A Guide for Novice Investors
This is not a new book. It was published way back in 2004 by the fund rating company Morningstar. It has just been reissued jointly by Macmillan and Wiley as an Indian edition, given the huge popularity it enjoys. It is a classic which appeals to those interested in understanding ‘moats’ that protect businesses from competition and lead to long-term value creation. Every budding analyst, I come across, claims that he has read this book to become a better investor. So, what are these five rules? 
 
1. Do Your Homework: This refers to the framework of investment knowledge required to analyse a business. This essentially includes knowledge of finance and investment accounting. Chapters 4-7 explain how to analyse companies. 
 
2. Find Economic Moats: This is the most important part of the book. Dorsey suggests looking at quantitative factors like free cash flows, net margins and return on equity and return on assets, as a first step. The second step would be to try to find qualitative factors behind the numbers that create the moat, such as brands, technology, switching costs or low cost of operations. 
 
3. Have a Margin of Safety: Even the world’s most wonderful business is a poor investment if purchased for too high a price. The book takes the reader through all the conventional measures of market valuation such as prices to sales, earnings and book value, earnings yield and price to earnings growth, etc. It ends with a little known measure—cash return—which is free cash flow to enterprise value and measures how efficiently the business is using its capital. A whole chapter is devoted to intrinsic value by the discounted cash flow method which, unfortunately, is of no practical utility.  
 
4. Hold for the Long Haul: This is obvious, especially in the US, where taxes and trading costs can eat into a large part of your profits.
 
5. Know When To Sell: Dorsey promises to explain this later but I could not find any elaboration on this. I find this a most callous and egregious slip-up. He has several pages devoted to when not to sell which does not really help much. 
 
After having explained these five points, about halfway through the book, Dorsey takes the readers through how to analyse two real companies. He picks up Advanced Micro Devices, a tech company, and Biomet, a maker of medical devices. This chapter gives readers a chance to put on an analyst’s cap. All this is in the first part of the book which also includes mistakes to avoid, how to spot financial fakery, a 10-minute test of an investment idea which will help you quickly reject stocks that are not worth researching, while filtering investment-worthy opportunities that demand further research.
 
There is a second part of the book which is a guided tour of individual sectors. This section is quite unique. Most books on investing show no awareness that each sector is different and may demand a different set of tools for analysis. 
 
The sectors covered in this book are: healthcare, consumer services, business services, banks, asset management and insurance, software, hardware, media, telecom, consumer goods, industrial materials, energy and utilities. Dorsey explains how companies make money in each of these sectors and how moats get created. Of course, these are all US-centric factors; nevertheless, it helps to develop the right analytical approach. The Five Rules for Successful Stock Investing is a great book for beginners and a good refresher to leaf through every once in a while, even for seasoned professionals. 
 
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COMMENTS

Ramesh Poapt

9 months ago

easy to read, but too though to implement!

What Do You Have To Lose?
As everyone by now knows, Nassim Nicholas Taleb is a Lebanese–American essayist, scholar, statistician, former trader and risk analyst whose books Fooled by Randomness, Black Swan, Anti-fragile have dealt with problems of randomness, probability and uncertainty. The Sunday Times has rated Black Swan as one of the 12 most influential books since World War II. Taleb now serves as a professor at several universities, including as distinguished professor of risk engineering at the New York University’s Tandon School of Engineering. 
 
Taleb is back with another book on a theme that is close to his heart and which he has been expounding for the past few years in his articles and Twitter comments: skin in the game (SITG). The idea is simple. If you grab the upside (of your actions or decisions), you should get the downside too. His argument is that the chances of informed action and prediction can be improved if we better comprehend the multiple causes of ignorance when dealing with everything from health, safety politics, sports, etc. One of the causes of ignorance is that, in an opaque system fraught with uncertainty, there is an opportunity for one set of players to hide risk: to benefit from the upside when things go well but not pay for the downside (Black Swan events) when one’s luck runs out. 
 
Taleb has made a natural progression from randomness to extreme events to, now, what he calls hidden asymmetries. Economic literature focuses on incentives as encouragement or deterrent, but not on disincentives that should eliminate from the system incompetent and nefarious risk-takers who inflict harm. An unskilled forecaster, who, if shielded from financially harmful consequences of his wrong forecasts, would continue to contribute to the build-up of risks in the system. But if he is under a disincentive to do so—the forecaster pays for his wrong forecasts—he would, eventually, be removed from forecasting. This disincentive is simply skin in the game.
 
You can have as good a risk management system as you want, but nothing can be better than an inherent and internal system of risk control exercised by the participants, knowing that they have to pay for it. 
 
This idea is old as the hills. Taleb, who was born in what he archaically calls Levant—a collection of cities on the eastern Mediterranean seaboard. The Levant is a short distance away from the principal centres of several older civilisations—Sumerian, Babylonian, Ottoman, Persian, Greek and Roman and Taleb, proud of this lineage, has always drawn his anecdotes and inspiration from these ‘ancients’. In this book, too, he assembles a lot of historical evidence to show that the ancients were fully aware of this incentive to hide risks and implemented very simple but potent heuristics or rules of thumb. 
 
About 3,800 years ago, Hammurabi’s code specified that if a builder builds a house and the house collapses and causes the death of the owner of the house, that builder shall be put to death—the best risk management rule ever. What the ancients understood very well was that the builder would always know more about the risks than the buyer, and can hide sources of fragility and improve his profitability by cutting corners. The foundation is the best place to hide such things. The builder can also fool the inspector, for the person hiding risk has a large informational advantage over the one who has to find it. Taleb also notes that Hammurabi’s law is not necessarily literal: damages can be ‘converted’ into monetary compensation. 
 
Over the centuries, the idea of SITG has appeared in many forms. The rule under Lex Talionis is “An eye for an eye, a tooth for a tooth.” The 15th Law of Holiness and Justice is “Love your neighbour as yourself.“ Isocrates, a Greek rhetorician, and Hillel the Elder, a famous Jewish religious leader and scholar, have both said: “Do not do unto others what you would not have them do unto you.” Philosopher Immanuel Kant’s Formula of the Universal Law is: “act only in accordance with that maxim through which you can at the same time will that it become a universal.” 
 
What are the modern-day applications of SITG? The best place to apply this is on policy-makers and politicians (though it is unclear who would apply it, since law and policies are framed by them.) One of the most important points Taleb makes is that this idea is not ‘scalable’. You cannot have the players in the national government with SITG; and it is far from international organisations. It is in the small, local, personal and decentralised systems where SITG works best because participants are, typically, kept in check by feelings of shame on harming others with their mistakes. In a large, national, multi-national, anonymous and centralised system, the sources of error are not so visible and pinpointing accountability is not easy. When it fails, everybody except the culprit ends up paying for it, leading to national and international measures of indebtedness against future generations or ‘austerity’ imposed—again by large global organisation run by those without SITG such as World Bank and International Monetary Fund. This naturally means that Taleb is dead against ‘big governments’. 
 
 
After policy-makers come corporate managers, especially the finance people—the ‘agents of capitalism’—for whom Taleb has special scorn. The manager who loses money does not return his bonus, forget about sharing the losses. Taleb has never concealed his hatred for economists, quantitative modellers and policy wonks. These people have no disincentive and are never penalised for their errors. So long as they please the journal editors, or produce cosmetically sound ‘scientific’ papers, their work is fine. So, we end up using models, such as portfolio theory and similar methods, without any remote empirical or mathematical reason. The solution is to prevent economists from teaching practitioners, simply because they have no mechanism to exit the system, in the event of causing risks that harm others. Again, this brings us to decentralisation by a system where policy is decided at a local level by smaller units and, hence, there’s no need for economists. 
 
Then come the predictors, who rarely pay for their predictions while their precise quantification encourages people to take more risks. The solution is to ask—and only take into account—what the predictor has done (what he has in his portfolio, if he is a stock-adviser), or is committed to doing in the future. Finally, to deal with warmongers, Taleb approvingly quotes Ralph Nader, an American activist who fought many battles for the consumer, and to whom Taleb dedicates the book. Nader has proposed that those who vote in favour of war should subject themselves (or their own kin) to the draft. Beyond all ‘isms’ and theories of how institutions should be run, what we really want is accountability for decision-makers who influence our lives. And that is what SITG suggests. But there are huge practical problems in trying to apply this approach in real life. Who will write out the rules of SITG? Wouldn’t human beings, being what they are, find exactly the same way to game the system to save their skin? 
 
Most importantly, Taleb’s strong, combative, haughty and thin-skinned personality comes through in every page. When he is not delving into SITG theory, he is either mocking someone (academics like Steven Pinker, Thomas Piketty and Nobel Laureate Richard Thaler, journalists, bureaucrats, social science departments, corporate managers, Monsanto and other GMO companies, large corporations, and so on) or praising himself. The number of people, disciplines and institutions that he thinks are charlatans and fools, is astoundingly vast and his rudeness breathtaking.
 
This book is nowhere in the same league as Fooled by Randomness and Black Swan. There are sweeping generalisations also (for example, about the change in public mood in UK, India and the US) that just don’t ring true. All that’s a pity because the core SITG idea is relevant, though with limited applicability. 
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COMMENTS

KARAN GARG

10 months ago

Fooled by Randomness and Black Swan , do we have reviews for these books ?

KARAN GARG

10 months ago

thanks for the review! gets the msg cross to us !

Prasanna -

10 months ago

Another blockbuster from the author of Black Swan.

The Grand Principles of Life & Work
Let me start with a confession. I have read only parts of this book and I don’t think I am likely to go back and read it—at least the 400-odd pages of principles. That is unfortunate because the cornerstone of all consistently high achievers is fundamental principles of thought and action that are consistently applied and explained. Come to think of it, nothing of lasting value can be created without such firm foundational principles.  And, yet, as the writer and hedge fund superstar, Ray Dalio, points out, it is surprising that such few successful people have shared their principles. We would certainly like to know what Steve Jobs’ principles were—that stunningly combined aesthetics and functionality and won the hearts of consumers. Or what principles guided Albert Einstein. 
 
Dalio does not want to make the same mistake; before he leaves this world, he wants to give us two books. This is the first one—on life and work principles. The next would be on investing and economics. The idea—in the mould of Greek classics—is to present to us the grand theories and philosophical ruminations that explain life, investing and the economic machine. This book, bound in black cloth with white lettering, reminds me of Discourses by the Greek stoic philosopher Epictetus. I suspect it will sink like a stone.  I have explained why, at the end. 
 
But what is Ray Dalio’s achievement? What makes him think we want to read his principles running into over 567 pages? Ray was born in a middle-class family in Long Island (USA) as the son of a Jazz musician. He had an unremarkable school record but was a curious boy and got hooked on to stocks in his teens. He started an investment company, Bridgewater Associates, from his two-bedroom apartment when he was just 26 years.Over the past four decades, he has built Bridgewater into, what Fortune magazine labels, the fifth most important private company in the US. Dalio has been called one of the 100 most influential persons (according to Time magazine) and 100 wealthiest (according to Forbes magazine) in the world. Bridgewater, today, is the world’s largest hedge fund, managing more than $150 billion. 
 
The first part of the book is a memoir (Where I Am Coming from) of Dalio’s journey over the decades; the second part discusses his Life Principles; and the third part enumerates his Work Principles. In the first part, over 124 fascinating pages, he narrates how he started his firm in 1975, internal conflicts and various mistakes and failures which convinced him that we learn much more from our mistakes than from our successes. Just a few years after he started the firm, Bridgewater nearly shut shop on bad bets on the bond market and strong belief that the US was heading for a deep recession, possibly depression. 
 
But the economy recovered and the US market went into a 18-year bull market. He writes: “being so wrong—and especially so publicly wrong—was incredibly humbling and cost me just about everything. I saw that I had been an arrogant jerk who was totally confident in a totally incorrect view. I was so broke I couldn’t muster enough money to pay for an airplane ticket to Texas to visit a prospective client.” In fact, from a strength of 20, Bridgwater was down to a single employee—Dalio. He had to borrow $4,000 from his father, until he could sell his second car and raise money.
 
But, unlike others, he took a cold-blooded approach to his mistakes. Dalio came to realise that, if he had to move forward, he needed to do four things. One, team up with other independent-minded thinkers like him, who thought differently, and to understand their reasoning. Two, know when not to have an opinion. Three, develop test, systematise the timeless and universal principles. Four, balance risks in such a way as to keep the big upside, while reducing the downside. He also started writing down his decision-making criteria. With time, he had a collection of recipes for decision-making which gave birth to principles. He then shared his principles with his colleagues and invited them to test his principles in action; this helped him continually refine them. Dalio also converted his decision-making criteria into algorithms that were fed into computers. 
 
Dalio had no interest in sharing these principles because of two reasons: he didn’t like attention and it was presumptuous to tell others what principles to have. After Bridgewater successfully sidestepped the crash of 2008, it started getting a lot of media attention. Dalio felt that a lot of these reports were distorted; so, in 2010, he posted his principles on the Bridgewater website so that people could judge from them. Incredibly, the ‘principles’ were downloaded three million times; thank you mails came from all over the world. Dalio then decided to publish two books enshrining all his principles.  This is the first one.
 
The Culture
The genesis of principles, and the start of the Bridgewater’s unique culture, goes back to 1993, when Dalio was delivered a memo signed by his top three lieutenants that was startlingly honest in its assessment of him. After mentioning his positive attributes, they spelt out the negatives. “Ray sometimes says or does things to employees which makes them feel incompetent, unnecessary, humiliated, overwhelmed, belittled, pressed or otherwise bad,” the memo read. “If he doesn’t manage people well, growth will be stunted and we will all be affected.” That memo hurt and surprised Dalio. 
 
He started thinking of how he approached people and began developing a unique culture at Bridgewater, the keywords of which are: “radical truth and radical transparency.” Dalio claims to have developed a culture of openly and thoughtfully disagreeing on the most important issues; this, he thinks, is the most powerful way of creating meaningful work, meaningful relationships and great outcomes. He wanted his colleagues to get past their ego and put out their honest thoughts, to be able to have thoughtful disagreements. Even if the disagreements remained, he wanted a way to get over them so that no bad blood remains.
 
Indeed, Bridgewater is the target of fascination for the social experiment it runs inside the firm, some of it quite hard for an average person to stomach. The firm explicitly orders its 1,500 employees to follow the rules of behaviour enunciated in the ‘Principles’ which can be very unsettling. One of the principles is “Evaluate accurately, not kindly.” Another is “Recognize that tough love is both the hardest and the most important type of love to give (because it is so rarely welcomed).”As a matter of routine, all conversations and meetings are video-recorded so that employees can analyse them later. Employees are supposed to rate each other—using the principle of ‘radical transparency’; they are known to use an app to score their colleagues’ arguments in real time. Feedback can be blunt and brutal and can come from a junior about her senior. And all this data is then analysed to see how the firm can improve.
 
Among the many other unusual practices at Bridgewater (apart from video-taping meetings) is publicising every employee’s performance review, interrupting investment meetings to provide personal feedback before dozens of colleagues and to openly and critically examine the firm’s practices, to generate high performance. Dalio’s book of principles also formed the basis for nightly ‘homework’ assignments that quiz people on their understanding of the principles. If you don’t fit into this culture, you quit. Staff turnover, especially among the new employees, is high; many leave in tears, according to the media, though Dalio calls such accounts fake and exaggerated. 
 
Dalio believes that everyone can benefit from a meritocracy based on radical truth and radical transparency. While his own achievement is, undoubtedly, great, it is worth wondering whether the culture has led to its success or the success has allowed it to get away with this weird culture. While Dalio does believe that his success flows from the principles, there are many successful and durable organisations with their own culture that are quite different from Bridgewater’s. It could be just a bit presumptuous that there is one correct way, which Dalio has found, and is letting others know it.
 
The biggest problem is that homilies (parts two and three), which will be impossible to apply in real life, are spread over a massive 440 pages. They are heavy, bland and, often, without context. After all, to know “don’t be afraid to fix the difficult things” and “clearly assign responsibilities” is not going to help much. There are literally hundreds of such small and big ideas. It’s exhausting even to glance at them. But I will certainly wait for the second book—on investing and economy—because Dalio’s distilled wisdom on these areas would be worth its weight in gold. 
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Ralph Rau

10 months ago

Mr Dalio has built an organisation of artificial intelligence and automatons. A dehumanised cyborg company. He is in this respect clearly ahead of his time.

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