April 11, 2007
Notes to the excellent book, "The Money Game" by Adam Smith.
I recently read 1976 edition of "The Money Game," by Adam Smith. For me, this was a fantastic book and a very enjoyable read. Adam Smith was the pen name for Harvard and Oxford trained, George J. W. Goodman. You can read about George Goodman at this link http://en.wikipedia.org:80/wiki/George_Goodman . I forget which of Warren Buffett's letters suggested reading this book. Buffett's old letters can be accessed here http://rbcpa.com/WEB_letters/WEB_Letters_pre_berkshire.html Very often I write these notes as a future reminder to me for what I found interesting, or perhaps items I would like to save for future reference. These notes could be error filled, and I apologize for any inadvertent errors. Although George Goodman allegedly wrote this book, I refer to him as "Smith" in my notes. Throughout this paper you will see a slew of quotes from the book. Please keep in mind that all of the plagiarisms from the book, are indicated as such with "quote marks."
1. "The market motion is more violent, not really conducive to serenity, and yet, as one wise investment counselor says, the end object of investment ought to be serenity."
2. "The first thing you have to know is yourself. A man who knows himself can step outside himself and watch his own reactions like an observer."
3. This quote appears in Chapter 2, "Mister Johnson's reading list." I am not certain if Smith was a believer of this concept or not. Perhaps it is total sarcasm, but I did enjoy the quote. "The market is a crowd, and if you've read Gustave Le Bon's "The Crowd" you know a crowd is a composite personality. In fact, a crowd of men acts like a single woman. The mind of a crowd is like a woman's mind. Then if you observed her for a long time, you begin to see little tricks little nervous movements of the hands when she is being false."
4. "What is it the good managers have? It's a kind of locked-in concentration, an intuition, a feel, nothing that can't be schooled. The first thing you have to know is yourself."
5. Throughout the book he sarcastically refers to the term "Australopithecus." According to Wikipedia, Australopithecus, "are a group of extinct hominids that are closely related to humans." "The brains of most species of Australopithecus were roughly 35% of the size of that of a modern human brain." http://en.wikipedia.org/wiki/Australopithecus I think he is relating to human behavior patterns that were inherited from our former human ancestors. I believe that Smith finds it important to observe and try to understand various behavior patterns. Once again referring to knowing yourself. Here is a section I previously wrote on this and how knowing ones self relates to my life. http://www.rbcpa.com/2006_09_14.html "I have studied Marty Whitman, Martin Zweig, James Rogers and countless others over the years. They have a common theme of always being concerned. Marty calls it, “always run scared.” As I get older, I need to never lose sight of that. Anyone who knows me, understands that I am always concerned or contingency planning. I am like that in sports, entertainment and business. That is my make-up. I mention that because, as I was preparing for this conference, I realized, I do not want my constant concern to ever be numbed because of things usually working out. Things have worked out because of my “concern.” Hence, I find it important to stay focused, unbiased, alert and open minded. I will always verify and exercise doubt. That is I. I know “thyself.” Of course, my family, friends and such often will get insulted, when they hear my often repeated phrase, “Are you sure?”
6. "Generally - but not always - a real sleuth of an analyst who doesn't have to spend time answering his own phone, talking to customers, selling stock to pension funds, and attending meetings, can crack an income statement and balance sheet in a couple of days. This means real donkey work, digging out notes, making comparisons, finding the tunnels, and in general unpainting the carefully painted picture. But most analysts do have to answer their own phones, sell stocks, attend meetings and still cover all the developments in their areas. So there are not many analysts who can do their job." I enjoyed that quote, as I spend most of my days researching and digging. I realize that if I was out selling and generating business, our firm would have higher current revenues. Yet, if I were to canvas for new clients with any frequency, my investment analysis skills would certainly suffer.
7. In Chapter 13, "But What Do the Numbers Mean,?" Smith discusses his "lingering skepticism of reported numbers." He discusses, "A leading Wall Street publication says the letters CPA do not stand for Certified Public Accountant but Certified Public Assassin." He then discusses an issue which I find quite interesting. He discusses a "conglomerate."
I find it most interesting because as I read the following paragraphs, I wonder if Buffett knew he was in the process of developing a conglomerate when he wrote his book recommendation of "The Money Game." Notice how the paragraph mentions an Ice-Cream freezer company, and merge it with a valve company. "If the profit numbers on income statements are treated with such reverence, it was obviously only a question of time before some smart fellows would start building companies not around the logical progression of a business but around what would beef up the numbers."
"Such a corporation is called a "conglomerate" or a "free-form" company, very popular when the market gets to tulip-time. A conglomerate is a company that grows by acquiring other companies, and other companies can be in wildly different businesses. Conglomerate managers are supposed to be a new breed of brilliant wheeler-dealers, and the idea of the whole game is to take an ice-cream freezer company and merge it into a valve company and merge with a flour mill. The valves and the flour and the ice cream never get together except on a balance sheet and an income statement, but Wall Street does look for growing earnings, and with the right accountant this whole process can make the earnings grow like crazy. Capitalism enters a new stage."
Any reader of our site knows how much I admire and study Warren Buffett. http://rbcpa.com/WEB.html I take the advice of Charles Munger http://rbcpa.com/Munger.html (Warren's life long business partner and the reincarnated Ben Franklin) and use his advice of "invert, always invert." How do I invert with Warren? That is so difficult. I trust him a great deal, I do my best to live by his words, and I think he is such a fantastic role model for me. Yet, I am always reminded of the quotes I have heard Bruce Springsteen say. One being, "trust the art, not the artist." and the other, "never have blind faith." As an analyzer of financial statements, I realize that Berkshire Hathaway is not transparent in her operations. We know the alleged Stockholder's Equity, the cash balances, etc. We do not know the inner workings of the wholly owned companies. We don't know the inventory turns of the retailers. We don't know the quality of earnings and cash flows of the manufacturers. We have to trust them, and hope that the unblemished record of Warren's 70+ years, remains intact. I am often reminded of the Wizard behind the curtain in "The Wizard of Oz." Here is one interesting question I had this year in regards to Berkshire. During 2007, I believe that potential Buffett replacement, Tony Nicely said referring to Wholly owned Berkshire subsidiary, Clayton Homes, "The company built 125,000 homes throughout the country in 2006, Nicely said, with Tennessee ranking among the top 10 for sales." It is my understanding that the entire industry shipped 117,510 homes in 2006. I wonder and have never found out, how did Clayton produce more homes than the entire industry built. There are many possible responses to that question. One could be, that Nicely is from Geico and was either misquoted, or he himself erred in the quote. Another possibility is that Clayton is experiencing excess inventory. Anyway, that is just some of the thoughts that I have as I review Berkshire.
As of this writing Berkshire remains one of our largest holdings. I was immediately reminded of Berkshire when I read the paragraphs in the book. This entire summary is becoming longer than I originally expected, please feel free to take a Kool-Aid break.
8. I loved the following section as Smith discusses a salesperson for the "Tadpole Fund." He writes, "Now I know full well that this salesman was dressed in a nice Brooks Brothers suit, with a vest, but such is the power of memory and experience that when I think of him now I see him as Professor Harold Hill, the Music Man ( http://www.imdb.com/title/tt0056262/ ) , dressed in a striped blazer and a straw hat and white spats. If you are sitting behind the desk, you do not have to ask the salesman, "Well, what are you hawking today?" You say, "What is the concept?" and you make a little teepee with your fingers to show you are not easily impressed. If you really want to make the salesperson uneasy you keep making your big toe go in a square while he talks. But Harold Hill was undaunted."
Smith goes onto describe that he totally fell for the sales pitch, was taken in, and eventually that error ended up haunting him. Hence, I remind myself to avoid blind faith, and to constantly invert.
9. Very Important section for me!!!! "It is a sobering experience to read through - as I once did - all the Wall Street Journals and Barron's from 1929 to 1933." Why is that so important for me? Because I spend a bit of time in the Library doing the same thing. I search to see if I could find similarities in today's environment of deemed prosperity and clues of how that could end. Please try to read and remember the next sections of this paragraph. "Quarterly reports came out saying, "the outlook is favorable, a sustained recovery is on its way," and so on. But nobody is listening. Those on margin had been sold out in 1929 and 1930. But from 1930 to 1933, a real blight of the spirit took place. The Prudent Men, not on margin, believing in the Long-Term Growth of the American Economy, saw their unmargined holdings in the bluest of American blue chips drop by 80 to 90 percent." "It was the psychology of panic." "It was mob psychology, and it was not, primarily, that the price level of the market was unsoundly high....the fall in the market was very largely due to the psychology by which it went down because it went down."
10. I like the way he described the lack of logic in short term investing. "Logic, to an outsider, would say that you have a company selling at 10 and you go and do a lot of research on it and figure out the sales and the profits and you figure if they can earn one dollar it will sell for 20. So you buy it and wait, and the story gets that they earn the one dollar and it goes to 20."
"But the market does not follow logic, it follows some mysterious tides of mass psychology. Thus earnings projections get marked up and down as the prices go up and down, just because Wall Streeters hate the insecurity of anarchy. If the stock is going down, the earnings must be falling apart. If it is going up, the earnings must be better than we thought. Somebody must know something that we don't know."
I am reminded of this section http://www.rbcpa.com/2006_09_14.html , where I wrote, "Arnold Van Den Berg said in the most recent issue of Outstanding Investors Digest (8/30/06) the following about buying value stocks. "You never feel good about buying a great bargain. When you buy a great bargain, you're doing it with sweaty palms, you’re leaning against the crowd, engaging in contrary thinking, and you're pretty much alone."
Crowds are a frequent discussion of mine. Here are a few examples:
A. "Fight the crowd." I think what Klarman is saying is that it is warm and fuzzy in the middle of crowds. You do not need to be warm and fuzzy with investing." That was in reference to Seth Klarman discussing crowds in "Margin of Safety." http://rbcpa.com/2006_05_03.html
B. John Templeton mentioned, "My job was being paid by wealthy families to help them choose stocks and bonds. And my results were much better when I was working from here than from Manhattan, Radio City and Rockefeller Center. I had good results in New York. But when I came here, I had better results. The secret, I think, is that in order to buy stocks at a bargain price, you have to do the opposite of the crowd. When you're going to the same meetings with the other people in Manhattan, it's hard to be different."
C. Marty Zweig notes, ( http://www.rbcpa.com/Notes_to_Winning_On_WallStreet.html ) Zweig discusses when to part company with the crowd. He states, "The crowd tends to follow the wrong signs near the market tops and bottoms." He discusses that at the greatest depths of a bear market, the economy is generally in recession and business profits are tumbling. Investors are punch drunk from suffering huge losses for a year or two of falling prices. Bad news dominates the headlines. Most people only see the downtrend continuing. This is the gloom and doom that bear markets bottom and bull markets begin. Watch for loosening credit and interest rate decreases. I guess one could argue that as of this date (1/11/05), that we are seeing the opposite.
D. Buffett discussed avoiding the crowd at this link http://www.rbcpa.com/WEB20050606.html "There is no doubt that there are far more "investment professionals" and way more IQ in the field, as it didn't use to look that promising. Investment data are available more conveniently and faster today. But the behavior of investors will not be more intelligent than in the past, despite all this. How people react will not change – their psychological makeup stays constant. You need to divorce your mind from the crowd. The herd mentality causes all these IQ's to become paralyzed. I don't think investors are now acting more intelligently, despite the intelligence. Smart doesn't always equal rational. To be a successful investor you must divorce yourself from the fears and greed of the people around you, although it is almost impossible."
E. Phil Fisher discussed crowds at this link http://www.rbcpa.com/What_we_can_learn.html "Nor will I buy market-favored stocks. I particularly notice it when I attend meetings for technology stocks and see all the people crowding into the room and so on. If there's standing room only, that's usually a pretty fair sign it's not a good time to buy the stock."
11. I found it interesting to see Smith discuss Gold in Chapter 19, "My Friend the Gnome of Zurich Says a Major Money Crisis is on its Way." He writes, "The gold-bugs have been around forever. The market still has gas. Who understands gold, anyway? And how can you worry about something you can't understand.?" I eliminated our 13 year precious metals position during 2005. It bothered me, that I couldn't figure out the reason it was a "safe haven" or "money substitute". I think Buffett said he grew up with gold, his dad loved gold, but he never understood it.
In chapter 20, Smith referred to silver. Keep in mind this book was written in 1966 (41 years ago). Yet, the comment sounds so similar to what I have heard about silver for the last 2 decades. He wrote this in what I interpret as a very sarcastic fashion. "And in India they don't have bank accounts; they wear three ounces of silver on each wrist. When the price goes up, off comes the silver. That's eight hundred million wrists, and I haven't started talking about Mexico."
In one section of the book, he hinted at Gold companies with sarcasm. He explained how their greatness was evident by the fact several of the companies were presenters at the New York Society of Security Analysts. I am a member of NYSSA, and they are a fantastic organization. They have industry conferences throughout the year, and various companies will present at these conferences. I don't think that presenting at these conferences lends any credence to the greatness of a company or an industry, yet some might incorrectly interpret a presentation at such an event, to be equivalent to a "buy signal" of a company. Throughout the book Smith discussed how these types of conferences could also be indicative of "follow the crowd" principles. I attend these conferences fairly frequently. I do not attend for ideas, but really to get a pulse of the industry. I have not attended NYSSA's annual Mining Conference.
12. "Markets are only a tiny facet of society, but being made by mass psychology, they are a good litmus paper for what is going on. Markets only work when they believe, and this confidence is based on the idea that men can mange their affairs rationally." Smith discussed that markets in order to survive, must be based on the belief that leadership knows what they are doing and that they are rational. "If that belief fades, then so do the markets. They do not merely dive, they dive and then they disappear. It happened here in the blight of the spirit from 1930 - 1933, and it happened in other countries." My concern of the markets, has been the terrible misuse of corporate fiduciary responsibility. This responsibility extends to shareholders, the environment and the employees of such corporations. The same fiduciary responsibility is required by our Government. Anyway, I found Smith's comment to be extremely relevant in our current environment.
13. He discussed his admiration of John Maynard Keynes http://en.wikipedia.org/wiki/John_Maynard_Keynes . " He is the master because he started with nothing, set out to become rich, did so, part time, from his bed, as a player in the Game, and having become rich, had some thoughts that must be integral to any study of the Game." He mentioned two of Keynes' works. One being "General Theory of Employment Interest and Money" the other being "Essays in Persuasion." As I wrote this, I journeyed to my bookshelf, and saw I have neither of these books. I hope to remember to read them. I really enjoyed the mention of his disdain of inside information. Smith discussed an admirer of Keynes, named Robert Heilbroner http://en.wikipedia.org/wiki/Robert_Heilbroner .
Smith quoted Heilbroner as follows: "He was a pillar of stability in delicate matters of international diplomacy, but his official correctness did not prevent him from acquiring knowledge of other European politicians that included their mistresses, neuroses and financial prejudices. he collected modern art long before it was fashionable to do so, but at the same time he was a classicist with the finest private collection of Newton's writings in the world. He ran a theater, and he came to be a director of the Bank of England. He knew Roosevelt and Churchill and also Bernard Shaw and Pablo Picasso. He played bridge like a speculator, preferring a spectacular play to a sound contract, and solitaire like a statistician, noting how long it took for the game to come out twice running. And he once claimed that he had but one regret in life - he wished he had drunk more champagne." I enjoyed the champagne comment a great deal. I often joke with my kids, telling them one day I might say my biggest regret in life, was spending too much time with my children. I say that in total jest, and I am so thankful that I have spent so much time with them as they are now 14, 12 and 8. I know how fast time goes, and I feel so blessed that I have the good fortune of hanging with them a great deal, and enjoying these times with great vigor and love. I am also reminded of my 2006 resolutions on our website, where I mentioned one goal of mine was to increase my beer intake. I failed that goal in 2006, and was also politely requested to remove that section from our website. :-)
Thank you for reading my notes of this wonderful book. Please feel free to email me any comments at email@example.com
Ronald R. Redfield CPA,PFS