• 052 08/23/2016 What Is the Best Textbook on Investing?

    Investing is unusual in that the greatest enjoy writing about their profession. I would skip the textbooks and read the investor letters, memos and books that these individuals write.

    Start with Joel Greenblatt: Not only is he excellent at outperforming the market - he managed an annualized return of 50% over the course of a decade at Gotham Capital - he also has an unusual sense of humor. I like to think it's why the cover of one of his books is covered in $100 bills and that perhaps he named his fund, Gotham Capital, in homage to Batman.

    The Little Book That Still Beats the Market - this book introduces Joel Greenblatt’s “magic formula” for investing. Whether you want to take this approach or not, the book does an excellent job explaining what he believes are the most important metrics: earnings yield and return on capital. This is described in an incredibly simple and insightful way.

    I would actually follow with another of Greenblatt’s books: You Can Be a Stock Market Genius - ignore the cheesy title and book cover, this is a brilliant text. It does an incredible job explaining the advantage of the individual over Wall Street professionals, and it does so with simple language. Consider his comments on concentrated investing:

    Statistics say that owning just two stocks eliminates 46 percent of the nonmarket risk of owning just one stock. This type of risk is supposedly reduced by 72 percent with a four-stock portfolio, by 81 percent with eight stocks, 93 percent with 16 stocks, 96 percent with 32 stocks, and 99 percent with 500 stocks. Without quibbling over the accuracy of these particular statistics, two things should be remembered:

    1. After purchasing six or eight stocks in different industries, the benefit of adding even more stocks to your portfolio in an effort to decrease risk is small, and

    2. Overall market risk will not be eliminated merely by adding more stocks to your portfolio.

    After that I would move on to Howard Marks’ book The Most Important Thing Illuminated. The book is annotated by some of the greatest investors including Christopher Davis, Joel Greenblatt, Paul Johnson and Seth Klarman, which makes it truly unique. Marks also does an excellent job of explaining difficult concepts in simple terms, and uses a lot of anecdotal or historical references that make the text enjoyable.

    Also, read his memos: Memos from Howard Marks

    Next, I would pick up The Little Book of Valuation by Aswath Damodaran (professor and investor). This will permit diving a little deeper into the math (not that it’s complicated). In fact, Damodaran writes in his introduction:

    I believe that valuation, at its core, is simple, and anyone who is willing to spend time collecting and analyzing information can do it. I show you how in this book.

    And in the first chapter:

    “When valuing an asset, use the simplest model you can. If you can value an asset with three inputs, don’t use five. If you can value a company with three years of forecasts, forecasting 10 years of cash flows is asking for trouble. Less is more.”

    After that the book dives right in with time value of money, acct 101, multiples and specific examples. (Don’t let the title fool you, the book contains an incredible amount of information).

    Also, check out his blog: Musings on Markets

    Finally, I have to recommend Irrational Exuberance - it is one of my favorite books on markets. The intro describes it well “this book is really about the behavior of all speculative markets, about human vulnerability to error, and about the instabilities of the capitalist system.” Written by Robert Shiller, this text is a little more dense, but it is brilliant.

    The amazing thing about all of these texts is that they are pretty easy to read. If this subject genuinely interests you, it should not be difficult to work through these.

    Additional writers / resources worth following:

    Charlie Munger - Anything he writes is worth reading.

    Berkshire Hathaway Annual Reports - http://www.berkshirehathaway.com...

    Michael Mauboussin - Reflections on the Ten Attributes of Great Investors (recent example)

    John C Bogle - Founder and retired CEO of Vanguard - http://johncbogle.com/wordpress/...

    Barron’s often publishes great interviews that offer a lot of insight as well.

    And if you’re willing to commit to dense material:

    Security Analysis by Benjamin Graham and David Dodd or The Intelligent Investor by Benjamin Graham

    And Valuation

    Note: Originally answered on Quora.


  • 051 08/04/2016

    Context: I recently received a message from a subscriber asking if I could explain the CAGR formula. He said that he had used it in one of his models, and when he looked it up online there was no explanation for the math. His response: “Welp, if you say so formula…” So I thought I would take a moment to explain the formula.

    Q: Do you have an explanation for the CAGR formula?

    CAGR Formula

    A: First, for the unfamiliar, let’s define the Compound Annual Growth Rate (CAGR). CAGR is a simple metric that measures the average rate of growth of a sum, be that a figure like sales or an investment, over any number of periods. It’s easy to picture visually:


    CAGR Growth Comparison


    In Example 1 above, a $1.00 investment grows by 20% for three years to a value of $1.73. The CAGR is 20%. Now, as you can see in Example 2, even if the growth each year is uneven, because the CAGR formula uses only the ending and beginning values to calculate average growth, the result will be the same. 

    With the definition out of the way we can move on to understanding the formula, and for that purpose I have developed the visual that follows:


    CAGR Formula Explained

    Click here to download the Excel file


  • 050 07/28/2016

    We are in the process of developing the next collection of videos and models for the Leveraged Buyout Model series. This new collection will cover the following topics:

    1. Transitioning from one worksheet to multiple worksheets.

    2. Adding preferred stock to the capital structure.

    3. Adding a cash flow sweep that will pay down all tranches of debt and preferred stock.

    The videos and financial models for items one and two are already up; only the notes for these two topics are pending. I have been receiving a lot of requests the third model listed, but do not yet have the video prepared. As an interim solution I thought I would post the Excel file here while I work on the video.


    To help guide you through the process of adding a cash flow sweep, rows altered for this update are indicated in Column A of every worksheet with pale purple shading (see image below).

    LBO Cash Sweep

    The purpose of this installment is to transition from a model that uses excess cash to pay down the revolver, to a model that will use excess cash to pay down all debt liabilities and preferred stock. It does not, however, permit specifying the percentage of excess cash flow that should be used to make optional repayments. If you want to maintain a certain amount of cash you can do that in this model by specifying the minimum cash balance.

    As always, all models on this website are intended for educational purposes only.



Models are:
A) really boring
B) pretty sweet
C) super important
D) somewhat easy
E) kind of hard
F) fun
G) all of the above



*Answers a, b, c, d, e, f and g are all correct.