The Winning Investment Habits of Warren Buffett & George Soros

He said there were only three times to sell a stock. The first was when you found you’d made a mistake, and the company didn’t meet the criteria after all. The second time was when the company ceased to meet the criteria: for example, a less able management assumed control; or, the company had grown so big it could no longer grow faster than the industry as a whole. And the third was when you came across a fantastic opportunity and the only way you could buy it was to sell something first

To Soros, our distorted perceptions are a factor in shaping events. As he puts it, “what beliefs do is alter facts”57 in a process he calls reflexivity, which he outlined in his book The Alchemy of Finance

That sends stocks up further, making investors even wealthier, so they spend even more. And so on it goes. This is what Soros calls a “reflexive process” — a feedback loop: a change in stock prices has caused a change in company fundamentals which, in turn, justifies a further rise in stock prices. And so on.

You have no doubt heard of this particular reflexive process. Academics have written about it; even the Federal Reserve has issued a paper on it. It’s known as “The Wealth Effect.”

Reflexivity is a feedback loop: perceptions change facts; and facts change perceptions. As happened when the Thai baht collapsed in 1997.

In July 1997 the Central Bank of Thailand let its currency float. The bank expected a devaluation of around 20%; but by December the baht collapsed from 26 to the US dollar to over 50, a fall of more than 50%.

The bank had figured out that the baht was “really worth” around 32 to the dollar. Which it may well have been according to the theoretical models of currency valuation. What the bank failed to take into account was that floating the baht set in motion a self-reinforcing process of reflexivity that sent the currency into free-fall.

Thailand was one of the “Asian Tigers,” a country that was developing rapidly and was seen to be following in Japan’s footsteps. Fixed by the government to the US dollar, the Thai baht was considered a stable currency. So international bankers were happy to lend Thai companies billions of US dollars. And the Thais were happy to borrow them because US dollar interest rates were lower.

When the currency collapsed, the value of the US dollar debts companies had to repay suddenly exploded…when measured in baht. The fundamentals had changed.

Seeing this investors dumped their Thai stocks. As they exited, foreigners converted their baht into dollars and took them home. The baht crumbled some more. More and more Thai companies looked like they would never be able to repay their debts. Both Thais and foreigners kept selling.

Thai companies cut back and sacked workers. Unemployment skyrocketed; workers had less to spend — and those who still had money to spend held onto it from fear of uncertainty. The Thai economy tanked…and the outlook for many large Thai companies, even those with no significant dollar debts, began to look more and more precarious.

As the baht fell, the Thai economy imploded — and the baht fell some more. A change in market prices had caused a change in market prices.

It was my first lesson in what later was to become part of my basic investment philosophy: reading the printed financial records about a company is never enough to justify an investment. One of the major steps in prudent investment must be to find out about a company’s affairs from those who have some direct familiarity with them.48

Philip Fisher, who wrote Common Stocks and Uncommon Profits

They must have a decided edge on their competition by being the lowest-cost producer in the industry, and/or have superior production, financial, research and marketing skills.
They must have outstanding management, which he saw as the underlying cause of outstanding results.
The economic characteristics of the business must all but ensure that the company’s current above-industry-average profits, return on assets, profit margin, and growth of sales will continue for an extended period of time.
The price must be attractive.
How did Fisher do it?

By talking to people.

Of course, a lot can be discovered from annual reports and other available company information. Mostly they will tell you which companies to avoid.

One of Fisher’s favorite sources of information was what he called “scuttlebutt”: what people were saying about the company and its products. He would talk to people who dealt with the company — customers, consumers and suppliers; to former employees; and, especially, to competitors. An executive may be reluctant to give you too much detail about his own company. But he’ll happily tell you everything he knows about his competition.

Benjamin Graham’s book, The Intelligent Investor

Don’t invest.
Reduce risk (the key to Warren Buffett’s approach).
Actively manage risk (the strategy George Soros uses so astoundingly well).
Manage risk actuarially.
There’s a fifth risk-avoidance strategy that’s highly recommended by the majority of investment advisors: diversification. But to Master Investors, diversification is for the birds (see Chapter 7).

No successful investor restricts himself to just one of these four risk-avoidance strategies. Some — like Soros — use them all

Four elements are needed to sustain a mental habit:

a belief that drives your behavior;
a mental strategy — a series of internal conscious and subconscious processes;
a sustaining emotion; and
associated skills