Greatest stock picking books

[almostthere]

So far in my early retirement, I am trying to check off the life to do list items. One of them was to give stock picking another shot. I was horrible at it previously (think buying Bank of America pre-2008). Thank goodness for William Bernstein and asset allocation or I would never made it to ERE.

That said, I have been re-reading the classics. So far, this is my list of greatest hits:

1) Intelligent Investor (no-brainer)
2) You can be a stock market genius by Greenblatt. This was actually my inspiration to give it another shot.
3) One up on wall street. Wow, I can't believe how good Lynch was.

Anyway, what are the other all time classics that people read and re-read?

Please limit to the stock picking genre. Note this also not meant to convince me that any other philosophy is 'better' (asset allocation, permanent portfolio etc).

[steveo73]

I think the best stock picking books are more about asset allocation- Bernstein is really good. There was a good one that I read by Larry Williams. I think it was called "The right stock at the right time".

[jacob]

For stock picking, you gotta know what you're picking, so
http://earlyretirementextreme.com/start ... sting.html
You want to memorize the first two and the last two on this list.

To your list above, I'd also add Seth Klarman's Margin of Safety if you can get a hold of it. But I'd consider your list and Klarman's book to be in the non-fiction department. They aren't books that'll teach you the technical skills.

I'd also get a subscription to AAII which is an investing magazine for "intelligent layman" (better than the "5 stocks to put into my 401k this fall" type articles you find at the kiosk).

Then pick a company and read the last few 10K and the 10Q of the last year.
https://www.sec.gov/edgar/searchedgar/c ... earch.html

Start making your own graphs, plots, and MENTAL MODELS(*)! This is typically where people specialize. Repeat this process for as many companies as possible. This is the main activity of stock pickers. Endless reading, data cleaning, and spreadsheet construction. I hope you enjoy this activity because in most cases you'll be doing a lot of work only to learn that the stock is not a good pick, so all the work is filed to be used later or even never. (This is how most analysts burn out.)

(*) E.g. how does a furniture company function compared to a grocery chain. They work differently. How do you understand a mining company inside the mining sector for a specific mineral, e.g. thermal coal.

For ideas/inspiration, I'd probably hang around seekingalpha a lot. This is not necessarily what I'd hang around for for other styles of investing. You probably also have access to S&P reports from your broker. Start writing your own reports, just for yourself. Then compare them to what the analysts came up with (blind tests). If you have $500 to burn, you can also read the reports from ValueLine (your library may have them for free!!) These are better set up than S&P's in my opinion.

Once you're good enough at this, that is, you're writing stuff that's equal or better than professional analysts (that is, generally your average 4 year business degree holder almost fresh out of college), I would strongly recommend (but hey, it's your money) to focus on small caps or stocks that generally aren't followed by many if any other analysts. This is where your competitive advantage is. Such companies are often inefficiently priced from a fundamental standpoint.

And if it wasn't obvious, you can "pick" stocks for value, technical behavior (e.g. intra-day scalping, momentum, ...), special cases, stories, ... and a host of other things.

[almostthere]

@Jacob, many thanks. I had the idea of the going back to text books hovering around on the edge of my consciousness for awhile. Your advice solidifies this idea for me.

Klarman. Check. There is pdf version floating on the web.

I am surprised by the AAII recommendation. I once had a membership, and I had no desire to renew. Maybe my mind was in different place at the time.

I have been reading SEC docs basically for fun b/c I like to see how different businesses work. I had not been creating the models. Will do.

As to ideas, I keep coming back to spinoffs. There is wide range of industries. They are generally small caps. They have been uniformly recommended by the great stock pickers for the last 30 years. Lack of long time term info makes them interesting valuation challenges. Each one reminds of detective novel with its various cast of characters.

It has been on my to do list to look at the yahoo finance api and figure out how to scrape yahoo stock pages analyst sections to figure out which stocks are the least followed. I am only an amateur scrapper so it may past my current ability.

I have generally tried to only go to Seeking Alpha once I had formed an opinion so as not to use it as a crutch to ding my own thinking. BTW, I keep thinking I could write SA articles myself. Maybe that is hubris on my part. How does the level analysis of the S&P / value line articles compare to the average SA article (I'd guess there must a wide variation in SA quality)?

I am also trying to use the same strategy I used to learn to code to learn to value companies. That is spending time doing valuations and writing analyses instead of spending time reading about how to do valuations and analyses. I think that was one of my great previous errors. Thinking that thinking and reading about stocks was the same as 'researching' and valuing stocks.

As to your last point, I am much more open now to the variety of ways to succeed in the markets than before.

Anyway, thank you for the advice and the opportunity to share my thoughts in response.

[jacob]

I'd also add that it often helps to be aware of other methods ... e.g. you might have a value buy ... but it could be a market or sector sell and the technicals might be negative ... or there's central bank rigging of the market cycle ... in which case, even if you're right about value, you're price-insensitive on all other dimensions.

Usually price-insensitive market participants wave their hands while mumbling something about diversification. The problem is that with deep analysis, you probably don't have the time to manage the 25+ individual securities to reach the required statistics. Indeed if one of the factors become overwhelmingly strong (e.g. QE), then it's almost possible to add any information analysis. That is, if the tide is strong enough, your waves don't matter much. To wit, I get the impression that most value investors are currently sitting in cash. Whereas I get the impression that the removal of QE and it's impact on volatility has made swing traders happier.

[BlueNote]

Jacob's response was quite good. Frankly all the 10K/10Q reading is too much for me and isn't my idea of a good time. If you are the type of person who enjoy's this kind of thing then you can probably make money doing it. Those reports just keep getting more verbose with increasing accounting regulation and it takes a lot of skill and time to go through them all. I also agree that you should stick to a niche that favours the small time investor. Ben Graham and Warren Buffett made fortunes focusing on small company's that were selling at prices below their cash on hand less all debt (net-nets). They're a rarity these days but if you look internationally you could probably find some opportunities, perhaps enough of them to diversify the risk of investing in these typically small and shitty businesses. Net-Nets are IMHO the simplest form of value investing, it's like someone is selling dollar bills for 65 cents only nobody is willing to buy those dollar bills for more then 65 cents right now. You don't need to perform a input sensitive DCF on net-nets because of the upfront cash. However you have to really , in your gut and intellectually, believe that the market will eventually recognize the intrinsic value at some reasonably close point in the future (could be years). You'll also need to scour the financial statements of potential opportunities for hidden liabilities.

[almostthere]

Hi BlueNote thanks for the comments. I have done a few analysis of Net-Nets. The current ones in the US really are some low quality companies (even that sentence is an understatement). It was already a to do list item to look for them abroad. In reference, to your thoughts on reading 10k etc., I went back and read some of your journal where you discussed burnout on individual stock investing while working. I am finding that when I am not working, I have so much more 'brain juice' to give my hobbies. I can 'work' on my hobbies seven days a week. I think maybe I could do the same with stock picking. However, as you rightly point out in one of your posts, I won't know if I have any talent for years to come. I am also just enjoying the journey. One other thing is that I have at least another 30 years to live with a reasonably agile mind, even if I just dedicate 10 hours a week to becoming a better stock picker, that will eventually add up.

[BlueNote]

If you're going to do real deep value stock picking than I would recommend you read the most recent edition of Security Analysis (Graham and Dodd). The intelligent investor was partially meant to help the every day investor who didn't have time to delve deeply into financials. It would be fair to say that the methods for defensive investors were likely the first widely used quant screens and Graham was trading off the fact that diversification would eliminate most of the risk of using those screens. Security analysis on the other hand gets down to the nuts and bolts what your after, it's a great book but much more technical than The intelligent investor.

[jacob]

Methinks that reading a couple of the textbooks on the lists I've given on the blog would make Security Analysis easier to understand and utilize. Security Analysis is a book that tells you which parts of the financial analysis books to pay attention to.

Rule #1 of deliberate and price-sensitive investing is: "If you're not finding anything, you have too many competitors who already agree with you." Combine that with rule #2: "You're not making alpha unless you can find an uninformed or ill-informed person who disagree with you at the current price."

Ponder this! It's extremely important for market success. I mean ... these are rules 1 and 2... not rules 37 and 94.

[BlueNote]

Methinks that reading a couple of the textbooks on the lists I've given on the blog would make Security Analysis easier to understand and utilize. Security Analysis is a book that tells you which parts of the financial analysis books to pay attention to.

Rule #1 of deliberate and price-sensitive investing is: "If you're not finding anything, you have too many competitors who already agree with you." Combine that with rule #2: "You're not making alpha unless you can find an uninformed or ill-informed person who disagree with you at the current price."

Ponder this! It's extremely important for market success. I mean ... these are rules 1 and 2... not rules 37 and 94.

Yeah I agree, you'll need to know the fundamentals before security analysis will be truly helpful and those texts (or something like them as they're all very similar) will get you there. I guess because I work in the general field already I take it for granted that people know about this stuff but you'll need to at least understand basic macro/micro economics, double entry bookkeeping, financial accounting basics (GAAP) and basic finance. On top of that it helps to understand the basics of business strategy which covers things like competitive advantage and the forces that create those advantages.

When I started my business degree around 2005 I was a financial imbecile. My first financial accounting class was very influential on me (I am a CPA, CMA now) because it taught me the language of business (accounting) and gave me an excellent mental model for measuring financial performance (double entry bookkeeping and GAAP). Many people cite rich dad poor dad as an influential book but by the time I read it I thought it was a quick and and very dirty explanation of accounting and finance for the lay person.

[almostthere]

@Bluenote, thank you for the lead on Security Analysis, I have not read it. I am working my way through financial accounting (for the third time in my life) and Damodaran's Valuation textbook now. I will tackle it sometime after that.
@ Jacob, when you say 'price-sensitive investing' what do you mean by 'price sensitive'?
In regard to rule one, do you mean for example, that if I were to look through a list of small low price to name-your-metric stocks, and not find anything I think that deserves more thought, I am tacitly in agreement with all my competitors because we all think that the current price is about correct? On the other hand, if I did find one that let's say had some assets that were not being considered by the market, then rule number two comes into play because the person who will sell to me at the current price is unaware of the mispricing?

[jacob]

Price-insensitive people do not care how much they pay for a given security because they believe that professional investors have already ensured that supply/demand has instantly been brought into equilibrium. IOW they believe in that the efficient market hypothesis holds for all securities at all times. They do not care at what price they're buying because they believe at that the value is always reflected by the price because "the professionals" are in charge. They are price-insensitive.

Price-sensitive people believe that professionals are not perfect.

WRT rule #1. If you think the market is efficiently priced as far as you know it ... your profit is random... and all you're doing/adding is liquidity. By rule #2, you would then need to figure out how to trade with uninformed people (typically index investors) in order to make money, since these guys will buy or sell for reasons entirely unrelated to value ... because they do not believe in the concept of value.

[BlueNote]

@Bluenote, thank you for the lead on Security Analysis, I have not read it. I am working my way through financial accounting (for the third time in my life) and Damodaran's Valuation textbook now. I will tackle it sometime after that.

Damodaran actually offers free high quality online versions of his valuation courses(I have gone through some of them). Those courses are part of the reason I no longer do deep value investing, it's way harder and more time consuming than most people think to do a good valuation. You really need a lot of time and a personality fit to do that kind of investing well. He has some really compelling advice on valuation in that he believes there is more money to be made valuing data scarce companies(like startups) vs companies that have tons of history and are heavily followed by analysts. The more difficult it is to value a company the greater the chances that one can make money doing it because of the lack of competition.

http://people.stern.nyu.edu/adamodar/Ne ... eclass.htm

[almostthere]

@Bluenote I am watching the Damodaran class videos and I read his blog, especially his valuation examples regularly. As to the time consuming, I think you are right. I am working on short term contract now, and I just do not have the mental energy on the weekends to do serious analysis work. Luckily, I'll be back to my FI lifestyle soon with more time and mental energy to delve deeper. I like Damodaran as an independent thinker and his idea that the rewards of valuation go to those who value companies with greatest uncertainty. I think I need to figure out for myself if he is right or not.

@Jacob, Here's another shot at trying to understand rules one and two. Could rule one be restated in positive form to be 'Look for opportunity where there is less competition' without loss of meaning?

Here is another example to try and illustrate my understanding of the two rules. I recently heard a story of value investor investing in Greece during the Greek crisis. Rule one is satisfied by investing in place where there is little competition. He buys Coca Cola Bottling Hellenic. According to him, 90% of its revenues come from outside Greece. Rule two is satisfied because he is buying from people who are either ignorant of the fact that the firm is only lightly associated with Greece's macro troubles or they just don't care.

[jacob]

Yes. Here's an analogy/example as it pertains to decluttering and cleaning up home. You're the cleaner. Your job is to move things from the wrong place where the home-owner doesn't need it to the right place. The home-owners never tell you immediately if they agree, but at the end of the day, they do award you money according to how good a job they think you've done---mainly how much stuff you moved and how far you moved it. The home-owners have simultaneously hired a bunch of other cleaners who work alongside you but make their own decisions.

Rule #1: If an area is already clean, you can not clean it further. (Your alternative interpretation: Look for places to clean where nobody else looks.)
Rule #2: You can only clean up if someone else has made a mess.

Price-sensitive in this regard means that you have an opinion on where all the stuff goes. Price-insensitive under the EMH means that one can assume that some other occupant will quickly clean up any mess that's made and therefore that the house can't be made any cleaner than it is. If your opinion matches the home-owners', they will pay you. If you disagree, they'll fire you and take your deposit.

You can make the most money if you can find a price-sensitive cleaner who disagrees with you. You pick up some clutter in the wrong place and puts it in its right place. He does the opposite. You make money all day. Such stupidity is rare because such cleaners don't last long in the cleaning business. However, it may be that you are the ill-informed one and you won't really know until the end of the day.

You can make some money from price-insensitive cleaners. These are the uninformed cleaners who think the house is already pretty clean so they just pick up stuff in random places and drop it down in other random places. You can make some money chasing these people around. But typically you won't make a lot because ... well, basically they're lazy and they never relocate stuff more than a couple of inches. Of course sometimes, there's a football game on and these guys all head for the door at the same time dropping everything at the door in the wrong place. Then you can make a lot of money.

[underscored]

What works on wall street, james o'shaughnessy and thinking fast and slow by daniel kahneman.

[almostthere]

@ Underscored, I loved both those books. I am actually looking forward to re-reading what works on wall street after I have had a little more experience. BTW, in case you haven't seen it, here is the link to an interview with o'shaughnessy:
http://www.theinvestorspodcast.com/epis ... nessy.html

Supposedly his son is becoming quite a thinker in quant value investing as well.

[underscored]

I think the greatest take homes for me are that as a human I am an emotional animal prone to making biased decisions that feel good. Such emotions are completely useless for stock picking, and I should therefore use some emotionless empirically tested emotionless strategy.

[jacob]

+1 on the What Works book. As far as I remember, it has a list of experiental rules in the back. Those (20? or so rules) are a very good start, but successful traders will have hundreds of these as accumulated from spending thousands of hours studying the markets and themselves. Statistics does a poor job of summarizing all these rules (it's like doing brain surgery with a broad axe), but it's certainly a better than assuming nothing (i.e. random walk).

[almostthere]

I am so happy to have the old Jacob back. You just keep throwing out this incredible tidbits of market wisdom.