The partnership letters are a great read, indeed. You can read them, for example, here.

DC,

I was wondering what you do to stay motivated. I have a tendency to stop reading and researching when results come in and I'm being proven right. I've been value investing with the principals laid out in Graham's work as my guideline. But when I started out, about 4 years ago I was super motivated to learn and read. Now that I've had some success (sample size, I know) I'm starting to slack. I can't get myself to read new books or look for new companies. Sometimes I even have problems keeping up with the companies I already own.

Maybe it's because I'm not doing this for a living and as a result there is no pressure to keep up, I'm not sure. But I do want to get myself motivated because I want to keep getting results in the coming years.

Mistakes are most motivating for me. Thinking about all the opportunities I missed in the last few years because of poker and other distractions made me re-commit this fall. I had an easy triple in 6 months in one position, but never bought as much as I should because I started late, it was literally on my desk for two months before I finally read the report, didn't buy aggressively when I finally did the research because I was so busy, and boom, after one announcement it was too late.

But you can only amp yourself up once in a while, you need to find a way to motivate over the long term. With me it's just the constant practise of putting investing and family first, and keeping poker and other distractions for after work and end of day.

If you are working full time, I'd recommend putting aside specific hours to read. I'm trying to quit watching evening TV and do my reading after putting the kids to bed.

DC,

Thank you for this thread. I've been a fan of yours.

Several Qs (again feel free to not answer them if youre not comfortable discussing it):
-leverage: are you leveraged? if so how are you employing such strategy?
-selling: buying is easier than selling, as many writers have pointed out. how have you done in your experience? once your catalyst is achieved then you go? when do you cut your losses? this is the biggest problem i have and the best advice ive heard is: would you buy this stock today? if not then you should sell. but most of the time i dont follow through...
-portfolio allocation: as a general rule i assume you have a decent chunk of cash at any time. how heavily are you invested in your respective positions? do you start out small and nimble to build a large position?
-sector preference: any industry you like to focus on? are there basically no industries you touch as a typical value investor (tech, biotech)?
-i remember you defending buffett against soros in the debate for the greatest investor ever. hes also shown a uncanny ability to pick great managers. what do you think of his pick @ the successor? would you pull your $ out of berkshire once buffett moves on?

i think thats a good start thank you DC!

I dont believe in your return numbers

Do you do liquidations or companies that are in legal dealings or turnaround cases? I find that many value investors who claim very outsized returns are doing these things, and they are probably much more savvy than me, but to me these things often seem like flipping coins and thus it's subject to significant survivorship bias (i.e the ones who badly burnt themselves aren't boasting of their returns).

Me I only do boring buys of stable companies, mostly small and micro caps, and while I do think that could give me 10-15% returns (and that would hardly be something to cry over) for the forseeable future, that is no way near the returns you seem to think are feasible on a risk-adjusted basis.

Of course it's also highly possible that you do the same thing as me but do it that much better, and that's why I am asking

This might be a dumb question, but can you speak to the logistics of selling? Not when to sell (strategy), but how to sell(tactics), especially illiquid microcaps. I know it's best to use limit orders, so lets say your holding has reached roughly what you consider intrinsic value. Is there any rhyme or reason to which limit price you enter? Should an investor upgrade to level 2 quotes to see at which prices there are big buyers? Above market price and sell on the uptick or below on the down? I realize round lots should be used, but do you sell in big chunks or sell off smaller share amounts over time? I'm sure a lot of these questions are situation dependent, but maybe some rules of thumb might be helpful.

sometimes I don't either. it's possible I made a math mistake, you can check it if u want. I don't have the specific numbers with me, but my portfolio is 3.75x what I started with 7 years ago, while my initial living expenses were about 1.5% per month, and have declined to about 0.8% a month (yes I spend too much).

That should be enough to estimate my after tax returns at least.

I know that in the long-run the stock market is a scale, but in the short-run, it's a vote machine-counter, but should the castle in the air theory be taken much more seriously. It's like in poker, everything boils down to the fundamentals of mathematics in terms of ranges and equities and you never have all the precise variables, but yout do your best in estimating. That's what makes psychology more important in poker, and does the same apply to the stock market? It seems that instead of trying to value a company by its assets or earning powers, it would be more prudent to try to stay ahead by hyping up a stock's story for a crowd, and leaving before the fundamentals are bursted.

I know I wasn't concise at all and will try to summarize my question. Valuations and fundamentals are overrated, and psychological factors are much more important. Everything eventually boils down to fundamentals and valuations, but the psychological part of the valulation is much more important because the stock price is always determined by the psychology of fellow investors and few will turn it into a weighing machine when it matters.

"Buffett did one of these back in the 60s with Dempster, a windmill manufacturer. Instead of just purchasing some shares, though, he bought the whole darn thing and hired a guy (Harry Bottle?) to wind it down"

Yes, Buffett purchased Dempster b/c it was trading at less than working capital at the time. Munger recommended Bottle to WEB and WEB hired him to restructure the company. Bottle closed underperforming divisions and liquidated inventory and WEB invested the profits in undervalued securities. Eventually the restructured company was sold to a PE firm (or what passed for a PE firm back then). Buffett made about 3X his investment in 2-3 years. He did a similar thing with Sanborn Map Company. Berkshire was another "less than working capital" idea straight from the Graham playbook. All of these are detailed in WEB's partnership letters and make for a good read.

Also, just wanted to add, TY for starting this thread. You are one of my most respected posters on here and I can't wait to hear what else you have to say.

The only leverage I use is a home equity loan. It's not something that a broker can pull or force liquidation of shares during a market crisis. Occasionally I'll use a some margin temporarily, or even credit cards, but rarely more than a few months. Don't ever want my hand forced.

Anchoring is a problem for everyone. I think the easiest solution is to do lots of research, when you find good new ideas it's easier to sell mistakes to fund their purchase. Usually I'm comparing my estimated returns of what I own to what I could buy and it takes out much of the emotion and makes it astraightforward process.

I often get fully invested and have to sell to buy. I usually buy whatever is available at an attractive price each day. Today I bought about $2,000 total in two positions.

None, just stuff I feel I can understand.

That was kind of a silly debate, as both are tremendously successful. I don't have much opinion on the "successor", other than I don't think he is one. Berkshire is going to be different when Buffett leaves, better in some ways, worse in others. If I owned any I would base my decision on my valuation of Berkshire.

Those are areas with risks, but doing extra research can sometimes minimize the risks and reveal opportunities. But it's a lot of work. I once spent two weeks researching securitized trusts a company owned before I was comfortable that I really understood it well enough to value it. Turned out to be worthwhile, but quite a drag at the time.

It can be tough in micro caps. Sometimes you just have to wait for buyers. At Ameritrade I used to leave limit orders out at what I thought were attractive prices for weeks on end. Occasionally I'd get hit for a tiny order, like $10 in stock that would cost me $7 in commissions. I think that was market makers angry at my trying to provide liquidity. But it was usually worthwhile because once in a which I'd sell $1,000 or $5,000 in a day.

Now I'm at InteractiveBrokers and use their algorithms to buy/sell without being required to put out an explicit limit order. It works very well.

If it's a stock that already has a bid at a price that I want to sell at, or an ask at a bargain price, I'll just pound it to see how deep the orders are.

I almost never look at level II unless I'm trying to buy/sell lots of shares quickly, though I subscribe to it on most exchanges.

I don't believe psychology of crowds can be anticipated, predicted or traded.

I believe that many companies can be valued with reasonable accuracy, and that occasionally the market will offer to buy or sell those companies at prices far from their very obvious value.

Buying at a big discount to intrinsic value protects you and helps you sleep well at night. But it doesn't guarantee high returns, so I try to predict reasonably predictable events that can force companies to trade back to their intrinsic value in a reasonable time frame. Corporate actions mostly.

Do you short stocks often or ever?

In reading through Security Analysis and The Intelligent Investor there is a lot of talk about accounting practices that result in reported per share earnings of, for instance, $5 when the true earnings are more like $2.50. Stuff like this leads me to believe that a lot of the time there are significantly more profitable (in terms of # of stocks and % difference from intrinsic value) short positions than there are long.

Almost never, because the risk reward is much worse when shorting than it is for going long. Short losses are essentially uncapped for a value investor. If you think a stock is worth $1 when it's trading for $5, there is nothing to stop it from running up to $20 (losing 300%) or $40 (-700%) or $100 (-1900%). How can you sell on the way up if you know it's IV is $1? don't worry. Soon your broker will sell for you when he liquidates your account.

And if you are 100% vindicated and the company goes under, the most you can make is double your money for taking all that risk.

If you buy $5 stock knowing it's worth $10, as long as you don't use leverage and the company is solid, you can wait forever for vindication without risk of loss no matter where it trades. And you might even do better than double your money.

Value investing is about taking advantage of Mr Markets mood swings, and not allowing them to force your hand. If you use leverage or short stocks, you risk having your broker decide when you will sell or cover, and always at the worst possible times that guarantee failure.

To paraphrase Lord Keynes, the market can stay irrational longer than you can stay solvent. Or, to finish first, first you must finish.

This brings me to my next question,

In Security Analysis they were pretty aggressive on the point that, in an example like the above, that once it hits $10 you become a speculator by holding on longer. I get that, but it didn't seem to expressly state that you should sell at that point, but it seemed at least largely implied.

If you had a $5 stock that you thought was worth $10, what kind of circumstance would you be more than doubling your money? Only if the intrinsic value increased beyond $10 in the time that the stock took to reach $10?

Also do you ever use options, whether to try and profit in a less risk-exposed way than shorting for stocks you think will go down over time, or otherwise?

Good stuff here.

While somewhat pedantic, I think the underpinnings of value investing (as you've mentioned previously) are behavioural and psychological (hyperbolic discounting, loving glamor & hating dogs, poor anchoring, institutional biases, group-think, the list goes on...) So implicitly a value-investor does believe in some forms of mean reversion (whether its multiples or returns on invested capital) and trading this, just not the timing of it.

As for your response on short-selling, I agree with the outline of the associated risks and asymmetry (risk/reward, and vis-a-vis the long side). However, there are steps to mitigate these structural tilts. For example, not shorting based on valuation alone (i.e. multiple compression), but tangibly decorating fundamentals, material drop in earnings and earnings power, covenant breaches, refinancing, and other "catalysts" that you've mentioned you pay attention to on the long side. Further, proper sizing of shorts can be critical in managing risk.

First, I would probably sell before IV, say at $9, but tax considerations might impact it. I think it was clear Buffett made a mistake not selling KO during the internet bubble, but he was anchored for two reasons, mainly he was a huge public cheerleader and board member, but also he had a huge amount of taxable gains he'd have to give up.

So if it's a long time holding and I think it's worth $10 and it gets there, I might only be able to keep $8 if I sell, and I might not see anything out there I like better than this company at a 20% discount to IV, I might hold. Probably not, probably go to cash. But taxes can impact the decision.

I had a thread here I did about 4 years ago where I shorted Krispey Kreme using options, I think I broke even or made a little money in the end, but it was a loser for a long time because the time cost of options is very high. That was actually a situation that would have worked far better as a short because it took a year or more to be proven right.

If I was do it again it would have to be a very compelling short like KKD, and I'd have to restrict it to about 5% of my portfolio, and I'd have to put in a stop loss, or hedge the upside with some options as an additional cost. Potentially if you can buy way out of the money long term options you could cap your upside loss near 100% without too much cost.

It's clear I can value things, so that's the difference. I don't have to predict when I'm going to be offered a great price on a good investment, just be able to do the math and have the disposition to accept the offer.

It would be even better if I could predict when prices reverted, but again, I don't think that's possible.

I agree with all of this, the post above outlines how I'd do it if I did it again. Besides using options to hedge, your point about catalysts is very important. I was just waiting around twiddling my thumbs for people to recognize how fraudulent Krispy Kremes financials were, and that took some time.

Can you talk a little more about catalysts. Would you ever buy a company that's introducing a new product and the market hasn't discounted it yet, or is that something your not comfortable predicting?

Suppose you've discovered a catalyst that you think will be realized in 8-12 months (new management or selling a unit) do you begin building your position right away? How far out would a catalyst need to be for you to stay on the sidelines?

I probably wouldn't feel comfortable predicting new product successes.

It all depends upon what my estimated return is vs. the estimated return of other ideas. Obv. if I have two ideas that I think are good for 40% annualized returns, but one will take a month and the other 8-12 months, the longer one is way more valuable.

I own NICK. It was sooooo cheap before the recent runup.

Fwiw, I disagree with the adjective used there. S/L have many uses, but the main ones for retail investors is that they're not going to be able to take the pain of being down 50%-70%+ or whatever, so they might as well exit down 30% [whatever their GMO point is], re-examine the stock with no position, and buy back in if they feel it is still a 'value,' as opposed to a value-trap.

Benefits: Clear head, immediately stops losing money, harvests a tax loss, if general market is crashing you're out of the way.

Costs: $8 or less in commission.

For a pro like D/C, they may be unnecessary, but a lot of top investors smarter than me use them.

Another way to answer the query [I mostly agree with DC] is that the psychology is *already* reflected in the price. "Psych" doesn't trade independently on some exchange, when RVI fell to $1 from $22 -- on its way back to $16 -- the negative psychology was at work in high gear already, you didn't need to attempt to measure it [which you can't do, really, although you can look at vol spreads on options to get a very short-term view].

The fact that it had fallen 30% more than its major asset, of which it is a majority holder already told you everything you needed to know. It was trading at ~25c on the dollar, and run by a guy who's one of the sharpest retail minds out there, and also Chairman of AEO. There wasn't going to be a 75% discount for long.

Or when Renault stub was trading at less than zero market value. For every $20 in Nissan they owned, the entire firm was valued at ~$17. That's market psychology in a nutshell.