May 4, 2013
The author, John Train, is probably best known for his other book Money Masters of Our Time, which analyzes the investment strategies of successful investors such as Warren Buffett, Paul Cabot, Philip Fisher, George Soros and many others. In The Craft of Investing, Train discusses how to generate and build capital over your lifetime and how to pass it on to your heirs. Fundamentally, the book explains in an entertaining and well written manner that all successful investing requires an investor to be able to successfully buy companies in the market for less than their true value. Although the idea is not new, the author does a good job of explaining how to implement a value oriented strategy across asset classes and geographies.
The book provides an excellent overview of the basic tenets of value investing, which can be summarized as follows:
- Focus on intrinsic value and only purchasing securities that have a margin of safety
- Understand and profit from the business cycle
- All great investors are contrarians
- Focus on avoiding permanent losses
- Truly great investment ideas are rare, resulting in portfolios with fewer but larger positions
One unique aspect of the book is the focus on growth investing. Typically, most value investing books treat anything related to growth as anathema. The reality is that unless you’re following a Benjamin Graham “cigar butt” type strategy, where you’re only interested about the liquidation value of a company, you are implicitly assuming future growth when making an investment. I think Train does an excellent job of outlining how growth investing can be profitable and how to approach it with a “value” mindset.
The other unique aspect of the book was the importance Train places on the overall market cycle. In my view, most value investors tend to focus solely on the profitability of individual companies and tend to ignore the broader macro outlook. At times this strategy works well, but I think value investors could enhance their returns by having a better understanding of the overall business cycle, which remains a constant part of all modern capitalistic economies. Train states the following, “you need to get deeply into your bones the sense that any market, and certainly the stock market, moves in cycles, so that you will infallibly get wonderful bargains every few years, and have a chance to sell again at ridiculously high prices a few years later.” I think a lot of investors mistakenly view tracking the business cycle as a form of market timing. I think this view is erroneous. By studying all recessions in the US post World War II, we can see that they all ended after the Fed reduced interest rates and flooded the economy with liquidity. The most recent experience in 2008 was no exception. As a value investor if you understand that the actions of central bankers will eventually result in a recovery you can take aggressive action and purchase high quality companies for a bargain. The key is to not get paralyzed when your computer screen is filled with red as the stock market is tanking.
Another general theme across the entire book is the idea of taking the long view in terms of investment perspective and the creation of wealth. The second half of the book deals in detail about the importance of being good stewards of capital for future generations. I think anyone who takes the long view in life and especially investing will undoubtedly meet with financial success. Thus, there will be a need for you to determine how to best preserve your wealth for the benefit of future generations. I think the most important point that Train highlights in terms of generational wealth is that any inheritance reflects the work, dreams and sacrifices of your ancestors. Thus, you have an obligation to not only preserve this capital but treat it with the respect it deserves.
I think the best anecdote in the book is about a Southern farmer who never lost money in the stock market by following a simple but effective investment strategy. Train explains the strategy as follows:
He explained his technique, which was the ultimate in simplicity. When during a bear market he would read in the papers that the market was down to new lows and the experts were predicting that it was sure to drop hundreds of points more on the Dow, the farmer would look through a Standard & Poor’s Stock Guide and select around 30 stocks that had fallen in price below $10 – solid, profit making, unheard of little companies (pecan growers, home furnishings, etc.) – and paid dividends. He would come to Houston and buy a $50,000 ‘package’ of them. And then, one , two, three or four years later, when the stock market was bubbling, and the prophets were talking about the Dow soaring to new highs, he would come to town and sell his whole package.
The biggest weakness in the book is that it lacks technical details on how to value a stock. I think it does a great job of explaining the mindset an investor must have but fails to explain the actual process of valuation. Fortunately, there are a number of other excellent books in the value investing cannon that go into significant detail about the vagaries of equity valuation. However, I think anyone interested in an entertaining overview of value investing and how it can help generate and grow capital over generations should read this book. I think The Craft of Investing is a good book for anyone starting out in investing and in need of a philosophical guide. Professional investors may not get much out of the book, but will still find the stories in the book reaffirming and entertaining. I think it’s a good place to start for those investors just beginning their journey along the path of value investing.