Tuesday, February 14, 2006

Book Review

Book Review

Every month I will try and discuss briefly the books I read the prior month and how, as a new investor, I found the material to be.

In this review I will briefly discuss the biography of Andrew Carnegie that I read.

What I will not be doing is providing an extensive background on the book itself. You can read standard book reviews at Amazon.com or other places.

What I hope to simply do is describe as briefly as possible what I found relevant or helpful to my goal of investing.

It also should be said that I firmly agree with the likes of Buffet, Munger, & c & c., who state that they read at least five hours a day on a variety of subjects. For me I think the point is that the more data points you can obtain the more successful you might be at selecting and performing analysis of companies to invest in.

With that in mind I will try to select two books a month to review, one will be on investing, the other on some subject which might not be clearly related. Most of my selections will come from recommendations that people like Buffet and Munger have made.

This past month I read a biography of Andrew Carnegie, although this book was not the exact one recommended by Munger, the subject is. As you may be familiar with Carnegie is considered to be the first or one of the first of the “robber barons” or to put it more politely the first “corporate king.” What most people do not realize that after selling what was to become U.S. Steel (X) for which his share was about $350 million, Mr. Carnegie spent the last 15 or so years of his life giving $325 million of it away at his death. P. 538 of the book. To put that into context the book states that in today’s dollars Mr. Carnegie’s $375 million would have been well over $100,000,000,000.00.

Also after reading this book I firmly believe that Mr. Carnegie’s attitude to wealth and giving it away to benefit society as opposed to retaining it within ones family has inspired both Gates and Buffet as well as others.

Now the two most important things I learned from the book with respect to investing reaffirmed two points I had seen mentioned before.

On page 89, 104 and 143 of the book there is a description how Carnegie would create a merger deal or sell bonds and receive stock of the company in lieu of any cash payment for his services. This theme occurs often in the book. Carnegie, unlike many of his partners, never wanted to take cash payments or even overly large dividends. Rather Carnegie continually deferred any realized gain in exchange for larger positions in companies. One because he realized he could make more in the long run and because more stock meant more power. Essentially that is how Carnegie built his wealth (of course the details I have glossed over, I merely cite to the process). Carnegie at every turn simply refused to realize any capital gain and instead accumulated larger and larger stock positions as a means of obtaining future greater wealth and control.

To me this sounds exactly like what Buffet and others believe in. Buffet is often quoted as saying that he is a “buy and hold” investor as in buy and hold forever. Why because I think Buffet agrees with Carnegie, that deferring current gains for future gains is the way you achieve great wealth. Not that achieving wealth is the goal, merely a by product of creating the best business in comparison to others. Carnegie wanted to be the best business man of his time and beat all others, becoming one of the richest was merely a consequence. Buffet also is said to desire to create a lasting monument to his genius; the money is merely the result. The only way they could do this is by reinvesting into those business which they controlled.

And that is the point I learned. Over 100 hundred years ago, the great wealth of Carnegie was earned not by buying and selling but by buying and reinvesting and delaying realized profit. This is similar to what Buffet, once he finds a company he wants to own at the price he wants, he does not sell absent some change in the fundamental nature of the business. In essence, the way to grow your own business (your investment portfolio) is to resist the temptation to take a profit on an increase in price of your investments in the short term in return for the compounding which occurs over time.

The second thing from the book is that Carnegies’ partners did not share his enthusiasm for deferring profits; they wanted money now and did not share Carnegie’s vision as to reinvestment of profits. They are quoted as saying that “Carnegie never wanted to know about the profits, he just wanted to know the costs.” Page 137. Carnegie’s mother taught him at a young age that if you mind the pennies the dollars take care of themselves. P. 24.

The message here is that when investing you should not focus on how much you think the price of a stock will be in the future, that is your profit; rather you should focus on how much you pay for it. That way the profit takes care of its own. If you buy a stock based on what you think it might be worth in 5 or 10 years as opposed to buy a stock at a discount to what it is worth now, then you are deepening on too much of a profit and not on the costs. Carnegie did not worry about how much he could sell steel for; he worried how much he could make it for. Because if he could make it for less than other companies than he knew he could make a profit because if his costs was lower than any one else’s than he could sell it fro less than the other companies cost, still make money, and drive them from the field. Again this is Buffet or more likely Graham (whose book I have read but not yet reviewed) who explains often that you should purchase a good company at a discount or with a margin of safety. In essence if you find a good company that is selling for less than it is worth than you have built in a margin of safety. Even if the stock reverts to its actual value, let alone exceed it, than you have made your money on the cost and not the profit.

So as an individual investor if you are keeping your costs below that of your competitors (other stock buyers) than you will make money because you are not depending on the profit increase because you have locked in a profit. In other words if you buy something that is worth a dollar for a dollar the only way to make money is wait until you convince someone else to give you more than a dollar for what you bought. But if you buy something for less than a dollar, 10, 20, 50% less, when it is actually worth a dollar than you have already made money.

Actually there was a third thing for the book. Carnegie was credited with a mantra that goes “put all good eggs in one basket and watch that basket.” Page 114. Carnegie therefore developed a philosophy contrary to popular wisdom. How often have we heard that we should NOT put all our eggs in one basket as if that was dangerous? Over 100 years ago Carnegie is saying that the true path to unlimited success is to focus your resources into a limited amount of endeavors and then watch those investments like a hawk. This is the same thing that Buffet says as well as other, that too much diversification is a bad thing. If you research stock and it is a great company selling at a discount, why not put a great portion of your capital into it and then watch it. After all is that not what Buffet has done by having virtually all his wealth tied to BRK? Hi eggs are all in one basket which he watches like a hawk. Now this is not to say that everyone should pick just one thing to invest in, it just means that if your idea is sound than putting a lot of money in to it is not risky. The problem does not come about because you have too much money in a few investments; rather the problems come about because the analysis is not done properly before you invest.

Well that is all for now. I see that I have 2 readers. Thanks for reading. If you or anyone else has a comment or a suggestion how I can make my blog more reader friendly or interesting please do not hesitate to comment. My Ernest hope is that I can save a new investor a lot of time trying to figure out what is what.

I hope to get my first review done over the long weekend upcoming.

More later