Although I think investing can actually be quite simple once it’s boiled down to the basics, it’s still useful and interesting to build up a mental context or framework that surrounds each of your investment decisions. Reading good books is an integral part of this for most people and it certainly has been for me.
The books below are a partial and ‘under construction’ list of books that I’ve read which have helped build up my mental model of the investing landscape.
Index Funds: The 12-Step Program for Active Investors
If you’re going to pick stocks and be an active investor you should probably know why many Nobel prize winners and professors think you’re wasting your time.
The Intelligent Investor
Most people who get into value investing will at some point read one of the various versions of this classic text. My favourite is this older 1949 edition. If you’re new to Ben Graham then I hope you like his style as for me there has never been a more understated and fact-based investment writer. Ben is constantly at pains to point out the difficulties that are inherent in stock picking and effectively suggests index tracking for all but the most intrepid. As Warren Buffett said, “By far the best book on investing ever written”.
Wall Street Revalued: Imperfect Markets and Inept Central Bankers
In this book Andrew Smithers goes to great lengths to show the empirical data which backs up the idea that markets can be approximately valued and that the price to value ratio is positively correlated to future returns. This means that if you can calculate the market’s value today you have a reasonably useful tool for estimating future returns over the next 1 to 30 years. Smithers values the market using both Tobin’s Q and CAPE (Cyclically Adjusted PE). Both of these tools appear to be highly useful when trying to minimize downside risk while retaining upside potential.
Personally I used this book as the basis for constructing the tactical asset allocation strategy mentioned on this blog.
The New Buffettology
When I first started on this book I thought it would be rubbish, but to my surprise I like it. The prose is breezy and a little bit OTT here and there, but the basic ideas covered in the book are very interesting and were instrumental in getting me to think about large companies that consistently grow earnings and dividends over long periods of time. Although I don’t use their valuation methods, my Defensive Value Investing strategy sits squarely in the same ballpark as this book.
The Little Book That Still Beats the Market
This is a truly great book. Joel Greenblatt (founder of hedge fund Gotham Capital which compounded returns at the somewhat ridiculous rate of approximately 50% between 1985 and 1995) covers investing from keeping under the mattress to following his ‘Magic Formula’ system. Simple to the point of being written for pre-teens, he somehow manages to do this without being patronising. The simple message is that good businesses (those that that can generate high rates of return on invested capital) which are available at low prices (giving a high earnings yield) make sound investments, especially if you diversify sufficiently. The only downside is that his system only looks at current year data and so it can pick up a large amount of junk which just happens to score highly through his formula. All the back testing shows that in the long run this doesn’t matter, but when running a real portfolio the inclusion of a fair degree of junk could be enough to keep an investor from sticking with the system long enough to see the potential rewards.
Seven Sins of Fund Management
(The link is to a PDF download of the booklet)
This approx. 100 page booklet is from James Montier during his time at Dresdner Kleinwort. It’s a great summary of the major pitfalls that pie ahead of us poor hapless humans as we attempt to estimate the intrinsic value of the volatile and uncertain assets otherwise known as equities. If I could only keep one book on the behavioural side of investing I’d say this would be it.
