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How Books Shaped My Investing Philosophy
My favorite finance book is One Up On Wall Street by Peter Lynch.
Peter Lynch books are an absolute delight to read because they are written in a light-hearted tone; it's as if you're having a casual conversation with him. Meanwhile, he was the top fund manager at Fidelity, achieving a 29% CAGR for the Magellan Fund for 14 years.
I love this book because it focuses on harnessing a developed perspective as you approach individual stock investing. Lynch breaks down how to classify individual companies as stalwarts, fast-growers, turnarounds, etc. Lynch truly believes retail investors can beat professional Wall Street analysts for a few different reasons. Retail investors have a unique edge versus large funds in the sense that we can invest in smaller companies before the big boys take a position. This is primarily due to:
- Less liquidity: Because small companies trade fewer $ worth every day than larger companies, the exit liquidity is a risk most funds will avoid
- Not being able to take a meaningful position early on: there are typically restrictions on max % of portfolio allocated to a position, and max % ownership of a company. A small position may not be impactful to portfolio returns for a big fund.
This is why I tend to focus on smaller companies, there is an inherent edge.
Peter Lynch also loves companies with ugly names, or something in your backyard. Somewhere Wall St analysts have yet to venture. I applied this perspective early in the pandemic when a microcap genetics testing company in my neighborhood, Fulgent Genetics ($FLGT), had gotten an EUA for Covid-testing. The Covid-testing revenues had not hit the income statement yet, and their most recent earnings call transcripts mentioned their facilities were running 24/7. The trade ended up working out very well, and at some point I had 100% allocated to it. My only regret is I didn't hold it any longer as it went on to 6X after my sale. Eh, better to leave a month early than a day late.
Another edge for retail investors that is mentioned in the book is that we can zoom out longer on our investment horizons. We don't need to justify any sluggish performance from specific companies to anyone. We can afford to hold through a bad quarter as we don't have any quarterly reports to satisfy clients with.
We also don't have % limits of allocation in our portfolio. While some practice diversification, I personally concentrate into my best ideas; I currently hold 4 names in my portfolio. It feels easier to hold through a downturn when I know a company inside-out versus keeping up with many companies. I also believe that if you hold too many companies, you may as well own the index. Again, just my personal investing philosophy, but everyone has their own style!
I understand why many investors feel safer in mega caps. The $GOOGL and $AMZN of the world are relevant in any industry they enter. They can easily swallow up any competition. It's a lot less stressful to own, but I tend to avoid these stocks for two reasons:
- The Law of Large Numbers: it takes more to move earnings once you are a trillion $ company
- Lack of Edge: What can you possibly know about Google that others do not? There's plenty of coverage by experts.
For these reasons, I believe the market gains from this point on will look closer to market-like returns (though great companies can likely outpace market even at lofty sizes).
The Most Important Thing by Howard Marks is my runner-up. This book taught me a lot about risk vs return. Marks mentions how reward is usually best when we feel things are riskiest, e.g. stocks are at lower prices. Said another way, we cannot assess risk of an asset without considering the price. Perhaps all the bad news is priced in, and thus the stock price is depressed to reflect the grim situation. If we as investors do not believe the situation is as grim as the price declares, this is our opportunity to buy companies at great prices for higher forward returns.
There are also the opposite situations: where companies are priced to perfection. We have seen many examples where stocks reflect a very optimistic outlook for the company, and any softened operations can send the stock crashing. I believe many larger caps exhibit this feature, simply due to "took big to fail" sentiment. After the recent drawdowns, mega caps look better here for future returns, but prior to the drawdown, everyone bid up the stocks to all time highs. This is when the stock likely has the highest risk.
This perspective is not true for traders who will argue the opposite. They follow only stocks with high relative strength making new 52 week highs. Trading is quite a different game than picking long term investments. Traders care for high volume, strength, and to get in and out - essentially the opposite of long-term investors. As a long-term investor, you have the ability to set and forget. Let the business execute and come back to check on the seeds you sowed years later.
These two books make up the basics of all my fundamental investing perspective. I highly recommend both of these books to any level investor, but especially when you are first starting out. Even an experienced investor can find nuggets of wisdom when revisiting any of the chapters. These books build a good foundation from which you can then bridge the gap into more advanced material. It's one of those 80/20 moments, where 80% can be learned from 20% of material, and the other 20% of knowledge takes 80% of the remaining material.
I hope you found this insightful. Thanks for reading.
What about you? Who is your favorite finance author and what is your favorite finance book? My book shelf could always use more fantastic literature.
Amazon links for both books:
I liked both of those. My personal favorite investing books are the Outsiders by William Thorndike and 100 Baggers by Christopher Mayer
