Net net investing is a negative art

In Security Analysis Graham writes:

Since the chief emphasis must be placed on avoidance of loss, bond selection is primarily a negative art. It is a process of exclusion and rejection, rather than of search and acceptance

My view of net-nets is similar to Graham’s view of bonds. The net-net investor, presuming he has screened out non-net nets, has already extracted the primary positive signal of good returns, namely low NCAV relative to market cap. Other qualities typically associated with good stocks: dividend, continuous record of positive earnings have not been shown to improve net-net returns.

And so the art of the net-net investor is primarily a negative one. What he should be doing is trying to avoid scams and companies that are not “real” companies. His process is one of exclusion.

Geoff Gannon has an excellent article on this which explains the general sort of things in investor should be on the look out for:

In my process there are a few practical guidelines I have found. In general you should avoid:

1) All Chinese reverse mergers and avoid HK listed stocks. Avoid all companies domiciled in China or with operations primarily in China

2) Companies having an abnormally large number of subsidiaries. See here for examples.

3) Companies which have increase share outstanding by more than 10% in the last 12 months

4) Companies that are looking to raise more capital either in the form of debt or equity

5) Companies which have gone or are in the process of going dark

6) Companies which discuss how they are trying to satisfy creditors in their financial statements.

7) Companies who shares have been suspended from trading or are being investigated by a regulator like the SEC.

Basically with net-nets the story should be that the company is boring, out of favor, has ample liquid assets, low debt and is deeply undervalued. Anything that contradicts this story, e.g. large share issuance, should be a red flag.

What I am attempting to do with the criteria above is avoid scammers. Some of the rules above sound overbroad and arbitrary e.g. Avoid all Chinese companies. But my reason for making them is sound. In practice, the vast majority of net-nets domiciled in China are scams and so you don’t lose a great deal by excluding the whole country.

Similarly there are dark companies which make sense as investments but again you are not gaining much by including them while you are eliminating a large number of duds by excluding them. Disclosure: I do have a few dark companies I have invested in based on the blog,

On occasion I will use positive screening criteria as a second pass on my exclusionary criteria and so for example I might invest in a company domiciled in China provided that it issued a dividend. My reasoning here being that a scammer will never give money away. So while I would not use the positive screening criteria under normal circumstances I may use them to include a candidate I would not normally consider. Similar to how a university admission officer may include student with lower SATS if they have other positive qualities like athletic accomplishments.

How I got out of prison

Not a real prison. A metaphorical one.

These days depression is considered an illness. I don’t think of it that way. To me its an adaptive mechanism that is quite common among people because it works. Depression is there to get you to change what you are doing. To come up with something better.

Logically it makes sense. If you are doing the wrong thing the logical thing is to stop whatever you are doing. To think a lot about what is wrong. To feel bad about all of the existing things you are doing and to be a relentless critic. Essentially that is what depression does. It reorients you.

Now I’ve been depressed for a lot of my life. One outstanding thing is that I have always felt like I’m in some sort of a prison from which there is no escape. Like my work, my expectations of life, societies expectations doomed me to being a loser living an unsatisfying life.

This all came to head last year. I had worked hard in a job and done some good work. But I wasn’t rewarded for it. Instead credit was taken from me and I was put in a pretty bad position by my boss. I spent months trying to figure out what I had done wrong. Why had a failed? I kept wracking my brain. I kept hating myself. WTF, had happened…why was I always such a failure?!

Eventually I realized that I had done nothing wrong. That it was never about me. The boss had a plan and I simply wasn’t a part of it.

At this point something remarkable happened. I began for the first time ever to believe in myself. In some way this was the consequence of the depression. I had spent so much time and effort mulling over my mistakes. Yet I was still unable to figure out what I done to cause them. This gave me a very strong confidence that I was right about it not being about me.

That was step 1. Now that I believed in myself I knew I would be ok no matter what happened. So I decided to quit my job and just give myself some time that was just for me. I knew that part of my problem was that I was in a prison and I needed to escape my prison.

What I mean is that I was in a psychological prison. Every person has expectations about the future. And society has expectations. And their friends and family have expectations. You have to have a job. You must get married and have children. You must do something: travel, work….something. Otherwise you are a loser. These expectations are a prison around a person.

I knew I had to escape. I needed to psychologically feel like my life was for me. Not society. Not my parents. Not other people. Me.

That means I needed something in my life that was without external justification. Therefore I quit my job. The excuse I originally gave people was that I was going to work at a startup. But the reality is that for one year I mostly did nothing.

In the beginning I felt like shit. I was depressed. I was concerned that I wasn’t doing anything. My parents were concerned. They knew I wasn’t doing anything. They kept bothering me to meet girls, to get a job. But I refused and I was confident I was right. But still for a long long time I was depressed. It took 6 months to get used to not have a job. And it took the same amount of time for my parent to stop asking me what I was going to do.

I started doing stuff that I enjoyed. Reading science and math books. Exercising. Watching TV.

At this point something remarkable happened…my depression lifted and I was happy. I began searching for a job.

I job searched, in a way I had never done before. Before when I used to job search, I would usually be depressed, desperate and would procrastinate a lot. This time I was pretty calm, cool and enjoyed the process. I didn’t stress. I took things easy. Partly this is because I didn’t feel tremendous pressure to get a job. I have never had a easier time in my life getting a job. Most of what I did was meet people and have conversations. Or maybe email people. The outcome was a job that I barely did anything to get. And the whole thing was easy.

Since then my whole life has gotten easier and I’ve gotten happier. There is this freedom that I now have. The future has all these possibilities. But in the end it all comes down to this one decision to quit my job. A decision that made no sense to anyone. But somehow it was the smartest thing I ever did.

Gurus and Games

The Book of EST, writes about a GURU as someone who hands out problems. I would call a GURU someone who creates a GAME. Thus a boss can be considered a GURU since he creates a GAME, with its own rewards and rules. The real interesting question is why do people follow GURU’s . Why do they play the game. What is in it for them?

Thus Socrates was a Guru who created a GAME called philosophy. Isaac Newton created a game called physics. There are rules to these games. And prizes.

One of the valuable services that a GURU provides is that he organizes people together. His game provides an organization to a large number of people. This can be the case even if the game is at some level is false. For instance, God doesn’t exist so Mohammed is a false prophet. Yet its pretty undeniable to me that he created value for Arabs by organizing them together through the Game we call Islam.

The other interesting phenomenon is that people come to identify and believe in the Game. In a way this isn’t too surprising since the games require large sacrifices of time and energy. Its easier to do this if to some extent you believe in the rules of the game, its values etc.

I’ve explained how games benefit society; they organize people. But beyond that games benefit the people that play. They benefit mentally by providing a sense of purpose. In addition they benefit people materially. Guys who are good Christians marry nice hot sweet Christian girls. They are respected and liked. They gain esteem from the community.

I don’t believe in purpose

I was at my relatives life one day. He’s a born again Christian and he started trying to sell me on the idea of a purpose driven life. His purpose being to glorify God. I remember while he was saying this his daughter was twirling happily and randomly running around, laughing and jumping as children often do. I looked at her and thought to myself: WTF is her purpose? Does her life have value given that its seems a lot of what she did was purposeless fun.

The whole purpose thing is basically a story. People like to craft their lives around some reason that is bigger and larger than them. But my view is that its all made up bullshit. Maybe humans need that made up bullshit.

But I cast my lot with the child whose life has no purpose. Its just a pursuit of random happiness and joy. Beyond that as an adult my life might be devoted to crafting a space for the people I love, the things I enjoy and helping make the world a smidgeon better. And that’s it. But a larger purpose. I don’t want or need it.

I’m Not An Investor

Commenter DYOW, on a Berkshire and Fairfax thread writes:

This applies to concentrated bets.  If you are diversified than i consider this closer to indexing and not investing – then i get it.
But I don’t understand how anyone can call a holding “an investment” and not look at all the filings, and at the least, go through every page of the 10K.

I thought quite a bit about this and I realized I am not an investor in the DYOW sense. And I don’t want to be. I refuse to waste my life holed up in a room reading financial statements. I have much better things to do.

But I have also come to realize that its pretty easy for a small investor to get excellent returns without doing much work. Net-nets are good example of a strategy that is highly effective and yet requires very little time and energy….certainly it does not require reading all disclosures.

In fact its an interesting question as to whether even Buffett himself needed to do the work he did to get the results he obtained. His early years were essentially deep value and in his later years he shifted to quality. I would argue that these asset allocations may have mattered a lot more than the particular stocks he picked.

How scientists come to agree on false facts

Lets say a bunch of different scientists around the world are measuring some factor X. And a bunch of different studies, using different methods come up with similar values. There is the common belief that the result must be right given the agreement between the different methods.

But this idea is false. Scientist can come to agreement even on things even if the fact is false. How does this happen? Lets say the first team to publish, Team T gets a result XT. The next team, Team U, tries their method and lets propose two counterfactual worlds. World A and World B.

In World A when Team U finishes their result is reasonably close to XT. Team U is pretty happy and publishes.

In World B, Team U’s result is very very different than  XT.  Team U is less happy and they therefore recheck the results again and again. They find some legitimate errors in their methods. They are now able to get a result less different than XT but still not in good agreement.

Now Team V enters the picture and when it does the world splits again. Again Team V is pressured to look for mistakes only when their results don’t agree with previously established ones. The more teams publish results the stronger the pressure and bias. Thus a scientific consensus is born.

A real world example of this phenomenon can be seen in a Nasa feature on the measurement of global ocean cooling by Josh Willis:

In 2006, he co-piloted a follow-up study led by John Lyman at Pacific Marine Environmental Laboratory in Seattle that updated the time series for 2003-2005. Surprisingly, the ocean seemed to have cooled

Not surprisingly, says Willis wryly, that paper got a lot of attention, not all of it the kind a scientist would appreciate. In speaking to reporters and the public, Willis described the results as a “speed bump” on the way to global warming,


Basically, I used the sea level data as a bridge to the in situ [ocean-based] data,” explains Willis, comparing them to one another figuring out where they didn’t agree. “First, I identified some new Argo floats that were giving bad data; they were too cool compared to other sources of data during the time period. It wasn’t a large number of floats, but the data were bad enough, so that when I tossed them, most of the cooling went away. But there was still a little bit, so I kept digging and digging.”

What I find amazing about this is that we have a NASA scientist admitting to throwing away data and its a feature on the NASA website. What is interesting about this is that he never bothered investigating the reason for the supposed “bad data”. And notice the one way nature of his corrections…he only threw away data that was “too cool”. And when he didn’t get agreement he kept digging and digging. This better than anything I have ever seen illustrates how scientists come to agreement on things.

Sometimes the ugly way is also the right way

In Episode 1 of Season 2 of Gotham, Bruce Wayne is trying to open a secret key code locked room his father created. He tries various combinations in vain. Finally he realizes that he can just use a bomb to blow the door open. Thus the title of this post:

Sometimes the ugly way is also the right way

As human beings we are used to living in a world of constraints and rules. And often we create these constraints ourselves. The ugly way violates our imposed constraints.

My good friend works at a place he hates. He often works from home because it would take him 2 hours to commute to the workplace. But he is unproductive at home and only does work at the last minute. As a result he is often rushing and sleeping late. This makes him too tired to search for jobs a new job.

He is stuck. He can’t leave his job because he is too tired to search. He can’t move closer to work because he knows he will soon switch jobs. And he doesn’t have the discipline to work from home.

Now I have suggested that he move closer to the job he hates. If only to give him the time he needs to search for a new job. He thinks this is stupid since he will only end up relocating once he finds a better job. He has imposed a set of constraints on himself that make his situation impossible to resolve.

I have found that some of my greatest ideas came to me because I started to questions the constraints I made up. Once I did this a solution was easy.

You get paid to do what other are unable to do

As an investor or for that matter in any situation generally you always get paid more to do what others won’t do. For instance, Michael Jordan got paid because he could play basketball in a way others were not.

Why might they not be doing what you are doing and getting paid more for? It could be because of lack of ability (intelligence, skill). It could be lack of resources (money, time). It could be an institutional constraint (scalability, career risk). It could be an agency problem. It could be for emotional or psychological reasons. It could be because they just don’t want to.

The trick in any situation is to find that area where you are able to take advantage of you ability to do something others can’t do and where you know your going to get paid more for it. Its even better if you suspect that they will never be able to do what you do and therefore the competition will always be limited.

Product over technology

There is this absolutely excellent video of Steve Job dealing with the technology equivalent of a heckler:

Jobs makes this incredibly insightful comment:

“The hardest thing is — how does that fit in to a cohesive larger vision, that’s going to allow you to sell — um — 8 billion dollars, 10 billion dollars of product a year.

And one of the things I’ve always found is that — you’ve got to start with the customer experience and work backwards to the technology. You can’t start with the technology and try to figure out where you’re going to try to sell it. And I’ve made this mistake probably more than anybody else in this room. And I’ve got the scar tissue to prove it. And I know that it’s the case.

And as we have tried to come up with a strategy, and a vision for Apple, um, it started with … what incredible benefits can we give to the customer? Where can we take the customer? Not starting with — let’s sit down with the engineers and figure out what awesome technology we have, and then how are we going to market that. Um … and I think that’s the right path to take.”

Its really quite amazing how often companies are often run in the manner of engineering solutions searching from problems instead of the other way around. Engineers often have the mindset: superior technology should always win. And Engineers also often end up thinking that whoever is the most technologically knowledgeable should essentially make decisions. Incidentally this strategy can work!!….just take a look at Google.

Of course it can also fail…just take a look at Samsung. Now Samsung does have many successes but Samsung should have achieved more. Its failures are largely due to the fact that they have an Engineers mindset. Thus they propose curved screens for cellphones and televisions. Who the fuck asked for curved screens?  No ones.

Samsung phones are filled with stupid features no one asked for. Like the phone detecting where your eyes are and scrolling based on your eyes.

The Engineering mindset has cost Google as well. Google basically invented a lot of cloud technologies, Big Data databases etc. Yet Amazon’s is crushing Google as a Cloud service provider. Why?

Islamism makes no sense

Its doesn’t take a large amount of critical thinking to understand that there are huge problems with Islamism.

Most Islamists believe in two incompatible ideas:

1) that all Muslims should live under Shariah law

2) That Mohammed’s life was perfect and that all Muslims should aspire to live as much like Mohammed as possible. This is why occasionally you will see some Muslim with an orange beard…because its believed Mohammed dyed is hair orange and that dying it black is forbidden.

The reason 1) and 2) are incompatible is simple…there was no Shariah in the time of Mohammed. So you cannot believe 2) while believing 1) since by following Shariah you are doing something that Mohammed was not doing.

To see this perform a thought experiment. Imagine that the closest person in your life believed you were incredible. So they wrote down every single thing you said. Then a religion was formed based on your life. Over hundreds of years numerous scholars debated you words, your ideas. They formed schools of thought, with principles, ideas, concepts and interpreted your life extensively through this theoretical structure. Then they spent hundreds of years codifying this into a set of laws. Finally at the end of this people started following these laws to the letter.

The question I would ask is at the end of this long complicated process, would the people living their lives according to these rules and laws be living a life that in anyway resembled yours?

The answer is of course no. The life of your future adherents would be much more rigid than yours and much less flexible. This is because rules in general tend to be rigid and inflexible. This has nothing to do with the nature of your life and everything to do with the nature of rules. Thus your adherents lives would be dominated by rules which is a different thing than living a life in a similar way to the one you lead or to the ideas you believed in.

Any rule based system has a certain type of structure and certain tendencies. For instance, rule based systems tend to resist exceptions. Exceptions in rule based systems always look ugly. They also resist inconsistencies. You can’t for instance have a rule saying you must not worship idols and another that says you must worship Mary. But a persons life is not like that. One day a person might do one thing and say one thing and the next day something else. If you try to examine this life and extract principles there is no reason that the principles have to be consistent. Thus a rule based structure encourages a logic, consistency and simplicity that simply does not exist in the chaos of the real world. It proposes a system of organization that does not match life.

Modern Muslims have more in common with other very ruled centered religions than they do with the religion Mohammed was preaching. In fact implicit in the very idea of Shariah is that Muslims can be more perfect than Mohammed himself. If I ask the rhetorical question: Why didn’t Mohammed follow Shariah law. The answer would have to be that he didn’t have the benefit of it but that Muslims have now progressed and been able to create a consistent set of rules. Are Islamists, not really saying, through Shariah we can be even more Islamic than Mohammed himself and is this not ridiculous.

A better medium for representing the practice of Islam might be art instead of rules. Stories, parables, fables, aphorisms, sayings, songs etc. Indeed this his how religion used to be transmitted. This is the content of most of the Bible and I believe most of the Koran.

Rules take on a life of their own and this is what has happened in Islam. Islamists are more interested in rules than they are in Islam. Both Islamists and Orthodox Jews should combine their religions together and call themselves rulists since their true God is Rules.