Buycasting Basics: Principles
If you find yourself in a time crunch or suddenly hear your brain begging for an Instagram dopamine hit, please take home this message if nothing else:
“Buy Low; Sell High” is not an actionable strategy. It assumes you know what “the right price” for a stock is. We (and some legends of investing) claim that it’s impossible to know “the right price”. Intrinsic Value is a mirage. So, don’t fret over it. Instead try this: “Buy Low Expectations; Sell High Expectations”. They Buycaster is built to help you do just that. Never overpay for a stock again.
Last week we released to the Beta Version of The Buycaster to select subscribers who’ve been with us for a while. They’re already playing around with it. By the end of November, the Buycaster – the best number-crunching tool for equity investors that we know of – will be our core service. And it will be available to anyone who’s concerned about their portfolio or their investing journey. This is the equity investing tool we needed but never had. So, we built it. Here’s a snapshot of the top half of the dashboard:
Here are some of the basic features:
- It covers over 3,000 stocks traded in US exchanges.
- The Buycaster’s main purpose is Analysis, not regurgitating facts.
- The Buycaster goes much deeper than rudimentary statistics or valuation ratios – into salient factors – fundamental factors – that actually drive stock prices in the real world.
- The Buycaster answers one question above all: “what do I need to believe about the future of the business to consider buying the stock today?”
- When combined with good, old-fashioned Qualitative Analysis, The Buycaster’s Quantitative Analysis turn into Actionable Insights.
- The Buycaster’s mission is: Never overpay for a stock again.
The Buycaster is built upon certain investing principles that we have learned both the easy way and the hard way. The easy way is when someone tells you how to do something…and it actually works in the real world! This could happen in school, through an interaction with someone, or by reading books written by legends. The hard way is when you stumble upon a piece of wisdom or nuance by doing something wrong and taking the punches. In investing, that could mean doing something “by the book” only to realize that it doesn’t work in the real world. In this business, nothing teaches us like watching our hard-earned savings burn in flames because we overpaid for a stock.
Over the last few years, both the easy way and the hard way have battled it out in our minds (and in our brokerage accounts). What’s shaken out of these daily battles is a set of unshakeable, timeless principles that we have seen work in the real world. Here are 10+1 (somewhat unconventional) philosophical principles of investing upon which we’ve built The Buycaster:
- “Invert, always invert.” – Charlie Munger
- Munger encourages investors (and everyone else, really) to approach problems by inverting the question. Instead of asking “what happens if we assume…?”, try asking, “what needs to be assumed if we want XYZ to happen…?” Try back solving from the desired result. Go backwards and forwards and back again to solve a problem. Dance a little.
- Avoid forecasting or listening to “professional” forecasts. But by all means, Buycast.
- Forecasting markets, stock prices, revenue or other cash flow numbers is futile. It’s good entertainment but doesn’t usually make money for anyone.
- “Forecasting: the attempt to predict the unknowable by measuring the irrelevant; this task employs most people on Wall Street.” – Jason Zweig in The Devil’s Financial Dictionary
- “Forming macro opinions or listening to the macro or market predictions of others is a waste of time. Indeed, it is dangerous because it may blur your vision of the facts that are truly important. (When I hear TV commentators glibly opine on what the market will do next, I am reminded of Mickey Mantle’s scathing comment: “You don’t know how easy this game is until you get into that broadcasting booth.”)” – Warren Buffett
- “Market forecasters will fill your ear but will never fill your wallet.” – Warren Buffett
- So, we decided to make Buycasting the core of our investing process. We back solve for “what needs to happen in the business to consider buying the stock?”
- All investment theses are wrong.
- We need to have the humility to know (and remember) that our investment theses are almost always wrong…to some degree. The best we (or even legends like Buffett and Soros) can shoot for is to be kinda, sorta, approximately right.
- “In my investing career I operated on the assumption that all investment theses are flawed…The fact that a thesis is flawed does not mean that we should not invest in it as long as other people believe in it and there is a large group of people left to be convinced. The point was made by John Maynard Keynes when he compared the stock market to a beauty contest where the winner is not the most beautiful contestant but the one whom the greatest number of people consider beautiful.” – George Soros
- To Soros’s quote above, we’d like to add that it’s better to bet that the market can be fooled in the short term, but in the long term (we won’t be dead in 3-5 years, we hope) the market tends to award the beauty queen title to stocks of companies that demonstrate tremendous cash generating power. Over the long term, outer beauty and inner beauty tend to converge.
- Keep Calm and Minimize Speculation.
- All investing involves some level of speculation. We should minimize the speculation component of our thesis as much as possible. That’s the best we can do. We cannot get rid of it.
- It’s better to bet on rationality rather than irrationality in the markets when investing for the long-term. The emotional pendulum of the markets will swing from crazy pessimism to crazy optimism and back. But it must always pass through the zone of rationality.
- “The line separating investment and speculation, which is never bright and clear, becomes blurred still further when most market participants have recently enjoyed triumphs. Nothing sedates rationality like large doses of effortless money. After a heady experience of that kind, normally sensible people drift into behavior akin to that of Cinderella at the ball. They know that overstaying the festivities that is, continuing to speculate in companies that have gigantic valuations relative to the cash they are likely to generate in the future will eventually bring on pumpkins and mice. But they nevertheless hate to miss a single minute of what is one helluva party. Therefore, the giddy participants all plan to leave just seconds before midnight. There’s a problem, though: They are dancing in a room in which the clocks have no hands.” - WB
- Intrinsic Value is a mirage.
- The “Intrinsic Value” of a business or stock is unknowable. So, we must work with ranges and probabilities, not with (the pretense of) certainties.
- “I can proclaim what I call the "human uncertainty principle". That principle holds that people's understanding of the world in which they live cannot correspond to the facts and be complete and coherent at the same time. Insofar as people's thinking is confined to the facts, it is not sufficient to reach decisions; and insofar as it serves as the basis of decisions, it cannot be confined to the facts. The human uncertainty principle applies to both thinking and reality. It ensures that our understanding is often incoherent and always incomplete and introduces an element of genuine uncertainty - as distinct from randomness - into the course of events.” – George Soros
- Nobody knows anything in the short term, but equity markets are somewhat rational over the long-term.
- In our experience, equity markets are reasonably efficient (rational) in the long run (3-5 years). They are often irrational and myopic in the short term. That presents buying and selling opportunities.
- “Of course, the best part of [Benjamin Graham's approach] was his concept of "Mr. Market". Instead of thinking the market was efficient, Graham treated it as a manic-depressive who comes by every day. And some days "Mr. Market" says, "I'll sell you some of my interest for way less than you think is worth." And other days, he comes by and says "I'll buy your interest at a price that's way higher than what you think it's worth." And you get the option of deciding whether you want to buy more, sell part of what you already have, or do nothing at all. To Graham, it was a blessing to be in a business with a manic-depressive who gave you this series of options all the time. That was a very significant mental construct. And it's been very useful to Buffett, for instance, over his whole adult lifetime.” – Charlie Munger
- Changes in Expectations of growth (of lack thereof) drive stock prices.
- Over the long term, “the way things are” in the underlying business doesn’t drive stock prices. The difference between the way things are, and the EXPECTATIONS of the way things will be in the business drive stock prices. We need to have a grip on what expectations are priced into a stock. This is – strangely – still unconventional among professional money-managers. But it is the basis of The Buycaster.
- “Perhaps the single greatest error in the investment business is a failure to distinguish between the knowledge of a company’s fundamentals and the expectations implied by the market price.” – Michael Mauboussin in More Than You Know
- “Wall Street’s method of using accounting ratios to determine value may capture the here and now but does a woefully poor job of calculating sustainable long-term growth. Or, put differently, more often than not, sustainable long-term growth is mispriced by the market.” – Robert Hagstrom from The Warren Buffett Way
- “...many investors will give heavy weight to the per-share earnings of the past five years in trying to decide whether a stock should be bought. To look at the per-share earnings by themselves and give the earnings of four or five years ago any significance is like trying to get useful work from an engine which is unconnected to any device to which that engine's power is supposed to be applied. Just knowing, by itself, that four or five years ago a company's per-share earnings were either four times or a quarter of this year's earnings has almost no significance in indicating whether a particular stock should be bought or sold.” – Phil Fisher in Common Stocks & Uncommon Profits
- Focus on the soft stuff – the qualitative aspects of the business…the story.
- It’s better to spend most of the time ruminating on the business – its competitive advantage, management strategy, market size etc. – as opposed to using fancy (often nonsensical) statistical techniques on stock price charts. Don’t worry too much about the numbers. The Buycaster’s got your back when it comes to number crunching.
- “If the choice is between a questionable business at a comfortable price or a comfortable business at a questionable price, we much prefer the latter.” - WB
- “Be a business analyst, not a market, macroeconomic, or security analyst.” – Charlie Munger
- Use The Buycaster as a supplementary tool. But we’d wager it is the most powerful supplementary tool out there.
- When parsing through numbers , always work with CASH numbers. We do.
- Accounting numbers reported by companies are often not useful in gauging the future profitability of a company. Focus on cash numbers.
- “When forced to choose between optimizing the appearance of our GAAP accounting and maximizing the present value of future cash flows, we'll take the cash flows.” – Jeff Bezos
- Don’t depend on valuation metrics to find “cheap” stocks.
- First of all, always look to invest in a growing company. Avoid companies with stagnating or declining revenues – even if they appear “cheap” on certain popular valuation metrics. They’re usually “falling knives” – they’re cheap for a good reason.
- Most investors misunderstand the term “Value Investing” – it doesn’t mean buying bad stories at fire-sale prices. It means buying good stories at relatively cheap prices. First, the story needs to be good. Value and Growth Investing are two sides of the same coin.
- “Common yardsticks such as dividend yield, the ratio of price to earnings or to book value, and even growth rates have nothing to do with valuation except to the extent they provide clues to the amount and timing of cash flows into and from the business. Indeed, growth can destroy value if it requires cash inputs in the early years of a project or enterprise that exceed the discounted value of the cash that those assets will generate in later years. Market commentators and investment managers who glibly refer to “growth” and “value” styles as contrasting approaches to investment are displaying their ignorance, not their sophistication. Growth is simply a component usually a plus, sometimes a minus in the value equation. Alas, though Aesop’s proposition and the third variable that is, interest rates are simple, plugging in numbers for the other two variables is a difficult task. Using precise numbers is, in fact, foolish; working with a range of possibilities is the better approach.” – Warren Buffett in the Berkshire Hathaway Shareholder Letters.
- Risk = Permanent Loss of Capital. Every other definition is theoretical and/or useless.
- The only definition of Risk that matters is “permanent loss of capital” – it’s probability and its magnitude. And permanent loss happens when we grossly overpay for something. Never overpay for a stock.
- “The greatest risk doesn’t come from low quality or high volatility. It comes from paying prices that are too high. This isn’t a theoretical risk; it’s very real.” – Howard Marks
- “The riskiness of an investment is not measured by beta (a Wall Street term encompassing volatility and often used in measuring risk) but rather by the probability – the reasoned probability – of that investment causing its owner a loss of purchasing-power over his contemplated holding period. Assets can fluctuate greatly in price and not be risky as long as they are reasonably certain to deliver increased purchasing power over their holding period.” – WB
The Buycaster doesn’t forecast. It buycasts. It back solves into what one needs to believe about the underlying business to justify buying the stock at its current price. This method – pioneered by Michael Mauboussin as Expectations Investing – is totally congruent with the 10+1 principles listed above. We’ve taken his work and combined it with our experience to build The Buycaster.
In the following sections, we’ll dig into some of the technical assumptions we’ve made behind The Buycaster. This might be a boring set of sections for you, so feel free to skip to the sections where we walk through the Buycasts for:
These examples will give you a good sense of how to use The Buycaster to your advantage.