Timothy Ferriss seems to be one of the world’s greatest self-promoters these days.  Don’t get me wrong, his book is solid, his methodology works, and he definitely practices what he preaches, which is a breath of fresh air in today’s guru-driven self-improvement market.  Still, I can’t help but conclude the good majority of his success comes from his incessant self-promotion.  This guy is everywhere these days telling you how great he is.  Note to self:  constantly tell everybody how great you are.

I still think the whole concept of the 4-hour workweek is unrealistic for most people.  Most just people can’t break out of the 9-t0-5 mindset.  They are happy where they are in life, even if their favorite past-time is complaining about work.  There is nothing wrong with that.  They are not losers.  Just just value security and comfort over adventure and mountains of money.  After all, there is risk involved in embarking down Timothy’s path, much of it he hasn’t even conceived of yet.  But he will, don’t you worry.

The 4-Hour Workweek Delivers On All The Hype

But does it work?  Absolutely it does.  Like most good self-improvement products, this book does a stellar job of laying the practically infinite possibilities in front of you.  Tim makes it sound as though the world is your oyster.  And he’s not lying:  it is, but that’s not the primary strength of this book.  The thing about the 4-Hour Workweek is, it actually shows you step-by-step how to accomplish what it promises.

The book starts with a bit of inspiration.  By the end of the first chapter, you’ll be tempted to run in and quit your job first thing in the morning.  I wouldn’t recommend doing that just yet, but you’ll begin to see how a steady, secure, full-time job can be as much of a hindrance to your happiness as anything else.   Having money and living in a decent neighborhood is nice, but is that really what makes you happy?  Chances are you didn’t spend your childhood aspiring to be a middle-class work-a-holic.

The Nuts And Bolts

The rest of the book reads like an outline for an Entrepreneurship For Dummies book with a twist:  only businesses not requiring a full-time effort will be considered.  The concept of “loving-what-you-do” is exposed as the bunk it is.  Do you love what you do for a living?  Great!  But most people simply don’t love anything enough to want to spend their entire life doing it.  There are plenty of things I like doing, maybe even a few I wouldn’t mind spending 40 hours per week doing for the next 3 or 4 years.  But for the next 40?  No thanks.

Ferriss spends a lot of time on preaching about hyper-optimizing your productivity.  If you’re to get away with working just a few hours per week, you’ve got to make sure you actually get the job done on the rare occasion you do sit down to work.  The theory (it’s totally true, by the way) is that most people spend half their time goofing off at work, and the majority of the work they do get done during the other half of the day isn’t terribly important.  In short, most people invent work to do just so they can feel they’ve accomplished something.  Don’t let this be you.  You can accomplish just as much in 10 hours per week as 40 if you only do what truly needs to be done.

The muse section of the book (that is, the section devoted to creating semi-passive income streams) leaves a bit to be desired.  Ferriss offers broad methodologies to follow for finding good low-maintenance businesses to start, but practically no information you could apply today.  There’s plenty to start, of course, but you’ll still probably struggle for a year or two to figure out exactly what works and what doesn’t.  Still, the basic methodology Ferriss sites is pretty much what I use (significantly less-effectively than he describes, of course) and it does work.  It’s just not quite as easy as he makes it sound.  Still, 4 or 5 years of part-time work is probably more than enough to go from rank beginner to six-figures if you’re persistent.

The 4-Hour Workweek is absolutely, positively, without a doubt worth a thorough read or two.  The time-saving tricks and productivity tips alone are worth the price of admission.  While I already knew much of what Ferriss writes in this book, I still learned plenty.  Many of the online resources and odd time-saving tools were completely new to me, and I’ve delighted at exploring them for myself.  I’ve found Evernote and Dropbox particularly useful.  I now use them regularly.

The 4-Hour Workweek is an easy read in the traditional sense, but don’t think it won’t challenge you mentally.  It will have you questioning everything you’ve ever taken for granted to be true.  I suppose the most complimentary thing I can say about this book is it got my questioning what is and is not possible in life.  I realized that to most people, “impossible” really just means “I haven’t tried it yet, but I’m assuming it can’t be done.”

Buy The 4-Hour Workweek from Amazon.com and learn what it takes to live the good life without the usual 80 hour work weeks!

Introducing Jack Bogle

The Bogleheads’ Guide to Investing is really the story of John (Jack) C. Bogle, founder of my favorite mutual fund company, Vanguard, and father of indexing (something else I quite enjoy).  Bogle has long been a fierce advocate for the small individual investor, decrying the crippling fees, dishonest sales techniques, and runaway greed so characteristic of the money management industry.

I Am A Boglehead

Not surprisingly, Bogle’s namesake investment group champions low-cost index funds, broad diversification across several different asset classes, and preach simplification (but not, too many asset classes) over complexity.  Sound familiar?  It should, because I am an unabashed Boglehead, as my portfolio attests.

In short, I really, really wanted to love this book.  But I didn’t.  The information contained therein is good stuff, of course, it’s just that it’s not terribly well organized.

Who Is This Book For?

Ordinarily, I ask the above question rhetorically, going on to describe what type of person I think would get the most out of whichever particular book I happen to be reviewing.  Not this time.  I honestly can’t tell who this book is for, myself.

The Bogleheads’ Guide to Investing reads like a book written for beginners.  It explains the how’s and why’s of indexing, why passive investing generally earns higher returns than active management, the basics of behavioral finance, and warns against common beginner mistakes like market timing.  This book was clearly written with beginners in mind, but it often slips up, introducing confusing investment jargon without providing a definition.  I had no trouble following the authors’ line of thought when that happened, but I can just imagine a beginner throwing the book at the wall in disgust, exclaiming “this investing thing is just too complicated for me.”

Thing is, investing isn’t complicated.  I know that.  The authors know that.  But somehow, what the authors know so well and looks so simply in their heads gets jumbled en route to the written page.  All in all, The Bogleheads’ Guide to Investing turns out to be a solid intermediate-level read, which is unfortunate since this book represented a golden opportunity to introduce the simple, elegant effectiveness that is Boglehead philosophy of investing.  Did I walk away convinced that investing is easier than most people believe and that I am fully capable of doing it myself?  Yes, but then again, I already thought that anyway.  I’m not sure I would have been convinced otherwise.

The Bogleheads’ Guide to Investing is an excellent read, no doubt.  It is written in a non-technical, conversational tone sure to appeal to the Johnny Everymans of the world.  But I don’t feel Johnny Everyman will get quite as much out of this book as he could have with better editing and just a bit more detail.  That said, I did walk away from this book having learned something new, which is quite impressive considering how many investment-related books I’ve read in the past 5 years (it’s well over 60).  Still, I can’t help but think The Bogleheads’ Guide to Investing could have been better if only they had defined their audience first.

Buy The Bogleheads’ Guide to Investing from Amazon and make up your own mind. For those who are curious, I recommend The Four Pillars of Investing by William Bernstein and Straight Talk on Investing by former Vanguard chairman Jack Brennan as my beginner investing books of choice.

A Classical Liberal

The term “liberal” has changed its meaning over the years.  These days, it means “progressive,” especially on social issues.  It’s taken on a bit of a negative connotation to outsiders, connoting one who makes decisions borne out of emotion, not logic, and one “out of touch” with reality.  That’s not what Friedman means when he uses the term “liberal.”

A classical liberal is somebody who champions the cause of freedom of the individual, even at a net cost to society;  who is a fierce advocate of the ideals of free trade;  who believes in limited government;  who promote strong property rights;  who holds the individual higher than the state.  Milton Friedman was by far the most visible classical liberal of his day, and defended his beliefs with clarity, eloquence, and grace.

Capitalism And Freedom

Originally published in 1962, Capitalism and Freedom is a product of its time.  It is divided into 12 chapters, each tackling a distinct  topic from the perspective of a 1960′s liberal economist at a time when protectionism and collectivism were gaining steam.  Almost five decades have passed, but Friedman’s lessons remain as potent as ever.

Chapter 1: The Relation Between Economic Freedom And Political Freedom

Friedman equates economic freedom, the ability of individual citizens to make whatever economic decisions he deems most likely to improve his own lot and the lot of his family, with political freedom.  Without economic freedom, Friedman argues, political freedom is impossible.  To Friedman, true democracy is impossible without capitalism.

Chapter 2:  The Role Of Government In A Free Society

While classical liberals like Friedman advocate a limited central government, they do admit that government plays an enormously-important role in a capitalist system.  Indeed, free trade is impossible without government regulation because of what he calls “neighborhood effects.”  In an unregulated economy certain entities, be their corporate or individual, sometimes make economic decisions that have negative effects on innocent third parties.  One example would be a power company dumping nuclear waste into a river.  The individuals downstream must pay part of the price for the company’s decision even though they bear none of the benefits and had no say in the outcome.  The government’s responsibility, according to Friedman, is to ensure the entities involved in any economic transaction bear the full cost of their decision, either through taxation, fines, regulation, or some other means.  The government also has the more obvious responsibilities of protecting property rights, keeping the peace, and maintaining an adequate infrastructure for private industry to build on.

Chapter 3:  The Control Of Money

Friedman was a fierce proponent of the Federal Reserve System, which isn’t a particularly popular position these days.  He lays out his case in clear, concise fashion in this chapter.  Critics won’t be convinced, but this chapter is a good introduction to the pro-Fed argument.

Chapter 4:  International Financial And Trade Agreements

Friedman advocates ending the Bretton Woods System, which subsequently happened in the early 70′s.  The jury is still out on whether or not he was right on this one, but I think he was probably more right than wrong.

Chapter 5:  Fiscal Policy

Friedman argues against the Keynesian policy of the government running a budget deficit during recessionary periods in an attempt to stimulate growth.  He backs his arguments up with a mountain of empirical research, much of which has since been confirmed independently.  Nonetheless,  the last several presidents have gone down that path anyway.

Chapter 6:  The Role Of Government In Education

Friedman promotes a school voucher program, but one that doesn’t bear a lot of resemblance to most such modern proposals.  For starters, Friedman advocates school vouchers instead of the current system, not as a supplement to.

Chapter 7:  Capitalism And Discrimination

Friedman argues against the policies of affirmative action, citing data that economic inequality has decreased the quickest when economic freedom was greatest.  Discrimination, argues Friedman, is expensive.  This is undoubtedly the most controversial chapter on this book.

Chapter 8:  Monopoly And Social Responsibility Of Business And Labor

There are three alternatives to monopoly:  public monopoly (such as the USPS), private monopoly, and public regulation.  None are desirable, but of the three Friedman holds private monopoly to be the least evil because market pressures tend to erode monopoly positions eventually, whereas public monopolies are nearly impossible to break, being immune to market forces.  The author also argues that the idea of “corporate responsibility” is subversive to the very notion of a free society and should not be an overriding goal.

Chapter 9:  Occupational Licensure

By far the most eye-opening for me is the chapter on occupation licensure.  Simply put, requiring all lawyers, doctors, and other professionals to meet such strict licensing standards actually reduces the average quality of care, decreases supply, and increases price.  He argues the American Medical Association holds a dangerous monopoly over medical school admissions.  Likewise, the American Bar Association’s monopoly of law-school admission is inefficient, discriminatory, and harmful to society.  I don’t quite buy it, although Friedman does make some very persuasive arguments.  An interesting read, to say the least.

Chapter 10:  The Distribution Of Income

Friedman details a negative graduated flat tax he thinks is better than the current progressive tax system.  Some of his ideas have been adopted into law over the years, although in severely diluted form.  There’s probably no chance his system will be implemented anytime soon, which is unfortunate since I think it has real potential.

Chapter 11:  Social Welfare Measures

Friedman argues not so much against the social security system, but against the government’s monopoly of the system.  He argues private industry could provide the same benefit far more efficiently and at lower cost.  He does, however, admit some sort of social security system is probably justified, if only from a “neighborhood effect” perspective.

Chapter 12:  Alleviation Of Poverty

No surprise here, Friedman believes free trade is the best cure for poverty.  He also proposes a negative income tax for those under the poverty line, guaranteeing everybody a minimum level of income.  He criticizes most welfare efforts as being ineffective money pits.

Conclusion

Capitalism and Freedom isn’t perfect.  Milton Friedman was not always right.  His theories were often the subject of intense academic scrutiny and were sometimes proven wrong.  But Friedman always took his failures in stride.  What’s more, in edition to being a respected economist he was a singularly-talented writer, a very rare combination.  He had a knack for explaining the most complicated of situations in straightforward, easy-to-understand language.  His most famous work is flawed, oft-dogmatic, and sometimes maddeningly naive, but it is also a work of genius.  If today’s society has worked out the solutions to some of these devilishly difficult social problems, it is only because we have stood on the shoulders of giants like Friedman.  This book is well worth a read.

Buy Capitalism and Freedom by Milton Friedman from Amazon.com today!

Nassim Taleb’s sublime Fooled by Randomness: The Hidden Role of Chance in Life and in the Markets is the first book I have read in a long while that really struck a chord with me.  Page after page I found myself nodding in agreement with Taleb’s keen insight.  More than any other author, Taleb has been able to articulate precisely my own thoughts and feelings on how the world works.  I’ve always had a nagging feeling that traditional thought had severe shortcomings, and now I know I’m not alone.  I’ve read this book at least 3 times and will probably read it several more before wearing through my copy.

Is It Skill Or Is It Luck?

The central question of Fooled by Randomness is a familiar one:  which is more important in determining success, skill or luck?  Of course we acknowledge the important role good fortune has in live, but human civilization in general and Western Civilization in particular owe their very existence to the pervasive belief that if you are skilled enough, determined enough, and above all work hard enough, the world is your oyster and success is sure to follow.  The occasional winning lottery ticket notwithstanding, it is hard work and ability that determine your lot in life, with good fortune playing a small supporting role.

Or is it?  Taleb isn’t so sure, and Fooled by Randomness is his attempt to flesh out his theory.  Taleb’s belief, which mirrors my own, is that people pay far, far too little attention to the role randomness plays in their lives.  Case in point, imagine you labored for years trying to build a new business from the ground up but that in the end was a failure.  What would be your response when asked about your failure?  Chances are, it would go something like this: “I worked hard and gave it my best shot.  I guess luck just wasn’t on my side.” Sounds reasonable, and it is, but now let’s flip things on their head.  Say you struggled for years and eventually caught a break that allowed you to build a billion-dollar enterprise.  In your old age (probably on your private yacht) you would relate to your biographer the details of how your childhood prepared you to run a company and your leadership skills allowed you to leverage your workforce more efficiently than the competition.  Or maybe you would cite your prudent organizational practices, superior financial management skills, or any one of a thousand different factors.  And you know what?  You’d probably be right.  All those things probably did help you succeed.  But would anybody in this situation seriously say, “Well, I guess I was just lucky…”? Of course not.  In general, people blame bad luck for their failures but claim full responsibility for their successes.

Rare Events Happen All The Time

We all have a strong predisposition for assuming events that are likely to happen are guaranteed to happen and that events very unlikely to happen are actually impossible.  The last decade of market history illustrates this quite clearly.  Over any given 10 year period, the chances are exceedingly good that stocks will yield positive returns.  The chance of stocks losing money over an entire decade?  Quite small.  Many people took this basic fact and somehow came back with the idea that losing money over a 10 year period in the market was actually impossible rather than merely improbable.  Of course, it’s happened, so we know it isn’t impossible (at least until the next bull market).

Perhaps a better example is the lottery.  The odds of winning the lottery are one in a million, and even that is probably generous.  And yet somebody wins the lottery almost every single week.  Rarely does more than a few weeks go by without a winner.  Herein lies Taleb’s most obvious and yet most profound point:  rare events actually happen all the time.  The chances of winning the lottery may be one in a million, but how many people do you think play it every week?  I’d wager at least a million.  So the surprise isn’t that somebody wins so often, it’s that somebody doesn’t win more often.  The same is true of market panics.  If the financial panic accompanying the Great Depression was a once-a-century thing, why are we so surprised it’s happened again?  After all, it’s been the better part of a century since the Great Depression…

Randomness Rules Our Lives

Fooled by Randomness lays out a convincing case that not only do random events rule our fate, we have cleverly succeeded in convincing ourselves we are in control of our own destinies.  Taleb doesn’t say we aren’t, he merely says it’s possible we aren’t.  I cannot recommend this book enough.  Anybody interested in mathematics, probability, financial markets, economic cycles, and sudden catastrophic rare events (what Taleb calls Black Swans, the subject of his most recent book) will love Fooled By Randomness.  It’s definitely the most intelligent book I’ve read in years, if not my entire life.

Buy Fooled by Randomness: The Hidden Role of Chance in Life and in the Markets from Amazon.com.

Freakonomics: A Rogue Economist Explores the Hidden Side of Everything by Steven Levitt and Stephen Dubner is one of those books I oh-so-badly wanted to love.  Levitt is the type of innovative young economist I admire, and his book has been receiving accolade after accolade for several years now.  On paper, I should have loved it, and I think that’s the problem:  Freakonomics is a very good book, but I was expecting exceptional.

An Economist Who Isn’t Any Good At Economics

Steven Levitt bills himself as “an economist who sucks at economics,” which is far to self-deprecating an assessment.  Economics, according to Levitt, is a field possessing exceptionally-effective analytical tools but a dearth of interesting problems on which to apply them.  In fact, according to many critics Levitt’s research isn’t economics at all.  While that may or may not be true, at the least Levitt has cornered the market on the interesting problems.

Freakonomics tackles a series of seemingly-trivial questions that nonetheless often have profound implications for the more “serious” issues of our day.  Why do drug dealers live with their mothers (the average dealer makes less than minimum wage)?  What really led to the mid-90′s drop in crime (it was Roe vs Wade)?  Enlightening though they are, Levitt’s actual results aren’t what’s important here; rather, it’s his ability to turn a seemingly unsolvable problem on its head to reveal novel methods of solving them.

Long On Exposition, Short On Numbers

What little data Levitt chooses to include is compelling, there’s just so darn little of it.  Levitt’s explanations of the data, on the other hand, are often long-winded to the point of being self-serving.  While I found no fault with his logic, per se, I did find his analysis somewhat less-than-rigorous at times.  Were Freakonomics a hefty tome Levitt could be forgiven for glossing over some of the data for the sake of brevity, but the books clocks in at just 200 pages all told;  hardly an epic.  Not that I would have necessarily had Levitt sacrifice the wit for the sake of rigor, but I would have definitely appreciated a deeper look at the data.  You pretty much have to take his word for it when he writes something like “the numbers clearly  illustrate x over y“  if the numbers referred to are nowhere to be found.  I don’t like taking anybody’s word for anything.

Who Should Read This Book?

Anybody with an soft spot for controversial debate or an appreciation for quirky, creative solutions to mundane problems will devour this book.  Certainly claiming that legalized abortion decreases crime at a party will draw plenty of attention, if not always of the positive variety.  Economics nerds like me will also find the book a refreshing respite from the over-serious likes of Milton Friedmam, Adam Smith, and Paul Krugman.  If, on the other hand, you are easily offended or trend more towards the conservative side of the political spectrum, Freakonomics might not be to your liking.

Personally, I very much enjoyed Freakonomics.  It is fun, light, and above-all entertaining look at a few old problems turned on their head.  Still, I couldn’t help being a bit let down when I was finished.  That’s what happens when you have unrealistic expectations, I suppose.

Buy Freakonomics: A Rogue Economist Explores the Hidden Side of Everything by Steven Levitt and Stephen Dubner from Amazon today!

Jim Rogers has made a name for himself sniffing out value when in oft-neglected corners of the market. In the early 70′s, that meant commodities at a time when the nifty-fifty blue chips were considered indestructible. Rogers was ridiculed, but the oil shortage and ensuing high inflation proved him correct. In the early 80′s, just as commodities were at their peak and the toast of Wall Street, Jim Rogers saw the writing on the wall and moved out of commodities and into stocks, which at that point hadn’t made anybody any money in over a decade. Once again, the ridicule gave way to praise when Rogers was proven correct by the subsequent bull market in stocks.

Now, after over 20 years of above-average returns in the public equities market, Jim Rogers says it’s once again time to invest in “things” such as sugar, copper, and oil.

The Start Of The Great Commodities Bull Market

Published in 2004, Hot Commodities: How Anyone Can Invest Profitably in the World’s Best Market lays out Rogers’ thesis that we are in the beginning stages of a great, decades-long bull market in commodities (lasting until 2015-2020 at least). Rogers expertly conveys his reasoning for believing not only does the current bull market in commodities have legs, the laws of supply and demand actually ensure commodities will continue setting new highs for years to come.

Rising Demand And Declining Supply On The Horizon

Most commodities are about to enter a period of supply outpacing demand according to Rogers, in large part due to rapidly increasing demand not only from China but the rest of the developing world. The bull market started sometime in 1999 and is likely to continue until at least 2015, if Rogers’ calculations correct.

So if prices are going higher, why don’t companies just produce more of it? The simple answer, according to Rogers, is that they can’t. At least not quickly. Consider that it takes 3-5 years for a new coffee tree to start producing beans and as many as 20 years for a new lead mine to come online and you’ll begin to under why producers can’t just turn on the spigot: it takes a long time for the spigot to warm up!

Since most investment in commodity production takes a while to bear fruit (at least a year or two, in the most optimistic of scenarios), prices are bound to continue rising in the meantime. After all, the prospect of larger coffee crops in 5 years does little to fill my cup tomorrow. If I want coffee tomorrow, I’m going to have no other alternative than to pay whatever is the going price.

In Hot Commodities Rogers devotes an entire chapter of in-depth analysis to a few of what he feels are the more promising commodities over the next decade, including lead, oil, sugar, and coffee. Interestingly, Rogers feels that while gold is likely to perform decently in the coming bull market, he doesn’t think it will be one of the big movers and doesn’t advise investing in it (I too discourage investing in gold). In fact, he devotes an entire chapter to dispelling the mythology of that little yellow metal.

How Do I Trade Commodities, Anyway?

While Rogers firmly believes small individual investors are capable of doing well in the commodities futures market if they do their research and avoid leverage, he agrees that investing in commodities via an index fund is the best way for the average investor to cash in on the coming bull market. To that end, he created the Rogers International Commodities Index fund; however, it is based in Ireland and somewhat difficult for Americans to gain access to.

Unfortunately, very few commodities-centric mutual funds exist. Probably the most accessible commodities fund available to small investors is the Pimco Commodity Real Return Strategies Fund (PCRAX), but it suffers from an unbearably high expense ratio. Conversely, the Dow Jones-AIG Commodity Index ETN (DJP) sports a reasonable expense ratio, but suffers from the structural disadvantages inherent in the Exchange Traded Note format (an argument for another day, but suffice it to say your investment could easily go to $0 in any ETN). Due to the lack of availability of a reasonably-price, well-diversified commodities mutual fund, I’ve had to put my plans to devote 10% of my asset allocation to commodities on hold. I’d love to invest in commodities, but can’t justify taking the plunge with any of the products currently on the market.

Who Would Benefit From Reading This Book?

I think understanding the dynamics of what drives the market of tangible commodities will benefit pretty much any investor who takes the time to study it. This book is an excellent primer on how to interpret the basic supply-and-demand factors of several of the most commonly-traded commodities and as such comes highly recommended. Could a novice take what’s written here and make a killing in the futures market? No, of course not. But Rogers does a good job of explaining how supply and demand works in the real world, which I think is a good lesson for everybody.

Buy Hot Commodities: How Anyone Can Invest Profitably in the World’s Best Market from Amazon.com.

In addition to The Aggressive Conservative Investor, Whitman has also written an excellent primer on value investing entitled Value Investing: A Balanced Approach and a brand-new book called Distress Investing: Principles and Technique, which I’ve yet to read but look forward to.

The Aggressive Conservative Investor Review

I’ve mentioned before that this is among my favorite all-time investing books; however, it’s not without its flaws.  For starters, Martin Whitman writes in a matter-of-fact, business-like style that seems to suit perfectly his investment approach:  he zeros in on what matters and discards the rest, even when “the rest” happens to be mainstream conventional investment wisdom.  He has no trouble making authoritative assertions, as if the correct answer is obvious and it’s inconceivable anyone could possibly disagree.  Fortunately for him, he’s usually right; however, his dismissive tone can sometimes hit a nerve in his ideological opponents.

Whitman’s Investment Thesis

Whitman’s investment thesis in  The Aggressive Conservative Investor centers around the financial integrity approach to company valuation, or what he likes to call the cheap and safe approach.  The book is written from the perspective of a real finance insider, somebody who knows how Wall Street really works.  In the massive appendices at the end of the book, Whitman walks you through two complete and highly-complex real-world case studies of actual corporate deals consummated in the decade leading up to the writing of this book (late 60′s – mid 70′s).

A central tenant of the financial integrity approach is the idea that all aspects of a company’s financial position are equally important in determining the company’s future earnings potential.  That is, no single attribute has value in isolation of the rest and everything from the balance sheet, cash flow, and income statements work together to help determine the company’s true value.  By contrast, conventional Wall Street wisdom holds that the income statement is the most important determinant of a company’s true investment value, with current accounting earnings being the single largest factor.  Whitman disagrees.

While he admits that current accounting earnings often do have the most effect on short-term price fluctuations, it rarely if ever gives a good picture of what the true future earning potential of a company is.  To Whitman, the majority of publicly-traded companies are involved in what he calls asset conversion activities of some kind or another.  An asset conversion activity is merely the act of a company converting an asset from one use to another, hopefully in a more useful way.  A prime example would be an industrial company selling of some of its valuable real estate holdings in order to finance additional manufacturing capacity.  While real estate holdings are an asset to any company, including industrials, they are relatively unproductive assets much of the time since they tie up cash that could be used to create the capacity needed for future earnings increases.  In this case, the investment extra manufacturing capacity made possible by liquidating non-productive real estate assets will drive higher profits for years if not decades to come.  By converting real estate assets to industrial assets, are example corporation has engaged in a form of asset conversion.  These conversions, posits Whitman, are usually the true source of wealth creation in the economy.

Who Should Read This Book?

Absolutely anybody interested in corporate finance and especially stock picking should read this book.  Whitman’s insights into how business leaders actually value whole companies in practice is pure gold for the individual investor.  You may be surprised to find that few movers-and-shakers use the same techniques as outside securities analysts when valuing companies.  Whitman cuts through the crap and shows you how deals are actually done in the real world and gives a glimpse of some of the financial wizardry corporate insiders almost always go through to get the best deal for themselves, often at the expense of outside investors.

If you have ever bought an individual stock, or ever plan to, you must read this book.  Even if you are a passive index investor, you will find this book fascinating if you have a general interest in the fields of economics or finance.  Investors who just want to know which mutual funds to buy and the basics of asset allocation so they can forget about it and go about their lives will undoubtedly find this book boring.  For them, I would recommend Richard Ferri’s All About Asset Allocation instead.

Buy The Aggressive Conservative Investor by Martin Whitman from Amazon.

Oblivious Investing

If you’re familiar with Mike’s blog, the thesis of his book will come as no surprise.  While the airwaves, magazine racks, and financial websites are full of information, advice, and statistics on the stock market, 99% of it is useless to the average investor.  Worse than being useless, most of this information will actually lead you astray, with dramatic negative consequences to your nest egg, if you pay too much attention to it.  Mike’s position on achieving investment success by ignoring the noise is very similar to my own (see my post What Matters In Investing), so I immediately took to his message.

The central idea of this philosophy can be boiled down to four simple steps:

1. Educate yourself on the basics of investing and various asset classes such as stocks, bonds, real estate, etc.
2. Devise an asset allocation and investment plan based on the research you’ve done, taking your own particular risk tolerance into consideration.
3. Construct a portfolio of low-cost mutual funds, preferably index funds (even if you think you can beat the market picking individual stocks).
4. Ignore the market, the financial media, coworkers, family, and friends when it comes to advice for your portfolio, logging onto your account only once a year to rebalance or position your portfolio more conservatively as your time horizon shortens.

The Book

The book clocks in at 120 pages including the appendix and is written in story form, unlike most investing books.  The story focuses on a 25-year-old woman named Shannon as she begins to save for retirement.  In the beginning, Shannon knows nothing about investing or the stock market and goes to her uncle Toby, who is set to retire relatively well-off at the early age of 55, for advice.  Over a series of conversations spanning a year, Toby gives Shannon advice on how to deal with investment losses, figure out which mutual funds to invest in, deal with well-intentioned advice from clueless coworkers, resist the temptation to time the market, and decide on an appropriate asset allocation.

Throughout the story, Shannon is tempted by many of the same things we are and makes many of the same mistakes, such as buying an individual stock on a hot tip.  Predictably, her results were about the same as ours:  she lost.  In the appendix, Mike includes some charts and graphs to reinforce many of the concepts introduced in the book.  One chart I particularly liked graphs out the return one would have earned by dollar cost averaging $100 per month into the market during the Great Depression, which is truly a worst-case scenario.  The result?  An investor dollar-cost averaging into the market from its peak in 1929 through the end of 1943 would have earned a return of 5.8% per year at a time when the market actually lost money.  Not a great return, but certainly not bad as a worst-case scenario.  Dollar cost averaging works!

A Great Primer For Beginners

While advanced investors can always benefit from the value of ignoring the noise being pounded into their head, I think beginners have the most to gain from reading this book.  It doesn’t have anything about correlation coefficients, alpha, or exotic asset classes but then, those things aren’t important for the average investor to know anyway.  For beginners, the importance of creating an investment policy, sticking to low-cost funds, and not trying to time the market far out-weighs the importance of more advanced topics.  Investing is truly an art where 90% of the benefits come from implementing 10% of the ideas properly.

Oblivious Investing would make an ideal gift for a recent college graduate or a reformed hyper-consumer getting serious about saving for retirement.  Coupled the classic book on personal finance, The Richest Man in Babylon (which does a great job explaining the “why” of prudent financial habits and not just the “how”), the information in this book, diligently applied, will get you 90% of the way there.  Sure, you could study more advanced topics and perhaps improve your returns slightly, but the work involved would be massive for such a small incremental improvement.

In fact, I think I’ll lend this copy to my mother (hi mom!).

Buy Oblivious Investing: Building Wealth by Ignoring the Noise from Amazon today!

A Practitioner’s Guide

The Intelligent Investor is all about investment philosophy with few concrete lessons.  Security Analysis, on the other hand, overwhelms the reader with real life example after mind-numbing real life example, coming in at well over 700 pages (yes, 700!).  This sort of detail is unquestionably valuable, but tends to make the book less than useful as a reference.  Enter The Interpretation Of Financial Statements, which strikes a happy medium between the two extremes.  At only 122 pages, this book delivers exactly what it promises:  detailed yet concise and easy-to-understand instructions on the down-and-dirty details of interpreting financial statements.

The book is divided into three parts.

Part I:  Balance Sheets And Income Accounts

Part I is about half the book and consists of small chapters (2-4 pages each) focusing on a single topic.  There are chapters on the Current Ratio (and how to calculate it), Working Capital, Inventories, Receivables, Capital And Surplus, Notes Payable, Reserves, Earning Power, and many other topics.  Each chapter completely explains and encapsulates the idea, tells you how to calculate it (if there’s math involved), relates why this particular entry or ratio is important, and gives an example to flesh out the idea.  Needless to say, this approach is absolutely invaluable as a concise learning tool or a quick brushup on a ratio that perhaps you haven’t used for a while.  But don’t let the brevity fool you either:  a beginner could easily learn everything necessary to become functionally competent in any of these areas just by reading the corresponding chapter and working through the examples.

Towards the end of this section, Graham puts it all together and works through typical industrial and railroad income accounts, calculates earnings from all the constituent parts, and even describes how to determine the safety of common stock dividends, interest payments.  The last chapter of this section, ultimately, gives an overview of how to determine the value of a common stock and relate it to the current price.

Part II:  Analyzing A Balance Sheet And Income Account By The Ratio Method

If part I contains the tools of the trade, part II is its bread and butter.  In it, Graham explains the ratio method (the now-popular P/E, P/B, etc) and does a complete analysis from top to bottom, stopping to explain all the relevant details and points of difficult.  The example used is a real-life one from a company you may have heard of, Bethlehem Steel (still going strong in Graham’s day).  Seeing the important ratios calculated and interpreted by a master of the craft proves extremely valuable and is something beginners and expert investors alike can learn something from.  Where in Security Analysis Graham’s hands-on writing approach can sometimes be overwhelming, here it’s brief enough to allow you to wrap your head around it without sacrificing accuracy or usefulness.

Part III:  Definitions Of Financial Terms And Phrases

Part III is exactly what it sounds like, a glossary of important financial terms and phrases you’re likely to hear on TV and see in financial statements.  This section is useful as a reference, but keep in mind some of the terms have changed since Graham wrote this book.  Still, it will be obvious what he’s talking about even if the name has changed.

Conclusion And Criticism

It’s no secret that I love this book.  While I don’t buy individual securities nearly as much as I used to, I used this book extensively when I did.  My process was to sit down with this book and the annual report, calculate all the important ratios, and try to arrive at a reasonable fair-value estimate for the company as a whole, particularly in relation to its Earning Power (Graham devotes a chapter to this).  While my method evolved over time and I eventually switched to a more discounted cash flow method, Graham’s teachings still forms the base of any value-based stock picking method.

The main flaw of this book, of course, is its age.  Modern secuirty analysis makes extensive use of the Cash Flow Statement, a statement, of course, that didn’t even exist in Graham’s day.  Needless to say, you won’t find anything about cash flow here.  Still, the current account and earning power are every bit as important today as they were in 1936.  Hence, The Interpretation Of Financial Statements should be used as a jumping-off point for modern investors and not as a complete solution.

With that one caveat in mind, I believe every investor should read this book and I’m not the only one. None other than Joel Greenblatt, author of one of my favorite investing books You Can Be A Stock Market Genius (read my full review), lists this gem as one of his all-time favorite investment books and recommends it as a good primer on financial statement analysis.

Buy The Interpretation of Financial Statements from Amazon.

Joel Greenblatt is the founder of Gotham Capital, a private investment partnership achieving 50% annual returns over a period of 10 years before closing its doors, so Greenblatt definitely practices what he preaches.  This book was written as a kind of guided tour for how he accomplished such impressive returns.  So far as I know, there are no other books (decent or otherwise) focusing specifically on these kinds of techniques which is unfortunate because this is definitely a topic I would like to learn more on.

Cast Your Line Where The Fish Are

The over-riding theme throughout this book is that if you want big returns, you have to search where nobody else is searching.  In the age of instant quotes and internet research, that is becoming an increasingly difficult task.  In fact, many of Greenblatt’s critics would argue that many of the tips Greenblatt gives here no longer work as well as they used to, if at all, due to increased competition.  They do have a point:  the book was first published in 1999 and a lot has changed since then;  however, Greenblatt addresses the question “will this keep working in the future?” head-on.  His answer is that for some of these techniques, absolutely.  For others, maybe not.

Where To Uncover The Big Profits

In You Can Be A Stock Market Genius, Greenblatt reveals four specific corporate events which tend to hold unusually large profit potential for thoughtful investors. 

1. Spin-offs:Spin-offs usually aren’t all that glamorous.  In fact, spin-offs are often (but not always) the result of a parent company wanting to rid itself of a subsidiary or peripheral division in order to focus on their core business.  Since these non-core divisions are usually neglected (why else would they be spun off to begin with?) they often hold vast potential.  Freed from the inflexibility and lack of proper attention brought on as a result of being part of uninterested corporate juggernaut, a young, talented, and motivated management team can make huge strides in improving profitability surprisingly quickly.  The key to a good spin-off opportunity, Greenblatt explains, is management having skin in the game.  If their compensation is based primarily on performance, they will tend to perform well.  Of course, there are a million caveats but, if you do your homework, specializing in corporate spin-offs can dramatically improve your odds of earning high, sustainable returns in the stock market.  What’s more, the nature of how these spin-offs work in the real world practically guarantees the spin-off niche will be profitable to enterprising investors far into the future.  As always, do your homework.
2. Risk Arbitrage And Merger Securities:  Greenblatt offers a stern warning about the dangers of attempting risk arbitrage (it’s too dangerous for small investors) so we won’t go into that here, but risk arbitrage’s close cousin, the merger security, can offer outstanding profits to careful investors.  Merger securities are generally non-standard, unusual securities originating from deep within the vagaries of merger negotiations, usually as some sort of compromise to get the deal done.  As a result, practically nobody takes the time to understand these securities and even fewer people are interested in owning them.  That gives you, the enterprising investor, a leg up on the competition.  Since these securities are so unpopular, they are nearly always at least a little undervalued.  The key is digging through all the documentation to figure out exactly what these securities are, how they work, and what they are likely to be worth in the future relative to more standard securities such as the common stock or senior debt.  Since literally nobody else is doing this kind of research, you have a huge advantage.
3. Corporate Restructurings:  Most of the time, a corporate restructuring means something went wrong.  Either the company wasn’t performing up to snuff, management is trying to mix things up, or an outright bankruptcy occurred.  Either way, that’s not the type of company you’d want to invest in, right?  Well, probably not the stock.  But many of these companies also issue relatively safe senior debt in a restructuring you can pick up at a significant discount if you know what to look for.  This is definitely an area where you want to pick your spots, though, because the consequence for failure if you’re long is pretty catastrophic.  If you want to dabble in this area but aren’t confident of your skills, there is a decent mutual fund available which deploys a significant portion of its capital in corporate restructurings:  Columbia Value & Restructuring (UMBIX).
4. Stub Stocks, Warrants, Options, and LEAPs:  Derivatives can make good investments, but leverage cuts both ways.  I don’t advocate buying options for investment purposes – only for hedging.  Stub stocks, on the other hand, can make excellent investments.  A stub stock is any stock in which the publicly traded shares represent only a small portion of the overall company.  Usually, the vast majority are owned by another corporation.  Since the majority shareholder is also the controlling shareholder in this case, you can be sure investors’ best interests always come first.  That doesn’t necessarily mean external investors will prosper, but it does increase the odds.  As always, pick your spots here.

You Can Be a Stock Market Genius is the most fun I’ve had reading an investment book in a long time.  Greenblatt’s writing style is refreshingly lighthearted and simple enough even absolute beginners will be able to follow most of what he’s saying.  Even if you never plan on buying an individual security or doing the research necessary to generate the kinds of returns Greenblatt has experienced, his book is still well worth a read for the entertainment value if nothing else.  If you are at all interested in investing, you will enjoy this book. 

If you are willing to work hard and do the research, the information in this book could be your key to huge stock market gains.  This is the exact same stuff all-star hedge fund managers do to generate their eye-popping returns.  It goes without saying that with large profit potential comes large risk, so I advise you to deploy only a small portion of your capital this way if you choose to go down that path.  Good luck!

Buy You Can Be a Stock Market Genius by Joel Greenblatt from Amazon.