Book Summary and Notes - Manual of Ideas.

The book, 'The Manual of Ideas', is an interesting book for experienced investors. The books discusses specific value investing strategies for generating ideas to pick stocks. Though these ideas are not new, as they have been written in classics such as - Security Analysis, Investment Fables, Little Book That Beats the Market, etc.

The Manual of Ideas discusses these ideas in context of modern stock picking discipline.

Given below are the short notes and my views on the different topics explained in the book. 

Chapter 1: A highly Personal Endeavor

- The structure of the investment vehicle matters.

- Understanding the philosophy of the manager.

- Think from a different perspective. Example: a business losing company is quoting a billion dollar market cap, is it worth buying it at that price since that money can develop 10 states in India!

Or a way of thinking can be that you can start up a new company in that cost.

"The stock selection framework begins by asking whether the net assets are available for less than the replacement cost. If this is not the case, we exclude the company from consideration because it might be cheaper to re-create the equity in the private market..... .......  In the vast majority of the cases, an equity will trade far above liquidation value, in which case we turn our attention to earning power."

- Think like an owner. Some amount of prediction is required (but no need to be excel ninja, see if back of the envelop calculation makes sense). Thinking like a capital allocation expert lends to identifying better investment opportunities.

Chapter 2: Deep Value: Ben Graham style bargains

- NOTE: Net net graham style of investment is difficult to practice in India because the corporate law makes it difficult to remove the management. Legal system is slow.

- If the investing opportunity trades at less than tangible book value (liquid assets). Add further criteria

(a) buybacks (b) insider investing (c) decline sales trend in a capital intense business.

- Invest in companies which are hitting a cyclical lows.

- Questions to assess the investment

·         what is the pessimistic scenario?

·         what wouldn't be an optimistic scenario?

·         can we conceptualize a base case while acknowledging the high likelihood that the future will play out differently.

- understand that liquidation value is more on the books, reality is different.

- Avoid concentration of investment when following this style.

- Important Reading on Graham's Net-Net: (a) Prof. Henry Oppemheimer's Ben Graham net current asset value: a performance update. (b) James Montier's Nets-Nets outdated and outstanding?

Chapter 3: Sum-of-the-parts Value

- To gain from sum of parts value always understand the trigger value for unlocking the value in company.

- For screening look out for

·         companies with multiple operating businesses

·         companies with large holdings of net cash

·         companies with investments in other companies

·         companies with large realm estate holdings

- One important suggestion is to understand the value of the company without the non-core assets. If it is a value trap then the market would be discounting the core business correctly.

Chapter 4: Joel Greenblatt

- This chapter is more dedicated to Greenblatt style of investment  and recommends the authors view on why the formula should be tweaked or a checklist created and how that will help.

- One of the important thing to understand is that it is possible that the magic formula style will not work in 2 or 3 years out of five years but in the end of five years the out-performance would be higher than then index.

-  Asking the right questions:

·         How durable is the firm's competitive advantage

·          Opportunity to reinvest capital at high rates of returns

·         How good are management's capital allocation practices

- An interesting checklist items to consider

·         Remove companies that have made one-time adjustments

·         Avoid companies that do not have high-return reinvestment of capital. Typically in industries with long-term decline

·         Avoid companies dependent on a specific customer and contracts

·         Avoid capital-intensive businesses that generate high returns on capital only during cyclical upswings in their respective industries

·         Avoid companies with products that are fad

·         Avoid companies where insiders are selling

·         Avoid companies with major CEO conflicts of interest or corporate governance abuses

·         Avoid companies that offer a questionable value proposition to their customers

·         Avoid companies which are mostly into merger & acquisition mode

NOTE: http://foolishgenerous.blogspot.in/2015/05/pick-stocks-like-joel-greenblatt.html

Chapter 5: Jockey Stocks: Making money alongside great managers

This is an interesting chapter and should be read. This summary note would be insufficient, hence not writing much here, please read the chapter.

- Rather than preparing a screen, use a checklist system to assess the ability of the management and use the following metrics against historical levels as well as competition. But learn to spot the differentiation between companies within the same industry.

- Checklist for identifying good management.

·         Management ability

o    Return  on capital employed

o    Growth of capital employed per share

o    Margin Profile

o    Asset Turnover

o    Capital Expenditure Trends

·         Management incentives

o    Stock ownership

o    Insider buying activity

·         Capital allocation ability

o    Share repurchases

o    Dividends

Chapter 6: Follow the leaders

- This chapter highlights the strategy of following an investment expert sometimes called as copy-cat investment style or side-car investment style, etc.

- One of the most important factor here is to understand who are you following?

- Do you share the investment philosophy?

- Does the information flow on time?

- Also look for the position size of the investor in a company in their portfolio, this will reveal the conviction level.,

NOTE: It is advisable to follow investors with contrarian investment style or deep value investment style. Investment experts who trade a lot in their portfolio should not be followed. Also check the lag in information flow.

Chapter 7: Small Stocks, Big Returns?

- Small cap investing is an interesting space for few reasons.

- It can be very illiquid and profitable perhaps. This space is very different in India. The given below screen has been adjusted to suit Indian stocks

·         Market caps of less than 1000 cr and more than 10 cr

·         Previous quarter numbers should be present. At least annual reports are compulsory and should be sharing the same within 6 months of FY ending for the company

·         Founders and management ownership should be 5-50% range

The above criteria should throw up investible universe. Further criteria to add:

·         Deep Value: Price to tangible book below 1.1; dent to equity below 0.2. And a PE multiple of above 0

·         Activist Targets: Price to tangible book value below 0.5; current assets minus total liabilities above 50% of market value ; insider ownership below 20 percent.

·         Margin Upside Potential: Enterprise value to sales below 1.5; debt to equity below 0.3

·         GARP: price to book value below 2; debt to equity below 0.5; P/E below 15; revenue growth  above 10%; (In US optional is dividend yield of 0.5%; don’t think its applicable to India).

Other idea generation techniques:

Look out for companies that fell out of favour and are part of the small and micro-cap now due to an industry or global event but these are strong balance sheet companies.

Asking the right questions of small-cap prospects

·         Did a company pass the right screen for the wrong reason?

·         Do the financial statements raise any red flags?

·         Who has been buying and selling the shares?

·         What is the management's attitude toward outside shareholders?

·         What are the shares relative to their historical range?

·         Understand the subjective qualities of the business.

Chapter 8: Special Situations

This is a different category of investment. The interesting part of the books is the source for identifying special situations.

Questions to ask--

·         What is the source of potential inefficiency

·         What is the margin of safety

·         What is the path of value creation

NOTE: Special situation is very difficult and different. Its best suited for private equity or hedge funds or for activist investor.

Chapter 9: Equity Stubs

This chapter basically dwells in the highly leveraged companies’ space and how to profit out of them.

NOTE: I believe it's more near to special situation and should be treated like one. Individual companies have to understood in the context of their industry and one has to understand how the company got there and the management's way out.

Chapter 10: International investing

It is well written but the message is more relevant for American investor but it should be read for interesting observation in understanding Japanese businesses.