No. of Recommendations: 11

This is a follow up to RaptorD2's question regarding due diligence. I believe the following passage from an investment manager who was interviewed for the latest Graham & Dodd newsletter at Columbia sums up my view and experience (a lot quicker than me trying to explain it :) (Also ties nicely I believe into rjf53's comments.)

*Generally speaking, we're big believers in the notion that you need to focus early on in the analysis on the major drivers of what's going to make or lose you money in the investment, and avoid the temptation to simply go out and gather a lot of data.*

The reason I say that is not only because it’s a waste of time to do the latter, but in the worst examples, extraneous data are a red herring that can cause a person to draw an incorrect conclusion.

There’s an interesting book written by the CIA for their internal use that talks about this concept. The book can actually be read online for free on the CIA’s website – just Google “CIA intelligence analysis book and you should be able to find it. In it, it describes how the human mind can keep very few concepts in mind at any one time. As an example, the book asks the reader to try to multiply any pair of two-digit numbers in one’s head, say 47 X 63. This is a task that is easy to do with a pen and paper but is tricky to do in one’s head because it’s hard to keep all the pieces of the puzzle at the forefront of one’s mind together at the same time.

In that regard, what I say to the students in my class as a tip, and something that we do around here, is to try and build the model very early in the process. If I ask you to analyze a bond that's trading at 52 cents on the dollar, and let's say it's a company that makes TVs, your first inclination is to read a hundred things about the company and go talk to them and do a bunch of calls and other stuff. That's all important work to do, of course, but I might suggest to you that you should do a little bit of work first, and then you should start to think about what's going to make that price look cheap or expensive. Think about the variables that go into the analysis: sales growth, margins, capex, whether they win or lose a contract, things like that, and then build your valuation model in Excel, and think about what the blue assumption cells are.

Without doing a lot of hard work, you won’t yet have good views about what the right numbers are to plug into your blue assumption cells, but you'll then go out and talk to the company and be able to ask targeted questions that specifically address the blue cells. Over time the model will evolve and become more refined, and you’ll be building on earlier work and making improvements, not just gathering more facts. What I found in my time doing this and going to conferences or sitting in small group meetings, is that a lot of people will have an hour with the CEO and ask about a lot of industry jargon that could only possibly matter if you knew absolutely all there is to know about everything else in the universe, and these were the last few things you didn’t know. But most of the time there's two or three big things that really matter and it makes sense to focus the research effort there...

Link to newsletter: http://www.grahamanddoddsville.net/?p=1631

If you are interested in the CIA book:

https://www.cia.gov/library/center-for-the-study-of-intellig...

Matthew

No. of Recommendations: 1

No. of Recommendations: 1

2961 takes a minute or so.

Dave

No. of Recommendations: 1

*As an example, the book asks the reader to try to multiply any pair of two-digit numbers in one’s head*

I would have picked 10 x 10. Easy. But that's just me.

kelbon

No. of Recommendations: 16

*Also ties nicely I believe into rjf53's comments....*

...There’s an interesting book written by the CIA for their internal use that talks about this concept.

Now you have done it, you've gone and revealed my secret identity.

I guess now I'll need to change my Fool screen name, anyone know if 007 is taken? :<)

*try to multiply any pair of two-digit numbers in one’s head, say 47 X 63. This is a task that is easy to do with a pen and paper but is tricky to do in one’s head because it’s hard to keep all the pieces of the puzzle at the forefront of one’s mind together at the same time. *

A sore subject even to this day.

When I was a kid in elementary school my math teacher (a nun) threatened to fail me if I didn't show my work. Not because my answers were wrong, they weren't, but simply because I didn't show my work.

The problem was I didn't have any work to show, at least of the "carry the two" variety. There was no "work" to show, I saw the answer or at least the pieces that allowed me to get it with out that piece of paper and pen.

I saw that 100 X 63 = 6300, which made it easy to see to see that 50 x 63 = 3150.

I saw that 3 x 63 = 189, which led me to see that when I subtracted it from 3150 the answer was 2961.

It is isn't it? :<)

Point being, I felt she treated me like a cheat instead of encouraging what might be construed as a natural talent. I learned later in Junior College, that they teach tricks like this in Rapid Calc, or so I'm told, I passed out of the subject so I really don't know.

Perhaps this might help to explain why I have a hard time embracing conventional wisdom with investing as well.

Dunno, but to this day I still believe getting the right answer is all that should matter, or in investing parlance.

**Just make money! **

007 (formerly known as B)

No. of Recommendations: 1

rjf53,

*I passed out of the subject so I really don't know.*

I guess that says it all.

No. of Recommendations: 5

47x63 in your head is not hard if you learn "speed math." I used to do this all the time, it's like a parlor trick. Yes, you need to be comfortable with numbers, but if you are, it's simple. I read a "speed math" book when I was a teenager, I don't remember the title, but it showed how to do all sorts of tricks with numbers. For instance:

Instead of 47x63, you multiple 50 x 60. 3000, right? You get the 50 is close to 47 and the 60 is close to the 63, capice? Easy so far.

Now you multiplied too much, so 3 (that's the 50 minus the 47) times 63 is 189. (You can do 3x60=180 then 3x3=9 to get there if you need to.)

Remember all the way, one whole step ago, to the first 3000? OK. Subtract 189 from 3000. Actually, subtract 190 from 3000 = 2810, then add the 1 extra to get to 189, it's 2811. If the "190" flummoxes you, you could subtract 200, then add back 10, then add 1.

But you didn't multiple by 63, you multiplied by 60 way up top, so you have to add another 3x50 (not the 47, because you already accounted for that in the first step.)

2811 + 100 = 2911 + 50 = 2961.

I know it sounds complicated, but when you learn to break down the processes and do it - *and get comfortable with it* - you can amaze your friends. It will not help you get girls, however.

I used to be able to beat someone with a calculator, but only if I made someone name the two numbers and then start mentally - while the other person *began* typing the digits into the keyboard. Of course my brain was more active then, now I'd have to stumble through it.

Anyway, the moral of the story is: find the big, basic parts. Break the problem down. Add up the pieces. Announce the answer. It's sort of like life, only with numbers.

No. of Recommendations: 1

*you can amaze your friends. It will not help you get girls, however.*

Speak for yourself, I married the Homecoming queen. :<)

B (Didn't read the book.)

No. of Recommendations: 1

*Instead of 47x63, you multiple 50 x 60. 3000, right?*

I thought you were then going to say, 50 x 60 is 5 steps away from a perfect square, 55 x 55. For every step away, you have to subtract a consecutive square, so 50 x 60 must be 1....4....9....16....25 less than 55 x 55, so 55 x 55 must have been 3025. Now go three more steps down from 50 x 60 (49 x 61....48 x 62....47 x 63), so we will now need to subtract: 36....49....64. The answer we're looking for is 3025 minus 64, so it's 2961.

Only works for numbers that are pretty close together, and this simple version needs the numbers to be an even number apart, but it works here. Equally useless for impressing girls.

Regards, DTM

No. of Recommendations: 2

47x63= (35^2)+(35/5)+ the Ramanujan-Hardy number, 1729...which is auspicious because it is the lowest number which can be expressed as the sum of 2 different cubes (1,12 and 9,10).

I know nothing else about math, so don't ask.

et :)

No. of Recommendations: 1

Goofy,

47 x 63

I added 441 plus 2520, the actual way it is done....but not the only way.....it took a minute to do it in my head....

Dave

No. of Recommendations: 6

I think for investing the correct answer is that 47x63 is roughly 3,000 and since it's selling for 2,961 then we shouldn't waste any more time on it.

(Unless you're leveraged like LTCM, then buy buy buy!)

No. of Recommendations: 2

*It will not help you get girls, however.*

Math rarely does.

No. of Recommendations: 3

Well I am not sure this thread went the way I had hoped. But to be clear -- the ability to do math in one's head while a good tool to have (even if just to get a date) is **exactly the opposite** of what I was saying.

And whether what I was saying was conventional wisdom -- I will reiterate that using an explicit model is the best way to avoid the screw-ups when trying to do it all in your head. I will leave with a passage from the referenced intelligence book:

*Another significant question concerns the extent to which analysts possess an accurate understanding of their own mental processes. How good is their insight into how they actually weight evidence in making judgments? For each situation to be analyzed, they have an implicit “mental model” consisting of beliefs and assumptions as to which variables are most important and how they are related to each other. If analysts have good insight into their own mental model, they should be able to identify and describe the variables they have considered most important in making judgments.*

There is strong experimental evidence, however, that such self-insight is usually faulty. The expert perceives his or her own judgmental process, including the number of different kinds of information taken into account, as being considerably more complex than is in fact the case. Experts overestimate the importance of factors that have only a minor impact on their judgment and underestimate the extent to which their decisions are based on a few major variables. In short, people’s mental models are simpler than they think, and the analyst is typically unaware not only of which variables should have the greatest influence, but also which variables actually are having the greatest influence.

Thanks

Matthew

No. of Recommendations: 1

*Well I am not sure this thread went the way I had hoped. But to be clear -- the ability to do math in one's head while a good tool to have (even if just to get a date) is exactly the opposite of what I was saying.*

That's why KitKat is so GOOD here. Like herding cats!

http://www.youtube.com/watch?v=Pk7yqlTMvp8

Bob

No. of Recommendations: 1

*But to be clear -- the ability to do math in one's head while a good tool to have (even if just to get a date) is exactly the opposite of what I was saying.*

I was thinking, you could also do 47 x 63 by taking out one of the factors of 63, say the 3 or the 7. For instance, 47 x 21 x 3, the first two are not hard to do in your head, 940 + 47 = 987, the multiply by 3. Using goofy's idea, that would be 3000, less the 3 x 13 that is in excess, giving you 2961.

Or you could do 47 x 9 x 7, again with goofy's method (works well with numbers close to 10, the first part is 470 - 47 = 423, then 423 x 7 is easier to do than 2 digits by 2 digits, essentially 2800 + 140 + 21 = 2961.

Regards, DTM

No. of Recommendations: 1

Just wondering if there are any women on this board? Never mind.

Dave

No. of Recommendations: 2

* Well I am not sure this thread went the way I had hoped.*

Mea culpa :<(

*In short, people’s mental models are simpler than they think, and the analyst is typically unaware not only of which variables should have the greatest influence, but also which variables actually are having the greatest influence.*

For someone who already subscribes to the KISS principle this is kind of scary. (I mean really, how much simpler can I be?) Unfortunately, with regards to investing anyway, in my case I have always known this to be true.

Often times when discussing investing, it is portrayed as a battle between emotions and making rational decisions. While there may be some truth in this, for me at least, this is dead wrong.

What is missing IMO is what I think of as intuition, which is likely influenced by one of the two, maybe both, and goes directly to the "variables" that should vs. do have the greatest influence.

Emotions are actually pretty easy for me to deal with. (At least that's what I tell myself.) Although I probably ride an emotional roller coaster more than most, I get that, and for the most part at least am able to have rules that prevent me from acting on them.

I seldom for example either buy or sell "the news", having learned over time, that in most cases at least, waiting for my emotional response to subside does more good than harm. On a grander scale when things are going badly I may find myself thinking I'm the biggest idiot on the planet, but then I tell, or ask myself, OK, so now that we have determined that, now what?

The rational part is easy for me as well. Whether you take a numbers based approach, or some other approach to build your thesis, it ought to be something you can measure. Being rational isn't a guarantee of being right, but for me at least I can live with the losers if I can honestly tell myself that I was being rational as I went through the selection process.

The intuition thing, is a different animal however. I frequently am nearly overwhelmed by a sense that I should take a course of action but simply can't put my finger on why. By itself I guess you might write that off as emotions, but the thing is that all to often, it ends up being right.

I'm struggling with an example of this right now. My two largest positions are both oil companies. Both are fully de-risked i.e. I have taken my original investment plus some off the table. Usually with situations like this I like to go to a somewhat mechanical approach in deciding issues such as position size and if or when to take money off the table.

An example of this is Mart Resources (MMT.V or Mauxf) where when it hit $1.40 (my cost basis was under $0.50) I was no longer prepared to have so much exposure to an admittedly risky company despite how bullish I may have been on it's future prospects. So I took 25% off the table and now only a few months later I'm pretty much right back where I started from a $ perspective.(Actually higher, the % of portfolio is lower due to other gains) The mechanical part that I referenced is how I intended to approach it going forward. Essentially, and this applies to any big winner I might have,is that once I have fully de-risked a position and based somewhat on my future expectations, I will continue to take money off the table periodically, but will allow the remaining $ exposure to increase vs. what I allowed at my previous sell point. This is really nothing more than a compromise on my part and an acknowledgement that "letting your winners run" is easier said then done, when it dawns on you that a single company blowing up could destroy much of what you have accomplished.

So what's this got to do with intuition? Well at $2.00 Mart isn't quite at the point where I'd sell with the idea of taking profits and allowing the remaining $ invested (after a sale) amount to grow, at $2.25 or so it is getting there and $2.50 it is there.(Absent significant fundamental change) That being said I've had this overwhelming sense that I should do it now that I simply can't explain.

I can explain part of it, at least I think I can. The stock now, if you visit particular message boards, has been overrun with investors proclaiming "Mart is my biggest holding" and comes complete with a newly self appointed Guru, that deservedly or not a lot of investors fawn over. I don't and I doubt I ever will enjoy crowds or Gurus and that alone might normally be the Genesis for my intuition.

My other Company which is Coastal (Cen.TO CENJF) in many ways is almost a mirror image of my experience with Mart (similar gains over a similar timeline, still a good story, fully de-risked and not quite where I see as the optimal time to take more money off the table.) including the same "it's my largest holding" crowd and the exact same Guru.

The problem is, I have zero desire to sell any Coastal shares which kind of shoots a hole into my crowd and Guru explanation for Mart.

I guess you could say I'm having a hard time figuring out the "variables" involved.

I think I'll go finish your book, maybe that will help, although I doubt it. :<)

Thanks for turning me on to it, although I'm only 50 or so pages into it It's already captured my interest.

B

No. of Recommendations: 1

math is too hard for me. I just ask Siri. Takes her a second but she eventually gets there

No. of Recommendations: 1

Mike,

I have bad news for you. About siri, she is dead. And she is not a real woman.

My condolences,

Dave