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A Magical Quest: The Journey of Learning about Investing
A little while ago, I wrote a thread on twitter that essentially documented the path I’ve taken to learn about investing (which is very much an ongoing journey) and I figured going back through that in a bit more detail was a good place to start my substack. I’ll add links to the books that I reference in each section. I’m hopeful this journey gives you a helpful overview of how to learn about investing and takes you from the practical and more technical aspects of investing to the history of money and how modern finance came to be, along with many places in between. I wrote it as the guide I wish I had when I started out. The journey is by no means linear, and there are many different paths that would make sense to learn the material covered here.
Phase 1: Intelligent Investor
I started in a place where I think a lot of people start, which is sort of the “classics”. The Intelligent Investor is a great place for people to start (who better to learn from than the man who taught Warren Buffett?) as it teaches the core tenets of what has historically been called “Value Investing” and can provide a great foundation for learning how to think about investing and how to value businesses. Joel Grenblatt’s The Little Book that Beats the Market is also a great choice for someone who’s just starting out, it’s written in a super approachable way while still managing to convey an immense amount of information in a relatively short book. Both these books provide the reader a fairly straightforward and simple approach to investing:
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Think like an owner - when you buy a stock, think past the ticker and the quote price and think of yourself as an owner who’s purchasing a stake in a business in exchange for a share of the profits. Learning how to understand a business’ operations and value its earnings is essential for any investor and is a great place for a beginner to get started.
The concept of “Mr. Market” - once you’re thinking like an owner (which also helps when valuing a business, because you must think of what you’d have to pay to own the entire business, even if you’re just buying a few shares) the books teach this metaphor for the how to think about markets (the following from Buffett’s 1987 shareholder letter):
Ben Graham, my friend and teacher, long ago described the mental attitude toward market fluctuations that I believe to be most conducive to investment success. He said that you should imagine market quotations as coming from a remarkably accommodating fellow named Mr. Market who is your partner in a private business. Without fail, Mr. Market appears daily and names a price at which he will either buy your interest or sell you his.
Even though the business that the two of you own may have economic characteristics that are stable, Mr. Market’s quotations will be anything but. For, sad to say, the poor fellow has incurable emotional problems. At times he feels euphoric and can see only the favorable factors affecting the business. When in that mood, he names a very high buy-sell price because he fears that you will snap up his interest and rob him of imminent gains. At other times he is depressed and can see nothing but trouble ahead for both the business and the world. On these occasions, he will name a very low price, since he is terrified that you will unload your interest on him.
Mr. Market has another endearing characteristic: He doesn’t mind being ignored. If his quotation is uninteresting to you today, he will be back with a new one tomorrow. Transactions are strictly at your option. Under these conditions, the more manic-depressive his behavior, the better for you.
But, like Cinderella at the ball, you must heed one warning or everything will turn into pumpkins and mice: Mr. Market is there to serve you, not to guide you. It is his pocketbook, not his wisdom, that you will find useful. If he shows up some day in a particularly foolish mood, you are free to either ignore him or to take advantage of him, but it will be disastrous if you fall under his influence. Indeed, if you aren’t certain that you understand and can value your business far better than Mr. Market, you don’t belong in the game. As they say in poker, “If you’ve been in the game 30 minutes and you don’t know who the patsy is, you’re the patsy.”
Ben’s Mr. Market allegory may seem out-of-date in today’s investment world, in which most professionals and academicians talk of efficient markets, dynamic hedging and betas. Their interest in such matters is understandable, since techniques shrouded in mystery clearly have value to the purveyor of investment advice. After all, what witch doctor has ever achieved fame and fortune by simply advising “Take two aspirins”?
The value of market esoterica to the consumer of investment advice is a different story. In my opinion, investment success will not be produced by arcane formulae, computer programs or signals flashed by the price behavior of stocks and markets. Rather an investor will succeed by coupling good business judgment with an ability to insulate his thoughts and behavior from the super-contagious emotions that swirl about the marketplace. In my own efforts to stay insulated, I have found it highly useful to keep Ben’s Mr. Market concept firmly in mind.
Following Ben’s teachings, Charlie and I let our marketable equities tell us by their operating results – not by their daily, or even yearly, price quotations – whether our investments are successful. The market may ignore business success for a while, but eventually will confirm it. As Ben said: “In the short run, the market is a voting machine but in the long run it is a weighing machine.” The speed at which a business’s success is recognized, furthermore, is not that important as long as the company’s intrinsic value is increasing at a satisfactory rate. In fact, delayed recognition can be an advantage: It may give us the chance to buy more of a good thing at a bargain price.
Valuation & Margin of Safety - while there’s never going to be a completely risk free equity investment, having a process where you learn what the business does is essential to understanding the value you’re receiving in exchange for the price you’re paying for the stock. Seth Klarman, founder of Baupost, wrote a book called Margin of Safety (which is a bit hard to find but I think there’s a pdf somewhere on the internet) in which he describes his investment philosophy and how he goes about deciding wether or not he’s comfortable investing in a company. Learning the basics of accounting & valuation is essential to learning about investing, and while learning how to read the 3 financial statements can be a bit intimidating to a beginner, these books do a good job covering both accounting and valuation, as well as the interplay between them. Buffett often talks about how, as he grew as a person and an investor, his strategy shifted from buying fair companies at wonderful prices, to buying wonderful companies at fair prices.
Circle of Competence, Knowing what you own - Peter Lynch, former manager of Fidelity’s Magellan Fund, has some great books for those just beginning their investing journey. One Up on Wall Street, Learn to Earn and Beating the Street are a few of his books, which are pretty widely regarded as classics in the world of value investing (A couple of them is on the list of books that Bill Ackman has all his incoming analysts read). One of the core Lynch principles is to “know what you own”. In other words, have a sense for what you’re able to understand and what you’re not. Knowing yourself is an absolute key no matter what kind of investing style you end up adopting and there’s no shame in having a “too hard” pile of companies. The thought process is that the better you understand the business, the more likely you are to be able to value it (at least somewhat) appropriately and feel comfortable owning it through volatility in the overall market. Lynch also has a good system for how to classify different kinds of investments, wether it be a company with lower but more predictable growth or a company with the potential for higher growth, and how to construct a portfolio with the different kinds of investments he identifies.
There are many core themes to this phase of investing - thinking long term & thinking like an owner, knowing what you own and understanding how to value it (and doing your best to pay what you consider to be a fair price), knowing yourself and understanding that the overall market is prone to violent mood swings which can cause extreme volatility from time to time. There’s a lot of good books to get started with accounting, one I’d recommend is Warren Buffett Accounting: Reading Financial Statements for Value Investing. Lawrence Cunningham has a great book, The Essays of Warren Buffett, where he organized Buffett’s shareholder letters by topic that I’d highly recommend, I wrote a brief thread about my thoughts after reading it.
One thing Buffett, Greenblatt, Klarman and Lynch all have in common is a long term track record of compounding capital at a reasonably high rate of return. Even if you end up adopting a style that’s nothing like “Value Investing” (a term even Buffett himself questions the meaning of) these books from some of the legends of investing provide a valuable foundation for all investors.
As an aside, I didn’t have anything in the thread about personal finance as I focused only on the journey of learning about investing. Ideally, personal finance education would come first or at least be learned while the investor is learning about how to invest. Things like budgeting, taxes, emergency funds & retirement accounts (amongst others) are all super important for everyone to understand. For a book on how to think about all things finance, investing and money I’d recommend Morgan Housel’s The Psychology of Money, which is a great read and a fantastic overview of a lot of important topics in finance.
Valuation and Accounting could have their own article (and maybe it’ll be one of the next ones I write) but for a book about how to look for investment opportunities, I’d recommend Greenblatt’s You Can Be A Stock Market Genius, which teaches readers his strategy for finding “special situations” in the market and how you can emulate his process to find opportunities of your own. One thing to stress about valuation is the importance of always doing your own work. It’s completely fine to source ideas from all sorts of places, all the best investors do this. Investment ideas may come from a magazine or newspaper article, or even from a podcast or twitter, but the important thing is to always do the research yourself to understand the business and the price you’re paying for owning it. Great long term investing requires patience and conviction, so you want to go to bed at night knowing you’ve done the work and being comfortable you paid a fair price for your share in the business. A good book for understanding common traits of ultra successful investments is 100 Baggers, which is a study of companies that returned 100x the initial investment, or $100 for every $1 invested.
Phase 2: Computers & Math for Investing
The next rabbit hole I went down was quantitive investing, how people use computers, math and statistical models to trade markets. There’s a great book about Jim Simons and his firm Renaissance, The Man Who Solved the Market and another wonderful book about Ed Thorp, A Man for All Markets. Quant firms employ all kinds of different strategies, many of which are unknown to the public (for obvious reasons) and have grown in both number and assets under management as computers, the internet and information technology overall have evolved over the years. Some of these firms employ directional strategies (profiting from movements up or down in the different assets and markets), other participate in what’s known as arbitrage (buying an asset in one market and selling it in another, in an attempt to make a nearly risk-free profit). Some firms act as “market makers” where they provide liquidity to the market and earning the spread between “the bid” (the highest price a buyer is willing to pay for a security) and “the ask” (the lowest price a seller is willing to receive for a security). These firms often compete with big tech for the most talented scientists and engineers, and for people with this kind of skillset, seeing the market as a puzzle to be solved and working on ways to profit from those ideas, can be one of the most exciting challenges you can find. This is a definitely a gross simplification of the vast quant industry, which is full of exciting opportunities to try to make money by finding patterns in markets. Theres lot of great accounts on twitter who know a lot more than I do about quant finance.
Phase 3: Academic Finance
After quantitive investing, it was academic finance. Learning about the efficient market hypothesis, the capital asset pricing model, modern portfolio theory and the Black-Scholes option pricing model, amongst other topics. There is a great MIT OpenCourseWare series, Finance Theory I, that does a great job covering the basics of academic finance.
While one’s natural instinct may be to dismiss markets as being too chaotic for one to describe their behavior with a set of equations (as we do for example in physics, where we formulate hypothesis about the natural world based on observable phenomena) understanding how academics attempt to make sense of markets is useful no matter your investing strategy, as its used in some form in almost every corner of finance. While it’s definitely Finance 101 and obvious to some, I wrote a thread about discounted cash flow analysis, what it is and how to do it, which may be helpful to understand not only because a DCF is one of the most common academic valuation techniques, but also because in creating a DCF model, one sees the real world application of many ideas from academic finance.
As I mention in the thread, a DCF is a tool, not an exact science for valuation. There are many instances where cash flows are difficult to forecast with any certainty, and in practice, it is common to evaluate and discuss the valuation of a company based on a multiple (whether free cash flow to enterprise value, price to earnings or ebitda/enterprise value amongst others). Learning about the DCF model helps investors understand one avenue towards valuing a business and for a beginner, it may be a good introduction to many topics in academic finance, as well as core principles like the time value of time, determining the present value of an asset and also the idea of a risk free asset (A US Government bond) and how interest rates affect asset prices. Another common technique in practice is to start with a desired rate of return and do a reverse DCF where you can see what assumptions that are necessary about the business in order to generate your desired return. While this may seem like it gives way to confirmation bias, it’s a good exercise when valuing a company because your job as an investor is to determine how confident you are that there’s a reasonable chance of the future lining up with your assumptions. A quick note about ratios, you’ll definitely come across a lot of different ratios which are all, for the most part, useful to some degree. One example of how ratios are used is in comparing companies in the same industry. One company might have better margins and a stronger brand, which may cause it to trade at higher multiple to its earnings than a peer company in it’s industry because investors are willing to pay a premium for a share of the “better” companies earnings. Two of my favorite ratios are Free Cash Flow to Enterprise Value (FCF/EV) which tells you how much free cash flow the firm earns as a percent of its overall value and Return on Invested Capital (ROIC) which measures how much operating profit a business generates with all the capital that’s been invested in it. At the most basic level, you want to understand - how much cash does the business generate (FCF/EV)? and if I reinvest that cash in the business, what kind of return do I get on my investment (ROIC)?
One point from academic finance that may be helpful for those beginning their journey is the idea of beta vs alpha. Basically, risk is measured as the historical volatility of a given asset. The asset’s sensitivity to moves in the overall market is the asset’s beta. An asset that moved exactly in line with the market has a beta of 1. If an asset is less volatile than the overall market, it has a beta below 1. And if an asset is more volatile than the market its beta is above 1. A volatile high growth stock, Nvidia has a beta of about 1.8, while a less volatile more stable company like Walmart, has a beta of 0.53. Since beta can measure an asset’s volatility compared to the overall market, its a useful metric when constructing a portfolio of assets. To put another idea from academic finance roughly, there’s risk that affects all securities - these are systematic risks that affect the entire market and thus cannot be lowered by diversification, and there’s risks that are specific to one company, unsystematic or idiosyncratic risks, and these can be diversified away by adding more securities to a portfolio. The idea is that there’s an optimal return for a given level of risk. Buying the market gets you the market return and the market beta, a portfolio with a higher beta will be more volatile so the investor will need a higher return (and thus discount future returns at a higher rate). Ideally, you’d construct a portfolio that would earn the optimal return for the level of risk taken once the portfolio has been constructed such to diversify unsystematic risk (an example of this is like, if you only own 1 company, you run the risk of it going bankrupt, which is unsystematic, the idea being that you can “diversify this risk away” by adding more securities and only having exposure to the “market risk” or the beta of the portfolio). Taking on additional risk to earn the same rate of return wouldn’t make any sense, but earning additional return on top of the market return with no additional volatility is called alpha. If that’s all a bit confusing, its totally ok, its just at term that you might hear a lot if you follow financial news and markets and academic finance is where these ideas come from. Hedge Funds are particularly interested in alpha because in theory, they are being paid to generate excess returns that (ideally) are mostly uncorrelated with any market betas.
A book that has been recommended to me often but that I have not yet read is Fooled By Randomness by Nassim Nicholas Taleb.
Phase 4: Macro & Market Wizards
After learning about how finance is taught in theory it is natural to want to understand how things happen in practice, and there are many great accounts of managers & traders who have consistently beat the market over a reasonably long period of time and how they’ve done it. Hedge Fund Market Wizards (and the entire Market Wizards series), Inside the House of Money and More Money Than God are a few great books to learn about the careers and strategies of some of these folks who managed to defy academic finance and beat the market consistently over a period of time. These books provide great insight into not only the history of the hedge fund industry but how the evolution of the investment industry is intertwined with the development of our modern world. From post-WW2 developments, to the formation of OPEC and the oil shocks of the 70s, to the US going off the gold standard in 1971, to the collapse of the Soviet Union and Russia’s entrance into global markets, as well as China’s rapid growth on its way to becoming one of the worlds major economies, these books contain great stories about how managers & traders navigated these frontiers and often found themselves wrapped up in the macroeconomic and geopolitical developments that would come to shape the world economy as we know it today.
While the history of hedge funds goes back to Alfred Winslow Jones’ “hedged fund” in 1949, a fund in which he was free to buy what he deemed to be best stocks and short those he deemed inferior, much of the modern industry traces its roots to various firms established in the 60s & 70s. George Soros is one famous figure, who authored a book titled The Alchemy of Finance, where he documents his experience and explains his theory of reflexivity, that is, the degree to which the psychology of market participants affects the markets in an ongoing feedback loop. Many modern funds got their start under Julian Robertson, founder of Tiger Management. Others descend from the Commodity Corporation, a firm established to find experts in each of the worlds commodities with the goal of trading them (and their derivatives) for profit. Others still emerged from the proprietary trading units at major banks around the globe. Many traders got their start trading some product, wether it was fixed income securities, currencies or their derivatives, (amongst various other assets that banks would trade) on behalf of a bank and would later go out on their own (sometimes with seed capital from the bank) to run their strategies as a stand alone fund.
Phase 5: History of Money & Financial Crises
This phase has a vast amount of information and is incredibly interesting. I’m currently reading The Price of Time by Edward Chancellor, which is a history of interest and money, and its been great so far. In this phase you’ll inevitably come across Ray Dalio’s books. Two of his books that are great are Big Debt Crises and The Changing World Order. They are written with the rigor of an academic historian and the learned knowledge of someone who has first hand experience trading markets through all kinds of different scenarios throughout the years. Big Debt Crises is a case study of historical financial crises and the commonalities between them, attempting to develop a general model of debt crises. The book takes an in depth look at the Great Depression in the US, the hyperinflation experienced in the Weimar Republic in Germany and the Financial Crisis of 2008. Ray likes to understand economic events as a series of cause and effect relationships, viewing the overall economic machine as one that can be understood by studying the mechanics of its components. The book also studies various other crises as it attempts to build a general model of the phases of a debt crisis and how they usually play out. The Changing World Order takes a look at the history of the world’s economies and markets, the importance of having the world’s reserve currency and is a fascinating study of geopolitical power through a financial lens. A fun story you’ll come across is that Ray is responsible for McDonald’s launching the chicken McNugget, as he helped the company hedge their cost of chicken supply by creating a synthetic future from corn and soymeal futures (with the price of chicken feed locked in, McDonald’s was comfortable buying the amount of chicken they needed to go forward with the launch and the chicken producer was happy to receive a fixed price for their chicken)> This phase is vast and there’s many great books that provide accounts of the evolution of money and interest and books that study financial crises in depth (there’s been more than a few, unfortunately). One I enjoyed and did a brief write up of is The Holy Grail of Macroeconomics by Richard Koo which details the fiscal & monetary policy response to Japan’s asset bubble in the 90s.
The connection between geopolitics, macroeconomics and financial assets is as fascinating as it is difficult to master, and macro funds specialize in trying to profit from whatever is happening in markets around the world. Learning how the Federal Reserve monitors the economy and responds to developments is important for all investors to understand, as is the role the US Treasury plays in how it carries out the fiscal policy set forth by the government.
Phase 6: When Genius Failed & Derivatives
At some point, perhaps when you’re learning about financial crises, you may wonder “what if some of the best minds came together and tried to figure out a foolproof strategy for returns?” This will lead you to When Genius Failed, which chronicles the story of Long Term Capital Management, a hedge fund started by some of the brightest minds in finance, and the perils of over-leveraged relative value trades. Wether in this phase or in the financial crises phase, you’ll inevitably learn about financial derivatives (products that derive their value from the price or change in price of another asset). Derivatives were used heavily by Long Term Capital and nearly caused an economic crisis when the fund attempted to unwind the trades it had made based on its proprietary models. Derivatives also were at the heart of the Financial Crisis in 2008, when collateralized debt obligations and credit default swaps forced some of the world’s largest financial institutions into bankruptcy and caused a global economic crisis. This is admittedly not my area of expertise but there are some wonderful minds of twitter who are treasure troves of knowledge about all kinds of financial derivatives. A modern example of how derivatives can lead to some crazy outcomes is the gamma squeezes we’ve seen during the meme stock mania in 2021. Learning about options is helpful not only for using them in investment strategies, but also for using the information contained in options contract to understand the perceived credit risk of a company and how the market is pricing the implied volatility of the security.
Phase 7: Private Markets
At some point you’ll learn about private markets, how they function and why investors would choose to invest in assets that are not traded over a public exchange. You’ll learn about the Venture Capital industry and its role in shaping the modern technology industry. The Power Law covers the history of the VC industry (I wrote a brief twitter thread after reading it) and Zero to One is Peter Thiel’s manual for “how to start a startup”.
You'll also learn about Private Equity and might read books like Barbarians at the Gate and Caesars Palace Coup. The world of private investments is vast and also spans into real estate, and forms of private lending like private credit and leveraged finance. This is an interesting subject as in recent years, we’ve seen the rise of the crossover fund, firms that invest in both public and private securities (hedge funds that have looked for opportunities in private markets and VCs that have looked to hold onto their investments for longer horizons instead of exiting once the companies they back go public). While 2022 was a challenging year for this model (this subject also raises the discussion of alpha vs levered beta), in theory if you were looking to underwrite value wherever you could find it, there would be some times when you would find yourself investing in private companies. I have a lot of thoughts on this topic and how its shaping the evolution of our capital markets and i’m guessing it will be the topic of a future post.
Phase 8: Crypto
This is certainly not my area of expertise and there’s lots of accounts on twitter that would be far more informative about the subject than I, but it would be impossible to learn about investing in the today’s day and age without coming across crypto. A resource I found helpful for learning some of the basics was another MIT OpenCourseWare course titled “Blockchain and Money” taught by Gary Gensler, who is now the director of the SEC. Depending on your technical proficiency, you might read the bitcoin white paper and learn about how it led Vitalik Buterin to creating Ethereum and the EVM.
At this point you’ve made it to the end of the relatively popular stuff. There’s still an infinite amount of information out there but you’ve at least begun to develop your own worldview. You’ve probably either convinced yourself you could develop a consistent edge and that you love the game, or you’ve become jaded and red-pilled and commit to only dollar cost averaging into index funds. As I mentioned at the start, I wrote this as the guide I wish I had when I started learning about investing. It by no means covers everything but hopefully it can be helpful to someone who’s just starting out on their investing journey. If you’re considering a career in finance, hopefully it can provide an overview of some of the different opportunities available in the field of investing. If you work in another industry and you’re interesting in learning about investing, hopefully it can provide some helpful resources to help you learn. In the spirit of curating all the best resources, please don’t hesitate to comment with some of your favorite resources or twitter accounts that you’ve learned from, either in the comments here on in the replies on twitter. Please also reach out with any feedback on the post or with any ideas that you’d like to see me write about in future articles. Thanks for reading and I hope your quest is a profitable one.
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