Investment Lessons from a Master Sushi Chef

December 19, 2016 / Richard Lewis / Leave a comment

The best investment book I read this year didn’t come from a Wall Street whiz or hot shot finance professor, rather it came from Jiro Ono, a Master Sushi Chef. Yes, “the Jiro”, the one from the acclaimed documentary “Jiro Dreams of Sushi.”

While in Japan this past September I picked up his book titled “Jiro Philophosy” and was quite surprised. Unlike most investment books, Jiro doesn’t talk about investing at all. In fact, it isn’t even an investment book. Rather Jiro Philosophy simply describes Jiro’s personal work-ethic.

2016-12-17-19-25-01 As I read this book, I quickly came to realize just how closely Jiro’s philosophy mirrors that of Warren Buffett, Charlie Munger, and Ben Graham. It was quite surprising to see that the same principles which lead to mastery in Sushi can also lead to mastery in investing.

As a result, I have distilled the book “Jiro Philosophy” down to its 12 core principles and relate each one to the investment philosophy of Buffett, Munger, and Graham.

1. Stick to the fundamentals. Stay grounded.

Jiro

“If you stray from the fundamentals – say, trying to set yourself apart from other chefs – you will completely stray off track. I believe that by adhering to the fundamentals and continuously striving to create delicious flavors, you will be able to be innovative.”

“If you continue to do things the right way, it’s a given that your sushi will turn out delicious.”

Investing

Market manias and bubbles all have two things in common; an abandonment of fundamental investment principles and an endless series of rationalizations.

Ben Graham understood the immense rationalization power of markets very well. He experienced it first hand during the lead up to the great depression. It was his understanding that as markets move higher, investors don’t become more reserved, but rather they invent knew valuation metrics to justify paying any price whatsoever. As been Graham observed, “We can find no evidence that…investors as a class have sold their holdings because PE ratios were too high.”

Consequently, Ben Graham developed an immutable investment philosophy based on strict fundamental analysis to keep investors from “completely straying off track”. And much like Jiro Ono, investors who have stuck to Ben Graham’s fundamentals of investing have delivered “delicious” results.

With this, I’m reminded of Lou Manheim ‘s advice to Bud Fox in the movie Wall Street, “Stick to the fundamentals…good things, sometimes take time.”

2. Gain Mastery.

Jiro

“You’ve got to master some skills to reach the next stage.”

“You won’t advance to the next level all on your own. You need to train properly up to a certain point. In the case of Jiro, after a decade of training, a craftsman will have mastered everything from preparation to making sushi. He will be ready to strike out on his own.”

Investing

Warren Buffett pursued and achieved mastery over Ben Graham’s investment philosophy before advancing to the next level. Warren’s path to mastery took on the following steps:

Discovered Ben Graham’s book “The Intelligent Investor” at the age of 19.
Read Graham’s 700+ page book, Securities Analysis, at least 12 times.
Attended Columbia so that he could study under Ben Graham.
Worked for Ben Graham at his investment fund.
Invested using Ben Graham’s investment principles at the Buffett Partnership.

3. Put Knowledge into Practice.

Jiro

“People will teach you new things and ideas, but if you don’t try them out you will not change.”

“No matter how good the teaching, unless you actually put it into practice, you won’t be able to progress. You will only have the knowledge. People passionate about their work are always trying to improve upon what they’ve made. It’s enjoyable and rewarding.”

“Because of this, we can keep trying new things every day.”

Investing

Throughout his life, Warren Buffett has shown an amazing willingness and ability to put knowledge into practice. This includes applying the teachings of Ben Graham as well as the four hour educational interview he had with GEICO executive Lorimar Davidson in 1950.

Much of Warren’s success simply boils down to seeking out the best knowledge and putting it into practice. Warren recommends you do the same thing:

“You need to fill your mind with various competing thoughts and decide which make sense. Then you have to jump in the water – take a small amount of money and do it yourself. Investing on paper is like reading a romance novel vs. doing something else. You’ll soon find out whether you like it. The earlier you start, the better.”

4. Improve upon what you’re taught. Otherwise you will always be an apprentice.

Jiro

“Just doing as you’re taught is the same as being an apprentice. I tell my young apprentices that they should think about how to achieve good flavor on their own, improve it and then experiment. I always tell them if they don’t, they will be apprentices for life.”

Investing

Although Warren Buffett began his career as Ben Graham’s apprentice, he did not simply stick to his teaching. Rather he modified and improved upon Graham’s teachings over time. As Charlie Munger describes it:

“If we’d stayed with the classic Graham, the way Ben Graham did it, we would never have had the record we have. And that’s because Graham wasn’t trying to do what we did.”

5. Practice Beginner’s Mind. (Shoshin)

Shoshin (初心) is a concept in Zen Buddhism meaning “beginner’s mind“. It refers to having an attitude of openness, eagerness, and lack of preconceptions when studying a subject, even when studying at an advanced level, just as a beginner in that subject would. (Wikipedia)

Jiro

“That said, once they’ve become independent they should still pursue improvement just like an apprentice.”

“Feeling you can still evolve is important.”

Investing

Both Warren Buffett and Charlie Munger are enthusiastic learners who enjoy the process. In fact, Charlie has said that he and Buffett are “dissatisfied with what they know.” As a result, they are always seeking to learn, adapt, and evolve.

Charlie further explains the importance of this mindset,

“Warren Buffett has become one hell of a lot better investor since the day I met him, and so have I. If we had been frozen at any given stage, with the knowledge we had, the record would have been much worse than it is. So the game is to keep learning, and I don’t think people are going to keep learning who don’t like the learning process.”

6. The way you do the small things reflects how you do the big things.

Jiro

Through Jiro’s Philosophy, he stresses the importance of the small things. From cleanliness, to hot towels, to the preparation process, rice, etc. All the smallest details are given the greatest care. The way you do the small things reflects how you do the big things.

Investing

Likewise, Buffett has a keen eye for detail as displayed by the following two stories:

Story 1:

Buffett also liked Cathy’s attention to detail. “When I asked her on the phone how many employees she had, she replied ‘504.’ I love this,” said Buffett. “Not ‘about 500.’ I think she has 505 now and is doing considerably more business. She won’t be happy until she has 100 percent market share.” (From the book “The Women of Berkshire Hathaway: Lessons from Warren Buffett’s Female CEOs”)

Story 2:

The following is an excerpt from the Q&A session at the 2016 Berkshire Hathaway Annual Meeting:

Warren Buffett: Yes, sloppy thinking in one area probably indicates there may well be sloppy thinking elsewhere. I have been a director of 19 public corporations. I’ve seen some very sloppy operations and I’ve seen a few really outstanding business operators, and there’s a huge difference. If you have a wonderful business, you can get away with being sloppy. We could be wasting a billion Dollars a year, at Berkshire, you know $640m after tax, that would be four percent of earnings, and maybe you wouldn’t notice it….

Charlie Munger: I would.

Warren Buffett: Charlie would notice it… It’s the really prosperous companies that well….the classic case were the tobacco companies many years ago. They went off into this thing and that thing, and it was practically play money because it was so easy to make. It didn’t require good management, and they took advantage of that fact. You can read about some of that in ‘Barbarians of the Gate’.

7. Listen to good advice.

Jiro

“I take customers’ advice when it makes sense.”

“Even when you think you are right often that’s not the case. No matter what kind of business you are in, if you only work in an inflexible way, you won’t find success.”

“If (a customer’s advice) makes sense, I will adopt it, otherwise I will never evolve.”

Investing

Warren Buffett and Charlie Munger have exhibited an open mind and willingness to listen to good advice throughout their careers. In fact, if it weren’t for some timely advice they might not have bought See’s Candies. As Charlie Munger recounts,

“[Munger’s friend] Ira Marshall said you guys are crazy — there are some things you should pay up for, like quality businesses and people. You are underestimating quality. We listened to the criticism and changed our mind. This is a good lesson for anyone: the ability to take criticism constructively and learn from it. If you take the indirect lessons we learned from See’s, you could say Berkshire was built on constructive criticism.”

8. Preserve your main asset…You.

Jiro

In his 40’s, Jiro recognized that his most critical asset as a Sushi Chef was the sensitivity in his finger tips. As a result, he began wearing gloves in order to preserve the long-term integrity of his hands.

This might seem like a mildly trivial matter, but for anybody looking to achieve and maintain success in their profession, follow Jiro’s example: Identify the physical or mental attribute that is necessary for success in your field and take measures to preserve it.

Investing

Warren Buffett identifies the most important trait of an investor as “emotional stability”. As Warren explains,

“To be a successful investor, you don’t need to understand higher math or law. It’s simple, but not easy. You do have to have an emotional stability that will take you through almost anything. If you have 150 IQ, sell 30 points to someone else. You need to be smart, but not a genius. What’s most important is inner peace; you have to be able to think for yourself. It’s not a complicated game.”

Similar to Jiro’s practice of wearing gloves to protect his hands, here are some routines and strategies which Buffett uses to maintain emotional stability, inner peace, and independent thought.

An alert and fresh mind:
- Warren gets good sleep and takes naps when necessary
- He plays bridge many hours every week.
A temperament uncorrupted by outside influences:
- He Lives in Omaha
- Maintains a Clear Schedule
- Keeps a quiet office where he can think.
Health:
- “My diet, though far from standard, is somewhat better than usually portrayed. I have a wonderful doctor who nudges me in your direction every time I see him. All in all, I’ve enjoyed remarkably good health — largely because of genes, of course — but also, I think, because I enjoy life so much every day.”

Furthermore, Warren explains the importance of preserving and enhancing yourself through life:

“Imagine that you had a car and that was the only car you’d have for your entire lifetime. Of course, you’d care for it well, changing the oil more frequently than necessary, driving carefully, etc. Now, consider that you only have one mind and one body. Prepare them for life, care for them. You can enhance your mind over time. A person’s main asset is themselves, so preserve and enhance yourself.”

9. Be a craftsman. Pursue work to satisfaction.

Jiro

“Pursuing work to satisfaction is the pride of a craftsman. No matter how time consuming, I will leave no task to others. I will do them all myself until satisfied. Even as I get older, I still do all the work, even if it’s bothersome. I feel very pleased when I develop and create something from a new idea of my own.”

Investing

Likewise, Buffett takes pleasure in doing all the investment analysis himself. He does not have a team of analysts working for him.

10. Be passionate about what you do.

Jiro

“People who love their work passionately want to continue working. I’m no exception. Although I’m 90 years old, I’d like to keep on going. That’s why I don’t find investing time in my work troublesome.”

Investing

At 86 years old, Buffett still tap-dances to work. He derives great enjoyment from researching different companies. He compares it to researching different species of animals.

11. Adapt to changing circumstances.

Jiro

“Since all sushi toppings are changing, sushi craftsman must now factor this in when working out flavors.”

“The oceans are quickly changing. For example, the season for katsuo (skipjack tuna) now starts six months later. But we have to serve the best of what’s in season. Fish and shellfish were tastier in the past and it is difficult to find their intense flavors. The next generation of sushi chefs will face challenges in trying to find ways to bring out and enhance fish flavors.”

Investing

Likewise, in investing you cannot wish for something which doesn’t exist. You must play the hand that you’re dealt.

When Warren Buffett started investing, he could find net-net investments everywhere. But the investment ocean quickly changed and he had to adapt to the circumstances. Over the years, Buffett has invested in a broad range of investment classes including, bonds, common equity, preferred stock, warrants, options, commodities, and special situations. He doesn’t wish for something that doesn’t exist, rather he adapts himself to whatever asset is on sale below his intrinsic value.

At the same time, Warren will never abandon his core principles and rationalize new investments. During the “Nifty 50” stock market, he declared that he couldn’t find any cheap stocks and refused to invest. Later Buffett refused to invest in tech stocks during the tech boom of the 90’s. In each case Warren has been rewarded for his patience and sticking to the fundamentals.

This leads to a crucial point. Although you must adapt to changing environments, you must also remember to stay true to the fundamentals. As it says in rule number 1, “If you stray from the fundamentals…you will completely stray off track.”

So remember: Adapt, but do not abandon.

12. It’s never too early to prepare

Jiro

“It’s never too early to prepare. You can start preparation way in advance.”

Jiro began working at a local restaurant from the age of seven.

Investing

Likewise, Warren Buffett recalls his youthful experience: “By the age of 10, I’d read every book in the Omaha public library about investing, some twice.”

Furthermore, Buffett said he read the 10Ks of IBM for fifty years before ultimately making an investment in the company. That’s fifty years of “preparation.”

Jiro Philosophy: Distilled

Haiku Review: Deep Value by Tobias Carlisle

October 19, 2016 / Richard Lewis / Leave a comment

Inspired by a recent trip to Japan, here are my 7 main insights distilled from Deep Value by Tobias Carlisle, in Haiku form. Arigatou gozaimasu.

Japanese Painting

1. Risk: “A Bundle of Twigs Cannot Easily Be Broken”

Stocks perceived risky,

Find resilience when bundled.

Have fewer down years.

2. Return: Buy the “Ugliest of the Ugly”

Deep Value defies

Investment Intuition.

Ugly is Better.

3. Trust in Mean Reversion & Avoid Naive Extrapolation

Trust Mean Reversion.

Naive Extrapolation

Ignores the Base Rate.

4. Expand Your Time Horizon

Seeking to avoid

Short-term underperformance,

They’re captured by it.

5. Behavioral Biases: Your Intuition is Killing You

Three Crude Heuristics,

Lead us to poor decisions.

What feels right is wrong.

6. Use a Statistical Approach: Focus on Simple & Effective Techniques

Ben Graham’s approach:

Stick to a few Techniques and

Simple Principles.

7. Stay out of the Way: Overconfidence Leads to Reduced Performance

Our judgment misleads,

We find broken legs abound.

Stay out of the way.

number 7 japanese

Deep Value’s 7 Main Takeaways

October 18, 2016 / Richard Lewis / Leave a comment

Deep Value by Tobias Carlisle reads somewhat like an investment version of “Mom’s” classic question, “If your friends jumped off a cliff, would you?” Wall Street is filled with people jumping off cliffs and the people who follow. The question is, why would so many people consistently invest in a way that’s bad for their well-being? The answer lies largely within the errors of our intuition. Carlisle warns that, often times, “the incorrect decision feels right, while the correct decision feels wrong.”

If our investment intuition is so often wrong, then the first step to becoming a better investor should be to recognize that we are naturally wired to jump off investing cliffs. The next step involves giving counter-intuitive ideas a chance. After all, as Einstein said, “The definition of insanity is to keep trying the same thing while expecting a different result.” Insanity in this case, is relying on our intuition to help us make wise investment decisions.

Consequently, we can view Deep Value as a sort of counter-intuitive survival guide to overcoming our self-destructive investment tendencies. (aka “How to stop jumping off of cliffs”)

Next to here you will find the summary of my seven main takeaways from Deep Value. Please feel free to print it out and re-read these points whenever your intuition tries to lead you off a cliff.

Risk:” A Bundle of Twigs Cannot Easily Be Broken”

Within traditional finance, risk is commonly defined as “the currency by which we pay for returns”. Meaning that if we want higher returns, we must bear greater risk. This intuitively makes sense if the markets are efficient. But Deep Value discredits this intuitive assumption.

Throughout the book, Carlisle focuses on two groups of stocks that exist at the opposite ends of the spectrum. Value Stocks and Glamour Stocks. Value stocks are considered risky investments. They are typified as companies that you wouldn’t want to own. They are often down and out companies that exist in unfavorable industries and have poor prospects. Meanwhile, glamour stocks are considered safe investments. These are companies that generally have high returns on capital, seemingly endless growth prospects, exist in favorable industries, and are widely admired. (i.e. companies you’d love to own)

On an individual basis, value stocks are indeed the riskier prospect. Value Stocks, as defined here as net-nets, lose 90% or more in a single year 5% of the time, versus only 2% of the time for all stocks.

But the nature of value stocks changes dramatically when they are bundled together. In fact, they have fewer down years than the market. In a study, net-net stocks only had 3 down years in 26 versus 6 down years for the market.

This investment phenomena mirrors a quote by Tecumseh, Native American leader of the Shawnee. He said, “A single twig breaks, but the bundle of twigs is strong.” A value stock by itself is like a twig that easily breaks, but finds strength when bundled together.

Return: Buy the “Ugliest of the Ugly”

If value stocks have less risk than glamour stocks, then traditional finance states that they should have lower returns. But yet again, Carlisle proves this notion to be wrong. In fact, he shows that value stocks generate superior returns to their riskier glamour stock counterparts.

Deep Value presents many studies which show that returns for value stocks are significantly greater than glamour stocks. But perhaps most surprising is Carlisle’s case that the ugliest stocks provide the best returns. The nature of this counter-intuitive element is steeped in Behavioral Finance. Everyone in their pursuit of safety, shun companies that look risky, which creates bargains.

The ugliest of the ugly phenomena extends to countries as well. The countries with the poorest recent performance outperform countries with the best recent performance.

This investment bias towards glamour and value stocks is perfectly capture by a poem I encountered by Ella Wheeler Wilcox titled Solitude. In it she wrote, “Be glad, and your friends are many; Be sad, and you lose them all”.

Furthermore, this poem explains why value investing is a successful strategy. The very nature of investing in value stocks is contrarian because you’re willing to do what very few will. Value Investors immerse themselves in grief, woe, gall, fasting, and pain. As a result of these counter-intuitive actions, value investors get counter-intuitive returns.

Put another way, value investors get pleasurable returns for hanging around companies in sorrow. While typical investors get sorrowful returns for hanging around companies in pleasure.

Trust in Mean Reversion & Avoid Naive Extrapolation

Deep Value contrasts two starkly different predictive assumptions about the future. The most commonly used assumption is naive extrapolation, whereby the past performance of a company is extrapolated out into the future. The less commonly used assumption is mean reversion, whereby a company’s financial performance will eventually revert towards the mean.

Carlisle demonstrates that, of the two methods, investors should rely on mean reversion. The importance of mean reversion should not be understated. Ben Graham identified mean reversion as the phenomenon that leads value strategies to beat the market. Furthermore, Carlisle writes, “An appreciation of mean reversion is critical to value investment.”

Mean Reversion is built upon a fundamental economic truth that;

Competition naturally eats away at high returns over time. “In most cases competition and other corrective forces work on the highly profitable business to push its return back to the mean.”
Low returns will more often than not, revert towards the mean. “Stocks with big market price losses and historically declining earnings tend to see their earnings grow faster, and outperform the market.”

On the other hand, naive extrapolation makes the assumption that past results will generally continue undeterred into the future. While this appears to be mathematically sounds, it ignores the “Base Rate”. The Base Rate shows that this simplifying assumption is not true for most companies.

As a results, predictions using naive extrapolation often disappoint, while predictions using mean reversion are the more likely outcome. The chart below provides a good visualization of these two methods at work.

Mean reversion appears to have an element of Biblical faith to it. It reminds me of a Bible Verse, Hebrews 11:1, which says, “Now faith is confidence in what we hope for and assurance about what we do not see.” Likewise, value investors have confidence in what they hope for (anticipating mean reversion in both fundamentals and valuation) and assurances (base rate, invisible hand) about what they do not see. Whereas most investors mistakenly invest based on what they see (historical figures), but shouldn’t expect (naive extrapolation).

Expand Your Time Horizon

To be a value investor, you must expand your time horizon. Mean reversion often takes time. In fact it can take 3-5 years, during which time, you may experience years of poor performance. Most investors don’t have this kind of patience. Wall Street generally isn’t kind to short-term underperformance.

Consequently, many fund managers will chase short-term performance at the expense of long-term success. Quarter on Quarter and Year on Year is their focus. But as Carlisle writes, “by attempting to avoid short-term underperformance, they are captured by it.”

Behavioral Biases: Your Intuition is Killing You

Behavioral Bias is really a dual sided topic. First, you must understand the various Behavioral Biases which contribute to your poor investment decisions. Secondly, you must recognize that even after understanding these biases, it remains difficult to overcome them.

Carlisle writes,

“Kahneman and Tversky found that we make decision about uncertain future events based on three heuristics…Each leads us to make poor decisions about uncertain events because it leads us to consider irrelevant evidence, and in so doing diverts us from considering the underlying probabilities about the events.”

The three biases as identified by Tversky & Kahneman are:

Anchoring & Adjusting: Causes us to stick with our first impression, even when evidence arrives that conflicts with our view.
Representativeness: We use stereotypes to make simplifying assumptions.
Availability: Only consider things that are quickly brought to mind.

It has been shown that people still fall victim to these three biases despite working to prevent them.

“No matter how well trained we are, humans tend to have difficulty with probabilistic, uncertain, and random process. Confronted with problems requiring an intuitive grasp of the odds in an unfamiliar context, even the best investors and behavioral finance experts flounder. If mere awareness that our judgment is clouded by our nature does little to correct the errors we make, how then can we protect against them?

So then, what can we do about it?

Use a Statistical Approach: Focus on Simple & Effective Techniques

Carlisle offers a solution to this behavioral bias dilemma: Remove yourself from the equation.

You can accomplish this by using a statistical based approach. Ben Graham found that the best investment approach is one that follows simple and effective techniques.

Tobias covers three value investing formulas in Deep Value which follow simple and effective techniques. They are:

Net-Nets by Ben Graham (http://www.libertyinvesting.com/benjamin-grahams-checklist/)
The Magic Formula by Joel Greenblatt (www.magicformulainvesting.com)
The Acquirer’s Multiple by Tobias Carlisle (http://acquirersmultiple.com/)

Net-Nets are excellent when you find them, but they are heavily exploited, illiquid, and there’s a limited opportunity set. Meaning that you can’t grow the strategy beyond a certain size.

The Magic Formula attempted to derive Buffett’s investment strategy down into two elements, and has had great results.

Quality of Business: ROIC = EBIT/(net working capital + net fixed assets).
Attractive Price: Earnings Yield/Enterprise Value

The Acquirer’s Multiple, developed by Carlisle, is an evolution of the Magic Formula. Carlisle finds that the Quality of Business element in the formula only serves to detract from overall returns. He finds that the formula can simply be boiled down to “Attractive Price”, as defined as (Enterprise Value/Operating Earnings).

Stay Out of the Way

After Choosing your statistical approach, you may be tempted to alter the results using your subjective judgment, but this should be avoided.

Carlisle demonstrates that the returns of the model are a ceiling from which we detract. Not a base from which we add. The reason being twofold:

We are largely over-confident in our abilities.
We find more broken legs than there really are.

In a sense, we want to de-correlate our thinking from that of the markets. But when we introduce our subjective judgment, we begin using more intuition and thereby increase our correlation with the market. Thus reducing returns.

Summary

The Deep Value strategy can be summarized in four steps:

Create a simple & effective statistical model using counter-intuitive value investing insights, including mean-reversion.
Remember, you are investing based on an expected group outcome, so don’t over-concentrate your portfolio in any one stock.
Expand your time horizon to 3-5+ years.
Recognize your limitations, and, for the most part, stay out of the way.

Despite many findings that demonstrate the soundness and relatively safe nature of a value portfolio, investment professionals largely shun value stocks. The reason for their reluctance is largely centered around self-preservation.

Managers must defend their investments to clients who are usually emotional, impatient, and unsophisticated. So if a manager invests in a group of poor companies which are undervalued, he’ll likely have to answer to his clients who see those investments as risky and imprudent. Especially if there’s any prolonged period of underperformance.

On the other hand, it is much easier for a manager to appear prudent by simply investing in a portfolio of slightly overvalued glamour stocks that look safe. Since the portfolio looks safe, clients will sleep well at night under the belief that the manager is acting prudently. The manager too will sleep well because he has less stress and greater job security. So be aware, appearances of prudence can be deceiving.

I recently came across an interview with Walter Schloss, the late great value investor, who gave an example of such a dilemma that he faced;

“People have certain emotions, and they wanted to not lose money. So we didn’t tell people what we owned, and one guy said, ‘You know Walter, I can’t stand it not knowing what we own.’ He was an old man, so I said, ‘Well we own some bankrupt bonds of the Pennsylvania Railroad.’ Which actually turned out very well later, and he said, ‘I can’t be in your partnership knowing that, it makes me too upset.’ So he withdrew. So people act emotionally, and if they know what you own, then they look at it and say, ‘Oh I don’t like that stock.’ Then they call you on the phone and say, ‘Well why do you own it?’ I don’t want to hear people complaining. They trusted me with their money, and that’s what a lot of hedge funds do, they don’t disclose what they own.”