Investing

A stock is technically a loan with inﬁnite maturity, so the company won't actually ever pay back the loan. In reality, most companies come to an end eventually, but there are many companies that have lasted for 100 years or more. Furthermore, a stock may not ever pay out any cash dividends at all, so you may not get any interest on the loan either.

Short selling: an investor borrows securities, sells the borrowed securities immediately, and then hopes to buy them back later at a lower price. Investors borrow securities when they believe that their value will fall.

Outcome

The problem is that extraordinary performance comes only from correct nonconsensus forecasts, but nonconsensus forecasts are hard to make, hard to make correctly and hard to act on.

The upshot is simple: to achieve superior investment results, you have to hold nonconsensus views regarding value, and they have to be accurate.

Risk vs Return

Considerations when looking at an opportunity:

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's 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?

Risk

"risk" is---first and foremost---the likelihood of losing money

Experience is what you got when you didn't get what you wanted.
In theory there's no difference between theory and practice, but in practice there is.
if riskier investments could be counted on to produce higher returns, they wouldn't be riskier.

Given the difficulty of quantifying the probability of loss, investors who want some objective measure of risk-adjusted return---and they are many ---can only look to the so-called Sharpe ratio. This is the ratio of a portfolio's excess return (its return above the "riskless rate," or the rate short-term Treasury bills) to the standard deviation of the return.

In a similar light, a Sortino ratio looks at only downside volatility rather than both upside and downside volatility. However, neither measure does a good job of measuring risk of future loss.

It's impossible to assess the accuracy of probability estimates other than 0 and 100 except over a very large number of trials

"Risk means more things can happen than will happen."

The best we can do is fashion a probability distribution that summarizes the possibilities and describes their relative likelihood. We must think about the full range, not just the ones that are most likely to materialize. Some of the greatest losses arise when investors ignore the improbable possibilities.

I encourage you to think about "good-enough returns." It's essential to realize that there are returns so high that they aren't worth going for and risks that aren't worth taking.

Risk means uncertainty about which outcome will occur and about the possibility of loss when the unfavorable ones do.

The riskiest things: The greatest risk doesn't come from low quality or high volatility. It comes from paying prices that are too high.

When investors feel risk is high, their actions serve to reduce risk. But when investors believe risk is low, they create dangerous conditions. The market is dynamic rather than static, and it behaves in ways that are counterintuitive.

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.

In the short run, a great deal of investment success can result from just being in the right place at the right time. I always say the keys to profit are aggressiveness, timing and skill, and someone who has enough aggressiveness at the right time doesn't need much skill. The quality of a decision is not determined by the outcome.

This is why it is all-important to look not at investors' track records but at what they are doing to achieve those records. Does it make sense? Does it appear replicable? Why haven't competitive forces priced away any apparent market inefficiencies that enabled this investment success?

Pro-risk, aggressive investors, for example, should be expected to make more than the index in good times and lose more in bad times. This is where beta comes in. By the word beta, theory means relative volatility, or the relative responsiveness of the portfolio return to the market return. A portfolio with a beta above 1 is expected to be more volatile than the reference market, and a beta below 1 means it'll be less volatile. Multiply the market return by the beta and you'll get the return that a given portfolio should be expected to achieve, omitting nonsystematic sources of risk. If the market is up 15 percent, a portfolio with a beta of 1.2 should return 18 percent (plus or minus alpha).

Efficient market theory: I have concluded that no market is completely one or the other. It's just a matter of degree. I wholeheartedly appreciate the opportunities that inefficiency can provide, but I also respect the concept of market efficiency, and I believe strongly that mainstream securities markets can be so efficient that it's largely a waste of time to work at finding winners there.

Think of investing similar to horse betting where the amount of money in the pool for betting determines the odds (betting on a weak horse costs less money if you win you win the pool but paid less than people that bet on a strong horse).

Always consider quality and price when buying stocks. Aim for getting more quality per price.

Anti-Fragile

E.g. youtuber winning with negative and positive comments

Fragile - robust - anti-fragile

Bailouts
Trying to protect your kid from all harms
Overly hygienic

Are all turning something robust or anti-fragile into something fragile

Something that is fragile (a car hitting a wall at increasing speeds). Exponential decrease

Something that is anti-fragile. Exponential growth:

Investing in bio-tech

When dealing with random events (or black-swan events) focus on prevention rather than trying to predict

Aim for small uncorrelated errors

Lindy effect = indicator of anti-fragile

That which is old is also that which is expected to survive the longest. Something that managed to survive for a long time has most likely developed anti-fragile features. Insurance for old vs. you and insurance against dropping out of book seller top chart:

All else equal better bet on a company that his been longer around and a font manager with a longer track record.

Focus on pay-off rather than probability

Pay-off: .1*2 = .2
Pay-off: .9* -.1 = -.09
.2 + .09 = .11 = 11%
Investing 100\$ = 100 * .2 + 100 * -.09 = 20 - 9 = 11%

Better multiple favorable bets with less pay-off but lower risk

Should you invest 100\$ in a start-up that has 40% probability of succeeding if a succeeding you win 500\$. Or put 25\$ in 4 (independent) start-ups with 40% probability of succeeding?

One company expected value = 500\$ * .4 - 100\$ * .6 = 140\$
Multiple companies
4* 500\$ * .4 - 4 * 25\$ * .6 = 750\$
60% p(failure)
60% failure happening 4 times in a row = (.6)^4^ = 12.96%
Chance of 40% event happening at least once = 100%-12.96% = 87.04%
The probability that 10 mutually independent start-ups all succeed is 0.01 % (0.4^10^) but the probability that at least one succeeds is 99.4% (1 - 0.6^10^).

Economy

https://www.youtube.com/watch?v=PHe0bXAIuk0&list=RDLV2kJxqIO5sxQ&index=3

The economy is mainly driven by three factors
Productivity growth
Short term debt cycle (5-8 years cycle)
Up-cycle
More debt/credit creates more spending
Economic expansion
Prices rise
Inflation
Inflation is countered by higher interest rates (decrease borrowing > debt)
Down-cycle
Higher interest rates cause less credits
Less spending
Economy shrinks
Prices go down
Deflation -> recession
Deflation is countered by lower interest rates to fuel the economy > with more credit
Long term debt cycle (75-100 years cycles)
People tend to borrow more than the repay
As longs as the income and asset values grow faster than the debts > that works
At one point the level of debt grows bigger than the income and > asset values
People have to spend more on repaying their loans than they can > afford
That causes people to spend less
Causing a depression and stock market crashes
Credit is an asset to the lender (bank) and a liability to the borrower.
Debt drives the economic cycles more than productivity growth (it usually follows a quite constant growth while debts swing up and down)

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Borrowing is a way of spending more money in the present rather than in the future (the settlement of the transaction based on debt is deferred)
In order to buy something that you can\'t afford you need to spend more than you currently make
You borrow from your future self
To pay the debt back at one point you need to spend less than you make.

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More debt allows people to purchase more than we produce and less debt prevents people from buying as much as we produce

Dividend discount model

The cash ﬂows that investors receive from stock are the dividends, so fundamentals-based models of stock price note that the current price of a share of stock is equal to the present discounted value of the sum of all its future dividends. Technically, this represents an inﬁnite number of future dividends.
There's a surprisingly simple formula for the present value of the sum of all future dividends: D/(r − g). This formula is called the dividend discount model.
- the amount of the next annual dividend: D = \$1.72 per share
- the expected return on the stock (based on CAPM): r
  - To use the CAPM to estimate the expected return, or discount rate, on a stock, we use the following formula:
  - E(r~i~) = expected return
  - r~f~ = risk-free-rate = return on a 10-year treasury bond (about 5%)
  - ß~i~ = beta
  - The ﬁnal term is the difference between the expected return on the entire market and the risk-free rate---called the market risk premium, or the compensation for bearing one unit of risk.
average growth rate of the dividend: g (average dividend growth rate over the past 5 years.)

Dividends

Companies usually don't reduce the relative amount of dividends (dividend yield) the pay but rather try to keep them stable or even increase. Reducing or increasing dividends is an indicator of strength or weakness.

Several academic studies show that the higher the fraction of earnings a company pays out as dividends, the higher the growth rate of earnings tends to be over the next 10 years.

A stock buyback, or share repurchase, is a transaction in which a company goes into the stock market and repurchases, or buys back, some of its outstanding shares. This is a substitute for a dividend because the company has to pay cash for these repurchased shares, which returns cash to the company's shareholders.

Advantage of long term investment over short term

https://www.visualcapitalist.com/stock-market-returns-time-periods-1872-2018/

https://themeasureofaplan.com/us-stock-market-returns-1870s-to-present/

Interest rates and stocks prices have a reverse relationship (compare P/E ratio overall in relation to interest rates)

Earnings yield = opposite of P/E shows % earning per stock price

10-yr- US treasure bonds as indicator for interest

Three pillars of trading

Psychology

Keep track of your trades including your assumptions and reasoning (plan to sell)
Setup rules and follow them
- Analyse your performance and change rules accordingly
- Measure adherence to rules
- Mood when entering and exiting the trade

Trading system

Man = trend

Dog = oscillator (oscillates around trend sometimes strays away may end up in a different direction=

Exponential moving averages are better than normal moving averages (stronger weight of more recent trend)
Try to confirm trends in related markets (e.g., ema of different stocks trending in the same direction)
Longer EMA = stronger signal

Entry criteria:

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Market tide: weekly MACD histogram (trend) - buy in that direction
Market wave: 2-day EMA (oscillator) - opposite of that direction
Intraday breakout: buy order 1 tick above the high of the previous day.

Money management

Cut losses short and let winners run

Box model for exit strategy

Buy stock when it moves into a higher box
Stop loss is lower end of box (previous high)
When box exceeds upper bound of box
Establish a new upper bound and make previous upper bound the new lower bound

Kelly Criterion

Determine position size based on:

Equity Balance (how much money available for trading)
Expected return (average R over time (Risk/Reward ratio)
Probability of winning/losing

Example:

Balance: 20K

Expected return: 4.04 (needs to be constantly adjusted to actual averages)

Win Rate: 59% (needs to be constantly adjusted to actual averages)

If the downside-case loss is less than 100%, as in the scenario above, a different Kelly formula is required: Kelly % = W/A -- (1 -- W)/B, where W is the win probability, B is the profit in the event of a win (20%), and A is the potential loss (also 20%).

(Expected return * (Win Rate - Losing Rate)) / Expected Return

(4.04 * .59 - (1-.59))/ 4.04 = 0.488 / 3 = .163% (/3 = fractional Kelly)

20000 * .163% = 3256.77 (actual risk is determined based on stop loss e.g. 10% of position size)

Van Tharp

R = Unit of risk
Buy price 100 \$ price and 90 \$ stop-loss = 1R = 10\$
Sale price = 140 \$ = 4R profit
Expectancy = average R over time
Look of the distribution of R multiples not only the average (e.g. volatility and drawdowns)
Exiting strategies
Percentage (7-8%) could be trailing
Time based (if based on fundamentals)
Volatility based (if outside normal vola of stock)
Opportunity (how often does the system generate signals)
Position sizing
Survival (never risk > 2% of equity in one trade including fees)

a. Set up stop-loss according to strategy

b. Stop-loss amount (stock prices - stop-loss amount) defines # of stocks to buy

c. Only move stop-loss in direction of the trade (higher)

Steady returns
High returns

Valuation of stock prices

Compare this in conjunction with P/E

Relative evaluation

Compare stocks to a similar competitor and take the cheaper one.

Competitive advantage

Find comparable
Compare price based on P/E ratio
Adjust for differences (e.g. take earning growths)

Intrinsic valuation (follow-up of above)

Discount rate = yearly return of the stock
Company share = claim against portion of the future earnings

Interpretation of financial statements

Watch out for overstated values in the balance sheet (e.g. intangible assets)
Look for consistency over several years (ideally 10)
Compare within the same industry

Intrinsic value (liquidation value)

Use book value = Sell all assets and repay all liabilities

Income statement (over a period)

Best is to express everything as a % of the of total revenue (top line) and compare with average of top 5 competitors

Balance sheet (snapshot in time)

Look at a percentage of total assets and compare with top competitors

Bad signs

Cash flow statement

Statement of actual ins and outs of money

Indicators

ROE return on equity

Net income (income statement) / Total equity (Balance sheet)

Return on tangible assets

Net margin

Highly dependent on industry
Net margin = Net income (earnings) / Revenue (+20% ideal)
Gross margin = gross profit / revenue (+40% ideal)

Tells you what percentage of how much the company earns on a dollar

Current Ratio

Current Ratio = Current Assets / Current liabilities
Should be positive (higher for low inventory industries)
Indicator of whether a company is able to fulfil its short-term obligations

P/B ratio price to book ratio

Highly dependent on industry
P/B = market cap (number of stocks * price of stock) / total assets

Inflation

During inflation it's good to invest in companies that have low capital requirements (low debt ratio) and high return on assets (produce once and sell many times)
Companies that can scale easier (intangible assets e.g. software)
Companies that have pricing power (e.g. they can increase the price according to inflation or higher)

Cycles

A market cycle oscillates around a secular trend.

The stock market is driven by bust and boom periods. Those are exaggerations in both directions followed by reversion to the mean.

Cycles are influenced by other cycles:

Economy (GDP)
Cycle of profits of businesses (P/E price to earnings ratio) (multpl.com)
Credit cycle
Psychology (attitudes towards risk)

Ideas

Look for most valuable brand with the lowest P/E

Conservative base investment

Dividend stocks (paying dividends for 10+ years)
Current ratio = assets / liabilities > 2 (conservative finance)
Earning money + earning growth (5+ years)
Net current assets (current assets -- liabilities) > price

Don't bet on companies that do a lot of acquisitions rather focus on organic grows

Acquirer\'s multiple

P/E = market cap / net earnings
AM = Enterprise value (market cap + cash reserves - debt) / operating earnings

Buy companies with low acquirer multiple
https://acquirersmultiple.com/largecapsuccess/

Diversify

10-20 stocks

Focus on avoiding mistakes instead of trying to be right all the time

Try to be consistently not stupid.
Focus on what you don't want to do (e.g. not investing in...)
Avoid disaster (e.g. running out of money)

Stay in circle of competence with humility (but think independently)

Know what you don't know
Look for evidence that goes against your conclusion/view
Don't follow the herd
Don't follow analysts or irrelevant news.

Evaluate risk

Use a margin of safety (e.g. buy under valued stocks)
More risk = higher compensation
What could go wrong?

Resist the urge to act (FOMO)

Avoid transaction fees
But not when it comes to cutting losss

Focus on macro rather than micro decisions

Don't save on small expenses or try to win on small bets
Use a credit card to get bonuses
Automatic saving plan
Compare based on total cost of ownership rather than purchase price

Don't fall in love with your investment/position

Always set a value at which you will sell before investing and follow it
What you paid for your house, stock, or car has no relevance to its value. If the value is below what you paid, you don\'t have to get even. If you bought a stock for \$100 and it is now \$50, you should sell it, if it is not worth more than \$50. Ask: Suppose I hadn\'t made the investment, would I make this investment today at today\'s price?