Saturday, August 30, 2008

Investing the Templeton Way - Book Review

Chapter 1

The chapter is primarily biographical, which details John Templeton's (JT) philosophy of value investing was an extension of his overall lifestyle. It demonstrates how his background influenced his outlook in life. His father a true capitalist who lost all his fortune truly betting everything he had accumulated in the commodities market. His mother, on the other hand, taught him to be curious, self-reliant, and instilled a sense of a greater mission in life through the Christian faith. He was a firm adherer to thrift, believing it was a cornerstone to securing one's well being.

Chapter 2

It details the basic premise from which Templeton believed was the way to obtain bargain stocks. The chapter can be nicely summarized by his observation that "bull markets are born on pessimism, grow on skepticism, mature on optimism, and die on euphoria. The time of maximum pessimism is the best time to buy, and the time of maximum optimism is the best time to sell." While this principle may appear easy to exercise, in fact human nature turns contrary to it. The psychological factors that affect markets are stressed nicely. Readers may resort to Nicholas Taleb's book, The Black Swan, which extensively explains these anomalies that shape people and markets.

Chapter 3

It stressed the salutary aspects of considering the universe of stocks, including those emanating from foreign sources. Although not expressing a strict number of different assets, Templeton believed that diversifying "was a good way to protect you from yourself." He emphasized a "bottom-up" approach to foreign investing. That is, once a particular company or companies were identified, one would then assess the macroeconomic environment. I found this advise helpful because my approach is the opposite: review the macroeconomy, spot areas or industries that may be depressed and are poised for a comeback, and then seek good companies. Templeton gives the reader a good rule of thumb on what to focus in terms of foreign economies. He esteemed unfavorably places where government was profligate, operating rules onerous for business, and prevented individual creativity from taking root (e.g. Venezuela).

Chapter 4

It details the analysis JT used that led him to invest in Japan before everyone else. He benefited from the general perception of the extreme pessimism and ignorant views of the country held by the market during the 1950s and 1960s. His analysis revealed that stocks were extremely undervalued in comparison to U.S. stocks. The chapters goes in further details of what made JT an impeccable stock picker: he scrutinized his assumptions and made his own decisions--not based on the "wisdom of crowds." Moreover, he used quantitative measures (e.g. price no longer reflects estimated worth) in comparison to an alternative when to sell a stock. This led him to reduce his Japanese exposure in the early 1980s, just when everyone was beginning to inflate the bubble. But more importantly, this practice prevents an investor to be married to a particular investment.

Chapter 5

Occasionally JT was asked where the best investment prospects lied, he pointed that one should rather ask "where is the outlook most miserable" to find the most promising stocks. This chapter goes into greater detail explaining this philosophy by focusing on how JT concluded that U.S. stocks demonstrated good value, despite that it had been declared that "equities were dead" in the early 1980s. JT used various yardsticks of value to make decisions (e.g. P/E, PEG, P/BK, Enterprise value). But beyond simply calculating these metrics, he relied on his learned acumen to pick apart the assumptions underlying them. One should continually think outside the box because quantitative decision metrics will "eventually cease to work when everyone practices them in unison."

Chapter 6

The chapter gives us a glimpse into the innate irrationality that seems to grip the market more frequently than recognized. JT was able to profit mightily from rightly timing the NASDAQ crash. He noted that "the point of maximum optimism was reached when there were no more buyers left in the market, and the sellers were about to take control"--the opposite logic with respect to the point of maximum pessimism. Thus, JT shorted 84 stocks, each position worth $2.2 million, which ultimately netted about $90+ million in profits. JT gives us his shorting methodology: 1) control your losses, 2) remember rule #1. In order to control losses, establish a a price ceiling, which could be in terms of percentage change, for the stock before covering your position. Similarly, you must establish a point where you'll take profits.

Chapter 7

This chapter is an extension of the previous one. It details the mindset of the "bargain hunter" when dealing with market crisis. Irrespective of its nature and present sentiment, market drops are an ideal situation to take advantage because fear is pervasive. When other are alarmed and panic selling, you must maintain your composure and buy good stocks. After 9/11, JT bought a set of airline stocks that met a certain criteria (one-day price drop of 50%) because he understood that the government would bail-out those firms. Indeed, his expectation came into fruition, and thus was able to make a handsome return on his investment. The last two chapters underscore JT's keep ability of politics and economics that went beyond crunching number. As a result, he was well prepared to take advantage of market volatility.

Chapter 8

In this chapter we learn the analytical process JT exercised when investing in the South Korean economy. Following his disciplines of looking for great bargains in markets that were weighted under pessimism, South Korea was a perfect candidate after the effects of the Asian Crisis. As the book repeats numerously, simply investing in depressed markets without doing your homework is akin to speculating. We are furthered exposed in this chapter to JT's uncanny ability to assess his environment beyond number in such a way that leaves the reader wondering about his/her intelligence. "Bargain hunters who understand history...can appreciate the fact that these patterns repeat themselves over time, again, and again." Indeed, the operative word is "understand", something that very few individuals are capable--irrespective of their training and longevity.

Chapter 9

In this chapter we are encouraged to exercise good judgment to profit in assets outside our immediate purview. While JT was an excellent stock picker, he demonstrates his dexterity in fixed income assets. We are told of his advice of buying bonds prior to the technology stock market crashing. He reasoned that the fall in the market would adversely affect the economy by way of lesser consumption due to a negative wealth effect. JT understood that the Federal Reserve would come to rescue the economy by lowering interest rates. As a result, he undertook a carry trade (i.e. borrow in a cheaper currency and buy an asset denominated in another currency) buying zero-coupon bonds. When the FED lowered the interest rate, the value of the bonds purchased by JT increased in value. We are reminded to look at all assets and position yourself in such a manner so as to benefit your expected market environment.

Chapter 10

This chapter introduces the reader to JT's view on "the sleeping dragon", that is China. At first we are given an a cursory overview of modern Chinese history. Given that JT believes that China will continue to grow, it is a market that one needs to look quite thoroughly. As any country that is growing tremendously, there will be times when valuations will be above and beyond what a bargain hunter feels comfortable. By the early 1980s, JT understood that the Chinese would continue to open their economy, away from communist hold. Indeed, he noted, politically the country leaves much to be desired; but in terms of economic policy, JT thought that in comparison to the U.S. the Chinese has more freedom right now. We are reminded of the extreme pessimism principle for bargain hunter, i.e. mostly sellers are in the market. Only during that time, the best values will be found. As JT stated, "bull markets are born on pessimism, grow on skepticism, mature on optimism, and die on euphoria."

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