit clip for the next 10 years, that is even better.  If the company is growing, the point is to avoid paying for the growth.  Growth in a company is a wonderful thing; your returns on a stock can go on for years if you spot good bargains in growing companies.  However, this is not an excuse to pay too much.  If you hypothesize that a company is about to knock the cover off the ball and be a long-term grower and then discover that the stock price has been bid up in anticipation of that growth, move on.  There is no reward for getting the fundamentals right if they already are built into the stock price.  As a bargain hunter, you should be focused on extreme mismatches between the way a stock is priced and what it is worth, not simple nuances.  These mismatches can occur in any type of company, at least from time to time.  Thus, as a successful bargain hunter you must remain agnostic about the superficial distinction between a value investor and a growth investor and resist creating biases that prevent you from spotting bargains.

Over time, Templeton thought carefully about when to sell a stock.  He came up with the notion that the time to sell a stock is “when you have found a much better stock to replace it.”  The authors note:

This practice of comparison is a productive exercise because it makes the decision to sell far easier than it is when you focus on the stock and the company in isolation.  When a stock price is approaching your assessment of what it is worth, that is a good time to be searching for a possible replacement…

To prevent the possibility of churning your stocks and creating wasteful activity, Uncle John recommends that you purchase a replacement only when you have found a stock that is 50 percent better.

Later, the authors write:

For Uncle John the decision to exit Japan was simple; he was finding better bargains in Canada, Australia, and the United States.  There was no qualitative factor that guided the decision; instead, the decision was predicated on the simple calculations of stock prices compared with the values of the companies.  Applying qualitative reasoning in this decision-making process would have muddled his judgment, and maintaining clear judgment is a central tenet in successful bargain hunting.



In August 1979, Business Week had the following statement:

The death of equities looks like an almost permanent condition.

During the decade of the 1970s, U.S. stocks moved sideways and also experienced a couple of big drops.  As a result, many investors did feel that equities were “dead.”  The cover of Business Week said “The Death of Equities.”

Moreover, investors who had invested in commodities, real estate, or collectibles had done quite well during the 1970s.  The authors point out:

Of course, nearly 30 years later the magazine cover and the article penned on this theme are thought of mostly as a joke.  Many point to the cover as a fantastic buy signal for the stock market and an equally good time to exit commodities.  Bargain hunters in the stock market should have taken the magazine cover and the views that supported it as a point of maximum pessimism.  The market of 1979 and the three years that followed represented a state of nirvana for bargain hunters.

The authors then comment on the fact that finally pension funds gave up on stocks and were preparing to invest in real estate, futures, gold, and even diamonds.  The authors write:

When we think about this… it appears to be saying that the last holdouts in stocks are ready to sell.  So if we have reached a point where the last group of sellers is exiting the market, can prices fall much more after they finish selling?  No.  If the last batch of sellers leaves the market, you must have a keen eye to be the buyer on the other side.  Once all the sellers are gone, logically, there are only buyers left in the market.  Conversely, what about commodities?  They had been on a good run, and now the last group of buyers was coming into that market.  Once they were in, who else was left to buy commodities and bid them higher?  No one.  It should not be taken as a coincidence that the commodities market and the stock market were on the verge of trading places once the last group of sellers in one because the last group of buyers in the other.  This is an example of the mechanical logic that underlies contrarian investing.

The authors reiterate the fact that whenever there is a bubble, whether in stocks, commodities, or something else, you hear statements that it is a “new age” for investing in it.  You also tend to hear that “older investors don’t get it.”  Ironically, older investors were the ones who owned stocks from 1979 to 1982, the bottom of the stock market and the beginning of an 18-year secular bull market in stocks.  In investing, being older is an advantage because investing is a game where you get better with age and experience.

In brief, it was widely thought that it was “the death of equities” and a “new age” for commodities.  Exactly the opposite was true.  It was one of the best times in history to buy equities and one of the worst times in history to buy commodities.

A value investor could have recognized that equities were at one of their cheapest points in history simply by looking at P/E (price-to-earnings) ratio’s, which were near all-time lows.  Similarly, the P/E ratio’s for commodity-related stocks were near all-time highs.

As usual, Templeton coolly evaluated the situation from a value investor’s point of view.  He saw that U.S. equities had exceptionally low P/E ratio’s.

By the time 1980 rolled around, Uncle John had 60 percent of his funds invested in the United States.   That was in stark contrast to the stock market consensus at the time, which was that equities were dying on the vine thanks to runaway inflation.  Investors ran away from U.S. stocks as if they were a building on fire, but Uncle John took the opposite approach and calmly walked in the front door to size up the damage.  He did benefit from a fresh perspective on the market since he had not been riding U.S. stocks down into the pit of despair along with everyone else over the previous 10 years…

Why was Uncle John so bullish on American stocks when no one else would touch them with a 10-foot pole?  One part of the answer is simple: No one would touch them with a 10-foot pole.  The second part is that this prevailing attitude left some of the best-known, most-heralded companies in the United States, members of the Dow, trading at historical lows relative to earnings as well as book value, among other measures.

In fact, Uncle John researched the matter and could not find an instance in the history of the U.S. market in which stocks had been cheaper.  Keep in mind that this includes the Great Depression and the crash that began in 1929…. the 1979 average P/E ratio of 6.8 was in fact the lowest market on record.  In contrast… the long-term average P/E ratio for the Dow is 14.2x.

The authors then note that Templeton used many different measures, not just the P/E ratio, to determine when stocks were undervalued and thus a bargain.

Uncle John’s approach to bargain hunting always involved being able to apply one of the ‘100 yardsticks of value’ that were available to a securities analyst.  There were two good reasons for taking this approach.  The first and perhaps most important is that if you are limited to a single method of evaluating stocks, you periodically will go through times, even years, when your method does not work.  This concept is analogous to why you should never invest solely in just one country’s stock market for the lifetime of your investments.  If you stick with one region, country, market, or industry, there will be periods when you will underperform the market averages… Thus, if you rely on only a P/E ratio to evaluate stocks, there will be times when you cannot find value with that measure, but perhaps you could have with another, such as the ratio of price to cash flow.  For that matter, one cannot guarantee that your method for bargain hunting will not become obsolete.

…The second good reason to use many yardsticks of value is to accumulate confirmation of your findings from different methods.  If you can see that a stock is a bargain on five different measures, that should increase your conviction that the stock is a bargain.  Raising your conviction level is an important psychological asset as you face the volatility of the stock market.

Note: The Boole Microcap Fund uses five metrics for measuring cheapness:

    • EV/EBITDA – enterprise value to EBITDA
    • P/E – price to earnings ratio
    • P/B – price to book ratio
    • P/CF – price to cash flow ratio
    • P/S – price to sales ratio

The authors continue by noting that Templeton found that many U.S. companies in the late 1970s and early 1980s were trading at a low P/B (price-to-book value).  When a company has a low P/B ratio, that means the market has low expectations for the business in question.  Often these low expectations are justified if the business is performing poorly and will probably keep performing poorly.  However, sometimes a low P/B is based on temporary rather than permanent problems, in which case the stock may be a bargain.

Furthermore, Templeton realized that the replacement value of the assets for many businesses was actually much higher than the stated book value of the assets.  As a result, the companies with low P/E were actually trading at exceptionally low price/replacement value.  In fact, Templeton argued that on this basis stocks were at all-time historical lows.  The price/replacement value was about 0.59.  The authors comment:

The practice of looking deeper into the numbers goes back to our lesson about Uncle John’s doctrine of the extra ounce.  Only bargain hunters willing to put in extra work and extra thought would have uncovered the notion that stocks had never been cheaper in the U.S. market when viewed in terms of their replacement value.

In a similar vein, there is a parallel between this replacement value analysis and the analysis that Uncle John used to uncover the hidden value in the Japanese market that was discussed in Chapter 4.  In the instance of Japan, Uncle John made adjustments to the earnings of Japanese companies to account for the unreported earnings of the subsidiary companies held by a parent company.  In this case, Uncle John uncovered hidden value by adjusting the asset values of U.S. companies to their market values.  In both cases, Uncle John exploited an inefficiency in information that was not seen by casual observers.

Another clue that Templeton focused on indicating that stocks were significantly undervalued was that there was a large number of corporate takeovers.  Most businesses are well aware of what their competitors are doing.  When a competitor becomes undervalued, many businesses will try to acquire it.  So the fact that there were many corporate takeovers means many businesses thought some of their competitors were undervalued.  The authors note:

Uncle John became even more encouraged that the market was full of bargains when he saw that the prices competitors were willing to pay for those companies ranged from 50 percent to 100 percent above the market value of the target’s stock price.  This observation can translate into an everyday bargain-hunting strategy.  Many astute bargain hunters keep an active watch on the market values of companies whose value becomes too low relative to historical takeover levels in the industry.  The most common way bargain hunters detect these relationships is by examining the “enterprise value” of a stock relative to its earnings calculated before interesting, depreciation charges, and tax charges (commonly called EBITDA, an acronym for earnings before interest, taxes, depreciation, and amortization).  The enterprise value of a firm is simply the stock market equity value of the company plus the amount of debt the company has minus the amount of cash the company carries on the balance sheet.  The idea behind the ratio in this use is to get an idea of what a company would cost to purchase in its entirety, since you would have to purchase the equity from the shareholders and assume the company’s debt or pay it off.

The point in this calculation is to get a thumbnail sketch of what the takeover value of a company is relative to its “cashlike” earnings.  We say that EBITDA is “cashlike” because it often is used as a proxy for cash earnings, but it has some obvious blind spots.  In a working example, if we divide the enterprise value of our company by its EBITDA and find that the company’s enterprise value is 3 times its EBITDA and we have observed competitors in the industry buying other companies for 6 times their EBITDA, we may be able to conclude that the stock is a bargain on this basis.

Yet another thing that Templeton saw was that many companies were buying back their own stock.  When business leaders, many of whom understand their company and its value well, are buying back stock, that means they believe the stock is very undervalued.

The last clue that Templeton noticed was that there was an overwhelming amount of cash on the sidelines.

In 1982, Templeton appeared on the Louis Rukeyser show Wall Street Week.  He predicted that the Dow, then trading in the low 800s, would reach 3,000 over the coming ten years.  Viewers of the show and other market watchers thought Templeton had lost his mind.  But Templeton was using simple arithmetic.

Uncle John said that if corporate profits grew at their long-term average growth rate of about 7 percent and inflation remained at an expected run rate of around 6 to 7 percent, overall profits would increase approximately 14 percent a year.  If those 14 percent gains compounded annually, the values of the stocks would nearly double over the next five years, and if that held up, they would double again in the next five.  This corporate earnings activity alone would not require the stock market to assign a higher P/E multple in order to double.  However, with the Dow’s P/E ratio at around 7x compared with the long-term average of 14x, it was reasonable to see the index getting a lift from a return to the average P/E ratio as well.  Then, with all the money sitting on the sidelines and not being invested by institutional buyers, he believed that they was latent firepower to be deployed that would help drive the index higher.  In sum, with the environment as poor as it was and all the bad news priced into stocks, the probabilities of conditions improving were very much in his favor as well as the favor of all those holding U.S. stocks.  In the nine years that followed, his prediction proved correct.

Templeton had the courage not only to examine the situation of U.S. stocks with an open mind, but also to act once he realized how cheap U.S. stocks were.  One strange thing about people is that, even if they realize there are bargains among stocks, most people will not buy them until much later when the stocks are no longer great bargains.  In other words, most people feel comfortable following the crowd and so they miss chances to buy bargain stocks.

The authors conclude the chapter:

The way to overcome this human handicap is to rely on quantitative reasoning versus qualitative reasoning.  Uncle John always told us that he was quantitative in practice and “never likes a company, only stocks.”  If your investing methodology is based primarily on calculating the value of a company and looking for prices that are lowest in relation to that value, you would not miss the opportunity found in the death of equities market.  However, if you take your cue only from market observers, newspapers, or friends, you will be dissuaded from investing in stocks where the outlook is not favorable.  In contrast, if you are independent-minded and focus primarily on numbers versus public opinion, you can create a virtuous investment strategy that will endure in all market conditions.  Put another way, if you are finding stocks that are trading at their all-time lows relative to their estimate worth and you find that all other investors have quit the market for those stocks, you are exploiting the point of maximum pessimism, which is the best time to invest.



Lauren C. Templeton describes visiting her Uncle John Templeton in early 1999.  Lauren asked him if he was buying technology stocks.

…[Templeton] described a number of financial market bubbles that spanned centuries, going back to tulips in Holland in the 1630s.  There was a Mississippi bubble conceived by French speculators, a South Sea bubble in England, and of course a railroad boom and bust.  Even in more modern times there have been speculative bubbles in wireless radio communication, cars, and televisions.  Uncle John has always been fascinated by this behavior, even to the point of having the Templeton Foundation Press issue a reprint of Extraordinary Popular Delusions and the Madness of Crowds.  What I found most remarkable about this recounting of economic activity that morphs into public euphoria were the common threads of economic circumstances and human behavior in each instance.  When you take the time to study the events, even the ones going back centuries, there are familiar elements in each one.  If you remember the Internet bubble, you probably have a rough sense of deja vu when you examine the South Sea bubble in spite of the fact that it occurred in eighteenth-century England.

The authors continue:

Take the automobile industry.  In its nascent stages during the early 1900s there were few barriers to entry in the business.  Just as the late 1990s and 2000 displayed a virtual explosion of dot-com companies, the early commercialization of the automobile in the United States in the period 1900-1908 brought a flurry of 500 automobile manufacturers into the industry.  The early automobile producers were really assemblers of parts rather than large-scale manufacturers, just as many early dot-coms simply had an idea and could build a Web site.  In either case it did not require much capital to start up a business.  Similarly, the public did not seem to contemplate the fate of the initially large number of players, and only the sheer force of competition eventually separated the winners from the losers.

This stands to reason, because the public usually grossly overestimates the industry at the outset.  In both industries whose booms and manias were separated by nearly 100 years, the large number of original players shrank dramatically after the busts.  Once competition forced the companies to survive on their own ability to make money rather than by raising money from investors, the party ended for the ones just along for the ride.  For every General Motors there are several New Era Motors Inc., and for every eBay there are several Webvans.  During the building mania phases when the public joins the fray, its willingness to support anything attached to the new industry is maximized.  In turn, investors often supply capital to even the most suspect newly hatched operators.  Those operators go belly-up when they are no longer supplied with capital, and the naive investors who backed them lose tremendous sums.

Another common thread in every stock mania is the outward display of optimism, with little regard for downside risk.  Typically, this optimism is buoyed by outrageous projections of growth for the industry.  Also, that growth is perceived to develop in a straight-line fashion without significant disruption.  When the automoble industry started a period of rapid growth during the 1910s, the unbridled optimism of endless growth was embraced as a simple fact.  Coinciding with this notion of endless growth was a latent assumption that there would not be a disruption in growth; instead, it would continue in a straight-line fashion.

The authors point out that in technology bubbles, it is often trumpeted that there is a “new age.”  This tends to be true in terms of the benefits of the new technology.  But that does not change the fact that there are so many new companies, most of which will never earn a profit and thus aren’t good investments for a bargain hunter.  The authors write:

Remember the first rule in bargain hunting for stocks: Distinguish between the stock price and the company the stock represents.  In this case speculators took the bright idea and bought it regardless of the stock price.  The stock price was irrelevant except that it was assumed it would continue to go higher becuase those companies were changing the world and nothing could stop their growth.  Speculators are always drawn into these investments because of the allure of the idea and the growth that is sure to follow.  As the automobile frenzy ensued in the years that followed, it became clear that the stock market had fallen under its spell of endless growth and profits.

The authors continue:

The auto stock traders bought cars with their winnings in the early 1900s, and the day traders of the 1990s took nice trips and bought electronics.  Different time, same story.  This behavior can lead to disastrous consequences when the speculators become more aggressive in spending their assumed wealth, which can be gone before the end of the trading day.  Similarly, when a large part of the public connects patterns with a forecast of increasing stock prices, it can have negative consequences for the economy when stock prices collapse and spending falls.

In the South Sea bubble in 1720, the South Sea Company,  a merchant shipping vessel company, struck a deal with the British parliament.  The South Sea Company would assume England’s debt, which the government would secure by giving South Sea a monopoly on trade in the Spanish Americas.  The authors report:

Seizing the opportunity, the South Sea operators quickly devised a plan to retire all of England’s debt in a similar fashion with the sale of equity.  Once the deal was approved and the stock was sold, visions of endless mines of gold and silver in South America and the riches that would accrue took hold of the public imagination.  Moreover, the directors of the company pushed those rumors to raise the stock price.  The draw of riches from the New World was too much to resist, and the English public became consumed with trading South Sea stock.  Observers who were befuddled by the day traders of the late 1990s would have been equally floored by the maverick day traders of South Sea stock in 1720.  Day traders have been an ongoing fixture in bubbles dating back at least to eighteenth-century England.  In every instance, their willingness to leave all their worldly duties behind in exchange for stock market riches has been unquenchable.

As the Pall Mall Gazette recorded in 1720:

“Landlords sold their ancestral estates; clergymen, philosophers, professors, dissenting ministers, men of fashion, poor widows, as well as the usual speculators on ‘Change, flung all their possessions into the new stock.”

The authors write:

The South Sea bubble, much like the Internet bubble, enticed all members of society.  The simple fact is that the attraction of easy wealth to a human is unbounded by time or geography.  No member of society is exempt.  Even the best minds of the time fall prey to it; Sir Isaac Newton lost substantially in the bubble.

There were people who warned against the South Sea bubble.  But there are always naysayers against bubbles, and the public tends to bowl right over the naysayers against bubbles.  In the dot-com bubble, day traders were glorified while old guard bargain hunters were criticized for missing the easy new wealth.  For instance, Julian Robertson and Warren Buffett, two of the greatest investors in history, were not long dot-com stocks and were criticized accordingly.  There was a Barron’s article titled, “What’s Wrong, Warren?”  The article said:

“To be blunt, Buffett, who turns 70 in 2000, is viewed by an increasing number of investors as too conservative, even passe.”

Moreover, during bubbles, there are always unscrupulous figures that emerge to take advantage of the situation.  Bernie Ebbers, the CEO of MCI WorldCom, was one such figure.  The company used its inflated share price as currency to buy out competitors.  However, eventually the company couldn’t find any more acquisitions, and so its reported earnings stopped going up and then later evaporated.  So Ebbers began fraudulent accounting in order to mask the declining conditions of the business.  Eventually the fraud came to light and Ebbers was imprisoned.  Investors ended up losing $180 billion.

The authors then mention Abraham White, who played a prominent role in the wireless telegraph bubble of 1904.  Guglielmo Marconi launched Marconi Wireless Telegraph Company, while a rival Lee De Forest formed the Wireless Telegraph Company of America.  De Forest, trying to catch the leader Marconi, needed to raise capital.  He met Abraham White.

White’s tactics as president can be be described as promotion on steroids with the intent of raising as much money as possible from the public.  There were publicity stunts such as fastening a wireless tower to a car and parking it on Wall Street, and they constructed a useless wireless tower in Atlanta to gain public attention.  Before long, White had raised the capital amount to $5 milion, or about $116 million in today’s dollars.  Shortly thereafter he merged the company with the International Wireless Company, [a] group of equally shady characters… Reportedly, the International Wireless Company, once the American Wireless Telephone and Telegraph Company, had been transformed under a string of acquisitions consisting of suspect stock-jobbing operators.  The combined company was thought to be worth $15 million ($350 million in 2006 dollars).

White pushed De Forest out and then focused on trying to inflate the stock price.  He issued phony financial reports to the press and sent promising prospectuses to investors.  He also used carnival-like publicity stunts.  Here is what White said in one speech:

“A few hundred dollars invested in De Forest stock now will make you independent for life.  Tremendous developments are under way.  Just as soon as the company is on a dividend basis the stock should advance to figures practically without limit.  If set aside for two years it is morally certain to be in demand at 1,000 percent or more present prices.  Those who buy will receive returns little less than marvelous.  A hundred dollars put into this stock now for your children will make them independently rich when they reach their majority.”

Money that came in from share sales were listed in the financial statements as revenue.  Thus the only way to boost revenue was to sell more shares.  White started exaggerating more than ever.  He promised President Roosevelt wireless messages to Manila in 18 months.  White promised a San Francisco-New York line.  He promised instant messages  from the Pacific coast to China.  The authors write:

By 1920, Abe White’s game was over.  The feds raided his offices in New York, citing the reams of literature that had been sent out extolling marvelous growth and an impregnable financial condition.  In sum, they were looking for mail fraud on the basis of the deluge of fantastical mailings and solicitations sent form the United Wireless offices.  What they found probably surprised them.  The feds discovered that the supposed assets of the company of $14 million did not exist; the value of the company’s assets was about $400,000.  The directors had controlled the stock through a lockup for the public holders by stamping the shares nontransferrable until 1911.  In the meantime, the directors kept adjusting the prices of the stock upward on the basis of new contracts (which were in fact money-losing) in $5 increments.  The stock began selling at $1.50 and was adjusted over time to $50.  In the meantime the directors unloaded their stock on the captive public, who could not sell it, at ever higher prices.  This scheme resulted in the fleecing of 28,000 shareholders who had been rabid for wireless company shares.  The feds relieved Abe White of his 15 million shares, which, priced at $50 before the raid, had run his personal stake to $750 million in 1910, or about $16.2 billion in today’s dollars.

The stories of Bernie Ebbers and Abe White unveil the ugly sides of stock manias.  Both show how crooks exploited greed among naive speculators and sold them a bag of lies.  However, even in the perfectly legal and morally acceptable circumstances surrounding stock manias, investors buy into a constant succession of newly issued stocks at exorbitant prices on the basis of what can only be called naive misconceptions.

In most stock manias, companies selling stock to the public for the first time through initial public offering (IPO) are even more frequent.  In the dot-com bubble, most companies that IPOed did so at vastly inflated prices, given that most of these companies ended up being worth zero.

John Templeton recognized the dot-com mania for what it was: a huge bubble.  Author Lauren C. Templeton writes:

I was at home with my parents for Christmas in 1999 when my father walked into the room and told me he had just received a fax from Uncle John.  The fax contained a relatively long list of NASDAQ technology stocks that Uncle John recommended selling short.

Again keep in mind that there were many technology stocks whose businesses were worth zero.  The P/E ratio of the NASDAQ in December 1999 was 151.7x.  Truly unbelievable!

However, leading up to 1999, there were many intelligent investors who tried to sell short the technology bubble.  These short sellers were crushed as stock prices kept rising.  The authors record:

Stocks went higher because the crowd willed them higher with more buying.  Stocks went higher simply because they had gone higher the day before.  Neophytes became stock market geniuses after one trade.  Day traders were running the show, and the main feature was momentum.  It was the only program, and if you did not like it, there was nothing else playing.  The concept of valuing a stock or the notion that a stock’s prices should be constrained by the company it represented was masked by the party tub of tech Kool-Aid, and too many people were drinking from it.

The authors talk about the perils of being early as a value investor.  When you’re long a stock that you believe is undervalued, but you’re early, you can have paper losses on your position.  But a stock that goes down becomes a smaller problem relative to the portfolio and is bearable.  The most you can lose is 100% if the stock goes to zero.

However, when you’re short a stock, you could potentially lose infinite amounts because there’s no limit on how high a stock can climb.  Therefore, it’s much more treacherous trying to short overvalued stocks, especially in a bubble when all stocks keep screaming higher.  There were many, many short sellers in 1997 to 1999 who lost tons of money and had to close their positions, locking in those losses.

So the question is: How do you short technology bubble stocks?  The authors write:

If only there was a way to figure outo what would spark the selling in those stocks and bring down the biggest charade in the history of twentieth-century markets.  There was.  Uncle John took a different perspective on this phenomenon to discover a hidden gem in the market and a highly probable approach to generating short sell profits rather than losses.  If there is one psychological element present in a stock market bubble, it is greed.  It is an old flaw among humans, and it is manifested routinely in the stock market.

The point is that there were buyers who were eager to cash out.  The young and old executives of the technology firms that were coming to the stock market in an IPO wanted to sell.

There are a couple of useful observations about IPOs in general that we can make as bargain hunters.  The first is that typically managers offer stock to the public when there is great enthusiasm for shares in an absolute sense.  It is widely accepted that no one can time the tops and bottoms of stock market runs, but it generally is accepted that a sudden surge in IPOs suggests that a market is inflating because managers and investment bankers try to maximize the amount of money they can raise for the company when they take it public.  Coincidentally, their efforts can run in parallel with more expensive market levels or, for that matter, with the later stages of a bull market.  The second observation is that when IPOs are made, the enthusiasm for the shares often pushes the offering price above its intrinsic value because of the heavier than normal demand.  It is not  unusual to see shares fall in price months after an IPO takes place as enthusiasm and demand die down and normalize when the stock is traded freely in the open market.

The authors continue:

In the IPO market of 1999 and 2000, the new-issue market was a quick way for business managers to cash out their inflated stakes at the public’s expense, and in many cases there were abuses.  Uncle John recognized that among all the participants in the technology stock bubble, those stockholders had the biggest incentive to sell.  Those company managers, or “insiders,” knew what kind of hand they were holding (a weak one) and were more than ready to cash out and take their winnings early.

That said, often there is a lockup period of 6 months during which insiders cannot sell after the IPO.  Templeton thought that when insiders were able to sell, they would do so, which would create the catalyst for the technology stock bubble to finally pop.  Day traders had the strategy of buying what was going up and selling what was going down.  If stocks were widely declining as insiders were selling, that would create a chain reaction in which day traders would also sell.  This would create a huge crash in technology shares.

Uncle John devised a strategy to sell short technology shares 11 days or so before the lockup expired in anticipation of heavy selling by insiders once they were allowed to unload their shares on the public.  He concentrated on technology issues whose values had increased three times over the initial offering price.  He reasoned that stocks that had increased that much in value provided an extra incentive to insiders to cash out and sell their holdings.  In sum, he found 84 stocks that met this criterion and decided to place a position of $2.2 million into each short sell.

All told, he bet $185 milliopn of his own money that tech stocks would plummet at the height of the bubble.  In the second week of March 2000, plummet they did…

Templeton taught to buy at the point of maximum pessimism, which is when there are no sellers left.  By the same logic, you want to sell (or short sell) at the point of maximum optimism, which is when there are no buyers left.

All of that said, it’s wise to use stop-losses if you decide to try to short bubble stocks.  In other words, determine ahead of time that you will close your short position if the stock goes up, say, 20% or more.  Templeton used an approach like this to control his losses from short selling.  Specifically, when a stock came out of its lockup period, if it increased strongly, Templeton closed his short position.



The authors write:

One way to think about the strategy of purchasing shares in the wake of a crisis is to relate the current crises to the same strategies that a bargain hunter employs on a daily basis in common market conditions.  First, the bargain hunter searches for stocks that have fallen in price and are priced too low relative to their intrinsic value.  Typically, the best opportunities to capture these bargains come during periods of highly volatile stock prices.  Second, the bargain hunter searches for situations in which a large misconception has driven stock prices down, such as the arrival of near-term difficulties for a business that are temporary in nature and should correct over time.  In other words, bargain hunters look for stocks that have become mispriced as a result of temporary changes in the near-term perspectives of selling.  Third, the bargain hunter always investigates stocks when the outlook is worst according to the  market, not best.

A crisis sends all these events into overdrive.  Put another way, when the market sells off in a panic or crisis, all the market phenomena a bargain hunter desires condense into a brief and compact period: maybe a day, a few weeks, a few months, perhaps even  longer.  Typically, though, the events and reactions to them do not last long.  Because of their ability to grip sellers, panics and crises create by far the best opportunities to pick up bargains, which drop into your lap if you have the ability to stay seated while everyone else dashes out the door.

To summarize, bargain hunters seek volatility in stock prices to find opportunities, and panicked selling creates the most volatility, usually at historically high levels.  Bargain hunters seek misconception, and panicked selling is the height of misconcepton because of the overwhelming presence of fear.  People’s fears become exaggerated in a crisis, and so do their reactions.  The typical reaction is to sell in a crisis, and the force of that selling also is exaggerated.  Bargain hunters look to take advantage of temporary problems that are exaggerated in the minds of sellers because of the sellers’ near-term focus.  History shows that crises always appear worse at the outset and that all panics are subdued in time.  When panics die down, stock prices rise.

When bargain hunters maintain the right perspective on crises and panics, they buy when everyone else is selling, which tends to produce excellent investment results.  The authors note:

If you have the psychological ability to add to your investments during future panics, you already have distinguished yourself as a superior investor.  If you can find the resolve to buy when the situation looks most bleak, you will have the upper hand in the stock market.

There is a strong historical precedent for buying in the wake of panic in the stock market, and those panics can come from a number of directions.  Panicked selling can arise form a political event (threat, assassination), an economic event (oil embargo, Asian financial crisis), or an act of war (Korean War, Gulf War, September 11 attacks).  Regardless of the underlying event, when markets make a concerted effort to sell on the basis of a negative surprise, bargain hunters should be looking to buy some of the shares others wish to sell.

Here is a list of recent crises including the number of days for the stock market to hit its low point, plus the percentage change of the drop:

Crisis Event Date Duration to Lows (days) % Change to Low
Attack on Pearl Harbor 12/7/1941 12 -8.2%
Korean War 6/25/1950 13 -12.0%
President Eisenhower’s Heart Attack 9/26/1955 12 -10.0%
Blue Monday—1962 Panic 5/28/1962 21 -12.4%
Cuban Missile Crisis 10/14/1962 8 -4.8%
President Kennedy Assassination 11/22/1963 1 -2.9%
1987 Crash 10/19/1987 1 -22.6%
United Airlines LBO Failure 10/13/1989 1 -6.9%
Persian Gulf War 8/2/1990 50 -18.4%
Asian Financial Crisis 10/27//1997 1 -7.2%
September 11 9/11/2001 5 -14.3%

The maximum number of days for the stock market to reach its low point was 50, whereas the average number of days for the stock market to reach its low point was close to 11 days.  Four out of eleven crisis took only one day for the stock market to reach its bottom.

These events seem to happen a few times per decade.   The authors comment:

The truth is that most seasoned bargain hunters salivate for these events and remain in constant anticipation for them because of the opportunities they afford.  Whenever you observe people in the stock market who want to sell, you should feel the same urgency to buy.

The authors continue:

The basic premise here is that the best time to buy is when there is blood in the streets, even if some of it is your own.  Do not waste time watching your profits shrink or your losses add up.  Do not go on the defensive with the rest of the market; instead, go on an offensive mission to find the bargains coming to the table.  The goal in investing is to raise your long-term returns, not to scramble to sell.  Fixate on your goal.

You must also cope with negative news because negative news sells whereas positive news does not.

You can be sure that once the bad news becomes public, a thousand Chicken Littles will come out to proclaim that the sky is falling.  They will appear on the television, in the newspaper, and on the Internet and will draw a lot of attention.  Smart bargain hunters keep a skeptical but open mind when processing this information.  Is the sky falling?  History has shown repeatedly that it is not.

Sometimes a given crisis is compared to the 1929 crash, the Great Depression, or the 1987 crash.  These are worst case scenarios that are rarely (if ever) relevant to the crisis at hand.  Even 1987, while a large drop, was a one-day event and was far from being anything like the Great Depression, although comparisons inevitably were made.

The authors describe great leaders, who distiguish themselves when the chips are down.  They then write:

Similarly, the most successful investors are defined by their actions in a bear market, not a bull market.  Making money is relatively easy when the entire stock market is rising.  Aggressively seeking the opportunity provided through deep adversity when the stock market is in a free fall requires far more than the ability to analyze a company.  It requires a mindset that looks for a chance to shine, and this requires confidence and courage.  The only way to execute under this pressure is to have a deep-seated belief in your abilities and the conviction that you are correct in your actions.

Templeton had a list of stocks that he wanted to buy if the stock prices fell signficantly.  In order to help ensure that he would buy while the market was selling off, Templeton placed long-term buy orders for specific stocks at levels far below (such as 40-50% below) their current prices.

The authors caution that it’s important, when selecting which companies to buy during a selloff, that you select companies that have low debt or no debt.  Otherwise, the company you pick won’t necessarily survive a recession or economic downturn.  Low debt or no debt is also an important criterion that Warren Buffett uses.

The authors also point out that you should examine the net income of the company over time:

…you will want to measure the variability of its results over time as they are subject to different business conditions in the industry or the overall economy.  If the company was accustomed to losing money during any of its prior annual periods, this should be taken into consideration in purchasing its stock in case business conditions worsen.  Of course, this is a worthy consideration before investing in any stock regardless of future conditions.



The Asian financial crisis started with the devaluation of Thailand’s currency (the Thai baht) in July 1997.  The authors record:

If the two currencies are misaligned too far, lenders to the government may realize that it cannot honor its ability to convert the currencies.  This realization can lead to a “run” on the currency as lenders and exponentially more investors speculating in the currency’s collapse rush to sell baht and convert to U.S. dollars.  If the government cannot honor those transfers, its typical response is to “devalue” the currency or release the stated pegged ratio that had been in place.  An example would be if you had 10 units of the local currency that equaled 1 U.S. dollar but the government did not have enough U.S. dollars on hand to accommodate the market and responded by saying that it now takes 20 units to buy 1 U.S. dollar.

The local currency buys far fewer U.S. dollars, or it takes a lot more local currency to buy a dollar.  Either way you look at it, it is a bad deal for people who want the government to honor its prior policy of converting local currency to U.S. dollars.  If the market senses that there is a high probability that the government will not be able to honor its obligation to convert the currency, a mad dash may ensue to pull money out before the government changes the peg.  The end result is a panicked selling of the government’s currency that drives its price down as well as the prices of assets denominated in that currency, such as stocks.

This dynamic became catastrophic for banks in a country such as Thailand, which secured its capital for lending by borrowing at the low interest rates for the U.S. dollar.  The bottom line is that if the local currency drops in value, loans taken out in U.S. dollars effectively increase in size.  If U.S. dollar loans increase too much, it can bankrupt the bank.

After the Thai baht lost significant value, investors then started worrying about other Asian countries whose currencies were pegged to the U.S. dollar.  As a result, there was heavy selling of these Asian currencies.  The authors note:

However, part of the problem in the case of Asia was that a group of countries referred to as the Asian miracles had posted strong growth rates in their economies over a number of years, and that attracted investors.   Over time the heavy investment led to too much money coming into the country, followed by overdevelopment in some sectors of the economy.  The overdevelopment would not generate the returns necessary to pay back lenders or investors.  In some ways, those countries were victims of their own success.  Nevertheless, the end result was a chain reaction of selling in those countries’ currencies as investors rushed to pull their money out as fast as possible.  The chain reaction leaped from Thailand to Malaysia, Indonesia, the Philippines, Singapore, and finally South Korea.  Eventually, similar fundamental dynamics led to deeply depressed currency values in Russia, Brazil, and Argentina in the years that followed.

Templeton singled out South Korea as a particularly interesting place in which to invest.  He had already identified the country as possibly “the next Japan.”  The authors say:

The reasons Uncle John may have considered South Korea to be the next Japan for investors could be seen in their striking similarities from an economic standpoint.  South Korea in effect was implementing the same game plan that had propelled Japan to economic success after its devastation in World War II.  South Korea had the same basic circumstances when it emerged from the Korean War.  It was a country that was left in an economic quagmire and forced to rebuild.  Although it took a bit longer to get on the right track, South Korea often is referred to as the best case of an economy rising from poverty to industrial power.

The authors compare South Korea with Japan:

First, both countries had heavy rates of domestic saving that funded investment in their economies.  Second, both were exporters but also, and perhaps more important, ambitious exporters.  In other words, Japan was dismissed as an unsophisticated producer of trinkets and cheap goods when it began rebuilding its economy after World War II.  South Korea had that reputation as it embarked on its economic journey to emerge as a powerful industrial nation.  It has been noted that well before South Korea developed its heavy industrial capabilities, it was known for exporting textile goods, and in its early stages of development its top exports were all basic “cheap” items.  For instance, in 1963 South Korea’s third biggest export was human hair wigs.  South Korea was directing itself down a path of progressive industrialization, and its economy was one of the fastest growing in the world as measured by growth in GDP.  The country’s economy had the highest average growth in the world over the 27-year period leading up to the Asian financial crisis.

Over the same period, the government’s direction of resources and capital into export-led businesses transformed the export mix from textiles and wigs to electronics and automobiles.  In addition to the overall higher growth rate, South Korea was able to resist signficant pauses in its growth as only the oil shock crisis of 1980 derailed a long period of uninterrupted high growth…

South Korea, like Japan, became less dependent on foreign borrowing and had ever-increasing domestic savings rates.  South Korea’s savings rate was above 30 percent until the 2000s.

When some of the noted chaebols, such as Kia Motors, Jinro, and Haitai, sought bankruptcy protection for failure to cover their interest payments in the summer of 1997, investors turned an increasingly critical eye toward South Korea and its financial situation.  The fear was that those bankruptcies and ones that could follow would feed back into the banking system.  Similarly, with large proportions of debt denominated in foreign currency, the appearance of risk was high.  From a perception standpoint, outside observers had no way to measure the potential severity of the problem, because disclosure was limited and the banks were controlled by the government.  Without being able to measure the problem, investors assumed the worst.

However, overall South Korea’s government borrowing was relatively modest at less than 20 percent of GDP before the crisis.  Nonetheless, South Korea had a real problem: A much larger percentage of its loans were in short-term maturities that had to be rolled over or extended on a regular basis.  That meant that the country’s debt had to be renewed in the middle of a regional financial meltdown.  The problem of defaulting borrowers in the Korean chaebol system was made worse by the simultaneous financial difficulties in Thailand and Malaysia.

One problem Korea shared with those countries was that they all seemed to have one major lender in common: Japan.  When the Japanese realized that they had so much exposure to the spreading defaults and bankruptcies in the region, they did not hesitate to pull the plug on South Korea.  The result was a near cessation of lending activity to South Korea despite the fact that its situation was not as dire as that of other countries.

Nonetheless, traders began heavily shorting the Korean won.  At first, the country wasted its reserves trying to support its currency.  This was futile, and after the country could no longer support its currency, the currency collapsed and that took down all asset markets with it, including the stock market.

The International Monetary Fund (IMF) arranged a $58.5 billion loan for South Korea, but it came with conditions.  South Korean had to open its financial markets to foreign investors and remove inefficient firms from the market.  South Korea agreed in early 1998.  South Koreans were not happy about inefficient firms being shut down because they were accustomed to holding a job indefinitely because of labor restrictions.  Furthermore, the government raised interest rates to prevent further deterioration in its currency.  This contributed to a recession, which further heightened the skepticism of investors with regard to South Korea.

Of course, Templeton, ever the contrarian, now decided to invest in South Korea because he thought the country was close to “maximum pessimism.”  Moreover, the P/E ratio’s in South Korea were low.  If an investor could look past the short-term difficulties including recession, the long-term outlook for South Korea remained very bright.

Most investors were of course avoiding South Korea.  Most investors, no matter how intelligent, do not have the willingness to buy near the point of maximum pessimism.

In the case of South Korea, although Templeton did invest in some individual stocks, he also invested in the Matthews Korea Fund, which had just declined 65%.  Investing in a mutual fund (or hedge fund) means you have to ensure that the mutual fund manager is a value investor, consistently buying stocks at low P/E ratio’s.  You also want a mutual fund or hedge fund that has good long-term performance.  If the short-term performance has been bad, that often represents a buying opportunity.

The Matthews Korea Fund ended up returning 278.5% from July, 1998, to July 1999.  It was the best-performing mutual fund in the world over that time period.

The authors comment:

Whereas most value investors in the United States were befuddled by the Internet frenzy, Uncle John was ringing up the best returns the market could offer.  This is the virtue of global bargain hunting.  Being a devout bargain hunter in only the United States would have kept you on the sidelines in 1999.  In contrast, being a global bargain hunter would have produced even better performance than was available gambling in the greatest stock mania of modern times.  Bargain hunting trumps the greater fool theorem once again.

In August 2004, Templeton invested $50 million into the Korean car manufacturer Kia Motors.  It has a P/E of 4.8x and was growing at almost 28 percent a year.  The stock then increased 174 percent.

The authors conclude the chapter:

Bargain hunters who understand history, focus on the long term and seek to buy at the point of maximum pessimism can appreciate the fact that these patterns repeat themselves over time, again and again.  Different place, different time; same story, same results.  While you may not be able to identify the exact repeating circumstances of emerging industrial powers in the future experiencing temporary problems you can be sure to find some that rhyme.



While Templeton shorted the U.S. stock market in early 2000, betting $185 million of his own money aqnd making a tidy profit, he was always very careful when dealing with other people’s money.  So his advice in March 2000, when asked, was to buy zero coupon bonds.  This was extraordinarily good advice.  When the economy slowed down, the Fed lowered interest rates several times, which significantly boosted the prices of zero coupon bonds.

Note: A zero coupon bond, instead of paying semiannual interest payments, incorporates the interest into the initial price of the bond so that the total capital gains over the life of the bond will include interest payments and the repayment of the principal.  The authors give the example of a 30-year zero coupon bond that pays 5 percent interest on a semiannual basis.  The price of this bond is about $227, which will become $1,000 by the time the bond matures.

Because Templeton thought the economy would slow and the Federal Reserve would therefore lower interest to boost the economy, the buyer of a 30-year zero coupon bond could make significant money over the course of just a few years.  Remember that the investor would initially pay $227 for a 3o-year zero coupon bond.  But if the Fed were to lower interest rates to stimulate the economy, the price of the 30-year zero coupon bond would jump up to reflect the new lower rates.

Before even considering these capital gains, though, it’s important to point out that, in early 2000, a U.S. investor could either (i) buy U.S. stocks and risk a 50 percent decline from very high P/E levels or (ii) buy U.S. government bonds yielding 6.3 percent.  That’s an easy decision.

But now back to the point about the Federal Reserve lowering interest rates.  The U.S. markets had gotten used to Alan Greenspan, the chair of the Federal Reserve, lowering interest rates when the economy was in danger of entering a recession or when stocks were crashing or when a financial crisis was possible, that the term the Greenspan put was invented.  The idea was that markets would always get bailed out by the Fed lowering rates at any sign of trouble.

A final step in Templeton’s recommendation was to buy 30-year zero coupon bonds from Canada, Australia, or New Zealand.  All of these countries had positive trade balances, small budget deficits (or surpluses in some cases), and low levels of government debt.

In March 2000, Canadian 30-year zero coupon bonds were yielding 5.3 percent.  As interest rates fell, those bonds would increase in price.  Rates actually declined to 4.9 percent, creating a 31.9 percent capital gain for the 30-year zero coupon bonds.  Translated back into U.S. dollars, the gain was 43.4 percent, or 12.8 percent anuualized.

Furthermore, Templeton recommended using borrowed money to purchase the Canadian 30-year zero coupon bonds.  An investor could borrow from the Japanese government at 0.1 percent.  Templeton recommended 2x leverage, which means instead of 43.4 percent the return would be 86.8 percent.

In other words, while U.S. stocks declined roughly 50 percent from early 2000 over the next few years, Templeton’s recommended investment strategy of borrowing from the Japanese government at 0.1 percent and buying 30-year Canadian zero coupon bonds generated a return of more than 86 percent over the same time period.  The three-year annualized return of Templeton’s recommended strategy was 25.5 percent.

The authors write:

The point of the discussion is that for a bargain hunter, it always pays to make relative comparisons.  Sometimes the comparisons must extend into securities such as bonds.  Although it represented an extreme situation in which Uncle John could not locate enough bargain stocks to place his money in, his process was sound enough to lead him into a profitable situation.  His process is and always has been defined by commonsense decision making and a willingness to do things others do not.  If we review his thought process on this trade, it came down to some simple questions: Should I risk losing substantial amounts of money in an inflated stock market or should I earn the 5 or 6 percent available in various long-term bond markets?  Anyone can see the logic behind this decision.  The reasoning is simple, not complicated.

The authors further point out that Templeton’s strategy was to hold the  bonds until there were cheap stocks, which would certainly be the case if the U.S. stock market declined 50 percent overall.

That said, Templeton was concerned about a housing bubble in the U.S.  He noticed that many homebuyers were paying four to five times more for a house than it would cost to contruct it.

Using his global lense, Templeton found a new market where there were bargains: China.



Templeton had identified China as the next great place to invest when he appeared in 1988 on Wall Street Week with Louis Rukeyser.  Then in a March 1990 interview for Fortune maganize, Templeton said the following:

“Hong Kong is rich in entrepreneurs who can start and run businesses, and there’s a great shortage in mainland China of people who know how to do that.  As a result, Hong Kong is likely to become the commercial and financial center for over a billion people, just as Manhatten is the commercial and financial center for a quarter of a billion people.”

The authors comment:

Today most readers and observers of financial markets take the significant economic presence of China in the world for granted.  However, when Uncle John described China as the next great economic power in the world in 1988, nearly 20 years earlier, that was very forward thinking.  Forward thinking is the calling card of successful bargain hunters.

The authors then compare Japan, Korea, and China.

All three countries had hit rock bottom, and Uncle John believed they were certain to emerge from that period of despair.  In the case of Japan, the country had been rendered economically prostrate by its disastrous fate in World War II.  It was left in such a state of ruin that investors believed it would remain an irrelevant economic backwater going forward.  In the same vein, when Japan began to rebuild, it attracted little serious attention from the major industrial nations, including the United States and Europe.  The industrial nations saw no impending threat from Japan, a producer of “cheap trinkets” in the 1950s.

South Korea was a nation left in economic devastation by the destruction caused by the Korean War.  Much like Japan before it, South Korea relied heavily on the financial aid of developed nations as it went through a rebuilding process during the 1960s.  When it took aim at becoming an industrial power, few believed there was any such capability in a country whose  third largest export at that time was human hair wigs.

In the case of China, no historical headline war event sent the country into an economic tailspin.  With a slightly closer look, though, we can see that political events within China during the middle to late twentieth century dismantled its economy and left the nation in shambles.  More specifically, we are referring to the regime of the communist leader Mao Tse-Tung and then the Cultural Revolution.  Both of those events left the country with the results that would have followed from losing a major war.

The authors continue:

The Great Leap Forward was an economic strategy developed and implemented by Mao in 1958 to move the country toward joint industrial and agrarian progress.  A central tenet of that strategy was that the state could manage the agricultural process, which then would generate the funds necessary for industrial ventures into steel production and eventually more advanced goods.  The first move by Mao to install the program involved the widespread collectivization of farmland into communes… This essentially meant that all property ownership was abolished, and reports suggest that 700 million Chinese were relocated into farming communes, with about 5,000 families per commune.  Once the families were relocated, they were forced to work in the fields to produce food for the country and fund the industrialization process.

Most bargain hunters will recall from earlier chapters that when the government nationalizes or expropriates private property, whether land or a  business, that stifles productivity and kills the spirit of progress.  Countries that implement those strategies make horrible investments as the effects are manifested in the economy.  In the case of China, the initial steps set the country on a fast track in the wrong direction.  Partly because of Mao’s willingness to lock up or expunge anyone who spoke against his policies and partly because of his stubbornness in not admitting a mistake sooner, the end result was massive starvation and loss of life.

To make matters worse, local government officials inflated the communes’ production statistics, perhaps out of hope for government praise or out of fear of the threat of retribution.

In the end, roughly 30 million Chinese starved to death and the same number of births were lost or postponed.

Mao conceded power to the prominent officials Liu Shaoqi and Deng Xiaopeng.  In 1966, Mao tried to regain his lost influence by instigating the Cultural Revolution.  Mao did this because the new leadership had become popular by reversing his reforms from the Great Leap Forward.

One consequence of Mao’s Cultural Revolution was the rise of the Red Guard, who began as a group of students defending Maoism.  Mao thought this was a way to spread socialism throughout China.

Part of that process was the eradication of “the four olds”: old customs, old culture, old habits, and old ideas.  The Red Guards had unlimited authority to enforce this dismissal of the four olds, and since they numbered in the millions, they exercised it ruthlessly.  The army and police were instructed to stand down and not interfere with the Red Guards’ actions or they would be considered to be defending the bourgeoisie and prosecuted.

The Red Guards took the opportunity to destroy churches, ancient buildings, antiques, books, and paintings and to torture and kill innocent people.  Some estimates put the casualties from the Cultural Revolution at 500,000 people or more…. The Cultural Revolution’s spirit of radical bullying persisted until the “gang of four” was arrested in 1976.  The gang was a group of powerful and high-ranking instigators (including Mao’s estranged wife) who were central to the drive of the Cultural Revolution under Mao.

The authors add:

As terrible as this event sounds from a humanitarian perspective, its consequences were equally severe and lasting on China’s economy.  During the Cultural Revolution nearly all economic activity shut down as the populace became concerned primarily with persecuting the old ways or running from persecution.  The government’s financial resources were redirected to support the Red Guard, and anyone who qualified as an “intellectual” was sent to a work camp for reeducation, including the two leaders Mao purged.  College entrance exams were canceled, and education stalled.  The lost 10 years in the educational system produced a gaping hole in China’s progress.

Only in 1977, after Deng Xiaopeng reemerged from a work camp to lead China again, did the country reinstitute its education system and implement serious reforms to undo the substantial damage caused by Mao over the previous two decades…

With Deng in control in 1977, China instituted a complete reversal and an open repudiation of the Cultural Revolution.  Deng’s intention to elevate the Chinese from their despair was made clear in 1979, when he said that “to get rich is glorious.”

Deng found a successful economic model near to China: Japan.

As you may recall from our earlier discussions of Japan and South Korea, there is a basic recipe that each of those Asian countries applied to rebuild its economy rapidly.  The Chinese were attracted to that recipe and began implementing it in their own way.  In each instance, a heavy savings rate is a major prerequisite for economic success.  A high savings rate is an attribute that Uncle John often favors in making foreign investments.  China proved adept at creating a large rate of saving across the country.  In fact, by the time Uncle John had mentioned China as the next great nation for investment in 1988, the country had achieved one of the highest savings rates in the world alongside Korea and Japan.

This heavy savings rate was the same strategy used by Japan and Korea to build financial reserves and finance industrial growth.  That growth would drive increasing exports with more value-added content over time.  China was determined to have the same success in exports that Japan and Korea had experienced in their rebuilding processes.  Like them, China began at the low end of the market by manufacturing textiles and “cheap stuff” for export.  That concentration on exports most often produced a trade surplus, which is another economic condition that Uncle John likes to find in a country.

… China was falling in love with capitalism and, of course, the spoils that follow business success.  The people needed little more than Deng’s prompt to strike while the iron was hot.

The authors later write:

Perhaps more important than the ambition of the Chinese was their ability to execute their strategy.  If we take a look at the country’s exports and their composition over time, we can see the familiar  progression from a onetime exporter of low-grade textiles mature to an exporter of industrial machinery and higher-value-added products.  If we compare the percentage of exports accounted for by textiles in 1992 with the percentage in 2005, we see a dramatic reversal.  That reversal was accompanied by tremendous growth and a higher percentage of exports in machinery, mechanical appliances, and electrical equipment.  In sum, textiles shrank to half their original percentage from 1992 and machinery increased to a percentage that was three times the 1992 level.  This reversal from low-value-added goods to more sophisticated exports of industrial goods mirrors the earlier advances in Japan and Korea.

China successfully transformed itself from a socialist system to a capitalism system.  China is now on track to overtaking the United States and becoming the largest economy in the world.

When the authors discussed China with Templeton, he said the following:

“The thing to always remember about China has to do with the people… You must not think of them as communists or capitalists… They are Chinese first, and that is how they see themselves.”

Templeton advised investing in China via investors who have their “feet on the ground” and who are up-to-date on local information.  Templeton also found two stocks in China in September 2004: China Life Insurance and China Mobile.

Templeton viewed China Life as a way to access the strength of the Chinese currency without paying a premium.  The stock traded as an ADR on the New York Stock Exchange.  The company would invest the premiums in the same currencies in which they did business, so as to minimize the risk of adverse currency developments.  Thus, buying China Life was a way for Templeton to access the local Chinese currency, which he found attractive over the long term.  Also, Templeton feared a decline in the U.S. dollar based on U.S. trade deficits combined with U.S. government debt levels.

Templeton’s China Life investment increased 1,050 percent over three years, a phenomenal investment.

Templeton’s other stock investment was China Mobile.  The company had a P/E of 11x, plus a growth rate of 20 percent.  So the PEG ratio (P/E divided by growth rate) was only 0.55, one of the cheapest stocks in the wireless telecommunications industry.  The worldwide wireless telecommunication 2004 group average PEG ratio was 0.84.

Templeton’s China Mobile investment ended up returning 656% over three years, another outstanding investment.

Templeton began advising that instead of forecasting a company’s earnings five years into the future, you should now try to forecast a company’s earnings ten years into the future.  The authors write:

…by focusing on the future prospects of a company as much as 10 years into the future, a bargain hunter has to think about the competitive positioning of a company in the market.  In short, bargain hunters must devote a large majority of their efforts to determining the competitive advantage of a business in relation to its competitors.  This requires putting a great deal of effort into studying not only the company whose stock you are considering for purchase but also that company’s competitors in the market.

Uncle John always said that when he visited a company in his early days as an analyst, he always got the best information from the company’s competitors, not from the company itself.  The aim of this analysis is to get a sense of how well a company will be able to maintain its profitability into the future.  This is a key consideration if you are going to make an estimation of a company’s earnings 10 years ahead.

The authors point out that a basic rule of economics is that excess profits attract competition, which tends to reduce those profits.  How defensible are the company’s profit margins in the face of increasing competition?  If a company has a sustainable competitive advantage—which is also something Warren Buffett and Charlie Munger look for—then that is an encouraging sign.  Whether its a low-cost advantage, a brand image advantage, a market share advantage, pricing power, or some other advantage, it pays to figure out if the company does have a competitive advantage and whether it is sustainable far into the future.

A key question is: How easy would it be for someone to replicate the business in question?  The more difficult it would be to replicate a given business, the more valuable that company’s earnings are to an investor.

The authors conclude:

Always looking for investments differently than others do (whether in a different country, with a different method, with a different time horizon, with a different level of optimism, or with a different level of pessimism) is the only way to separate yourself from the crowd.  By now you should know that the only way to achieve superior investment results is to buy what others are despondently selling and sell what others are avidly buying in the market.

The authors quote Templeton:

“If you want to have a better performance than the crowd, you must do things differently from the crowd.”



An equal weighted group of micro caps generally far outperforms an equal weighted (or cap-weighted) group of larger stocks over time.

This outperformance increases significantly by focusing on cheap micro caps.  Performance can be further boosted by isolating cheap microcap companies that show improving fundamentals.  We rank microcap stocks based on these and similar criteria.

There are roughly 10-20 positions in the portfolio.  The size of each position is determined by its rank.  Typically the largest position is 15-20% (at cost), while the average position is 8-10% (at cost).  Positions are held for 3 to 5 years unless a stock approaches intrinsic value sooner or an error has been discovered.

The mission of the Boole Fund is to outperform the S&P 500 Index by at least 5% per year (net of fees) over 5-year periods.  We also aim to outpace the Russell Microcap Index by at least 2% per year (net).  The Boole Fund has low fees.


If you are interested in finding out more, please e-mail me or leave a comment.

My e-mail: jb@boolefund.com



Disclosures: Past performance is not a guarantee or a reliable indicator of future results. All investments contain risk and may lose value. This material is distributed for informational purposes only. Forecasts, estimates, and certain information contained herein should not be considered as investment advice or a recommendation of any particular security, strategy or investment product. Information contained herein has been obtained from sources believed to be reliable, but not guaranteed. No part of this article may be reproduced in any form, or referred to in any other publication, without express written permission of Boole Capital, LLC.

The Most Important Thing

September 24, 2023

Howard Marks is one of the great value investors.  The Most Important Thing is a book Marks created based on his memos to clients.  Marks noticed that in his meetings with clients, he would often say, “The most important thing is X,” and then a bit later say, “The most important thing is Y,” and so on.  So the book, The Most Important Thing, has many “most important things,” all of which truly are important according to Marks.

Outstanding books are often worth reading at least four or five times.  The Most Important Thing is clearly outstanding, and is filled with investment wisdom.  As a result, this blog post is longer than usual.  It’s worth spending time to absorb the wisdom of Howard Marks.



Marks writes:

Where does an investment philosophy come from?  The one thing I’m sure of is that no one arrives on the doorstep of an investment career with his or her philosophy fully formed.  A philosophy has to be the sum of many ideas accumulated over a long period of time from a variety of sources.  One cannot develop an effective philosophy without having been exposed to life’s lessons.  In my life I’ve been quite fortunate in terms of both rich experiences and powerful lessons.

Marks adds:

Good times teach only bad lessons: that investing is easy, that you know its secrets, and that you needn’t worry about risk.  The most valuable lessons are learned in tough times.



Marks first points out how variable the investing landscape is:

No rule always works.  The environment isn’t controllable, and circumstances rarely repeat exactly.  Psychology plays a major role in markets, and because it’s highly variable, cause-and-effect relationships aren’t reliable.

The goal for an investor is to do better than the market over time.  Otherwise, the best option for most investors is simply to buy and hold low-cost broad market index funds.  Doing better than the market requires an identifiable edge:

Since other investors may be smart, well-informed and highly computerized, you must find an edge they don’t have.  You must think of something they haven’t thought of, see things they miss or bring insight they don’t possess.  You have to react differently and behave differently.  In short, being right may be a necessary condition for investment success, but it won’t be sufficient.  You must be more right than others… which by definition means your thinking has to be different.

Marks gives some examples of second-level thinking:

    • First-level thinking says, ‘It’s a good company; let’s buy the stock.’ Second-level thinking says, ‘It’s a good company, but everyone thinks it’s a great company, and it’s not.  So the stock’s overrated and overpriced; let’s sell.’
    • First-level thinking says, ‘The outlook calls for low growth and rising inflation. Let’s dump our stocks.’   Second-level thinking says, ‘The outlook stinks, but everyone else is selling in panic.  Buy!’
    • First-level thinking says, ‘I think the company’s earnings will fall; sell.’ Second-level thinking says, ‘I think the company’s earnings will fall less than people expect, and the pleasant surprise will lift the stock; buy.’

Marks explains that first-level thinking is generally simplistic.  By contrast, second-level thinking requires thinking of the full range of possible future outcomes, along with estimating probabilities for each possible outcome.  Second-level thinking means understanding what the consensus thinks, why one has a different view, and the likelihood that one’s contrarian view is correct.  Marks observes that second-level thinking is far more difficult than first-level thinking, thus few investors truly engage in second-level thinking.  First-level thinkers cannot expect to outperform the market.  Marks:

To outperform the average investor, you have to be able to outthink the consensus.  Are you capable of doing so?  What makes you think so?

Marks again:

The upshot is simple: to achieve superior investment results, you have to hold nonconsensus views regarding value, and they have to be accurate.  That’s not easy.



Marks holds a view of market efficiency similar to that of Buffett:  The market is usually efficient, but it is far from always efficient.  Marks says that the market reflects the consensus view, but the consensus is not always right:

In January 2000, Yahoo sold at $237.  In April 2001 it was $11.  Anyone who argues that the market was right both times has his or her head in the clouds; it has to have been wrong on at least one of those occasions.  But that doesn’t mean many investors were able to detect and act on the market’s error.

Marks summarizes his view:

The bottom line for me is that, although the more efficient markets often misvalue assets, it’s not easy for any one person – working with the same information as everyone else and subject to the same psychological influences – to consistently hold views that are different from the consensus and closer to being correct.  That’s what makes the mainstream markets awfully hard to beat – even if they aren’t always right.

Marks makes an important point about riskier investments:

Once in a while we experience periods when everything goes well and riskier investments deliver the higher returns they seem to promise.  Those halcyon periods lull people into believing that to get higher returns, all they have to do is make riskier investments.  But they ignore something that is easily forgotten in good times: this can’t be true, because if riskier investments could be counted on to produce higher returns, they wouldn’t be riskier.

Marks notes that inefficient prices imply that for each investor who buys at a cheap price, another investor must sell at that cheap price.  Inefficiency essentially implies that each investment that beats the market implies another investment that trails the market by an equal amount.

Generally it is exceedingly difficult to beat the market.  To highlight this fact, Marks asks a series of questions:

    • Why should a bargain exist despite the presence of thousands of investors who stand ready and willing to bid up the price of anything that is too cheap?
    • If the return appears so generous in proportion to the risk, might you be overlooking some hidden risk?
    • Why would the seller of the asset be willing to part with it at a price from which it will give you an excessive return?
    • Do you really know more about the asset than the seller does?
    • If it’s such a great proposition, why hasn’t someone else snapped it up?

Market inefficiency alone, argues Marks, is not a sufficient condition for outperformance:

All that means is that prices aren’t always fair and mistakes are occurring: some assets are priced too low and some too high.  You still have to be more insightful than others in order to regularly buy more of the former than the latter.  Many of the best bargains at any point in time are found among the things other investors can’t or won’t do.

Marks ends this section by saying that a key turning point in his career was when he concluded that he should focus on relatively inefficient markets.  (Note:  micro-cap stocks is one area that is relatively inefficient, which is why I created the Boole Microcap Fund.)

A few notes about deep value (contrarian value) investing:

In order to buy a stock that is very cheap in relation to its intrinsic value, some other investor must be willing to sell the stock at such an irrationally low price.  Sometimes such sales happen due to forced selling.  The rest of the time, the seller must be making a mistake in order for the value investor to make a market-beating investment.

Many deep value approaches are fully quantitative, however.  (Deep value is also called contrarian value.)  The quantitative deep value investor is not necessarily making an exceedingly detailed judgment on each individual deep value stock – a judgment which would imply that the value investor is correct in this particular case, and that the seller is wrong.  Rather, the quantitative deep value investor forms a portfolio of the statistically cheapest 20 or more stocks.  All of the studies have shown that a basket of quantitatively cheap stocks does better than the market over time, and is less risky (especially during down markets).

One of the best papers on quantitative deep value investing is Lakonishok, Shleifer, and Vishny (1994), “Contrarian Investment, Extrapolation, and Risk.”  Link: http://scholar.harvard.edu/files/shleifer/files/contrarianinvestment.pdf

A concentrated deep value approach, by contrast, typically involves the effort to select the most promising and the cheapest stocks available.  Warren Buffett and Charlie Munger both followed this approach when they were managing smaller amounts of capital.  They would typically have between 3 and 8 positions making up nearly the entire portfolio.  (Joel Greenblatt also used this approach when he was managing smaller amounts.  Greenblatt produced a ten-year record of 50.0% gross per year using a concentrated value approach focused on special situations.  See Greenblatt’s book, You Can Be a Stock Market Genius.)



Marks begins by saying that “buy low; sell high” is one of the oldest rules in investing.  But since selling will occur in the future, how can one figure out a price today that will be lower than some future price?  What’s needed is an ability to accurately assess the intrinsic value of the asset.  The intrinsic value of a stock can be derived from the price that an informed buyer would pay for the entire company, based on the net asset value or the earnings power of the company.  Writes Marks:

The quest in value investing is for cheapness.  Value investors typically look at financial metrics such as earnings, cash flow, dividends, hard assets and enterprise value and emphasize buying cheap on these bases.  The primary goal of value investors, then, is to quantify the company’s current value and buy its securities when they can do so cheaply.

Marks also notes that successful value investing requires an estimate of current net asset value, or the current earnings power, that is unrecognized by the consensus.  Successful growth investing, by contrast, requires an estimate of future earnings that is higher than what the consensus currently thinks.  Often the rewards for successful growth investing are higher, but a successful value investing approach is much more repeatable and achievable.

Buying assets below fair value, however, does not mean those assets will outperform right away.  Thus value investing requires having a firmly held view, because quite often after buying, cheap assets will continue to underperform the market.  Marks elaborates:

If you liked it at 60, you should like it more at 50… and much more at 40 and 30.  But it’s not that easy.  No one’s comfortable with losses, and eventually any human will wonder, ‘Maybe it’s not me who’s right.  Maybe it’s the market.’…”

Thus, successful value investing requires not only the consistent ability to identify assets available at cheap prices; it also requires the ability to ignore various signals (many of which are subconscious) flashing the message that one is wrong.  As Marks writes:

Value investors score their biggest gains when they buy an underpriced asset, average down unfailingly and have their analysis proved out.  Thus, there are two essential ingredients for profit in a declining market: you have to have a view on intrinsic value, and you have to hold that view strongly enough to be able to hang in and buy even as price declines suggest that you’re wrong.  Oh yes, there’s a third: you have to be right.



Many investors make the mistake of thinking that a good company is automatically a good investment, while a bad company is automatically a bad investment.  But what really matters for the value investor is the relationship between price and value:

For a value investor, price has to be the starting point.  It has been demonstrated time and time again that no asset is so good that it can’t become a bad investment if bought at too high a price.  And there are few assets so bad that they can’t be a good investment when bought cheaply enough.

In the 1960’s, there was a group of stocks called the Nifty Fifty – companies that were viewed as being so good that all one had to do was buy at any price and then hold for the long term.  But it turned out not to be true for many stocks in the basket.  Moreover, the early 1970’s led to huge declines:

Within a few years, those price/earnings ratios of 80 or 90 had fallen to 8 or 9, meaning investors in America’s best companies had lost 90 percent of their money.  People may have bought into great companies, but they paid the wrong price.

Marks explains the policy at his firm Oaktree:

‘Well bought is half sold.’

By this we mean we don’t spend a lot of time thinking about what price we’re going to be able to sell a holding for, or to whom, or though what mechanism.  If you’ve bought it cheap, eventually those questions will answer themselves.  If your estimate of intrinsic value is correct, over time an asset’s price should converge with its value.

Marks, similar to Warren Buffett and Charlie Munger, holds that psychology plays a central role in value investing:

Whereas the key to ascertaining value is skilled financial analysis, the key to understanding the price/value relationship – and the outlook for it – lies largely in insight into other investor’s minds.  Investor psychology can cause a security to be priced just about anywhere in the short run, regardless of its fundamentals.

The safest and most potentially profitable thing is to buy something when no one likes it.  Given time, its popularity, and thus its price, can only go one way: up.

A successful value investor must build systems or rules for self-protection because all investors – all humans – suffer from psychological biases, which often operate subconsciously.  For more on cognitive biases, see the following two blog posts:

Cognitive Biases

The Psychology of Misjudgment

Marks continues:

Of all the possible routes to investment profit, buying cheap is clearly the most reliable.  Even that, however, isn’t sure to work.  You can be wrong about the current value.  Or events can come along that reduce value.  Or deterioration in attitudes or markets can make something sell even further below its value.  Or the convergence of price and intrinsic value can take more time than you have…

Trying to buy below value isn’t infallible, but it’s the best chance we have.



As Buffett frequently observes, the future is always uncertain.  Prices far below probable intrinsic value usually only exist when the future is highly uncertain.  When there is not much uncertainty, asset prices will be much higher than otherwise.  So high uncertainty about the future is the friend of the value investor.

On the other hand, in general, assets that promise higher returns always entail higher risk.  If a potentially higher-returning asset was obviously as low risk as a U.S. Treasury, then investors would rush to buy the higher-returning asset, thereby pushing up its price to the point where it would promise returns on par with a U.S. Treasury.

A successful value investor has to determine whether the potential return on an ostensibly cheap asset is worth the risk.  High risk is not necessarily bad as long as it is properly controlled and as long as the potential return is high enough.  But if the risk is too high, then it’s not the type of repeatable bet that can produce long-term success for a value investor.  Repeatedly taking too much risk – by sizing positions too large relative to risk-reward – virtually guarantees long-term failure.

Consider the Kelly criterion.  If the probability of success and the returns from a potential investment can be quantified, then the Kelly criterion tells one exactly how much to bet in order to maximize the long-term compound returns from a long series of such bets.  Betting any other amount than what the Kelly criterion says will inevitably lead to less than the maximum potential returns.  Most importantly, betting more than what the Kelly criterion says guarantees zero or negative long-term returns.  Repeatedly overbetting guarantees long-term failure.  For more about the Kelly criterion, see:  https://boolefund.com/the-dhandho-investor/

This is why Howard Marks, Warren Buffett, Charlie Munger, and other great value investors often point out that minimizing big mistakes is more important for long-term investing success than hitting home runs.  Buffett and Munger apply the same logic to life itself:  avoiding big mistakes is more important than trying to hit home runs.  Buffett:  “You have to do very few things right in life so long as you don’t do too many things wrong.”

Again, Marks points out, while riskier investments promise higher returns, those higher returns are not guaranteed, otherwise riskier investments wouldn’t be riskier!  The probability distribution of potential returns is wider for riskier investments, typically including some large potential losses.  A certain percentage of future outcomes will be zero or negative for riskier investments.

Marks agrees with Buffett and Munger that the best definition of risk is the potential to experience loss.

Of course, as John Templeton, Ray Dalio, and other great investors observe, even the best investors are typically only right two-thirds of the time, while they are wrong one-third of the time.  Thus, following a successful long-term value investing framework where one consistently and carefully pays cheap prices for assets still entails being wrong roughly one-third of the time.  Being wrong often means that the lower probability future negative scenarios do in fact occur a certain percentage of the time.  Back luck does happen a certain percentage of the time.  (Mistakes in analysis or psychology also happen.)

It’s important to bet big when the odds are heavily in one’s favor.  But one should be psychologically prepared to be wrong roughly one-third of the time, whether due to bad luck or to mistakes.  The overall portfolio should be able to withstand at least a 33% error rate.

More Notes on Deep Value

Investors are systematically too pessimistic about companies that have been doing poorly, and systematically too optimistic about companies that have been doing well.  This is why a deep value (contrarian value) approach, if applied systematically, is very likely to produce market-beating returns over a long enough period of time.

Marks explains:

Dull, ignored, possibly tarnished and beaten-down securities – often bargains exactly because they haven’t been performing well – are often ones value investors favor for high returns…. Much of the time, the greatest risk in these low-luster bargains lies in the possibility of underperforming in heated bull markets.  That’s something the risk-conscious value investor is willing to live with.

Measuring Risk-Adjusted Returns

Marks mentions the Sharpe ratio – or excess return compared to the standard deviation of the return.  While not perfect, the Sharpe ratio is a solid measure of risk-adjusted return for many public market securities.

It’s important to point out again that risk can no more be objectively measured after an investment than it can be objectively measured before the investment.  Marks:

The point is that even after an investment has been closed out, it’s impossible to tell how much risk it entailed.  Certainly the fact that an investment worked doesn’t mean it wasn’t risky, and vice versa.  With regard to a successful investment, where do you look to learn whether the favorable outcome was inescapable or just one of a hundred possibilities (many of them unpleasant)?  And ditto for a loser: how do we ascertain whether it was a reasonable but ill-fated venture, or just a wild stab that deserved to be punished?

Did the investor do a good job of assessing the risk entailed?  That’s another good questions that’s hard to answer.  Need a model?  Think of the weatherman.  He says there’s a 70 percent chance of rain tomorrow.  It rains; was he right or wrong?  Or it doesn’t rain; was he right or wrong?  It’s impossible to assess the accuracy of probability estimates other than 0 and 100 except over a very large number of trials.

Marks believes (as do Buffett, Munger, and other top value investors) that there is some merit to the expected value framework whereby one attempts to identify possible future scenarios and the probabilities of their occurrence:

If we have a sense for the future, we’ll be able to say which outcome is most likely, what other outcomes also have a good chance of occurring, how broad the range of possible outcomes is and thus what the ‘expected result’ is.  The expected result is calculated by weighing each outcome by its probability of occurring; it’s a figure that says a lot – but not everything – about the likely future.

Again, though, having a reasonable estimate of the future probability distribution is not enough.  One must also make sure that one’s portfolio can withstand a run of bad luck; and one must recognize when one has experienced a run of good luck.  Marks quotes his friend Bruce Newberg (with whom he has played cards and dice):

There’s a big difference between probability and outcome.  Probable things fail to happen – and improbable things happen – all the time.

This is one of the most important lessons to know about investing, asserts Marks.

Marks defines investment performance:

… investment performance is what happens when a set of developments – geopolitical, macro-economic, company-level, technical and psychological – collide with an extant portfolio.  Many futures are possible, to paraphrase Dimson, but only one future occurs.  The future you get may be beneficial to your portfolio or harmful, and that may be attributable to your foresight, prudence or luck.  The performance of your portfolio under the one scenario that unfolds says nothing about how it would have fared under the many ‘alternative histories’ that were possible.

A portfolio can be set up to withstand 99 percent of all scenarios but succumb because it’s the remaining 1 percent that materializes.  Based on the outcome, it may seem to have been risky, whereas the investor might have been quite cautious.

Another portfolio may be structured so that it will do very well in half the scenarios and very poorly in the other half.  But if the desired environment materializes and it prospers, onlookers can conclude that it was a low-risk portfolio.

The success of a third portfolio can be entirely contingent on one oddball development, but if it occurs, wild aggression can be mistaken for conservatism and foresight.

Marks again:

Risk can be judged only by sophisticated, experienced second-level thinkers.

The past seems very definite: for every evolving set of possible scenarios, only one scenario happened at each point along the way.  But that does not at all mean that the scenarios that actually occurred were the only scenarios that could have occurred.

Furthermore, most people assume that the future will be like the past, especially the more recent past.  As Ray Dalio says, the biggest mistake most investors make is to assume that the recent past will continue into the future.

Marks also reminds us that the “worst-case” assumed by most investors is typically not negative enough.  Marks relates a funny story his father told about a gambler who bet everything on a race with only one horse in it.  How could he lose?

Halfway around the track, the horse jumped over the fence and ran away.  Invariably things can get worse than people expect.

Taking more risk usually leads to higher returns, but not always.

And when risk bearing doesn’t work, it really doesn’t work, and people are reminded what risk’s all about.



The main source of risk, argues Marks, is high prices.  When stock prices move higher, for instance, most investors feel more optimistic and less concerned about downside risk.  But value investors have the opposite point of view: risk is typically very low when stock prices are very low, while risk tends to increase significantly when stock prices have increased significantly.

Most investors are not value investors:

So a prime element in risk creation is a belief that risk is low, perhaps even gone altogether.  That belief drives up prices and leads to the embrace of risky actions despite the lowness of prospective returns.

Marks emphasizes that recognizing risk – which comes primarily from high prices – has nothing to do with predicting the future, which cannot be done with any sort of consistency when it comes to the overall stock market or the economy.

Marks also highlights, again, how the psychology of eager buyers – who are unworried about risk – is precisely what creates greater levels of risk as they drive prices higher:

Thus, the market is not a static arena in which investors operate.  It is responsive, shaped by investors’ own behavior.  Their increasing confidence creates more that they should worry about, just as their rising fear and risk aversion combine to widen risk premiums at the same time as they reduce risk.  I call this the ‘perversity of risk.’

In a nutshell:

When everyone believes something is risky, their unwillingness to buy usually reduces its price to the point where it’s not risky at all.  Broadly negative opinion can make it the least risky thing, since all optimism has been driven out of its price.

And, of course, as demonstrated by the experience of Nifty Fifty investors, when everyone believes something embodies no risk they usually bid it up to the point where it’s enormously risky.  No risk is feared, and thus no reward for risk bearing – no ‘risk premium’ – is demanded or provided.  That can make the thing that’s most esteemed the riskiest.

Marks again:

This paradox exists because most investors think quality, as opposed to price, is the determinant of whether something’s risky.  But high quality assets can be risky, and low quality assets can be safe.  It’s just a matter of the price paid for them…



Outstanding investors, in my opinion, are distinguished at least as much for their ability to control risk as they are for generating return.

Great investors generate high returns with moderate risk, or moderate returns with low risk.  If they generate high returns with “high risk,” but they do so consistently for many years, then perhaps the high risk “either wasn’t really high or was exceptionally well-managed.”  Mark says that great investors such as Buffett or Peter Lynch tend to have very few losing years over a relatively long period of time.

It’s important, notes Marks, to see that risk leads to loss only when lower probability negative scenarios occur:

… loss is what happens when risk meets adversity.  Risk is the potential for loss if things go wrong.  As long as things go well, loss does not arise.  Risk gives rise to loss only when negative events occur in the environment.

We must remember that when the environment is salutary, that is only one of the environments that could have materialized that day (or that year).  (This is Nassim Nicholas Taleb’s idea of alternative histories…)  The fact that the environment wasn’t negative does not mean that it couldn’t have been.  Thus, the fact that the environment wasn’t negative doesn’t mean risk control wasn’t desirable, even though – as things turned out – it wasn’t needed at that time.

The absence of losses does not mean that there was no risk.  Only a skilled investor can look at a portfolio during good times and tell how much risk has been taken.

Bottom line: risk control is invisible in good times but still essential, since good times can so easily turn into bad times.

Marks says that an investment manager adds value by generating higher than market returns for a given level of risk.  Achieving the same return as the market, but with less risk, is adding value.  Achieving better than market returns without undue risk is also adding value.

Many value investors, such as Marks and Buffett, somewhat underperform during up markets, but far outperform during down markets.  The net result over a long period of time is market-beating performance with very little incremental risk.  But it does take some time in order to see the value-added.

Controlling the risk in your portfolio is a very important and worthwhile pursuit.  The fruits, however, come only in the form of losses that don’t happen.  Such what-if calculations are difficult in placid times.


On the other hand, the intelligent acceptance of recognized risk for profit underlies some of the wisest, most profitable investments – even though (or perhaps due to the fact that) most investors dismiss them as dangerous speculations.

Marks’ firm Oaktree invests in high yield bonds.  High yield bonds can be good investments over time if the prices are low enough:

I’ve said for years that risky assets can make for good investments if they’re cheap enough.  The essential element is knowing when that’s the case.  That’s it: the intelligent bearing of risk for profit, the best test for which is a record of repeated success over a long period of time.

Risk bearing per se is neither wise nor unwise, says Marks.  Investing in the more aggressive niches with risk properly controlled is ideal.  But controlling risk always entails being prepared for bad scenarios.

Extreme volatility and loss surface only infrequently.  And as time passes without that happening, it appears more and more likely that it’ll never happen – that assumptions regarding risk were too conservative.  Thus, it becomes tempting to relax rules and increase leverage.  And often this is done just before the risk finally rears its head…

Marks quotes Nassim Taleb:

Reality is far more vicious than Russian roulette.  First, it delivers the fatal bullet rather infrequently, like a revolver that would have hundreds, even thousands of chambers instead of six.  After a few dozen tries, one forgets about the existence of the bullet, under a numbing false sense of security… Second, unlike a well-defined precise game like Russian roulette, where the risks are visible to anyone capable of multiplying and dividing by six, one does not observe the barrel of reality… One is thus capable of unwittingly playing Russian roulette – and calling it by some alternative ‘low risk’ name.

A good example, which Marks does mention, is large financial institutions in 2004-2007.  Virtually no one thought that home prices could decline on a nationwide scale, since they had never done so before.

Of course, it’s also possible to be too conservative.  You can’t run a business on the  basis of worst-case assumptions.  You wouldn’t be able to do anything.  And anyway, a ‘worst-case assumption’ is really a misnomer; there’s no such thing, short of a total loss.  Now, we know the quants shouldn’t have assumed there couldn’t be a nationwide decline in home prices.  But once you grant that such a decline can happen… what should you prepare for?  Two percent?  Ten?  Fifty?

Marks continues:

If every portfolio was required to be able to withstand declines on the scale we’ve witnessed this year [2008], it’s possible no leverage would ever be used.  Is that a reasonable reaction?

Even if we realize that unusual, unlikely things can happen, in order to act we make reasoned decisions and knowingly accept that risk when well paid to do so.  Once in a while, a ‘black swan’ will materialize.  But if in the future we always said, ‘We can’t do such-and-such, because the outcome could be worse than we’ve ever seen before,’ we’d be frozen in inaction.

… It’s by bearing risk when we’re well paid to do so – and especially by taking risks toward which others are averse in the extreme – that we strive to add value for our clients.



    • Rule number one: most things will prove to be cyclical.
    • Rule number two: some of the greatest opportunities for gain and loss come when other people forget rule number one.

Marks explains:

… processes in fields like history and economics involve people, and when people are involved, the results are variable and cyclical.  The main reason for this, I think, is that people are emotional and inconsistent, not steady and clinical.

Objective factors do play a large part in cycles, of course – factors such as quantitative relationships, world events, environmental changes, technological developments and corporate decisions.  But it’s the application of psychology to these things that causes investors to overreact or underreact, and thus determines the amplitude of the cyclical fluctuations.

Marks continues:

Economies will wax and wane as consumers spend more or less, responding emotionally to economic factors or exogenous events, geopolitical or naturally occurring.  Companies will anticipate a rosy future during the up cycle and thus overexpand facilities and inventories; these will become burdensome when the economy turns down.  Providers of capital will be too generous when the economy’s doing well, abetting overexpansion with cheap money, and then they’ll pull the reins too tight when things cease to look as good.

Investors will overvalue companies when they’re doing well and undervalue them when things get difficult.



Marks holds that there are two risks in investing:

the risk of losing money and the risk of missing opportunity.

Most investors consistently do the wrong things at the wrong time:  when prices are high, most investors rush to buy; when prices are low, most investors rush to sell.  Thus, the value investor can profit over time by following Warren Buffett’s advice:

Be fearful when others are greedy.  Be greedy when others are fearful.


Stocks are cheapest when everything looks grim.  The depressing outlook keeps them there, and only a few astute and daring bargain hunters are willing to take new positions.



Marks writes as follows:

Many people possess the intellect needed to analyze data, but far fewer are able to look more deeply into things and withstand the powerful influence of psychology.  To say this another way, many people will reach similar cognitive conclusions from their analysis, but what they do with those conclusions varies all over the lot because psychology influences them differently.  The biggest investing errors come not from factors that are informational or analytical, but from those that are psychological.  Investor psychology includes many separate elements, which we will look at in this chapter, but the key thing to remember is that they consistently lead to incorrect decisions.  Much of this falls under the heading of ‘human nature.’

Cognitive Biases

As humans, we all have psychological tendencies or cognitive biases that were mostly helpful to us during much of our evolutionary history, but that often lead us to make bad judgments in many areas of modern life.

Marks writes about the following psychological tendencies:

    • Greed
    • Fear
    • Self-deception
    • Conformity to the crowd
    • Envy
    • Ego or overconfidence
    • Capitulation

How might these psychological tendencies have been useful in our evolutionary history?  

When food was often scarce, being greedy by hoarding food (whether at the individual or community level) made sense.  When a movement in the grass occasionally meant the presence of a dangerous predator, immediate fear (this fear is triggered by the amygdala even before the conscious mind is aware of it) was essential for survival.  When hunting for food was dangerous, often with low odds of success, self-deception – accompanied by various naturally occurring chemicals – helped hunters to persevere over long periods of time, regardless of high danger and often regardless of injury.  (Chemical reactions could often cause an injured hunter not to feel the pain much.)  If everyone in one’s hunting group, or in one’s community, was running away as fast as possible, following the crowd was usually the most rational response.  If a starving hunter saw another person with a huge pile of food, envy would trigger a strong desire to possess such a large pile of food, whether by trying to take it or by going on a hunting expedition with a heightened level of determination.  When hunting a dangerous prey, with low odds of success, ego or overconfidence would cause the hunter to be convinced that he would succeed.  From the point of view of the community, having self-deceiving and overconfident hunters was a net benefit because the hunters would persevere despite often low odds of success, and despite inevitable injuries and deaths among individual hunters.

How do these psychological tendencies cause people to make errors in modern activities such as investing?

Greed causes people to follow the crowd by paying high prices for stocks in the hope that there will be even higher prices in the future.  Fear causes people to sell or to avoid ugly stocks – stocks trading at low multiples because the businesses in question are facing major difficulties.

As humans, we have an amazingly strong tendency towards self-deception:

    • The first principle is that you must not fool yourself, and you are the easiest person to fool. – Richard Feynman
    • Nothing is easier than self-deceit. For what each man wishes, that he also believes to be true. – Demosthenes, as quoted by Charlie Munger

There have been many times in history when self-deception was probably crucial for the survival of a given individual or community.  I’ve mentioned hunters pursuing dangerous prey.  A much more recent example might be Winston Churchill, who was firmly convinced – even when virtually all the evidence was against it – that England would defeat Germany in World War II.  Churchill’s absolute belief helped sustain England long enough for both good luck and aid to arrive:  the Germans ended up overextended in Russia, and huge numbers of American troops (along with mass amounts of equipment) arrived in England.

Like other psychological tendencies, self-deception not only was important in evolutionary history, but it still often plays a constructive role.  Yet when it comes to investing, self-deception is clearly harmful, especially as the time horizon is extended so that luck evens out.

Conformity to the crowd is another psychological tendency that many (if not most) investors seem to display.  Marks notes the famous experiment by Solomon Asch.  The subject is shown lines of obviously different lengths.  But in the same room with the subject are shills, who unbeknownst to the subject have already been instructed to say that two lines of obviously different lengths actually have the same length.  So the subject of the experiment has to decide between the obvious evidence of his eyes – the two lines are clearly different lengths – and the opinion of the crowd.  A significant number (36.8 percent) ignored their own eyes and went with the crowd, saying that the two lines had equal length, despite the obvious fact that they didn’t.

(The experiment involved a control group in which there were no shills.  Almost every subject – over 99 percent – gave the correct answer under these circumstances.)

Greed, conformity, and envy together operate powerfully on the brain of many investors:

Time and time again, the combination of pressure to conform and the desire to get rich causes people to drop their independence and skepticism, overcome their innate risk aversion and believe things that don’t make sense.

A good example from history is the tulip mania in Holland, during which otherwise rational people ended up paying exorbitant sums for colorful tulip bulbs.  The South Sea Bubble is another example, during which even the extremely intelligent Isaac Newton, after selling out early for a solid profit, could not resist buying in again as prices seemed headed for the stratosphere.  Newton and many others lost huge sums when prices inevitably returned to earth.

Envy has a very powerful and often negative effect on most human brains.  And as Charlie Munger always points out, envy is particularly stupid because it’s a sin that, unlike many other sins, is not any fun at all.  There are many people who could easily learn to be very happy – grateful for blessings, grateful for the wonders of life itself, etc. – who become miserable because they fixate on other people who have more of something, or who are doing better in some way.  Envy is fundamentally irrational and stupid, but it is powerful enough to consume many people.  Buffett: “It’s not greed that drives the world, but envy.”  Envy and jealousy have for a very long time caused the downfall of human beings.  This certainly holds true in investing.

Ego is another powerful psychological tendency humans have.  As with the other potential pitfalls, many of the best investors – from Warren Buffett to Ray Dalio – are fundamentally humble.  Overconfidence (closely related to ego) is a very strong bias that humans have, and if it is not overcome by learning humility and objectivity, it will kill any investor eventually.  Marks writes:

In contrast, thoughtful investors can toil in obscurity, achieving solid gains in the good years and losing less than others in the bad years.  They avoid sharing in the riskiest behavior because they’re so aware of how much they don’t know and because they have their egos in check.  This, in my opinion, is the greatest formula for long-term wealth creation – but it doesn’t provide much ego gratification in the short run.  It’s just not that glamorous to follow a path that emphasizes humility, prudence, and risk control.  Of course, investing shouldn’t be about glamour, but often it is.

Capitulation is a final phenomenon that Marks emphasizes.  In general, people become overly negative about a stock that is deeply out of favor because the business in question is going through hard times.  Moreover, when overly negative investors are filled with fear and when they see everyone selling in a panic, they themselves often sell near the very bottom.  Often these investors know analytically that the stock is cheap, but their emotions (fear of loss, conformity to the crowd, etc.) are too strong, so they disbelieve their own sound logic.  The rational, contrarian, long-term value investor does just the opposite:  he or she buys near the point of maximum pessimism (to use John Templeton’s phrase).

Similarly, most investors become overly optimistic when a stock is near its all-time highs.  They see many other investors who have done well with the sky-high stock, and so they tend to buy at a price that is near the all-time highs.  Again, many of these investors – like Isaac Newton – know analytically that buying a stock when it is near its all-time highs is often not a good idea.  But greed, envy, self-deception, crowd conformity, etc. (fear of missing out, dream of a sure thing), overwhelm their own sound logic.  By contrast, the rational, long-term value investor does the opposite:  he or she sells near the point of maximum optimism.

Marks gives a marvelous example from the tech bubble of 1998-2000:

From the perspective of psychology, what was happening with IPOs is particularly fascinating.  It went something like this: The guy next to you in the office tells you about an IPO he’s buying.  You ask what the company does.  He says he doesn’t know, but his broker told him its going to double on the day of issue.  So you say that’s ridiculous.  A week later he tells you it didn’t double… it tripled.  And he still doesn’t know what it does.  After a few more of these, it gets hard to resist.  You know it doesn’t make sense, but you want protection against continuing to feel like an idiot.  So, in a prime example of capitulation, you put in for a few hundred shares of the next IPO… and the bonfire grows still higher on the buying from new converts like you.



To buy when others are despondently selling and to sell when others are euphorically buying takes the greatest courage, but provides the greatest profit. – Sir John Templeton

Superior value investors buy when others are selling, and sell when others are buying.  Value investing is simple in concept, but it is very difficult in practice.

Of course, it’s not enough just to be contrarian.  Your facts and your reasoning also have to be right:

You’re neither right nor wrong because the crowd disagrees with you.  You’re right because your data and reasoning are right – and that’s the only thing that makes you right.  And if your facts and reasoning are right, you don’t have to worry about anybody else. – Warren Buffett

Or, as Seth Klarman puts it:

Value investing is at its core the marriage of a contrarian streak with a calculator.

Only by being right about the facts and the reasoning can a long-term value investor hold (or add to) a position when everyone else continues to sell.  Getting the facts and reasoning right still involves being wrong roughly one-third of the time, often due to bad luck but also sometimes due to mistakes in analysis or psychology.  But getting the facts and reasoning right leads to ‘being right’ roughly two-third of the time.

‘Being right’ usually means a robust process correctly followed – both analytically and psychologically – and the absence of bad luck.  But sometimes good luck plays a role.  Either way, a robust process correctly followed should produce positive results (on both an absolute and relative basis) over most rolling five-year periods, and over nearly all rolling ten-year periods.

It’s never easy to consistently follow a careful, contrarian value investing approach.  Marks quotes David Swensen:

Investment success requires sticking with positions made uncomfortable by their variance with popular opinion… Only with the confidence created by a strong decision-making process can investors sell speculative excess and buy despair-driven value.

… Establishing and maintaining an unconventional investment profile requires acceptance of uncomfortably idiosyncratic portfolios, which frequently appear downright imprudent in the eyes of conventional wisdom.

Marks puts it in his own words:

The most profitable investment actions are by definition contrarian:  you’re buying when everyone else is selling (and the price is thus low) or you’re selling when everyone else is buying (and the price is high).  These actions are lonely and… uncomfortable.

Marks writes about the paradoxical nature of investing:

The thing I find most interesting about investing is how paradoxical it is: how often the things that seem most obvious – on which everyone agrees – turn out not to be true.

The best bargains are typically only available when pessimism and uncertainty are high.  Many investors say, ‘We’re not going to try to catch a falling knife; it’s too dangerous… We’re going to wait until the dust settles and the uncertainty is resolved.’  But waiting until uncertainty gets resolved usually means missing the best bargains, as Marks says:

The one thing I’m sure of is that by the time the knife has stopped falling, the dust has settled and the uncertainty has been resolved, there’ll be no great bargains left.  When buying something has become comfortable again, its price will no longer be so low that it’s a great bargain.  Thus, a hugely profitable investment that doesn’t begin with discomfort is usually an oxymoron.

It’s our job as contrarians to catch falling knives, hopefully with care and skill.  That’s why the concept of intrinsic value is so important.  If we hold a view of value that enables us to buy when everyone else is selling – and if our view turns out to be right – that’s the route to the greatest rewards earned with the least risk.



It cannot be too often repeated:

A high-quality asset can constitute a good or bad buy, and a low-quality asset can constitute a good or bad buy.  The tendency to mistake objective merit for investment opportunity, and the failure to distinguish between good assets and good buys, gets most investors into trouble.

What is the process by which some assets become cheap relative to intrinsic value?  Marks explains:

    • Unlike assets that become the subject of manias, potential bargains usually display some objective defect. An asset class may have weaknesses, a company may be a laggard in its industry, a balance sheet may be over-levered, or a security may afford its holders inadequate structural protection.
    • Since the efficient-market process of setting fair prices requires the involvement of people who are analytical and objective, bargains usually are based on irrationality or incomplete understanding. Thus, bargains are often created when investors either fail to consider an asset fairly, or fail to look beneath the surface to understand it thoroughly, or fail to overcome some non-value-based tradition, bias or stricture.
    • Unlike market darlings, the orphan asset is ignored or scorned. To the extent it’s mentioned at all by the media and at cocktail parties, it’s in unflattering terms.
    • Usually its price has been falling, making the first-level thinker as, ‘Who would want to own that?’ (It bears repeating that most investors extrapolate past performance, expecting the continuation of trends rather than the far-more-dependable regression to the mean.  First-level thinkers tend to view price weakness as worrisome, not as a sign that the asset has gotten cheaper.)
    • As a result, a bargain asset tends to be one that’s highly unpopular. Capital stays away from it or flees, and no one can think of a reason to own it.

Where is the best place to look for underpriced assets?  Marks observes that a good place to start is among things that are:

    • little known and not fully understood;
    • fundamentally questionable on the surface;
    • controversial, unseemly or scary;
    • deemed inappropriate for ‘respectable’ portfolios;
    • unappreciated, unpopular and unloved;
    • trailing a record of poor returns; and
    • recently the subject of disinvestment, not accumulation.


To boil it all down to just one sentence, I’d say the necessary condition for the existence of bargains is that perception has to be considerably worse than reality.  That means the best opportunities are usually found among things most others won’t do.  After all, if everyone feels good about something and is glad to join in, it won’t be bargain-priced.

Marks started a fund for high yield bonds – junk bonds – in 1978.  One rating agency described high yield bonds as “generally lacking the characteristics of a desirable investment.”  Marks points out the obvious: “if nobody owns something, demand for it (and thus the price) can only go up and…. by going from taboo to even just tolerated, it can perform quite well.”

In 1987, Marks formed a fund to invest in distressed debt:

Who would invest in companies that already had demonstrated their lack of financial viability and the weakness of their management?  How could anyone invest responsibly in companies in free fall?  Of course, given the way investors behave, whatever asset is considered worst at a given point in time has a good likelihood of being the cheapest.  Investment bargains needn’t have anything to do with high quality.  In fact, things tend to be cheaper if low quality has scared people away.



Marks makes the same point that Warren Buffett and Charlie Munger often make: Most of the time, by far the best thing to do is absolutely nothing.  Finding one good idea a year is enough to get outstanding returns over time.  Writes Marks:

So here’s a tip: You’ll do better if you wait for investments to come to you rather than go chasing after them.  You tend to get better buys if you select from the list of things sellers are motivated to sell rather than start with a fixed notion as to what you want to own.  An opportunist buys things because they’re offered at bargain prices.  There’s nothing special about buying when prices aren’t low.

Marks took five courses in Japanese studies as an undergraduate business major in order to fulfill his requirement for a minor.  He learned the Japanese value of mujo:

mujo means cycles will rise and fall, things will come and go, and our environment will change in ways beyond our control.  Thus we must recognize, accept, cope and respond.  Isn’t that the essence of investing?

… What’s past is past and can’t be undone.  It has led to the circumstances we now face.  All we can do is recognize our circumstances for what they are and make the best decisions we can, given the givens.

Marks quotes Buffett, who notes that there are no called strikes in investing:

Investing is the greatest business in the world because you never have to swing.  You stand at the plate; the pitcher throws you General Motors at 47!  U.S. steel at 39!  And nobody calls a strike on you.  There’s no penalty except opportunity.  All day you wait for the pitch you like; then, when the fielders are asleep, you step up and hit it.

It’s dumb to invest when the opportunities are not there.  But when the overall market is high, there are still a few ways to do well as a long-term value investor.  If one is able to ignore short-term volatility and focus on the next five to ten years, then one can invest in undervalued stocks.

If one’s assets under management are small enough, then there can be certain parts of the market where one can still find excellent bargains.  An example would be micro-cap stocks, since very few professional investors look there.  (This is the focus of the Boole Microcap Fund.)

Another example of potentially cheap (albeit volatile) stocks in an otherwise expensive stock market is old-related companies.  Energy companies recently were as cheap as they’ve ever been.  See: https://www.gmo.com/americas/research-library/resource-equities/?utm_source=linkedin&utm_medium=social&utm_campaign=insights_resource_equities



We have two classes of forecasters: Those who don’t know – and those who don’t know they don’t know. – John Kenneth Galbraith

Marks, like Buffett, Munger, and most other top value investors, thinks that financial forecasting simply cannot be done with any sort of consistency.  But Marks has two caveats:

    • The more we concentrate on smaller-picture things, the more it’s possible to gain a knowledge advantage. With hard work and skill, we can consistently know more than the next person about individual companies and securities, but that’s much less likely with regard to markets and economies.  Thus, I suggest people try to ‘know the knowable.’
    • An exception comes in the form of my suggestion, on which I elaborate in the next chapter, that investors should make an effort to figure out where they stand at a moment in time in terms of cycles and pendulums. That won’t render the future twists and turns knowable, but it can help one prepare for likely developments.


Marks has tracked (in a limited way) many macro predictions, including U.S. interest rates, the U.S. stock market, and the yen/dollar exchange rate.  He found quite clearly that most forecasts were not correct.

I can elaborate on two examples that I spent much time on (when I should have stayed focused on finding individual companies available at cheap prices):

    • the U.S. stock market
    • the yen/dollar exchange

A secular bear market for U.S. stocks began (arguably) in the year 2000, when the 10-year Graham-Shiller P/E – also called the CAPE (cyclically adjusted P/E) – was over 30, its highest level in U.S. history.  The long-term average CAPE is around 16.  Based on over one hundred years of history, the pattern for U.S. stocks in a secular bear market would be relatively flat or lower until the CAPE approached 10.  However, ever since Greenspan started running the Fed in the 1980’s, the Fed has usually had a policy of stimulating the economy and stocks by lowering rates or keeping rates as low as possible.  This has caused U.S. stocks to be much higher than otherwise.  For instance, with rates today staying near zero, U.S. stocks could easily be twice as high as or three times as high as “normal” indefinitely, assuming the Fed decides to keep rates low for many more years.  As Buffett has noted, near-zero rates for many decades would eventually mean price/earnings ratios on stocks of 100.

In any case, in the year 2012 to 2013, some of the smartest market historians (including Russell Napier, author of Anatomy of the Bear) started predicting that the S&P 500 Index would fall towards a CAPE of 10 or lower, which is how every previous U.S. secular bear market concluded.  It didn’t happen in 2012, or in 2013, or in 2014, or in 2015, or in 2016, or in 2017, or in 2018, or in 2019.  (Also, the stock market decline in early 2020 was a temporary response to the coronavirus.)  Eventually the U.S. stock market will experience another major bear market.  But by the time that happens, it may start from a level over 4,000 or 4,500 in the next year or two, and it may not decline below 2000, which is actually far above the level from which the smartest forecasters (such as Russell Napier) said the decline would begin.

Robert Shiller, the Nobel Prize-winning economist who perfected the CAPE (Shiller P/E), said in 1996 that U.S. stocks were high.  But if an investor had gone to cash in 1996, they wouldn’t have had any chance of being ahead of the stock market until 2008 to 2009, more than 10 years later during the biggest financial crisis since the Great Depression.

Shiller has recently explained the CAPE with more clarity: http://www.businessinsider.com/robert-shiller-on-stocks-2013-1

When the CAPE is high, as it is today, the long-term investor should still have a large position in U.S. stocks.  But the long-term investor should expect fairly low ten-year returns, a few percent per annum, and they also should some investments outside of U.S. stocks.  Shiller also has observed that certain sectors in the U.S. economy can be cheap (low CAPE).  Many oil-related stocks, for example, are very probably quite cheap today (mid 2021) relative to their long-term normalized earnings power.

The main point here, though, is that forecasting the next bear market or the next recession with any precision is generally impossible.  Another example would be the Economic Cycle Research Institute (https://www.businesscycle.com/), which predicted a U.S. recession around 2011-2012 based on its previously quite successful set of leading economic indicators.  But they were wrong, and they later admitted that the Fed printing so much money not only may have kept the U.S. barely out of recession, but also may have led to distortions in the economic data, making ECRI’s set of leading economic indicators no longer as reliable.

As for the yen/dollar exchange, the story begins in a familiar way:  some of the smartest macro folks around predicted (in 2010 and later) that shorting the yen vs. the U.S. dollar would be the “trade of the decade,” and that the yen/dollar exchange would exceed 200.  But it’s not 2021, and the yen/dollar exchange rate has come nowhere near 200.

The “trade of the decade argument” was the following:  the debt-to-GDP in Japan has reached stratospheric levels, , government deficits have continued to widen, and the Japanese population is actually shrinking.  Since long-term GDP growth is a function of population growth plus innovation, it should become mathematically impossible for the Japanese government to pay back its debt without a significant devaluation of their currency.  If the BOJ could devalue the yen by 67% – which would imply a yen/dollar exchange rate of well over 200 – then Japan could repay the government debt in seriously devalued currency.  In this scenario – a yen devaluation of 67% – Japan effectively would only have to repay 33% of the government debt.  Currency devaluation – inflating away the debts – is what most major economies throughout history have done.

The bottom line as regards the yen is the following:  Either Japan must devalue the Yen by 67% – implying a yen/dollar exchange rate of well over 200 – or Japan will inevitably reach the point where it is quite simply impossible for it to repay a large portion of the government debt.  That’s the argument.  There could be other solutions, however.  The human economy is likely to be much larger in the future, and there may be some way to help the Japanese government with its debts.  After all, the situation wouldn’t seem so insurmountable if Japan could grow its population.  But this might happen in some indirect way if the human economy becomes more open in the future, perhaps involving the creation of a new universal currency.

In any case, for the past five to ten years, and even longer, it has been argued that either the yen/dollar would eventually exceed 200 (thus inflating away as much as 67% of the debt), or the Japanese government would inevitably default on JGB’s (Japanese government bonds).  In either case, the yen should collapse relative to the U.S. dollar, meaning a yen/dollar of well over 200.  This has been described as “the trade of the decade,” but it may not happen for several decades.

In the end, one could have spent decades trying to short the Yen or trying to short JGB’s, without much to show for it.  Or one could have spent those decades doing value investing:  finding and buying cheap stocks, year in and year out.  Decades later, value investing would almost certainly have produced a far better result, and with a relatively low level of risk.

The same logic applies to market timing, or trying to profit on the basis of predicting bull markets, bear markets, recessions, etc.  For the huge majority of investors, they would get much better profits, at relatively low risk, by following a value investing approach (whether by investing in a value fund, or by applying the value approach directly to stocks) or simply investing in low-cost broad market index funds.

In Sum

In sum, financial forecasting cannot be done with any sort of consistency.  Every year, there are many people making financial forecasts, and so purely as a matter of chance, a few will be correct in a given year.  But the ones correct this year are almost never the ones correct the next time around, because what they’re trying to predict can’t be predicted with any consistency.  Marks writes thus:

I am not going to try to prove my contention that the future is unknowable.  You can’t prove a negative, and that certainly includes this one.  However, I have yet to meet anyone who consistently knows what lies ahead macro-wise…

One way to get to be right sometimes is to always be bullish or always be bearish; if you hold a fixed view long enough, you may be right sooner or later.  And if you’re always an outlier, you’re likely to eventually be applauded for an extremely unconventional forecast that correctly foresaw what no one else did.  But that doesn’t mean your forecasts are regularly of any value…

It’s possible to be right about the macro-future once in a while, but not on a regular basis.  It doesn’t do any good to possess a survey of sixty-four forecasts that includes a few that are accurate; you have to know which ones they are.  And if the accurate forecasts each six months are made by different economists, it’s hard to believe there’s much value in the collective forecasts.

Marks gives one more example: How many predicted the crisis of 2007-2008?  Of those who did predict it – there was bound to be some from pure chance alone – how many of those then predicted the recovery starting in 2009 and continuing until early 2020?  The answer is “very few.”  The reason, observes Marks, is that those who got 2007-2008 right “did so at least in part because of a tendency toward negative views.”  They probably were negative well before 2007-2008, and more importantly, they probably stayed negative afterwards, during which the U.S. stock market increased (from the low) more than 400% as the U.S. economy expanded from 2009 to early 2020.


Marks has a description for investors who believe in the value of forecasts.  They belong to the “I know” school, and it’s easy to identify them:

    • They think knowledge of the future direction of economies, interest rates, markets and widely followed mainstream stocks is essential for investment success.
    • They’re confident it can be achieved.
    • They know they can do it.
    • They’re aware that lots of other people are trying to do it too, but they figure either (a) everyone can be successful at the same time, or (b) only a few can be, but they’re among them.
    • They’re comfortable investing based on their opinions regarding the future.
    • They’re also glad to share their views with others, even though correct forecasts should be of such great value that no one would give them away gratis.
    • They rarely look back to rigorously assess their record as forecasters.

Marks contrasts the confident “I know” folks with the guarded “I don’t know” folks.  The latter believe you can’t predict the macro-future, and thus the proper goal for investing is to do the best possible job analyzing individual securities.  Marks points out that if you belong to the “I don’t know” school, eventually everyone will stop asking you where you think the market’s going.

You’ll never get to enjoy that one-in-a-thousand moment when your forecast comes true and the Wall Street Journal runs your picture.  On the other hand, you’ll be spared all those times when forecasts miss the mark, as well as the losses that can result from investing based on overrated knowledge of the future.

Marks continues by noting that no one likes investing on the assumption that the future is unknowable.  But if the future IS largely unknowable, then it’s far better as an investor to acknowledge that fact than to pretend otherwise.

Furthermore, says Marks, the biggest problems for investors tend to happen when investors forget the difference between probability and outcome (i.e., the limits of foreknowledge):

    • when they believe the shape of the probability distribution is knowable with certainty (and that they know it),
    • when they assume the most likely outcome is the one that will happen,
    • when they assume the expected result accurately represents the actual result, or
    • perhaps most important, when they ignore the possibility of improbable outcomes.

Marks sums it up:

Overestimating what you’re capable of knowing or doing can be extremely dangerous – in brain surgery, transocean racing or investing.  Acknowledging the boundaries of what you can know – and working within those limits rather than venturing beyond – can give you a great advantage.



Marks believes that market cycles – inevitable ups and downs – cannot be predicted as to extent and (especially) as to timing, but have a profound influence on us as investors.  The only thing we can predict is that market cycles are inevitable.

Marks holds that as investors, we can have a rough idea of market cycles.  We can’t predict what will happen exactly or when.  But we can at least develop valuable insight into various future events.

So look around, and ask yourself: Are investors optimistic or pessimistic?  Do the media talking heads say the markets should be piled into or avoided?  Are novel investment schemes readily accepted or dismissed out of hand?  Are securities offerings and fund openings being treated as opportunities to get rich or possible pitfalls?  Has the credit cycle rendered capital readily available or impossible to obtain?  Are price/earnings ratios high or low in the context of history, and are yield spreads tight or generous?  All of these things are important, and yet none of them entails forecasting.  We can make excellent investment decisions on the basis of present observations, with no need to make guesses about the future.

Marks likens the process of assessing the current cycle with “taking the temperature” of the market.  Again, one can never precisely time market turning points, but one can at least become aware of when markets are becoming overheated, or when they’ve become unusually cheap.

It may be more difficult today to take the market’s temperature because of the policy of near-zero (or negative) interest rates in many of the world’s major economies.  This obviously distorts all asset prices.  As Buffett remarked recently, if U.S. rates were going to stay near zero for many decades into the future, U.S. stocks would eventually be much higher than they are today.  Zero rates indefinitely would easily mean price/earnings ratios of 100 (or even 200).

Stanley Druckenmiller, one of the most successful macro investors, has consistently said that the stock market is driven in large part not by earnings, but by central bank liquidity.

In any case, timing the next major bear market is virtually impossible, as acknowledged by the majority of great investors such as Howard Marks, Warren Buffett, Charlie Munger, Seth Klarman, Bill Ackman, and others.

What Marks, Buffett, and Munger stress is to focus on finding cheap stocks.  Pay cheap enough prices so that, on average, one can make a profit over the next five years or ten years.  At some point – no one knows precisely when – the U.S. stock market is likely to drop roughly 30-50%.  One must be psychologically prepared for this.  And one’s portfolio must also be prepared for this.

If one is able to buy enough cheap stocks, while maintaining a focus on the next five years or ten years, and if one is psychologically prepared for a big drop at some point, which always happens periodically, then one will be in good position.

Note:  Cheap stocks (whether oil-related or otherwise) typically have lower correlation than usual with the broader stock market.  Even if the broader market declines, some cheap stocks may do much better on both a relative and absolute basis.

Finally, some percentage in cash may seem like a wise position to have in the event of a major (or minor) bear market.  The tricky part, again, is what percentage to have in cash and when.  Many excellent value investors have had 50% or more in cash since 2012 or 2013. Since 2012, the market has more than doubled.  So cash has been a significant drag on the performance of investors who have had large cash positions.

For these reasons, many great value investors – including Marks, Buffett, Munger, and many others – simply never try to time the market.  Many of these value investors essentially stay fully invested in the cheapest stocks they can find.  Over a very long period of time, many studies have shown that hedges, short positions, and cash lower the volatility of the portfolio, but also lower the long-term returns.  Given how many smart people have been hedging since 2012,  the eight or so years up until early 2020 have provided yet another clear example of why market timing is impossible to do with any consistency.

Henry Singleton, described by both Buffett and Munger as being the best capital allocator (among CEO’s) in U.S. history, compounded business value at Teledyne at incredible rates for decades by buying stocks (including Teledyne) when they were cheap.  Singleton’s amazing track record included the 1970’s, when the broader U.S. stock market went virtually nowhere.  Singleton was a genius (100 points away from being a chess grandmaster).  On the subject of market timing, Singleton has said:

I don’t believe all this nonsense about market timing. Just buy very good value and when the market is ready that value will be recognized.



Luck – chance or randomness – influences investment outcomes.  Marks considers Nassim Taleb’s Fooled by Randomness to be essential reading for investors.  Writes Marks:

Randomness (or luck) plays a huge part in life’s results, and outcomes that hinge on random events should be viewed as different from those that do not.

Marks quotes Taleb:

If we have heard of [history’s great generals and inventors], it is simply because they took considerable risks, along with thousands of others, and happened to win.  They were intelligent, courageous, noble (at times), had the highest possible obtainable culture in their day – but so did thousands of others who live in the musty footnotes of history.

A central concept from Taleb is that of “alternative histories.”  What actually has happened in history is merely a small subset of all the things that could have happened, at least as far as we know.  As long as there is a component of indeterminacy in human behavior (not to mention the rest of reality), one must usually assume that many “alternative histories” were possible.  From the practical point of view of investing, given a future that is currently unknowable in many respects, one must develop a reasonable set of scenarios along with estimated probabilities for each scenario.  And, when judging the quality of past decisions, one must think carefully about various possible (“alternative”) histories, of which what actually happened appears to be a small subset.

Thus, the fact that a stratagem or action worked – under the circumstances that unfolded – doesn’t necessarily prove that the decision behind it was wise.


Marks says he agrees with all of Taleb’s important points:

    • Investors are right (and wrong) all the time for the ‘wrong reason.’ Someone buys a stock because he or she expects a certain development; it doesn’t occur; the market takes the stock up anyway; the investor looks good (and invariably accepts credit).
    • The correctness of a decision can’t be judged from the outcome. Neverthelss, that’s how people assess it.  A good decision is one that’s optimal at the time it’s made, when the future is by definition unknown.  Thus, correct decisions are often unsuccessful, and vice versa.
    • Randomness alone can produce just about any outcome in the short run. In portfolios that are allowed to reflect them fully, market movements can easily swamp the skillfulness of the manager (or lack thereof).  But certainly market movements cannot be credited to the manager (unless he or she is the rare market timer who’s capable of getting it right repeatedly).
    • For these reasons, investors often receive credit they don’t deserve. One good coup can be enough to build a reputation, but clearly a coup can arise out of randomness alone.  Few of these “geniuses” are right more than once or twice in a row.
    • Thus, it’s essential to have a large number of observations – lots of years of data – before judging a given manager’s ability.

Over the long run, the rational investor learns, refines, and sticks with a robust investment process that reliably produces good results.  In the short run, when a good process sometimes leads to bad outcomes (often due to bad luck but sometimes due to a mistake), one must simply be stoic and patient.

Marks continues:

The actions of the ‘I know’ school are based on a view of a single future that is knowable and conquerable.  My ‘I don’t know’ school thinks of future events in terms of a probability distribution.  That’s a big difference.  In the latter case, we may have an idea which one outcome is most likely to occur, but we also know there are many other possibilities, and those other outcomes may have a collective likelihood much higher than the one we consider most likely.

Marks concludes:

    • We should spend our time trying to find value among the knowable – industries, companies and securities – rather than base our decisions on what we expect from the less-knowable macro world of economies and broad market performance.
    • Given that we don’t know exactly which future will obtain, we have to get value on our side by having a strongly held, analytically derived opinion of it and buying for less when opportunities to do so present themselves.
    • We have to practice defensive investing, since many of the outcomes are likely to go against us. It’s more important to ensure survival under negative outcomes than it is to guarantee maximum returns under favorable ones.
    • To improve our chances of success, we have to emphasize acting contrary to the herd when it’s at extremes, being aggressive when the market is low and cautious when it’s high.
    • Given the highly indeterminate nature of outcomes, we must view strategies and their results – both good and bad – with suspicion until proved over a large number of trials.



Unlike professional tennis, where a successful outcome depends on which player hits the most winners, successful investing generally depends on minimizing mistakes more than it does on finding winners.

… investing is full of bad bounces and unanticipated developments, and the dimensions of the court and the height of the net change all the time.  The workings of economies and markets are highly imprecise and variable, and the thinking and behavior of the other players constantly alter the environment.  Even if you do everything right, other investors can ignore your favorite stock; management can squander the company’s opportunities; government can change the rules; or nature can serve up a catastrophe.

Marks argues that successful investing is a balance between offense and defense, and that this balance often differs for each individual investor.  What’s important is to stick with an investment process that works over the long term:

… Few people (if any) have the ability to switch tactics to match market conditions on a timely basis.  So investors should commit to an approach – hopefully one that will serve them through a variety of scenarios.  They can be aggressive, hoping they’ll make a lot on the winners and not give it back on the losers.  They can emphasize defense, hoping to keep up in good times and excel by losing less than others in bad times.  Or they can balance offense and defense, largely giving up on tactical timing but aiming to win through superior security selection in both up and down markets.

And by the way, there’s no right choice between offense and defense.  Lots of possible routes can bring you to success, and your decision should be a function of your personality and leanings, the extent of your belief in your ability, and the peculiarities of the markets you work in and the clients you work for.

Marks argues that defense can be viewed as aiming for higher returns, but through the avoidance of mistakes and through consistency, rather than through home runs and occasional flashes of brilliancy.

Avoiding losses first involves buying assets at cheap prices (well below intrinsic value).  Another element to avoiding losses is to ensure that one’s portfolio can survive a bear market.  If the five-year or ten-year returns appear to be high enough, an investor still may choose to play more offense than defense, even when he or she knows that a bear market is likely within five years or less.  But one must be fully prepared – psychologically and in one’s portfolio – for many already very cheap stocks to get cut in half or worse during a bear market.

Again, some investors can accept higher volatility in exchange for higher long-term returns.  One must know oneself.  One must know one’s clients.  One must really think through all the possible scenarios, because things can get much worse than one can imagine during bear markets.  And bear markets are inevitable.

There is always a trade-off between potential return and potential downside.  Choosing to aim for higher long-term returns means accepting higher downside volatility over shorter periods of time.

But it’s important to keep in mind that many investors fail not due to lack of home runs, but due to having too many strikeouts.  Overbetting is thus a common cause of failure for long-term investors.  We know from the Kelly criterion that overbetting guarantees zero or negative long-term returns.  Therefore, it’s wise for most investors to aim for consistency – a high batting average based on many singles and doubles – rather than to aim for the maximum number of home runs.

Put differently, it is easier for most investors to minimize losses than it is to hit a lot of home runs.  Thus, most investors are much more likely to achieve long-term success by minimizing losses and mistakes, than by hitting a lot of home runs.

Investing defensively can cause you to miss out on things that are hot and get hotter, and it can leave you with your bat on your shoulder in trip after trip to the plate.  You may hit fewer home runs than another investor… but you’re also likely to have fewer strikeouts and fewer inning-ending double plays.

Defensive investing sounds very erudite, but I can simplify it: Invest scared!  Worry about the possibility of loss.  Worry that there’s something you don’t know.  Worry that you can make high-quality decisions but still be hit by bad luck or surprise events.  Investing scared will prevent hubris; will keep your guard up and your mental adrenaline flowing; will make you insist on adequate margin of safety; and will increase the chances that your portfolio is prepared for things going wrong.  And if nothing does go wrong, surely the winners will take care of themselves.



An equal weighted group of micro caps generally far outperforms an equal weighted (or cap-weighted) group of larger stocks over time.  See the historical chart here:  https://boolefund.com/best-performers-microcap-stocks/

This outperformance increases significantly by focusing on cheap micro caps.  Performance can be further boosted by isolating cheap microcap companies that show improving fundamentals.  We rank microcap stocks based on these and similar criteria.

There are roughly 10-20 positions in the portfolio.  The size of each position is determined by its rank.  Typically the largest position is 15-20% (at cost), while the average position is 8-10% (at cost).  Positions are held for 3 to 5 years unless a stock approaches intrinsic value sooner or an error has been discovered.

The goal of the Boole Microcap Fund is to outperform the Russell Microcap Index over time, net of fees.  The Boole Fund has low fees. 


If you are interested in finding out more, please e-mail me or leave a comment.

My e-mail: jb@boolefund.com




Disclosures: Past performance is not a guarantee or a reliable indicator of future results. All investments contain risk and may lose value. This material is distributed for informational purposes only. Forecasts, estimates, and certain information contained herein should not be considered as investment advice or a recommendation of any particular security, strategy or investment product. Information contained herein has been obtained from sources believed to be reliable, but not guaranteed. No part of this article may be reproduced in any form, or referred to in any other publication, without express written permission of Boole Capital, LLC.

Big Profits from Small Stocks

September 17, 2023

Hilary Kramer is the author of The Little Book of Big Profits from Small Stocks (2012, Wiley).  Kramer is a highly successful investor who has made most of her money by investing in single-digit priced stocks.  She reveals her methods in this book.

Important Note:  I am a value investor.  I am looking to buy stocks at 50% or less of intrinsic value.  Kramer’s approach is similar in many ways, but she is not a value investor per se.  Kramer is still trying to buy stocks for less than they are worth, either relative to future earnings or relative to book value.

Kramer writes:

So why aren’t more Main Street investors looking to low-priced stocks?  Well, one of the biggest beliefs on Wall Street is that stocks under $10 are too dangerous for most investors.  Many institutional investors, such as mutual funds and pensions, are actually prohibited from owning stocks that trade in the single digits.  Stock that have fallen below that magic $10 mark often lose the attention of the research departments, so no analysts follow them and they tend to be ignored.  Wall Street often treats the single-digit priced stock sector as a graveyard, best passed as quickly as possible while whistling on the way to other endeavors.

Kramer has identified three categories of low-priced stocks:

    • Fall angels: These are large company stocks that have stumbled and fallen out of favor for various reasons.  Some are cyclical stocks, while some were companies where management made mistakes and earnings fell short of Wall Street expectations.
    • Undiscovered growth companies: Many of these happen to be overlooked because they are in unattractive industries.
    • Bargain bin stocks: These are stocks trading below book value.

Kramer notes that it’s essential to read the company’s financial statements and investor presentations.  There’s no easy way to high stock market profits.

Here’s an outline:

    • The Classic Under $10 Stock
    • The Price Is Not Just Right, It’s Critical
    • Oh, How the Mighty Have Fallen
    • Growing Out of Sight
    • Shopping the Bargain Bin
    • Getting the World Healthy and Wealthy
    • Around the World Under $10
    • Forget Everything You Thought You Knew
    • Looking for the Right Stuff
    • Well Bought is Half Sold
    • Beware the Wolves of Wall Street
    • Low Prices and High Profits



Kramer mentions Darling International (DAR) as the classic $10 stock.  The company collects used cooking oil and grease from restaurants all over the United States.  Another division stops at slaughterhouses and butcher shops to collect hides, bone, and other animal by-products.  They turn all this unusable stuff into useable products.

Kramer noticed Darling stock when it fell from $16 to $4.  She found that Darling’s competitors were small, locally-owned companies that had a hard time competing with Darling’s economies of scale.  At the time, the company had 39 facilities around the United States and 970 trucks and tractor-trailers collecting raw materials from 115,000 locations.  Most of Darling’s customers were on long-term contracts.

Darling was growing rapidly both organically and by acquisition of smaller competitors.  Revenues had increased from $323 million in 2003 to $645 million in 2007.  Profits had almost doubled from $.29 a share to $.59 a share.  The company had also paid down it’s long-term debt.  Kramer:

Darling may be in a stinky business, but it is one profitable company.  In spite of this, by the end of 2008 the stock was solidly in the single digits, trading at $5 and change.  Recently, the company had moved into alternative energy where the collected grease could be used to create biofuel.

Darling stock hit $4, which is where Kramer bought.  A little less than three years later, the stock exceeded $16.  Kramer’s investment had produced a 300 percent gain.  Kramer writes:

In this book, my goal is to help you find your Darlings.  After two decades of investing, I can tell you that low-priced stocks are a great way to build, or rebuild, your wealth.  Many of my biggest winning stocks over the years started out as single-digit priced stocks.  They were stocks that were way off Wall Street’s radar screens for a variety of reasons, but once the Street and large institutional investors discovered them, they often soared in price.

Kramer says these breakout stocks share three characteristics:

    1. Low-priced (mainly under $10).
    2. Undervalued.
    3. Have specific catalysts in the near future that put them on the threshold of breaking out to much higher prices.

That said, some stocks under $10 are cheap because they deserve to be.  So it’s essential to have a good investment process, including reading the company’s financial statements and presentations.  Kramer adds that she wish she hadn’t sold Darling, as the stock was soon in the mid-20s.

Kramer points out that there will always be recessions and economic slowdowns periodically.  It is wise to build a list of obsessive lifestyle stocks, because usually these stocks sell off just like other stocks during a recession but the businesses in question tend not to decline nearly as much.



The major brokerage houses have gone to great lengths to discourage trading in low-priced stocks.  To be sure, there are many low-priced stocks belonging to bad businesses, bankrupt companies, and overhyped enterprises.  But there are many solid companies that just happen to have hit challenges, causing their stocks to drop.

Kramer gives another example of a stock that hit single digits where the business itself was solid: Dendreon (DNDN).

Dendreon was developing a new drug manufactured from the patient’s own immune cells.  This new drug represented a potentially groundbreaking step in the fight against prostate cancer.  FDA approval looked imminent.

However, in May of 2007, the FDA decided they needed more trials and more information before they could approve the drug for widespread usage.  The stock began dropping and by May of 2009, Dendreon stock hit $2.60.  The market cap of the company had gone from $3 billion to $400 million.

Kramer did her homework and found that Dendreon’s new drug was likely to be approved after the new trials.  It took some time for Kramer to buy a full position, but she ended up getting one at an average price of $5 per share.

In May 2009, the FDA approved Dendreon’s new drug.  In less than two weeks, the stock was back over $20 and worth $3 billion again.  The stock kept going up from there because it was clear the new drug would be a commercial success.  A year later, Kramer sold for more than $50, a 900 percent profit—a ten-bagger.  Kramer:

I am not going to tell you that every low-priced stock you buy in your lifetime will breakout and become a ten-bagger.  Most investors only have a few of those in a lifetime.  I am going to tell you that we can make Wall Street’s aversion to low-priced stocks work for you more often than not and produce consistent and exciting profits.  Any ten-baggers you run across long the way will just be icing on the cake!



Kramer writes:

These are companies that were once considered blue chip or growth darlings that have fallen monstrously out of favor with Wall Street and investors.  These are stocks that were once widely owned and if not loved, at least admired and respected.  Something went drastically wrong for these companies and the share price plummeted into single digits.  In most cases investors sold too late and much money was lost along the way, often creating a cloud of ill will and outright distrust for these companies in many cases…

Often in the stock market, though, aversion can signal opportunity.

Kramer explains:

When it comes to identifying true fallen angels, there are two key questions you need to ask.  The first question is what went wrong?  Did management overdiversify the basic business and expand into areas where they had no expertise or advantage?  Did the company borrow too much money and is now having a hard time generating sufficient cash flow to service their debt load?  Has a competitor surpassed them in the marketplace?  Has there been a change in consumers’ buying habits and preferences that have left the company behind?  Have there been accounting irregularities or regulatory issues that the company must put behind it in a satisfactory manner before the company can return to profitability?  Are there customer or supplier lawsuits weighing on the company and its stock price?  The list of problems, mistakes, and management stumbles that make a once great company into a fallen angel are legion.  Before you even consider investing in a fallen angel stock you need to know exactly what went wrong and who is responsible for the problems.

The next question then becomes can it be fixed?  Can the company shed itself of unprofitable divisions or subsidiaries that take away from the core business?  Can management regain focus and catch back up to its competitors?  Can the company generate sufficient cash flow to pay down its debt or can the balance sheet be restructured in a fashion that allows a return to profitability?  Can regulatory issues be solved without permanent harm to the company?  Can they maintain a reasonable relationship with key suppliers and customers until the current crisis has passed?  Are the accounting and regulatory issues mistakes or are they fraudulent or criminal activity?  Can their products and services regain acceptance from consumers?  Once we figure out what has gone wrong, we need to figure out if the problems can be fixed.  If so, we have a candidate for a fallen angel stock, and in my experience the companies that do achieve a turnaround can then see their stock price double or even triple before too much time passes.

Kramer is quick to note that many of these stocks are not good investments for a variety of reasons.  So the investor has to carefully examine many such companies in order to identify one or a tiny handful of fallen angels.

Kramer gives the example of Ford Motor Company (F).  For a long time, Ford was the bluest of blue chips.  The company was incorporated in 1903 and is credited with inventing the production line method of assembling vehicles.  In World War II, Ford creating a great number of vehicles to meet military demand.

Froom 2005 to 2010 however, the company stumbled.  Not only had they acquired many other car companies and divisions that were not profitable, but they had rising healthcare costs combined with slowing sales and declining margins.  Management then made a bet in 2006 that they might need cash.  So they raised $23.6 billion in debt.  The CEO said this would cushion the company if there were a recession.  Kramer:

In 2008 the bottom came out from under the U.S. car market.  The automakers were heavily exposed to the consumer lending market and as the credit crisis deepened default rates climbed and profits evaporated.  In 2008 For had the worst year in its history, losing over $414 billion as the recession deepened.  Auto industry executives ended up going hat in hand to Capitol Hill to plead for a federal bailout.

Here is where Ford’s gamble at the end of 2006 paid off.  Both Chrysler and General Motors (GM) ended up having to file bankruptcy and accept government bailouts and funding.  Ford had enough cash on hand from the cash-out refinancing that they did not have to go to those lengths to survive.  Because they had cash on hand they could run their day-to-day operations without government assistance.  They engineered an equity-for-debt sawp that reduced debt loads by more than $10 billion.  Management worked out a deal with the UAW to accept stock in lieu of cash for pension and healthcare expenses.  Ford’s stock fell under $2 in 2009 as things looked bleak for the entire industry, and it began to divest some of its noncore lines like Jaguar, Land Rover, and Volvo.

This was where Kramer got interested in Ford’s stock.  Ford had lowered its debt and also Kramer found, after doing some research, that Ford’s F150 line of trucks was still dominant and the company had a loyal customer base.  Two years later, Ford stock (F) had gone from $2 to $18.

Kramer next describes her greatest fallen angel investment ever, one where the stock increased dramatically over the 8+ years that Kramer held it: Priceline.com (PCLN).  Many internet stocks had crashed after the bubble in 1999-2000.  This included Priceline, which had hit $1 per share.

The company had made some misteps by trying to expand beyond travel services using a name-your-own-price model to sell gasoline, groceries, long distance telephone plans, and a host of other items.  They also tried to compete with eBay (EBAY) in the online auction business.  They even tried a name-your-own-price home mortgage program.  Nearly all these ventures failed.

The stock had fallen from $165 to $1.  But Kramer discovered that the company still had plenty of cash.  And Priceline was exiting all of their noncore operations and schemes and returning to their basic travel business.  Friends told Kramer they were still using the service and were still very satisfied.  Kramer bought the stock in February 2003.

The company did a one for six reverse stock split.  This made Kramer’s cost basis, adjusted for the reverse split, $7.63 per share.   By 2011, the stock had hit $543 and Kramer was continuing to hold it.  Kramer:

I have made over 70 times my money by finding this fallen angel and asking two crucial questions: What went wrong? and Can it be fixed?

What went wrong was obvious.  The stock got caught up in the collapse of the Internet boom and management tried to enter businesses where they had no competitive advantage.  And once they returned to their original core focus, I felt it could be fixed and that it was only a matter of time before business and the stock price began to grow again.

What’s the best way to find fallen angel candidates?  Kramer offers several methods.  Read the news, as the stocks of one-time leaders that have fallen are usually paid attention in the media.  Look at 52-week low lists.  Check all the stocks in the S&P 500 to see which ones are single-digit stocks.  Finally, one of the best tools is to use a web-based stock screener.

After you have a list of candidates, you have to go to work reading the financial statements and company presentations.  You have to ask the two questions: What went wrong? and Can it be fixed?



You can make a lot of money if you own a growth stock, but the key is to buy at a low price.  Kramer explains that many growth stocks are already very popular, which means their stock prices are already quite high.  Kramer writes:

We are more interested in the type of stocks that legendary Peter Lynch described in his classic book One Up On Wall Street.  Mr. Lynch described the perfect stock as one that was in a boring niche business.  Preferably the company would be a business that was dull or downright disagreeable.  He jokingly said that he would also like it if there were rumors of toxic waste or Mafia involvement!  This type of stock would be way off the Wall Street radar screen, and few institutions would own it and analysts would not cover it or write reports for the sales force to pump the stock.

Kramer reminds the reader that she had already described just such a stock in the first chapter: Darling International.  Rendering and grease collection is a dull messy business, but a necessary one.  Kramer jokes that she has never been to a party and heard someone talking about the wonderful hide rendering company that was in their portfolio.  Kramer:

This is exactly what made Darling such an outstanding investment opportunity.  No one was paying any attention to the company as they grew into the largest company in the business and grew earnings rapidly.  Darling was not only a classic under $10 breakout stock, it was also an undiscovered growth stock.

Of course, not all growth stocks that are still cheap are unknown.  Sometimes investors simply give up on a company, which makes the stock low-priced.

Kramer suggests a class of companies she calls “obsessive product companies.”

These companies make products that people simply do not want to live without regardless of what is going on in the economy or the world.  There are some hobbies or products that become lifestyles.  Many of these are not recognized on Wall Street for the simple reason that they do not share the same interests or recognize that in many cases the company in question makes a product that is not going to go away regardless of the economy.  If business does slow down a bit, it is simply going to create pent-up demand.  Purchases may be delayed but they will not be denied!

Krames gives the example of Cabela’s (CAB), the outdoor superstore company.  In late 2008, like other retailers, Cabela’s saw slowing sales and the stock fell to $5.  Kramer explains what Wall Street missed: Cabela’s sells hunting and fishing products, and the buyers of these products are very serious about their chosen hobby.  Also, while Cabela’s had over $300 million in debt, the company had close to $400 million in cash.  Moreover, their credit card operation never really experienced big losses, again because their customers were very serious about their hobby and didn’t want to let their Cabela’s account become delinquent.

Furthermore, the company was asset rich.  It owned 24 of their 29 locations, and the book value of the stock was over $12.

In 2008, Kramer began buying the stock under $5.  By the end of 2009, Cabela’s had over $500 million in cash and they had reduced their debt.  Kramer sold at $14.92, for a return of almost 200 percent in less than a year.

Kramer notes that there will always be recessions and slowdowns periodically.  It is wise to build a list of obsessive lifestyle stocks.  When recession hits, these stocks tend to decline just like other stocks even though the obsessive lifestyle businesses tend not to decline nearly as much as other businesses.

Furthermore, Kramer suggests looking for companies that can experience earnings growth without necessarily being exciting.  She gives the example of Dole Foods (DOLE).  The company was founded in 1891.  In 2003, businessman David Murdoch bought the company from Castle and Cook.  The company expanded into other lines of fruits and vegetables.  In 2009, the company went public at $12.50 a share.

Nobody paid any attention.  Kramer:

Dole had grown into the largest producer and distributor of fruits and vegetables in the world but to investors these were not exciting products.  The stock price languished and early in 2010 it fell below the $10 mark where I began to take notice of the company.

Kramer believed that the demand for healthy foods was only going to grow in the years ahead.  This was true not only in the United States, but also in many emerging markets globally.  The stock soon increased 50 percent.  Kramer writes:

The mantra of most growth stock investors is bigger, better, faster.  They are looking for the newest fads and the most exciting products.  The truth is that the best growth stories are often found in our cupboards and refrigerators.  The regular seemingly boring products we use every day can create growth stories and when those companies see their stock price fall into the single digits, they become tremendous profit opportunities.

Kramer also recommends running a web-based stock screen.  Search for companies that have been growing steadily for at least five years.  Most of these stocks will already be high-priced, but occasionally you may find a low-priced one.  Kramer:

…just finding one of these before Wall Street does can make a huge difference in your net worth over time.


To run this search, set the screener to look for stocks that have grown earnings and revenues by at least 15 percent a year for the past five years.  We also want companies that do not owe a lot of money and have decent balance sheets.  Legendary investor Benjamin Graham once set that threshold as owning twice what you owe, so I think that’s a reasonable threshold.  Set the debt to equity ratio at a maximum of .3.  This will give us a company with at least 70 percent equity and 30 percent debt as part of the total capital structure.

Of course, you also include on the screen the requirement that the stock price be below $10.  Kramer:

Your list of stocks is going to be short and the companies will be small.  In fact if you ran it right now for U.S. stocks the resulting list would be just 51 names out of all the stocks listed on major exchanges and markets here in the United States.  The largest company on this list is going to be just $750 million in market capitalization and the smallest is just under $30 million in total market cap.  There are some pretty interesting companies and it will be worth your time to search this list and dig a little deeper to find the real winners out of this list.  You want to look for companies with products that have exposure to huge potential markets like alternative energy, smartphones, and other communication devices, social networking, or any other product or service that can see continued steady growth for years to come… Decent levels of insider ownership are also preferable in these small, steady growers.  If the founders and managers of these little growth gems still own a good share of the company, say 10 percent or more, they have a vested interest in seeing the stock price go higher over time.

Kramer next mentions a screen for explosive growers.  These are low-priced breakout stocks that have seen a surge of earnings and revenues in the past year.  Kramer:

We usually find two types of companies on this list.  One is a company that stumbled or is caught by the economic cycle and has had depressed earnings and sales.  Now the cycle has swung back in their direction and they are set to surge.  The other is a company that has a breakthrough with some product or service that suddenly takes the world by storm and is set to explode upward.

We want explosive growth here so we will initially set the bar high.  Set your screener to look for companies with earnings growth of at least 100 percent annually.  Often profit margins are also exploding so revenue growth is not as critical with this screen.  Again, we do not want too much debt, but we can give these exploders a little more room, so set the debt to equity ratio ceiling at 50 percent.

Once again, a recession or a bear market can create many low-priced stocks among the explosive growers.  Kramer says the investor will learn to love recessions and bear markets for this very reason.



This is the method of finding stocks that are trading below tangible book value.  (Intangible assets are not included.)  Kramer:

Bargain bin stocks sell below book value for many reasons.  The company could be experiencing a slowdown in its business and Wall Street has abandoned the stock.  The whole industry may be unloved, as was once the case with electric utility stocks back in the 1980s.  Cost overruns on nuclear power plants and a hostile regulatory environment had all of these stocks selling for less than their book value.  In the aftermath of the Savings and Loan crisis in the early 1990s, almost all small bank and thrift stocks sold well below the value of their assets.  Sometimes it is just a stock that is too small for analysts to follow and the stock price has languished as the assets have grown.  Our job is to figure out if those assets can be converted to either a higher stock price or be turned into cash via a takeover or restructuring in the near future.

Kramer gives the example of Tesoro (TSO), a major North American refiner of petroleum products.  In 2008, its stock fell well below its book value.  When the economy slows down, business is awful for refiners.  However, the company had many tangible assets and we knew the recession would eventually end.  Tesoro owned seven refineries and 879 retail gas stations.  Tesoro also owned 900 miles of oil pipelines around the country.  The most important point, writes Kramer, is that there are not many refineries in the United States.  There hasn’t been a new refinery built in the United States since 1977.  Therefore, these are irreplaceable assets.  Kramer:

The assets already appeared pretty valuable to me.  Although the business was terrible the asset pile was worth a lot of money.  With the stock trading around $8 or so the tangible book value of Tesoro was about $23 a share.  The assets were being discounted in the marketplace by more than 65 percent.  That was just the discount from the accounting value of the assets.  Because refineries are irreplaceable assets the discount was even greater when you considered the real value of Tesoro’s asset collection.

Kramer bought Tesoro around $8.  Once the economy recovered, so did Tesoro’s profits and the stock soon tripled.

As far as screening for companies trading below tangible book, Kramer also recommends that the companies be profitable so that they are not burning through their assets.  Kramer then recommends including on the screen that the debt to equity be a maximum of .30.  And of course, the screen includes stocks that are below $10.  Kramer concludes the chapter:

When we look over the list of stocks priced cheap compared to their assets, we want to consider what the actual assets are.  The key question is: Can they be turned into profits at some point?  If the assets are cash or commodity inventories, the answer is probably yes.  They can be sold, returned to shareholders, or perhaps a competitor or private equity investor will recognize the value and buy the company at a premium.  Are the assets real estate, such as commercial properties, hotels, or apartments?  If so they can also probably be sold at a profit at a point in the future.



The opportunities in low-priced stocks, whether fallen angels, undiscovered growth gems, or bargain stocks, occur in a variety of sectors.  That said, some sectors may be particularly interesting, depending upon the investor and his or her expertise.  Kramer mentions the biotech and pharmaceutical sector:

This particular sector is absolutely overflowing with low-priced investment opportunities—a trend I expect to continue in the near future.

There are a few key reasons for the sector’s hot hand.  The most obvious reason is the advancements in technology.  It seems like there is a new breakthrough drug, medical treatment, or device almost every week.  We have seen advances not just in biotechnology, but in robotic surgery, titanium hips, cancer protocols, and life extension programs.  Increasingly we are seeing the breakthroughs come from smaller companies wth smaller stock prices.

Kramer adds that there is a real need for these products.  For example, in 2010, nearly 1.6 million Americans were diagnosed with cancer, and 570,000 died from the disease, according to the American Cancer Society.  Furthermore, according to the University of Texas M.D. Anderson Cancer Center, the number of new cancer cases diagnosed annually in the United States is expected to increase by 45 percent to 2.3 million in 2030.  There are also increasingly more cancer cases globally.

In the United States, according to the National Cancer Institute, part of the National Institute of Health (NIH), total expenditures on cancer treatment will grow at least 27 percent from 2010 to 2020, advancing from $127.6 billion to $158 billion.  Kramer notes that the good news is that these treatment dollars are being funneled into innovative companies fighting this disease.

Here’s where the importance of smaller, lower-priced companies in this sector comes into play.  The giant drug companies are looking to partner with these smaller companies to develop new products as an addition to their own research and development efforts.

Sometimes big pharmaceuticals, if they don’t partner with a smaller company, will acquire the company instead.

Kramer mentions that she bought Ariad Pharmaceuticals at $8 a share in 2011.  Ariad is an emerging biopharmaceutical company that at the time had three potentially game-changing cancer treatments.  Kramer explains that for one of these treatments, Merck partnered with Ariad.  Kramer comments:

The partnership approach to developing drugs is going to be the model of groundbreaking research in the future.  By setting up news searches and tracking the news of the largest pharmaceutical companies, you can keep on top of the exciting smaller companies that are working on potential blockbuster drugs.

Successful partnerships with larger drug companies have turned some single-digit stocks into huge winners.  Regeneron (RGEN) has seen its stock price go from under $6 a share to well over $60 in just over five years as its partnership with pharmaceutical giant Sanofi-aventis has allowed it to develop promising cancer and autoimmune system drugs.  Incyte’s partnership with Novartis helped drive the strock price from $2 to over $20 in three years.

Smaller biotechnology companies can push the curve in new research in ways that larger more established companies simply cannot.  Rather than invest in unproven drugs and technologies, the larger companies prefer to provide cash and assistance to the up-and-coming companies.  In return they can access potential breakthrough drugs with less overhead.  It is a win for the company, for investors in the smaller company, and often for patients.  As researchers and biotech companies continue to search for the answers for mankind’s medical issues these opportunities for low-priced breakout stocks will be increasingly available to attentive investors.

Kramer also mentions breakthroughs in medical devices and surgical techniques.  This includes new cardiac stents being developed, new robotic surgical devices, new bone and joint replacement products, and many other devices and products to improve health and combat age-old problems.

Kramer points out that it takes some specialized effort to effectively search the universe of healthcare, drug, and biotechnology companies.  Sometimes growth screens will produce ideas, but often more digging is required.  Kramer concludes:

You can find news on such developments at www.fda.gov.  The site has a wealth of information of new drugs being approved and which companies are developing them.  It also tracks which drugs are in short supply and could lead to production ramp-up or higher margins for their manufacturers.  The site also has information and reports that will help you understand the approval process for new drugs which will prove useful over the long run as you search for cheap stocks in the medical and drug fields.

This is an area where you probably need to learn to steal ideas as well… It took me many years to develop the expertise and contacts needed to continually uncover the potential big winners, particularly in biotech stocks.  You can get ideas from top managers in the field by searching through the portfolios of top mutual fund managers specializing in the medical and biootech fields.  They have to disclose their portfolio to the SEC and are widely available on various research and financial sites on the Internet.

One new drug or technology can take a company from obscurity to superstardom and the stock price will go higher than you could have ever though possible.  Staying on top of which smaller single-digit stocks have promising research and strong partnerships with large drug companies can be a tremendous source of single-digit stock winners over your investing career.



Emerging markets have evolved and become more like U.S. markets.  There are the same cycles of fear and greed that create fallen angel stocks.  Kramer:

Companies will be created that have exciting new products with the potential for strong long-term growth and yet stay under the radar screen for an extended period of time.  We can find low-priced potential breakout stocks located all around the world in today’s dynamic, connected stock markets.

Kramer comments:

In a lot of ways emerging economies look a lot like the United States did back around the turn of the century.  Back then people moved from the rural towns into the cities as jobs in new industries became available.  Automobiles began to replace the horse and buggy.  Radios and telephones became items that were desired by every household.  Investing in companies that built infrastructure, like the steel and railroad companies, was hugely successful.  So was putting your money into electric utilities and energy companies that served the growing demand for power.  Early investors in companies that sprang up to serve these new consumers, like Sears, Roebuck and Company, also did very well.

Today we are seeing similar trends developing, as smartphones and portable commmunications and entertainment devices are adopted throughout the world and are in high demand in emerging economies like China, Brazil, and India.  Further, the robust demographic growth in emerging economies is creating the need for bigger, better, and more efficient infrastructure to maintain such growth.

Kramer gives the example of Cemex (CX).  When she was in Mexico in 2001, Kramer noticed the country was experiencing a building boom.  She got curious about all the cement trucks and construction vehicles, not to mention cranes.  CX not only sold cement in Mexico, but also in the United States, Europe, the Philippines, and the Middle East.  Kramer bought the stock around $8 in early 2003, and over the next three years, the stock went over $30, allowing her so sell at around $29.  Kramer continues:

Interestingly, the stock collapsed again in the global recession of 2008.  As global building began to collapse as credit tightened and the economy slowed, the shares fell all the way back into the single digits.  In fact, Cemex stock fell below $4.  Once again, as the global economy began to dig itself out, the stock slowly reversed and reached a high of $14 a share a little more than a year later.

Building materials stocks like Cemex are going to get hit hard during a time of a global slowdown, but will be among the first and fastest to recover at the first sign of an improvement in economic conditions.  Emerging markets may have frequent stumbles along the way to progress but once the trend towards a more industrialized consumer society begins, history tells us it rarely reverses itself.  Following building supply- and infrastructure-related stocks and buying when they are low priced and unpopular can be a path to large long-term profits.

Moreover, as an emerging economy creates a new middle class, there will be demand for goods and services that make life more interesting.



First, the efficient market hypothesis, which says all available information is already reflected in all stocks and therefore it’s impossible to beat the market except by luck, is simply not true.  Most of the examples Kramer has given illustrate this.  Also, various value investors have beaten the market over time for nearly a century.

Second, a low P/E ratio is not typically how to find a low-priced breakout stock because often a low-priced breakout stock has very little earnings, which makes the P/E ratio very high.

My note here:  My fund, the Boole Microcap Fund, uses five metrics for cheapness:

    • low price-to-earnings (low P/E)
    • low price-to-cash flow (low P/CF)
    • low price-to-sales (low P/S)
    • low price-to-book (low P/B)
    • low enterprise value-to-EBITDA (low EV/EBITDA)

In the terrific book, What Works on Wall Street (4th edition), James P. O’Shaughnessy demonstrates that using all five of these metrics of cheapness simultaneously has produced the highest returns historically.

My fund also uses other quantitative information like a high Piotroski F-Score, low debt, high insider ownership, insider buying, high ROE, and positive 6-month and 1-year momentum.

So while I do agree with Kramer’s explanation of fallen angels, undiscovered growth stocks, and bargain bin favorites, I don’t entirely agree on low P/E.  It’s OK for the P/E to be high (or even negative!) as long as most of the other metrics of cheapness are low.  However, I do estimate normalized sales, earnings, and cash flows, and if most of the metrics for cheapness are quite low relative to normalized estimates, then these can be particularly interesting stocks.

Moreover, if a company has been profitable for years, and then suddenly has its profits disappear for temporary reasons like a recession, that can be the makings of an excellent investment when the stock price has collapsed.

Kramer says a high P/E is OK if earnings have temporarily collapsed, but she does write the following:

As a rule we want our companies to be profitable.  As we discussed, many of them stumbled and that’s why they are a low-priced stock in the first place.  The fact that they are still profitable in the worst of times gives us an indication management knows what they are doing and can return to higher profitability levels in short order.  If they are not profitable there needs to be some reason or catalyst that we can see that will restore the bottom line to black ink in a relatively short period of time.

Kramer continues by explaining that an improvement or deterioration in various metrics can be more important than the absolute level:

Let’s consider return on equity for a second.  This is a widely used measure in financial research that evaluates how much a company is earning relative to the amount of equity invested in the company.  It is a pretty good measure of how profitably management is using the money entrusted to it by shareholders.  However just the number by itself is not enough to evaluate a stock for breakout potential.

Kramer gives the example of Toll Brothers (TOL).  The company has a decent year in 2006 and had a return on equity (ROE) of 20 percent.  That seems good, however year over year the ROE had declined from 53 percent to 20 percent.  This was, for Kramer, a huge red flag.  The trend continued and TOL had a small ROE in 2007 and negative ROE in 2008.  This example illustrates why the direction of many metrics can be more important than the absolute level.



Kramer holds that the company should have a relatively strong balance sheet, and own at least as much as they owe.  In other words, the debt to total capitalization should be below 0.50.  If it’s higher than that, there is an increased risk of bankruptcy during a recession or business slowdown.

Kramer writes:

It is also very important to read the footnotes and fine print in a filing of a prospective stock.  I want to see if the auditors signed off and issued an unqualified opinion of the company’s financials.  If they issued a qualified opinion that’s a huge red flag that something may be wrong with the data I am using to evaluate the company.  Has the company recently changed auditors?  That can be a flag as well, and indicates the previous firm had some questions that company didn’t want to answer or did not like the conclusions the auditor drew out of the financial data.  Is there a concern about the company’s ability to continue as a going concern?  Are there a lot of complex off-balance-sheet arrangements?  These could have a substantial negative influence on the company’s leverage and operating ratios that are not included in the basic balance sheet and income statement presentation.

Kramer highly recommends going to the investor relations part of a company’s website.  She gives Wendy’s/Arby’s Group (WEN).  (Keep in mind Kramer was writing this book in 2011.  Today Wendy’s and Arby’s are separate entities.)

When I go to the investor relations section of their website I find links to all their SEC filings, historical information about their finances, and stock price.  The last few years of press releases, including quarterly earnings reports, are readily available.  The really interesting section to me is webcasts and presentations.  Here I find links to recent presentations at various conferences and investor meetings, including videos and PowerPoint presentations.

I see from the presentation that the company is introducing a new line of burger products in the second half of 2011 that look pretty enticing.  They have a strong balance sheet and are buying back stock.  I see in the presentation that they have recently increased the dividend.  Managing is continuing with their efforts to sell the Arby’s business and refocus on the core Wendy’s brand.  The presentation contains information about international expansion plans, menu changes, as well as a discussion of finances.  This is all valuable information and reinforced my conviction about owning the company.

Kramer adds that not all companies have in-depth investor presentations, but many do.  Note: Many microcap companies—the focus of my fund, the Boole Microcap Fund—do not have these presentations, but some do.

Kramer continues:

The next thing I like to do is look at the stock price chart.  I am not a chartist by any means, but the price chart can provide valuable information, especially in timing my purchase of a low-priced breakout stock.  Is the stock moving higher on increased buying activity in the stock?  This could be a sign that the larger investors, such as hedge funds, are starting to notice the company and I want to get in as soon as possible.  Is the stock breaking out to new highs?  Has it bounced off a level of support, such as a double price bottom that might indicate institutional buying is putting a bottom in the stock and the time to buy has been reached?  I never make a decision because of the chart itself but if the stock has passed the research process, charts can provide valuable information about what other investors think of the company.

Kramer adds:

Another important piece of information I like to check when evaluating a stock is who is buying and selling the shares.  Are insiders buying or selling the stock?  If they are selling is it just one officer or director or several of them?  One seller could be someone in need of cash for some personal reason but many sellers over a period of time is a huge red flag.  If the folks running the company are selling, I am not so sure I should be buying the stock.  I need to check my conclusion.  Insiders may sell for several reasons, but they only buy for one: They like the potential of the company and think the stock is underpriced relative to the potential for gains in the future.  Insider buying increases my conviction about a company that has passed all my other tests.

Kramer also recommends calling experts, which is easier if you happen to know some, but can still be done even if you don’t.

Moreover, Kramer mentions some great research resources, including Value Line, which not only has momentum-based rankings, but also has a decade’s worth of historical financial data plus analyst commentary.  Standard and Poor’s also publishes valuable stock research.  Furthermore, some of Morningstar’s equity research is available for free.  Yahoo! finance has free information on companies.

Note: There are other resouces, too, including Seeking Alpha, for which you have to pay roughly $33 a month.  And, for microocap investors, there is the Micro Cap Club (https://microcapclub.com/), which you can join for $500 a year (or for free if you write up an investment idea and it is accepted) and also Small Cap Discoveries (https://smallcapdiscoveries.com/), which costs $1,000 a year.



First, every investor will make plenty of mistakes.  Many top investors are only right 49% of the time or up to 60% of the time.  How you deal with mistakes is important.  I wrote last week about this: https://boolefund.com/the-art-of-execution/

Sometimes, if the stock falls, it makes sense to buy more.  Other times, it’s best to sell.  The most important question to ask yourself is: Knowing what I know now, would I buy the stock at its current price?  If yes, then buying more after the decline is the right move.  If no, then immediately selling is the right move.  Remember the quote attributed to John Maynard Keynes:

When the facts change, I change my mind; what do you do?

Kramer writes:

You want to read any filings or news releases since you bought the stock.  Has the company taken on more debt?  Did they miss a key product launch date?  Is the company spending its cash at an alarming rate?  Are inventories growing as customers delay or cancel orders?  Have regulatory or legal issues emerged that change the outlook for the company?  Have the macroeconomic issues that face the company changed since you bought the stock?  You are looking for material negative changes in the company or its outlook since you originally bought the stock.  If there are any, then you want to sell the stock.  The old adage that the first loss is the best one holds true.  If the situation worsens, do not wait for a bounce or to get back to even—sell the stock and move on.

Kramer next handles the topic of when to sell winners.  If the stock price has gone up, you want to review the situation.  Are revenues and profits still growing or rebounding?  Is the company paying down debt or otherwise fixing any balance sheet issues?  Are the company’s products being well-received?

Kramer then adds:

On the technical side of things, is daily trading volume increasing or at least staying steady?  This can be a sign that the big institutions that sold the stock when it was falling are now buying back in and this is going to push the stock price still higher.  Is the stock making new 52-week highs?  Are you seeing a steady pattern of higher highs and, more importantly, higher short-term lows in the stock?  Stocks are always going to move in ebbs and flows.  When you chart a low point of a pullback above the low point of the prior round of profit taking, this is a very bullish sign for the stock.  Buyers are moving in and the stock is probably heading higher, so ride the wave and let your profits grow.

As long as things are improving you want to own the stock.  I have stocks today like Priceline that I have simply never sold even though they have risen by hundreds of percent.

Kramer then writes:

As a stock move higher there are some indications that indicate it is time to part ways with the stock.  If business starts to slow and is no longer improving it is time to sell.  If revenues and earnings have been rising and then the company announces a down quarter, it is time to ring the register and take your profits.  If you have a stock that has moved higher and the company announces a large debt or equity offering, you want to consider selling the shares…. The need to raise moeny is a sign that the company is not generating enough cash to meet its goal and it’s a reason to consider taking profits.

Sometimes it also makes sense to sell part of the position as the stock movies higher.  This, too, is covered in last week’s blog post about The Art of Execution: https://boolefund.com/the-art-of-execution/

Kramer makes another important point:  If it seems like now everyone loves the stock, whereas previously (when the stock price was low) they hated or ignored the stock—which is what created the opportunity for you to buy at a low price—then it’s time to consider selling.  The question becomes: if everyone loves it, who is left to buy?

Finally, sometimes the stock you own will get acquired, in which case you have to sell but can usually do so at a higher price than you paid.  It also makes sense, argues Kramer, to be aware of when larger companies may want to buy smaller competitors.  Often such inorganic growth (via acquistions) is less expensive than organic growth (opening new locations, developing new products, etc.).  As discussed earlier, this can frequently be the case for large drug companies: In order to expand their product lines, they will look to acquire smaller companies.



Low-priced stocks are viewed as riskier than higher-priced stocks, but usually that’s not case.  Kramer writes:

All things being equal, the answers to the risk versus reward equation are found in the financial statements, not the stock price.  This is a classic case of broad-based statements, such as ‘all low-priced stocks are risky,’ just being wrong.

That said, as an investor you do have to be careful of “pump and dump” schemes, which historically have often happened with very low-priced stocks.  Kramer:

Unscrupulous operators accumulate or create a large block of stock at a very low price.  They then hype the stock as the next big thing to unsuspecting investors.  They talk about getting in on the ground floor, revolutionary breakthroughs, and other buzzwords designed to get the blood pumping and the greed flowing.  When investors get excited about this wonderful company, the operators simply dump their stock at much higher prices and walk away with investors’ hard-earned money.

Most of the time these companies have no real business or assets.  They are just shell companies set up for the specific purpose of fleecing investors.  Some of them may be little mining stocks or small tech companies that are badly underfunded and will be broke and bankrupt very shortly.

Kramer adds:

The SEC has done a great job of cleaning up the penny stock brokerage firms and they are not as prevalent as they once were.  However there are still a few out there and as long as greed and dishonesty exist there always will be.

Krames then writes:

I do not want to imply that all Internet-based research on low-priced stocks or advisory services devoted to low-priced stocks are bad.  I run such a service myself and I know several other reputable conscientious folks who do the same.  The best defense against being taken advantage of in the stock market is to do the homework yourself and check the facts before you buy the story!  You will quickly be able to see who is trying to make you money and who is trying to rip you off.

Furthermore, you must be aware that there are many low-priced stocks that deserve to be low-priced.  Also, nearly every company that goes bankrupt sees its stock go to a low price before bankruptcy.  That’s why it’s important, again, to do your homework.  You have to be sure the company doesn’t have too much debt.  Also, is the company making money or losing money?  If the company is losing money, do they have a credible turnaround plan in place?  Kramer:

If you see allegations of accounting or securities fraud in a company’s reports, it is best just to take a pass on that issue even if you think there is potential.  Unless you are a very experienced forensic accountant or securities attorney, it becomes very difficult to decipher exactly how these cases will end.  Lots of people thought companies like Enron and WorldCom would be able to survive after the initial fraud allegations were revealed.  They were not and a lot of people lost a lot of money.

Kramer concludes the chapter:

The key to avoiding risks in the stock market, especially in low-priced stocks, is to use common sense.  No one is going to send you an email to tell you all about a stock that is going to make you rich beyond your wildest dreams.  As I have said earlier in this book, finding these gems takes work and effort on your part and no one is going to give you the keys to the kingdom with no effort or cost on your part.  Keep in mind, if your Uncle Fred were really a great stock picker he would not borrow $100 every time you see him.  Read the 10Q and 10K, go through the financials, and read management’s discussion of the business.  Check the footnotes for warning signs and red flags.

Most of the time the alleged risks of low-priced stocks are just that—alleged.  If you find a stock with the right financial and business characteristics the risks are actually nonexistent.  It is the perception of greatly increased risks with low-priced stocks that is creating the opportunities for us to earn breakout profits.



In this chapter, Kramer wraps up the book.  She writes:

Hopefully I have given you the tools and information you need to begin investing in the exciting world of low-priced breakout stocks.  Over my years in and around the financial markets I have found this to be the single best area for investors to earn explosive gains in stocks.

Kramer again:

By getting ahead of Wall Street in lower-priced stocks we benefit from the institutional pack-mentality that dominates many traditional investment managers.  When they are selling and pushing stocks to low prices, we are buying.  Then, when their excitement for these stocks return, we are selling to them.  We are finding solid growth stocks before Wall Street notices and will see our stocks soar when they show up on the Street’s radar screen.  There simply is no better way for individual investors to outperform the market in my opinion.

Kramer argues that it pays to be optimistic about the long term:

If you focus on the fear you miss opportunities.  If you focused on all that was wrong with the auto industry in 2008, you would have totally missed the fact that Ford was in fine shape and stood to benefit fomr the problems of its competitors.  If you gave up when Dendreon got the first delay from the FDA, you would have missed some spectacular gains by never investigating further to discover that it was just a delay and approval for their cancer drugs was probably forthcoming.

The same applies to the stock market itself.  Markets are going to have declines.  There will be recessions and bear markets throughout your career.  The right way to look at these occasions is as inventory creation events, not catastrophes.

I would add that often microcap stocks have a low correlation with the broader market.  Warren Buffett, arguably the greatest investor of all time, said in 1999 during the internet bubble:

If I was running $1 million today, or $10 million for that matter, I’d be fully invested.  Anyone who says that size does not hurt investment performance is selling.  The highest rates of return I’ve ever achieved were in the 1950s.  I killed the Dow.  You ought to see the numbers.  But I was investing peanuts then.  It’s a huge structural advantage not to have a lot of money.  I think I could make you 50% a year on $1 million.  No, I know I could.  I guarantee that.

Kramer writes:

There is another advantage to owning low-priced stocks when the market corrects.  Many of these stocks are fallen angels or growth companies that stumbled briefly, driving the stock below $10.  Wall Street and the big institutions already sold their shares and your stocks will not experience the type of selling pressure higher-priced issues are experiencing.  When the large leveraged investors, like hedge funds, need to sell stocks they sell the higher priced more liquid issues to meet margin calls, not lower-priced smaller companies.  So not only does the selling not hit your stocks as hard as the big names, they often push the big companies down to where they become inventory for you!

Kramer continues:

The best investors fit into the category that I like to call optimistic cynics.  They are well aware that every bear market has ended and every economic recession has been followed by an economic recovery.  They also know that the world is fully of entrepreneurs and innovators who will discover new solutions to old problems and the world gets better over time throughout history.  They know that companies that are out of favor today are often tomorrow’s darlings.  In the stock market, optimism pays off over time.  It always has and always will.

The cynical part comes from not taking anyone’s word for anything.  Trust but verify is the order of the day.  Great investors do not act on tips, rumors, and sales pitches.  By doing their research and homework they avoid many of the mistakes investors can make that will damage their net worth.  They dig into the financial filings and company presentations to determine what is really going on with the company and the likelihood they can recover or continue to grow.  When markets are soaring and everyone is piling into stocks, great investors ask the most critical question of all: Is it really different this time?  When markets are collapsing they ask themselves if the world is really ending.  The answers to those questions help to temper your enthusiasm at market tops and turn your fear into action at market bottoms.

Kramer advises reading as much as possible, which she says is “some of the best advice I can give you about successful investing.”  Not just people who agree with your views of the world, the market, and stocks, but also people who disagree with your views.  Sometimes you will find holes in your thought process and other times you will gain more confidence in your previous conclusions.  Either way, it can make you a better investor.

Kramer reminds us that we have to pay close attention to the footnotes to search for any red flags or time bombs.  Also, the company presentation, often available on their website, usually contains valuable information about new products, services, or markets, as well as management’s plans.

It’s also a good idea to see if insiders are buying.  If they are, that’s always a bullish signal because it means the people running the company believe the stock is undervalued.  On the other hand, if groups of insiders are selling, especially at a low price, that’s a huge red flag.  Moreover, if excellent professional investors are buying or selling, it’s a good idea to pay attention to that.

Kramer ends with the following:

Investing in low-priced potential breakout stocks is work.  However it can increase your net worth quicker than almost any other effort applied to investing I am aware of.  One investment like Priceline can make it easier to put the kids through college or retire a few years earlier.  An investment in an undiscovered growth gem like Darling can pay for a dream vacation or even a dream home.  If you are willing to work at it, investing in single-digit stocks should add many digits to your account values over time.



An equal weighted group of micro caps generally far outperforms an equal weighted (or cap-weighted) group of larger stocks over time.

This outperformance increases significantly by focusing on cheap micro caps.  Performance can be further boosted by isolating cheap microcap companies that show improving fundamentals.  We rank microcap stocks based on these and similar criteria.

There are roughly 10-20 positions in the portfolio.  The size of each position is determined by its rank.  Typically the largest position is 15-20% (at cost), while the average position is 8-10% (at cost).  Positions are held for 3 to 5 years unless a stock approaches intrinsic value sooner or an error has been discovered.

The mission of the Boole Fund is to outperform the S&P 500 Index by at least 5% per year (net of fees) over 5-year periods.  We also aim to outpace the Russell Microcap Index by at least 2% per year (net).  The Boole Fund has low fees.


If you are interested in finding out more, please e-mail me or leave a comment.

My e-mail: jb@boolefund.com



Disclosures: Past performance is not a guarantee or a reliable indicator of future results. All investments contain risk and may lose value. This material is distributed for informational purposes only. Forecasts, estimates, and certain information contained herein should not be considered as investment advice or a recommendation of any particular security, strategy or investment product. Information contained herein has been obtained from sources believed to be reliable, but not guaranteed. No part of this article may be reproduced in any form, or referred to in any other publication, without express written permission of Boole Capital, LLC.

The Art of Execution

September 10, 2023

Investor Lee Freeman-Shor hired 45 of the world’s top investors and gave each between $20 million and $150 million to invest.  He instructed each one to invest only in their ten best ideas.  Freeman-Shor then examined the 1,866 investments made by this elite group over the course of June 2006 to October 2013.  The result is the book, The Art of Execution: How the world’s best investors get it wrong and still make millions (2015).

Freeman-Shor explains that the best ideas of the best investors could reasonably be expected to generate excellent long-term results.  Freeman-Shor:

These were ideas that they had significant confidence in, and were often the result of hundreds of hours of research by some of the smartest people on the planet.

Given all this, I was sure that I would make a lot of money.

It might surprise you, then, to be told that most of their investments lost money.

Out of 1,866 investments, a total of 920—about 49% of the total—made money.

However, almost all of these investors made money.  How was this possible?  Freeman-Shor studied every single trade in order to analyze what had happened.

Freeman-Shor quotes Leo Melamed, a successful futures trader:

I could be wrong 60% of the time and come out a big winner.  The key is money management.

Paul Tudor Jones:

The reason for all the Wall Street success stories he knew was down to: money management, money management, money management.

George Soros:

It’s not whether you’re right or wrong that’s important, but how much money you make when you’re right and how much you lose when you’re wrong.

Here’s the outline for the book:


    • The Rabbits: Caught in the Capital Impairment
    • The Assassins: The Art of Killing Losses
    • The Hunters: Pursuing Losing Shares


    • The Raiders: Snatching at Treasure
    • The Connoisseurs: Enjoying Every Last Drop



    1. Best ideas only
    2. Position size matters
    3. Be greedy when winning
    4. Materially adapt when you are losing
    5. Only invest in liquid stocks


    1. Invest in lots of ideas
    2. Invest a small amount in each idea
    3. Take small profits
    4. Stay in an investment idea and refuse to adapt when losing
    5. Do not consider liquidity



The Rabbits: Caught in the Capital Impairment

Freeman-Shor remarks that the Rabbits ended up being the least successful investors working for him, despite the fact that these were all prestigious investors.

Freeman-Shor gives a case study: Vyke Communications, a UK-based company that specialized in software that allowed users to make phone calls and send text messages.  The investor bought shares on October 31, 2007 at £2.10.  When the price fell, the investor bought more.  This was the right move if the investor still believed in the idea.  However, the stock kept falling and the investor decided to stay invested.  Two and a half years later on July 2, 2010, the investor sold the entire position at £0.02, for a 99% loss.

Another case study: Vostok Nafta, an investment company listed on the Swedish stock exchange that invests in assets in the Commonwealth of Independent States, a loose associtaion of some of the countries that used to make up the USSR.  This investor bought shares April 11, 2008, at £9.14.  Five months later, he sold at £3.95, for a loss of 57%.  Freeman-Shor notes that the only reason the investor sold was because Free-Shor was pressuring him to either buy more or sell.

Yet another case study: Raymarine, a company that specializes in marine electronics.  An investor bought shares on May 31, 2007, at £4.27.  23 months later the price had collapsed, but the investor still believed in the idea.  Eventually, partly due to pressure, the investor sold his entire position on April 15, 2009, at £0.17.  This was a loss of 96%.

Where did the Rabbits go wrong?  Freeman-Shor states ten reasons for why the Rabbits failed:

(1) The narrative fallacy framing bias

Framing bias, discovered by Amos Tversky and Daniel Kahneman, means that people tend to reach a conclusion based on the way a problem is presented.  In the case of the Rabbits, they allowed their favorite types of investment to influence how they viewed the stock in question.  The Rabbits still believed in the investment thesis for a stock that had fallen a great deal and so they still believed they would make money going forward.  Freeman-Shor:

The Rabbits are a great example of how professional investors often react to a black-swan event—an event they did not anticipate and which has negatively impacted their investment story.  They tend to dismiss it.

(2) Primacy error

Primacy error means that first impressions have a lasting and disproportional effect on a person.  Because the Rabbits had a very positive first impression, they failed to update their investment thesis to incorporate new information.

(3) Anchoring

Related to primacy error is anchoring.  Rabbits tended to anchor to initial information, being very slow to change their minds.  Freeman-Shor:

It took one Rabbit two and a half years to change his mind on Vyke, and another Rabbit almost two years to react to Raymarine’s decline.  The other never changed his mind on Vostok.  Similar stubbornness occurred on many other investments.

(4) Endowment bias

As humans, we tend to overvalue our own possessions, which includes the investments we’ve made.

When there are large losses that happen quickly, they are almost impossible to accept.  It’s easier to hold on to a losing position.  Rabbits did not want to admit the loss by selling because they were too fixated on what they had paid for the stock.

(5) The pull of the crowd

There were many other investors who got burned on the same investments that the Rabbits got burned on.  This could have contributed further to the Rabbits being unable to admit their error and sell.   Freeman-Shor quotes John Maynard Keynes:

It is the long-term investor… who will in practice come in for most criticism… if in the short run he is unsuccessful, which is very likely, he will not receive much mercy.  Worldly wisdom teaches that it is better for reputation to fail conventionally than to succeed unconventionally.

(6) Ego

Freeman-Shor says that the Rabbits were more interested in being right than in making money.  Many professional investors are this way.

The Rabbits simply could not admit that they were wrong.  Freeman-Shor observes:

The fact is, the greatest minds on the planet can be wrong.  My findings suggest you should expect to be wrong at least half of the time.  The very best investment minds are!

(7) Self-attribution bias

Self-attribution bias means that we blame others or external factors for our misfortunes but take full credit when things go well.  This is why we tend not to learn from past mistakes, but to keep repeating them.

The Rabbits, writes Freeman-Shor, tended to blame Mr. Market (“The market is being stupid”) or Mr. Unlucky (“It wasn’t muy fault, I was unlucky because of XYZ that no one could have foreseen”).

(8) The wrong information


Because many of the Rabbits had been professionally investing for a couple of decades, controlling a significant amount of assets, they had Rolodexes to die for.  When they found the ‘story’ behind an investment being challenged, they liked nothing better than picking up the phone and dialling the CEO on his or her personal number to get to the bottom of things.  Despite being reassured by the CEO that the setback was merely a bump in the road and the media was making a mountain out of a mole hill, the Rabbits would do nothing.  They neither bought more shares nor sold their holdings.

A hugely appealing temptation for more information comes from the need to abrogate responsibility in times of crisis.  It is very common when a difficult decision has to be made to see the decision-maker involving more people.  The more people involved, the more they can relax because if it goes wrong it was not their fault.

(9) Too big to fail

Like many investors, Rabbits found it far more difficult to walk away from a large losing investment than a small losing investment.

(10) The gambler’s fallacy

The gambler’s fallacy is the mistaken belief that after a period of poor performance, a given stock was due to perform well.

Each coin toss in a series has a 50/50 chance of coming up heads and each toss is independent of prior tosses.  The gambler’s fallacy ignores this and instead involves the belief that, after a series of tails, the next toss was likely to be heads.  But there’s only a 50/50 chance of this because each toss is independent.

What could the Rabbits have done differently?

Freeman-Shor writes:

The bad news is, everyone can be a Rabbit.  The good news is, no one needs to be.  There are a few simple things they could have done to overcome their problems.

(1) Always have a plan.


Investing is all about probabilities.  Whether you invest should depend on the odds and the edge you think you have.  Given the odds and your edge you should know exactly what you are going to do if the stock you are investing in falls or rises by 20%, 50% and so on.

When faced with a painful loss-making position, most people do nothing.  They turn into a Rabbit and procrastinate, letting all their biases play havoc with their decision-making, hoping time will resolve their issues so they don’t have to.

It’s essential to have a plan.

(2) Sell or buy more


The only solution to a losing situation is to sell out or significantly increase your stake.

Freeman-Shor says the investor needs to ask himself or herself a key question:

If I had a blank piece of paper and were looking to invest today, would I buy into that stock given what I now know?

If the answer is “no,” then the investor must sell.  If the answer is “yes,” then the investor should significantly add to the position.

Freeman-Shor notes that legendary investor Peter Lynch would (i) sell if the fundamentals were worse but the price had increased or (ii) buy if the fundamentals were better but the price had decreased.  This is logical.

The real mistake the Rabbits made was doing nothing when their investment had declined in price.  The logical thing is either to admit a mistake and sell, or buy more at the lower price.  Freeman-Shor:

I have learnt that I cannot trust great investors to do the right thing when they are losing—like top athletes, they require coaching and management.

(3) Don’t go all in

As an investor, you should always be able to add to an investment if the price falls, assuming you have taken a fresh look at the investment and decided it’s a good one at the new price.  This means you don’t want one position to become too large.  Freeman-Shor quotes Mohnish Pabrai:

In my own portfolios at Pabrai Funds, I adjust for this [getting the odds wrong] by simply placing bets at 10% of assets for each bet.  It is suboptimal, but it takes care of the Bet 6 being superior to Bet 2 problem.  Many times the bottom three to four bets outperform the ones I felt the best about.

(4) Don’t be hasty to jump in, do be hasty to jump out

Cutting your losses early makes excellent sense, although it is difficult.  Freeman-Shor writes the following, ending with a quote from Ned Davis:

Not least because selling out of a stock helps clear your head and enables you to assess a situation more objectively.  It’s like taking a decongestion pill when suffering from a cold.

And buying slowly over time (known as dollar or pound-cost averaging), with a reduced position size at the outset, ensures you have plenty of ammunition left to load up when a share finally capitulates (assuming it does).

“[W]hat separates the winners from the losers?  The answer is simple—the winners makes small mistakes while the losers make big mistakes.”

(5) Remember there is a difference between ‘being right’ and ‘making money’


In investing, a lot of success can be attributed to being in the right place at the right time—otherwise known as luck.

(6) Seek out opposition

When people lose money they don’t want to be told they are wrong…

What you should really do is to speak to someone with an opposing view.

Ideally you should also sell out of the stock while you do that, so that you have removed the emotional attachment of a vested interest.  This mitigates endowment bias and you can always buy the stock back later.

If you would not put money to work in a particular share today, knowing what you now know, then you have to concede that the investment is dead—and if you haven’t already sold, you absolutely should now.

(7) Be humble

Freeman-Shor notes that the Rabbits, on the whole, were incredibly smart and never said, “I don’t know.”

But this is a very dangerous mindset to have.  First, it assumes the market is made up of buyers and sellers that are not equally expert, when in fact many will be.  Second, ‘knowing more’ often leads to a person not seeing the wood for the trees.

Throughout history there have been many examples that demonstrate this.  My favourites are Harry Warner, of Warner Bros., who in 1927 said, “Who the hell wants to hear actors talk?”, and Thomas Watson, chairman of IBM, who in 1943 said, “I think there is a world market for maybe five computers.”

Experts are surprisingly bad at forecasting.  Falling for your own hype can also often lead to mistakes that the least intelligent person in the world would not be capable of.  Warren Buffett, when talking about the collapse of Long-Term Capital Management, marvelled at “10 or 15 guys with an average IQ of maybe 170 getting themselves into a position where they can lose all their money.”

And crowds are often surprisingly wise—the market can be right even when everyone who makes it up is individually wrong.

Freeman-Shor mentions the jelly beans in a jar experiment.  If you take a jar full of jelly beans and ask everyone in a room of 50 or 60 to guess at how many jelly beans are in the jar, typically the average guess is very close to the truth.  Moreover, the best individual guess is often not even as good as the average guess, and of course there are many individual guesses that are wildly wrong.  This experiment is analogous to the stock market.

Again, only 49% of the best ideas from some of the best investors—those Freeman-Shor hired—ended up being right.

(8) Keep quiet and carry on

Some investors make the mistake of talking publicly about their investments and their anticipated returns.  This makes it much more difficult to change their minds if new facts warrant it.

(9) Don’t underestimate the downside—adapt to it

Many Rabbits like stocks that could shoot for the moon.  However, often such stocks can get wiped out if they don’t work.  Freeman-Shor suggests treating such stocks as options: Size the position as if it were an option—almost like a venture capital investment—so that, if it works, you can do well, whereas if it doesn’t work, the loss will be contained.

(10) Be open to different kinds of story

Deep value investing can produce the highest long-term returns.  Freeman-Shor:

Many studies have shown that stocks with the worst stories tend to produce the highest returns.

Stated differently, value investing—investing in cheap stocks that no one likes because they have terrible stories that led to their stock price falling—produce the highest returns over time.

(11) Get sick of sick notes

Freeman-Shor suggests getting familiar with the typical excuses investors like to offer:

    • The ‘If only’ defence.
    • The ‘I would have been right but for’ defence.
    • The ‘It just hasn’t happened yet” defence.
    • The ‘Who could have foreseen at the time I invested that XYZ would happen…’ defence.
    • If it’s gone down this much already, it can’t go much lower.
    • You can always tell when a stock hits rock bottom.
    • Eventually they always come back.
    • When it rebounds slightly, I’ll sell.

(12) Be suspicious of status.

Freeman-Shor writes:

Lastly, whether you work in the investment industry or are thinking about trusting your money to someone who does, there is a bonus moral in the story of the Rabbits: it is dangerous to assume that just because an investment professional is highly educated and has years of experience, he or she will be good at making money and getting the big calls right.


Freeman-Shor says:

One of the reasons that the Rabbits held on to losing investments was fear of the unnkown: if they sold out, the shares might rally, and they would miss out.  It was better to stick with a current loss than worry about that double-whammy.

This is known as ambiguity aversion, and describes why people prefer to stick with intolerable situations merely because a hypothetical alternative might be worse.  Better the devil you know.

Freeman-Shor again:

I believe that even the best investors often overlook the fact that a stock’s price would need a practically supernatural rise of 900% to break even if they have foolishly ridden it down 90% and done nothing.


Freeman-Shor observes:

Stories are the biggest factor in determining what decisions we make.  For the Rabbits, the stories in their heads led them to invest many millions in companies that ultimatley lost them and me vast amounts of money.  Their actions post-investment were clouded by the story that led them to invest on day one.

The moral here is to try to avoid being blinded by your story.  Above all, have a plan of action as to what you will do if you find yourself in a losing position, even if you still think you are right.

The key difference between the Rabbits and successful investors in this book is that when the Rabbits were losing they did nothing.  As we will see with the Assassins and Hunters, they acted decisively to bail themselves out of the holes they found themselves in.

Freeman-Shor quotes Darwin:

It is not the strongest of the species that survive, nor the most intelligent, but the one most responsive to change.

Freeman-Shor then writes:

If only the Rabbits had played poker.  Any poker player knows that it is not how many hands you win that matters, it’s how much you win when you win, and how much you lose when you lose.

Each hand in poker represents a story and the goal for a poker player is to try to make money with whatever story they have been given—good or bad.  If the story is poor then you don’t stick with it and throw money at the problem; the odds are stacked against you.   You fold your hand, cut your losses and live to fight another day.

Likewise, if you are dealt a good hand but then see the flop and realise the hand is now nowhere near as strong as you thought, you fold.


The Assassins: The Art of Killing Losses

Freeman-Shor quotes the legendary investor Warren Buffett’s rules for investing success:

Rule No. 1—Never lose money.

Rule No. 2—Never forget rule No.1.

Freeman-Shor then explains:

The Assassins are the investors who really lived and breathed this principle while working for me.  When it came to selling losing positions so as to preserve their capital they were ruthless, like cold-hearted hitmen, pulling the trigger without emotion.  Then they carried on with their lives like nothing had happened.

Hedge fund titan Stanley Druckenmiller had this to say about fellow hedge fund titan George Soros.

[He is] the best loss taker I have seen.  He doesn’t care whether he wins or loses on a trade.  If a trade doesn’t work, he’s confident enough about his ability to win on other trades that he can easily walk away from the position.

Freeman-Shor explains that successful investing is all about asymmetric returns:

…winning is about ensuring the upside return potential is significantly greater than the downside potential loss.

Despite that you might imagine, in reality we can all be as cold and ruthless as the Assassins.

Freeman-Shor adds:

What I liked about the Assassins was that they lived by a pair of sacred rules.

The rules were derived from their own experience and beliefs, and the key to their success was that when they were losing they would always let the rules, not their emotions or feelings, drive their decision.

They knew that when faced with the uncertainty that naturally follows when the market has turned against them, they could not rely on themselves to do the right thing.

They therefore committed to becoming slaves to the rules.  When a loss occurred they would follow their commandments to the letter.

Importantly, these two rules had been well thought through when the Assassins were in an emotionally ‘cold state’.  They planned well in advance; before they invested, they knew what they would do afterwards.  They did this because they knew that when push came to shove they were likely to make poor decisions in a ‘hot’ (or emotionally charged) state of mind.


(1) Kill all losers at 20-33%.

The Assassins know that it’s very tempting, when it comes time to kill a losing trade, to wait.  That’s why they used a device: the stop-loss.  Freeman-Shor:

The Assassins’ rules required them to put a stop-loss in place at the same time they they bought any share.  If the stop-loss was triggered by a share price going down a certain amount, it automatically sold their entire stake.

Freeman-Shor comments that some investors use a “review” instead of a stop-loss, but that a stop-loss is often better.  Freeman-Shor continues:

Legendary investor and art collector Roy Neuberger, whose investment firm Neuberger Berman bears his name, credits the 10% rule as part of the reason for his success.  He always cuts his losses when they hit 10%—no matter what.  Recognise your mistakes early and take immediate action was his mantra.

The Assassins’ rule was the same, but they despatched their losers at slightly different predetermined points depending on their own experience and preferences: almost always somewhere between 20% and 33% (it depended on the Assassin).  Despite Neuberger’s rule, my findings support the Assassins’ approach.  This range of stop-loss levels avoids you getting whipsawed while giving a realistic chance of being able to recover from the loss incurred.

Freeman-Shor offers a case study: Genmab, a Danish biotechnology company that specializes in creating human antibody treatments for people suffering from cancer.  Two weeks after investing, the Assassin was down 30%.  His stop-loss activated at -32% and he sold on Nvember 16, 2009, with the shares trading at £12.43, having originally bought the company on October 29, 2009, at £18.34.  This was a good decision because the shares then fell another 49%.  While it was tough to take a 30% loss so quickly, that was much better than a 65% loss.

Freeman-Shor gives another case study: Dods, a media company that provides information, organizes events, and does publishing.  Dods had become the most trusted source for political data.  An Assassin bought shares on December 29, 2006, at £0.51.  Ten months later, his stop-loss at 39% sold out on October 31, 2007 at £0.31.  After that, the stock fell another 63%.  So the Assassin was clearly right to sell when his stop-loss had been triggered.

Freeman-Shor comments:

In the world of investments there is no such thing as a safe bet.  If you invest in a company and think that it is bulletproof, I urge you to have an action plan to decide what to do when things go wrong—things often do.

The next case study: Royal Bank of Scotland.  It is one of three banks in the UK that is permitted to issue UK banknotes.  An Assassin bought shares on May 30, 2008, at £22.29.  When the credit crisis started, this Assassin actually moved faster than his stop-loss, selling out at £18.62.  This was a loss of 16%.  The stock then lost a further 82%.  Good decision by this assassin.

(2) Kill losers after a fixed amount of time.

Freeman-Shor explains the logic of this rule: Time is money.

Being in a losing position too long—even if the size of that loss hasn’t hit 20% or more—can have a devastating effect on your wealth.  This was something the Assassins were acutely aware of.


While having a strict discipline for dealing with losing stocks is important, you don’t want to be overly strict or too quick.

Freeman-Shor gives the example of Compass Group, the world’s largest food service company.  It serves billions of meals a year.  One of the investors that Freeman-Shor manages bought on November 20, 2007 at £3.19.  He then stold the entire stake twelve months later at £3.04, for a loss of only 5%.  At the time Freeman-Shor was writing the book, the stock had already increased 143% since it was sold, which was more than the overall market increased.

Freeman-Shor offers the example of BMW.  One of his investors bought BMW on April 11, 2008 at £34.95.  He sold two months later on June 23, 2008, at a price of £32.35 for a loss of 7%.  The stock then went up 95%.

Another example: Perelli, the Italian tyre manufacturer.  One of Freeman-Shor’s investors bought on January 22, 2010 at £4.61.  He sold one month later at £4.26, a loss of 8%.  Perilli subsequently increased 103% as of the time Freeman-Shor was writing the book.

And: Rightmove, where people in the UK look for a property to rent or buy.  One of Freeman-Shor’s investors bought shares at £5.51 on November 13, 2009.  A month later, on December 30, 2009, he sold at a price of £4.91, a loss of 11%.  The shares then shot up 202%.


When a person sells a losing investment, they often become risk-seeking, which is called the break-even effect.  This is not a good idea.


Freeman-Shor writes:

The Assassins were some of the most disciplined investors I have met, and a significant factor in their ability to make money was that they cut their losses consistently.  A study by Professor Frazzini supports the Assassins’ approach too: it shows that the highest investment returns were achieved by those investors that had the highest rate of selling out of losing positions.  Those that realised the least amount of losing positions experienced the lowest returns.

The losing trait of riding losing positions while taking profits on winning positions has been called the disposition effect by Frazzini.


The Hunters: Pursuing Losing Shares

Instead of using a stop-loss like the Assassins, the Hunters instead would—in certain situations—buy more of a stock that had decreased.  Quite often, the Hunters would end up making a profit.

It’s important to note that the Hunters committed to buying more at lower prices—if they became available—before they even bought their initial stake.  Freeman-Shor explains:

The key reason for the Hunters’ approach lay in their invariably contrarian style.  They were value investors.  They generally found themselves buying when everyone else was seling, and this was an extension of that philosophy, another way of exploiting Mr. Market when he was acting irrationally.


Many successful Hunters had at least one terrible year near the beginning of their career.  The Hunters learned how to be contrarian but also to be right more often than not.  (Otherwise, there’s no benefit from being a contrarian.)  Just as important, the Hunters learned to admit when they had made a mistake.  Freeman-Shor:

They also grew unafraid to sell if it became clear they really had made a mistake.  Poor value investors I have come across refuse to adapt when they are losing and tend to support their lack of action by saying, “I got it wrong but the stock is simply too cheap to sell now.”  A bad contrarian investor can make for a very committed Rabbit.

But if a stock still passed the vital ‘Would I buy this knowing what I know now?’ test, the Hunters followed their plan, and started to put their money on the side to work as the share price dropped.


Many Hunters enjoyed the game of trying to pick a bottom in a given stock.  It’s often not possible to do this, but sometimes it is possible to come close.  As Freeman-Shor explains, successfully investing near the bottom can often create a nice profit.  The Hunters enjoyed snatching victory from the jaws of defeat.


Be under no illusions: being a Hunter requires patience and discipline.  You have to expect a share price to go against you in the near term and not panic when it does.  You have to be prepared to make money from stocks that may never recapture the original price you paid for your first lost of shares.  If you know your personality is one which demands instant gratification, this approach is not for you.

Freeman-Shor quote Peter Lynch:

I’m accustomed to hanging around with a stock when the price is going nowhere.  Most of the money I make is in the third or fourth year that I’ve owned something.

Freeman-Shor offers some case studies.

Aker Solutions is a Norwegian oil services company.  It provides products and services related to the construction, maintenance, and operation of oil and gas fields.  One of Freeman-Shor’s Hunters bought the stock on April 14, 2008, at £15.84 per share.  A year and a half later, the stock was much lower.  The Hunter bought significantly more on September 28, 2009, so that his average cost was only £7.61.  He sold at £9.58 because he realized his original thesis was no longer true.  Had he not done anything, he would have had a loss of 40%.  Instead, he made a 24% profit.

Experian is an Irish company that operates globally.  The company collects information on individuals and produces credit scores used by lenders.  A Hunter bought the stock on June 13, 2006, at an initial price of £9.02.  After the price declined, the Hunter bought more, reducing his average cost to £5.66.  When he sold at £7.06, he realized a profit of 19%.  Had he done nothing, he would have lost 22%.  Freeman-Shor notes that the Hunter, by his actions, had turned a losing position into a winning position.

Technip is a French company that does engineering and construction for the oil and gas industry.  It’s a leader in areas such as subsea drilling, laying specially built pipelines, producing floating offshore platforms, and planning the development of oil and gas fields.  A Hunter bought the stock on April 11, 2008, at a price of £55.42.  When the stock declined, the Hunter bought much more, reducing his average cost to £42.24.  He later sold at £52.13.  He realized a gain of 22%.  Once again, a Hunter had turned a loss into a gain by buying more shares on the decline.

Thomson Reuters is a global media company based on New York.  It provides the latest content and data to the finance industry.  It also produces material to help lawyers and accountants ensure they are up-to-date on the professional education.  Moreover, the company produces research for the pharmaceutical industry.  A Hunter bought stock on June 13, 2006, at £22.25.  The stock dropped and the Hunter bought materially more, reducing his average cost to £15.82.  He sold on September 10, 2009, at £18.92.  Instead of a loss of 15%, the Hunter made a profit of 17%.


Freeman-Shor mentions the Kelly criterion.  Freeman-Shor doesn’t mention the details, but they’re important, so here they are:

The Kelly criterion can be written as follows:

    • F = p – [q/o]


    • F = Kelly criterion fraction of current capital to bet
    • o = Net odds, or dollars won per $1 bet if the bet wins (e.g., the bet may pay 5 to 1, meaning you win $5 per each $1 bet if the bet wins)
    • p = probability of winning
    • q = probability of losing = 1 – p

The Kelly criterion has a unique mathematical property: if you know the probability of winning and the net odds (payoff), then betting exactly the percentage determined by the Kelly criterion leads to the maximum long-term compounding of capital, assuming that you’re going to make a long series of bets.  Betting any percentage that is not equal to that given by the Kelly criterion will inevitably lead to lower compound growth over a long period of time.

Both Warren Buffett and Charlie Munger are proponents of the essential logic of the Kelly criterion.  Here’s Charlie Munger:

The wise ones bet heavily when the world offers them that opportunity.  They bet big when they have the odds.  And the rest of the time, they don’t.  It’s just that simple.

As for Buffett, he famously invested 40% of his hedge fund into American Express in the late 1960s.  Buffett realized a large profit.  Later, Buffett invested 25% of Berkshire Hathaway’s portfolio in Coca-Cola.  Buffett again enjoyed a large profit of more than 10x (and counting).

Freeman-Shor notes the following:

If a stock you are invested in has fallen materially in price, but nothing else has changed—the investment thesis is still intact—your odds will have improved significantly and you should materially increase your stake in that company.

Freeman-Shor adds:

If you are a Hunter… you choose not to control risk by diversification but by thoroughly understanding the risk and returns of a particular stock or handful or stocks.  Your goal is to find companies that have an unbelievably attractive, asymmetric payoff profile.

The fact that you are only investing in a few companies means that you have the opportunity to invest big on day one, and then follow up with large top-up investments should the share price fall.

Warren Buffett wrote in his 1993 letter to the shareholders of Berkshire Hathaway:

If you are a know-something investor, able to understand business economics and to find five to ten sensibly-priced companies that possess important long-term competitive advantages, conventional diversification make no sense for you.  It is apt to simply hurt your results and increase your risk.  I cannot understand why an investor of that sort elects to put money into a business that is his 20th favorite rather than simply adding that money to his top choices—the businesses he understands best and that present the least risk, along with the greatest profit potential.

Freeman-Shor concludes by pointing out that coaches would be quite helpful for investors:

I find it bizarre that top athletes and sportsmen and women have coaches but the majority of investment professionals do not.

How can they expect to improve their game if they do not have constructive feedback?



The Raiders: Snatching at Treasure

Freeman-Shor writes:

Raiders occupy a thin line between success and disaster.  These are investors who like nothing better than taking a profit as soon as practical.  They are the stock market equivalent of gold-age adventurers: having penetrated through the dense jungle, found the lost temple or buried treasure, they fill their pockts with all the ancient coins and gems they can—then turn tail and run.

Unlike gold-age adventurers, they are rarely chased by angry locals or rivals.  The only boulders rolling after them are in their imaginations.  They are terrified of getting caught and losing everything, and to ensure they at least come away with something end up leaving countless chests and swagbags of treasure behind completely unnecessarily.

Freeman-Shor continues:

I discovered the Raiders when I noticed the rather distressing fact that one of my investors had an incredible success rate—almost 70% of his ideas were correct, which is truly phenomenal—but he hadn’t made me any money.

I broke down the data for his investments and discovered that whenever he made a small gain, say 10%, he would immediately sell the stock and take the profit.

Interestingly, he was a hedge fund manager and in his own trading was an expert at shorting shares—and staying short.  But when it came to long-only investments, he and the other Raiders lacked a key habit that the successful investors I worked with possessed.  He did not embrace the right tail of the distribution curve.  In ordinary terms, the Raiders did not run their winners.

Freeman-Shor then gives some examples.

Chicago Bridge & Iron is a multinational company that does energy industry infrastructure projects.  One of the Raiders bought the stock on September 3, 2009, at £10.66.  A month later, on October 5, 2009, he sold at £12.29.  A few years later, the stock was at £30.38.  The stock had increased 147% since the Raider had so prematurely sold it.

British American Tobacco manufactures and sells tobacco products, including the brands Lucky Strike, Pall Mall, Vogue, John Player, Benson & Hedges, and Kent.  One of Freeman-Shor’s Raiders bought on July 3, 2009, at £19.96.  Two and a half months later, on September 21, 2009, he sold at £21.75, a profit of 9%.   A few years later, the stock was at £37.93, 74% higher than where the Raider had sold it.

Swedish Match is a world leader in chewable tobacco.  The Raider bought on October 10, 2008, when the shares were at €10.56.  This investor sold after two months on December 16, 2008, at €10.18, a 4% loss.  He decided to buy back in on June 24, 2009, at €11.23, before selling on April 22, 2010, at €17.54, for a profit of 56%.  A couple of years later, the stock was at €25.88, a further increase of 49%.

Novo Nordisk is a Danish pharmaceutical company and a world leader in diabetes medication (insulin) and care equipment (injection devices and needles).  The company is also a leader in hemophilia care and hormone-replacement therapy.  One of Freeman-Shor’s investors bought on April 22, 2009, at €35.71.  He later sold on December 4, 2009, at €45.32, a profit of 27%.  A couple of years later, the stock was at €124.92, a further increase of 175%.  This Raider had made a huge error, assuming the intrinsic value of the stock was near €124.92 or higher.

Freeman-Shor summarizes by saying that Raiders are right most of the time, but still lose money because their losses are bigger than their gains.  If they could learn to stick with winning ideas, they would be winning investors.  Freeman-Shor comments:

…the most successful investors I worked with, those that made the most money, all had one thing in common: the presence of a couple of big winners in their portfolios.  Any approach that does not embrace the possibility of winning big is doomed.


(1) It feels so good.  Selling for a profit feels nice.  We get a hit from testosterone and dopamine.

(2) I’m bored.  As Peter Lynch observed:

[I]t’s normally harder to stick with a winning stock… than it is to believe in it after the price goes down.

(3) Frustration.  It’s very difficult to patiently wait for years.  One factor is hyperbolic discounting, which makes people prefer $1 today versus $2 tomorrow.

(4) Fear.  Because of loss aversion, we tend to feel the pain of a loss at least twice as much as the pleasure of an equivalent gain.  When a Raider’s investment starts doing well, he often fears what might happen if he doesn’t sell.

(5) Short-termism.  There is recency bias.  Freeman-Shor:

My own fund—the Old Mutual European Best Ideas fund—is a good example of this.  If you took a three-year view from 2009 to 2011 you would have said I was a superstar.  If you viewed my performance during August 2011, or for the year 2011 alone, you would have said quite the reverse.

The flows my fund experienced showed just this.  Shortly after delivering those three-year performance figures I had over $200 million invested into my fund.  But during August 2011, clients withdrew tens of millions of dollars.

Since 2011 the performance of the fund has been strong and, surprise surprise, we have attacted inflows again.

Imposing different time frames on an investment can produce very different results—and Raiders invariably impose short-term ones.  This can be deadly for winning trades.

(6) Risk aversion.  People are risk-averse when winning—and tend to take profits—and they are risk-seeking when losing.  When winning, selling is appealing because the certainty of a small victory is better than the uncertainty of a loss or greater victory.  When losing, risk is appealing because anything is better than a certain loss.


(1) Rarity value.  Freeman-Shor:

All the successful investors I have managed made money because they won big in a few names, while ensuring the bad ideas did not materially hurt them.

… Stock market returns over time show kurtosis, which means fat tails are larger than would be expected from a normal distribution curve.  This means that a few big winners and losers distort the overall market return—and an investor’s return.  If you are not invested in those big winners your returns are drastically reduced.

(2) Beat your rivals.  Honing your ability to let winners run can give you a very significant advantage as an investor.

(3) You cannot trust your next investment.  The odds of picking a winning trade—based on the results of some of the best investors in the world working for Freeman-Shor—are roughly 49%.  This means the odds of picking five winning investments in a row are roughly 2.8%.  So if you have a winning investment, stick with it as long as possible.

(4) Winners can keep winning.  The research says that a momentum strategy can be a winning strategy.  A stock that has gone up over 6 months or a year often continues to go up.  Of course, no stock goes up forever, so even though you should let a winner run—as long as the investment thesis is intact and the intrinsic value is higher than the current stock price—you should eventually sell unless it’s a company with a sustainably high return on equity (ROE).

(5) You can never predict big winners when you first invest.  Freeman-Shor:

Many legendary investors did not predict their biggest winners—and have admitted it.  Some all-time greats even built their investment style around not knowing how big a winner might be: Jesse Livermore became of of the wealthiest men in America in the 20th century by adopting a simple trend-following approach.

In effect he bought stocks that were being bid up and rode them up, never knowing if it would turn out to be a big winner when he initiated the position.


Some reasons why professional investors tend to sell too soon.

(1) Bonuses.  Many fund managers are paid an annual bonus.  (It would make much more sense to pay a bonus—and allow the bonus to be large—every five or ten years.)

(2) Expectations.  Some fund managers feel the outperformance cannot continue.  The error being made is that essentially no investor can predict their biggest winners ahead of time.  So it’s best to stick with a winner as long as the investment thesis is intact and the estimated intrinsic value is high enough (or the company has a sustainably high ROE).

(3) Forecasting.  Often when fund managers look one or two years ahead and use conservative assumptions, the estimated intrinsic value is not much higher than the current stock price.   This makes it difficult to stick with the big winners.

(4) Relativity.  Unfortunately, many fund managers are evaluated on a shorter-term basis.  This makes them obsess over shorter-term results.  However, the biggest winners often increase the most in year 3 or year 4 or later.  A fund manager worried about 6-month or 1-year performance will tend to miss the biggest winners.

Freeman-Shor writes:

So being assessed on a relative basis leads fund managers to pay a lot of attention to how they are performing relative to both the benchmark index and their peer group.  Worse still, some do this on a daily basis.  They know the value of their holdings almost to the hour.

And it leads to a lot of unnecessary early selling.  It helps professional investors think that stocks are riskier than they actually are.  By monitoring a stock they are invested in several times a day, they notice the share price moves up and down quite a bit.  The price seems volatile.

But what if you just reviewed an investment every ten years?  You would probably find that the stock has made you quite a lot of money.  Moreover, because you did not check the stock price during that ten-year period, you did not notice the price moving up and down every day.  You never experienced the pain of a 20% fall in one day—perhaps 50% in a year.  You were completely unaware of the volatility of the ride you were on.  You therefore come to the conclusion that investing in the stock market is not risky at all.

My note: Fidelity did a study of its accounts and it found that the best-performing accounts belonged to people who either forgot they had an account or to people who had died.


The Connoisseurs: Enjoying Every Last Drop

Freeman-Shor writes:

The Connoisseurs are the last and most successful investment tribe I discovered among the top investors who worked for me.  These are the investors whose performance lived up to the billing—or exceeded it.  They did not get paralysed by unexpected losses or carried away with victories.  They treated every investment like a vintage of wine: if it was off, they got rid of it immediately, but if it was good they knew it would only get better with age.  They usually drank the odd bottle now and then, to tide them over—but otherwise they sat back and waited.

It takes a long of nerve to do nothing or merely trim a position when winning.  Everything points to us being hard-wired to sell out of an investment when we have made a reasonable profit.

Taking small profits along the journey like a Connoisseur allows us to get instant gratification without ruining our long-term wealth aspirations.  This ‘trick’ is one that I have seen in action and which allowed my best investors to stay in absolutely phenomenal winners.



In terms of hit rate, as a group [Connoissers] actually had a worse record than the average for my investors.  Six out of ten ideas the Connoisseurs invested in lost money.  The trick was that when they won, they won big.  They rode their winners far beyond most people’s comfort zone.

How to be like a Connoisseur:

(1) Find unsurprising companies.

The Connoisseurs’ approach was to identify companies with a view to holding them for ten or more years.  They would buy businesses that they viewed as low ‘negative surprise’ companies.  In other words, it was hard to envisage anything that could cause these companies to fail in generating profits over the years ahead.

Even if in the future they had terrible management at the helm, that management would have to be extraordinarily incompetent to destroy the profit-making ability of the enterprise.  The companies were effectively money-printing machines.

The future growth of earnings was seen as very predictable, and because the Connoisseurs believed earnings growth drove stock prices, the stock price should therefore drift higher over time.

The main risk of buying these stocks was if they were rated highly at the outset (i.e. with high price/earnings ratio).  This could mean that the company fundamentally performs as expected but the share price doesn’t follow earnings upwards due to it getting derated.

(2) Look for big upside potential.  Where many investors go wrong is in investing in a lot of ideas with limited upside potential.  Since your win rate may be between 40% and 49%, it’s essential to focus only on stocks with the biggest upside potential—or stocks trading at the greatest discount to intrinsic value.

(3) Invest big—and focused.  Connoisseurs could end up with 50% of their portfolio in just two stocks.  Freeman-Shor:

Having massive belief in a couple of names meant they were prepared to ride the stocks with big positions even when they were up 200% or more.  Their success was testament to Stanley Druckenmiller’s comment that “position size can be more important than entry price.”

This is one of the reasons that I allow each of my current investors to invest up to 25% of the money I give them in a single idea.

Freeman-Shor quotes New Market Wizards:

When you have tremendous conviction on a trade, you have to go for the jugular.  It takes courage to be a pig.  It takes courage to ride a profit with huge leverage.  As far as Soros is concerned, when you’re right on something, you can’t own enough.

Freeman-Shor comments:

It is no use having a small investment in a big winner; you have to have a large position size to generate big returns.

(4) Don’t be scared.  One key to sticking with a big winner and not being attracted by another great investment is to take small profits as the potential big winner is going up.  But the bulk of the potential big winner should be maintained and not sold.

(5) Make sure you have a pillow.  Freeman-Shor writes about having a high boredom threshold:

Meeting some of my Connoisseurs could be very, very boring because nothing ever changed.  They would talk about the same stocks they had been invested in for the past five years or longer…

The fact is, most of us will find it difficult to emulate the Connoisseurs because we feel the need to do something when we get to the office (or home trading desk) every day.  We look at stock price charts, listen to the latest market news on Bloomberg TV, and fool ourselves into believing we could add value from making a few small trades here and there.  It is very hard to do nothing but focus on the same handful of companies every year, only researching new ideas on the side.

Many of us, seeing we have made a profit of 40% in one of our stocks, start actively looking for another company to invest the money into—instead of leaving it invested.  This is precisely why lots of investors never become very successful.

Freeman-Shor next gives some real-life examples.

Shoprite Holdings is the largest food retailer in Africa.  It also operates furniture outlets, fast food outlets, and pharmacies.  It is the Wal-Mart of Africa.  One of the Connoisseurs invested in Shoprite on May 20, 2009, at £3.96 per share.  He sold the position three years later on August 9, 2012, at £13.10 per share.  This was a return of 231% in only three years.  This investor trimmed along the way and realized an overall profit of 104%.

Spirax-Sarco Engineering is a UK company that builds and maintains steam and industrial fluid plants.  The company’s products—which include boilder and pipeline control valves and clean steam generators—are being used more and more.  One of the Connoisseurs had known about this company for decades.  He bought a position on November 30, 2007, at £9.63.  He sold five years later on October 22, 2012, at £19.70.  The Connoisseur trimmed along the way and so realized a profit of 70% by selling at an average price of £16.40.

Rotork is a UK-based business and the world’s leading manufacturer of valve actuators, whether electric, pneumatic, or hydraulic.  The Connoisseur had known about the company for a long time.  He bought a position on November 30, 2007, at £9.84.  He sold five years later at £25.18.  Because the investor took profits along the way, he realized an average selling price of £17.26, banking a profit of 74%.

President Chain Stores is a Taiwanese company.  The company is an international food conglomerate operating in Taiwan and China.  It’s similar to Wal-Mart.  One of the Connoisseurs established a position on June 15, 2006, at £1.37 per share.  He sold five years later on August 23, 2011, with the shares at £3.73.  Because he trimmed along the way, the investor realized an average selling price of £3.17.  This was a profit of 132%.

Kasikornbank is a commercial bank in Thailand.  Through its wholly-owned subsidiaries, it does everything from investment banking to securities brokerage, fund management, hire purchase, and machinery/equipment leasing.  A Connoiser initiated a position on June 20, 2008, at £1.09.  He sold two years later on November 1, 2010, when the shares were at £2.65.  Because the investor sold along the way, his average selling price was £1.88.  Thus, he realized a profit of 79%.

Freeman-Shor  writes an important point:

Remember, despite their successful approach, only one-in-three of the Connoisseurs’ ideas made money.  In other words, every Connoisseur was also an Assassin or a Hunter when it came to losses.


Most people on the Forbes rich list not only have created a wonderful business, but also have never sold out.  Many of these folks received buyout offers along the way, but they decided not to sell.  Freeman-Shor:

Over the past decade or so, I would imagine Bezos has been approached by hundreds, possibly thousands of other companies wanting to buy Amazon from him.  Could you have resisted if someone offered  you $10m or $100m for your company?  Resisting temptation and staying invested in a great idea is critical.  Had Jeff sold out earlier when he was building Amazon, we may never have heard about him today.

Freeman-Shor adds:

When you are winning, dedication and discipline is what you require.  The Pareto principle, otherwise known as the 80/20 rule, states that 80% of the effects come from 20% of the causes.  It helps explain why great investors can be wrong most of the time and still make money.  A few big winners make a massive difference to the eventual outcome.


Freeman-Shor writes that many fund managers find it nearly impossible to be Connoisseurs.

Firstly, many professional investors over-diversify when they invest because they are managing career risk.  Most are judged by their bosses and employers based on how they perform against an index or peer group over a short period of time.  This militates against concentrating investments in potential long-term winners.

Secondly, regulators—based on investment theories from the 1970s—have put into place rules that prohibit professional fund managers from holding large positions in just a handful of their very best money-making ideas.


Because they believed diversified portfolios represent less risk than a concentrated portfolio of stocks.  The reality, however, is that all you are doing is swapping one type of risk for another.  You are exchanging company specific risk (idiosyncratic risk), which may be very low depending on the type of company you invest in, for market risk (systematic risk).

Risk hasn’t been reduced, it has been transferred.

The legendary investor Warren Buffett has written that if you know the companies you’re investing in very well and if you’ve focused only on your very best ideas, risk is actually lower than if you added more ideas about which you had both less conviction and less knowledge.


There was a paper that looked at the performance of investment managers’ best ideas.  They found:

    • The single highest-conviction stock of every manager taken together outperformed the market, as well as the other stocks in those managers’ portfolios, by approximately 1-4% a quarter.  That is a staggering 4-16% a year.  Over a ten-year time frame, that means these stocks could have outperformed the market by a phenomenal 48-341%!
    • The managers’ top five stocks also outperformed the market, as well as the other stocks in those managers’ portfolios, significantly.
    • The managers’ worst ideas—those stocks with the lowest weighting—performed significantly worse than the managers’ best ideas.

The study also found that there was little overlap in terms of the specific best ideas of the investors they studied.  The bottom line: Success comes from investing in your best idea.

The authors of the paper conclude:

What if each mutual fund manager had only to pick a few stocks, their best ideas?  Could they outperform under those circumstances?  We document strong evidence that they could, as the best ideas of the active managers generate up to an order of magnitude more alpha than their portfolio as a whole.

The paper also notes:

The poor overall performance of mutual fund managers in the past is not due to a lack of stock-picking ability, but rather to institutional factors that encourage them to over diversify, i.e. pick more stocks than their best alpha-generating ideas.


…the organization of the money management industry appears to make it optimal for managers to introduce stocks into their portfolios that are not outperformers… [in other words] managers attempt to maximise profits by maximizing assets under management… while investors benefit from concentration… managers under most commonly-used fee structures are better off with a more diversified portfolio.


Freeman-Shor notes that while being a Connoisseur generates the highest returns, it is not easy and there are dangers, three in particular:

(1) You can be too late.  After a stock has increased a greal deal, at some point it won’t and the investor may be too late.  I would add: As long as the intrinsic value is higher than the current stock price, or as long as the ROE is sustainably high (if you’re buying a higher quality business as your value investment strategy) and the stock price reasonable, then you should be OK.

(2) Momentum can be illusory—and end abruptly.  See the previous point.

One must also beware of bubbles.  Freeman-Shor mentions the book by Charles Mackay, Extraordinary Popular Delusions and the Madness of Crowds (1841).

His research showed how people lose the ability to think rationally under pressures of crowd behavior.  At the height of a bull market or in the depths of a bear market people become herd-minded.

This suggests that sipping some of those profits over time makes a lot of sense.  While you stay invested and therefore have the potential to win big, you are mitigating the potential damage should the shares disappoint.

(3) You can get stuck.  If panic takes over, it can be difficult to sell.



Freeman-Shor writes:

Having had the privilege of investing over a billion dollars with the best investors in the world, and managing them on a daily basis for over eight years, my preconceptions about successful investors have been shattered.

I discovered that the success enjoyed by top investors is not due to possessing a special gift, nor from having a privileged upbringing (though some who worked for me did).  Nor is it down to being born geniuses, though many were very smart.  Instead, any success ultimately came down to just one thing: execution.

This was the common thread that connected all of them.  And the secrets of successful execution were really just a matter of habit.

Each had learned the unseen art of executing ideas in a way that meant that even if they were wrong most of the time, they would still make a lot of money.

These successful investors didn’t have any clairvoyant forecasting abilities, but they knew what to do when they were winning or losing.  Freeman-Shor:

If they were losing they knew they had to materially adapt, like a poker player being dealt a poor hand.  A losing position was feedback from the market showing them that they were wrong to invest when they did.  They knew that doing nothing, or a little, was futile.  They had each independently developed a habit of significantly reducing or materially buying more shares when they were losing.

When winning, to take an analogy from baseball, the successful investors knew they had to try to hit a home run, as opposed to stealing first base.  This meant that they had developed the hidden habit of being resolved to stay invested in a winning position even when inside they were burning to take the profits they had made, and their inner voice was screaming, ‘Take the profit before you lose it!’

Freeman-Shor adds the following:

Success in investing is open to anyone, whatever their level of education or background, whether old or young, experienced or inexperienced.  You simply need to materially adapt when losing and remain faithful when winning.

If you have the discipline to do that, you can succeed.

I have no doubt that many professional investors reading this will neither change the way they invest nor adopt the winning habits I have revealed.  They will consider them too simple or common.  Most think they are just too smart and that they know best.  They are overconfident in the same way all drivers think they are better than average.  It’s their loss.

Freeman-Shor makes an additional, important point:

Some people may worry that adopting the habits of the successful investing tribes means losing their identity—or looking to invest with ideas that aren’t really theirs.  The good news is that the investors within each group all had radically different opinions about almost everything.  Their habits of execution overlapped, but the ideas that got them into an investment in the first place could not have been more different.



(1) BEST IDEAS ONLY.  You should only invest in your very best ideas.  Period.  One or two big winners is essential for success.

(2) POSITION SIZE MATTERS.  Again, it’s essential not to over-diversify.  Invest only in your very best ideas.  But have a handful of these ideas, not just one, because sometimes there are unforseen events or bad luck.

(3) BE GREEDY WHEN WINNING.  You have to let your winners run.  Embrace the possibility of the big win.  Embrace the right tail, the statistical long shots, of the distribution curve.  Give your investments the possibility of growing into ‘ten baggers.’

(4) MATERIALLY ADAPT WHEN YOU ARE LOSING.  Either add significantly to a losing position or sell out.  If you add more, you can turn a loser into a winner.

(5) ONLY INVEST IN LIQUID STOCKS.  How liquid a stock is depends in part on how much you’re investing.  If you’re investing $10 million or less, then most of the best investments will be microcap stocks.



(1) INVEST IN LOTS OF IDEAS.  As noted earlier, Warren Buffett has pointed out that you should concentrate on your best ideas and that adding more ideas than that would only increase risk and decrease returns.  Or as Charlie Munger said:

Wide diversification, which necessarily includes investment in mediocre businesses, only guarantees ordinary results.

(2) INVEST A SMALL AMOUNT IN EACH IDEA.  This is related to the previous point.  If you do not invest big in your best ideas, you won’t be able to do very well because a few big winners are what make the difference between an extraordinary track record and a mediocre one.

(3) TAKE SMALL PROFITS.  If you sell too much of your best ideas before giving them a chance to really run, you are cutting off your best chance for excellent overall results.






An equal weighted group of micro caps generally far outperforms an equal weighted (or cap-weighted) group of larger stocks over time.

This outperformance increases significantly by focusing on cheap micro caps.  Performance can be further boosted by isolating cheap microcap companies that show improving fundamentals.  We rank microcap stocks based on these and similar criteria.

There are roughly 10-20 positions in the portfolio.  The size of each position is determined by its rank.  Typically the largest position is 15-20% (at cost), while the average position is 8-10% (at cost).  Positions are held for 3 to 5 years unless a stock approaches intrinsic value sooner or an error has been discovered.

The mission of the Boole Fund is to outperform the S&P 500 Index by at least 5% per year (net of fees) over 5-year periods.  We also aim to outpace the Russell Microcap Index by at least 2% per year (net).  The Boole Fund has low fees.


If you are interested in finding out more, please e-mail me or leave a comment.

My e-mail: jb@boolefund.com



Disclosures: Past performance is not a guarantee or a reliable indicator of future results. All investments contain risk and may lose value. This material is distributed for informational purposes only. Forecasts, estimates, and certain information contained herein should not be considered as investment advice or a recommendation of any particular security, strategy or investment product. Information contained herein has been obtained from sources believed to be reliable, but not guaranteed. No part of this article may be reproduced in any form, or referred to in any other publication, without express written permission of Boole Capital, LLC.