Fake Martial Arts and the World of Investing!
How I believe investing should be approached
Bruce Lee is known by many as one of the greatest martial artists in the world. Most people know him for his martial arts films. Bruce Lee was influential to me not because of his movies but because of his martial arts philosophy. Bruce Lee is what I call an "applied practitioner." Meaning, he only uses martial arts techniques he believes are most useful in a real fight. This is also the philosophy behind his martial art, Jeet Kune Do. Jeet Kune Do is formless and styleless, meaning there are no set movements for striking, kicking, or takedowns. Its end goal is to defeat one’s opponent; hence, it allows for the utilization of any martial arts technique that serves that purpose.
If one’s goal is to beat the market's return, then, applying the Jeet Kune Do theory to investing, one should only adopt techniques that are proven or likely to beat the market.
If one were to go on YouTube to consume martial arts content, there is a new trend of martial arts practitioners exposing "fake martial artists." Terms commonly used are:
McDojo: McDonalds Dojo for short. The purpose of this Dojo is to sell courses to kids and provide them with an extracurricular activity. The students who graduate from these courses likely won’t do well in a real fight.
Bullshido: Bullsh*t-Do. A play on words, like hapkido, taekwondo, and aikido (I am not saying these 3 are bullshido). A martial art that is completely useless, where the techniques can only be applied in a simulated environment and have no real-world application.
The first question a student should have when choosing a sensei or martial arts trainer is, “Can they fight?”
I’m sure some of you have watched a martial arts tutorial video. Common scenarios include what to do if someone has a gun to your head or an attacker is holding your neck. They provide a step-by-step guide on how to neutralize the situation. The problem with 99% of these instructional videos is that you are controlling for variables. In the real world, anything goes. You can’t tell the attacker that you were supposed to hold me a certain way or that your gun is supposed to be within arm’s reach.
With the popularity of MMA in recent years, we have essentially figured out for the most part what are the main martial arts that perform the best in a real-life hand-to-hand combat situation. If we study the best practitioners in MMA today, one must be well versed in striking, kicking, takedowns, and grappling. The most commonly trained martial arts that serve this purpose are boxing (striking), Muay Thai (kicking and striking), and Brazilian jiu-jitsu and wrestling (takedowns and grappling). Muay Thai gives a fighter options when your opponent is within kicking distance but too far for punching. Boxing and Muay Thai provide striking options when an opponent is within arms' reach. Often times, in a fight, you both collide and end up holding each other on the ground. BJJ and wrestling help restrict the movements of your opponent and immobilize them. The problem with 99% of martial arts is that they are weak in at least 1 of the above 3 scenarios or more. Even MMA is a simulated world, because if one were to introduce a knife, a gun, or multiple attackers, the equation changes completely. MMA is the closest thing we have currently to a simulation of a hand-to-hand combat scenario.
How does this relate to investing?
The people who earn the highest returns and consistently beat the market in the investing world tend to be “applied practitioners.” Some notable practitioners I would follow and learn from are:
-Warren Buffett
-Charlie Munger
-Philip Fisher
-Joel Greenblatt
-Mohnish Pabrai
-Guy Spier
-Seth Klarman
-Bill Ruane
What do the above investors all have in common, with the exception of Philip Fisher (growth investing)? They all graduated from the dojo of Benjamin Graham. Benjamin Graham is the grandmaster, sensei, and professor of value investing. In the bible of value investing, "Security Analysis" by Benjamin Graham, the core philosophy behind value investing is described. Before Graham, stock investing was practiced by many as a form of speculation. Benjamin Graham laid the groundwork for fundamental, rational, and logical investing. Stocks were not seen as numbers on a price chart but as equity stakes in an actual business.
What is sad nowadays is that the name Benjamin Graham isn’t even mentioned at most business schools. If you took finance in college, think to yourself how many times the methods of Benjamin Graham or Warren Buffett were discussed. Besides NYU (professor Aswath Damodaran) and Columbia University (professor Bruce Greenwald), which have an applied fundamental value investing course, most business schools do not teach applied value investing.
My main criticism of modern finance and how it is taught at most business schools today is that most people who come out of business school won’t be able to beat the market. This is evidenced by how a majority of portfolio managers don’t beat the market either. This is an oversimplification since assets under management (AUM) is the name of the game, and the incentive structures don't heavily reward portfolio managers for outperforming the market but heavily penalize those who underperform too much as investors will withdraw funds. As Joel Greenblatt mentioned in an interview, and I am paraphrasing, those that beat the market spend at least a couple years in the bottom 25th percentile of returns.
This is my personal statement, so let it sink in:
"Modern finance is taught to people who want to be employed and work in finance.”
Finance is mostly taught to people who are happy to earn a salary, generate a commission, and work for someone else. If the prerequisite to being hired was the ability to beat the market, most of Wall Street would be unemployed.
Another hard-hitting personal statement:
“Most finance programs taught at business schools are McDojos and Bullshido when it comes to beating the market.”
To clarify, most reputable finance programs do a good job of preparing students for the workplace, but most are inadequate for learning how to beat the market. Business schools exist to sell you the future salary that a finance professional will earn. Your skills only need to be applied for the job, not for beating the market. An analogy to this is that earning a black belt would allow you to be employed as a trainer at a franchised McDojo location but may not mean you can win in a street fight. Look no further than your sensei, a PhD student working on some finance theory who hasn’t operated a business, invested, or proven the ability to beat the market for a day of their life. Similar to providing step-by-step instructions on how to immobilize an attacker, your professor is teaching you examples with controlled variables. Joel Greenblatt is one of the only exceptions that I can think of—a portfolio manager who earned a CAGR (compound annual growth rate) return of 30% over a decade and taught a value investing course at Columbia to MBA students. Joel Greenblatt is a rare individual who has a solid understanding of both the theory and applied aspects of investing. Sadly, he no longer teaches at Columbia.
“What is worse than finance programs at business schools and is plain sewage are day-trading academies and people teaching technical analysis.”
As a person who has dabbled in technical analysis, in theory, it is possible to make money trading, but the actual process to do it properly is too technical for most people to adopt. Technically, I didn’t just dabble; I did an entire internship as an equity trader, combining technical analysis and fundamental analysis, and earned the highest returns out of my fellow interns, so I have some authority on the topic. The proper process to trade profitably is to find trading patterns that are +EV (positive expected value). Meaning you need to be able to back-test your trading pattern and strategy to ensure your rewards exceed the costs. When you find a pattern that is statistically significant enough to work, the last thing someone should do is sell it to a bunch of students in a course because the more people who know about a trading pattern or strategy, the less likely it will remain profitable. Think perfect competition in economics. See why it doesn’t make sense for trading McDojos to exist? I don’t believe in businesses where the objective is to kill the goose that lays golden eggs periodically in hopes of extracting all the golden eggs at once. What is seldom taught is how to properly identify new trading patterns that work. If you aren’t coding and back-testing your strategy on a large dataset, then technical analysis and day trading are as scientifically rigorous as astrology. The best quant fund is Renaissance Technologies. Renaissance uses mathematics and statistical models to find trading strategies. From 1988-2021, Renaissance generated 62% annualized returns (before fees) and 37% annualized returns (net of fees). They safeguard their trading strategies. Employees are not allowed to take, leak, or copy their trading strategies. Similar to Coca Cola, if you come across a secret recipe for success, you will safeguard it with your life and never release it to the public. Why then do trading academies offer you their secret sauce for a monthly subscription or a fee?
“It is difficult to get a man to understand something, when his salary depends upon his not understanding it.” -Upton Sinclair
The reason why it is okay for professors to not beat the market is because the students that come out of these programs are part of a commission structure. The equity research analyst’s pay is paid out of trading commissions. The investment banker’s salary is paid out of fees from an IPO or M&A deal. The skills that are taught make you a great employee in the finance industry, but not necessarily a great investor.
So am I, the author, the sensei of a bullshido?
Despite being taught modern finance, my foundational knowledge of finance was initially honed through the lenses of Graham and Buffett. I am a student of value investing and a veracious consumer of value investing content and education. Before learning anything about value investing, my upbringing was a value upbringing, maximizing the value per dollar spent; hence, my temperament is aligned with value investing.
On my drive to UBC when I was a student, I would enjoy listening to finance interviews and audio books by investment greats. I have lost track of how many value investing books I have read. Hence, in 2016, for the very first “Capitalize 4 Kids” portfolio management competition, I placed second out of over 1000+ participants across all post-secondary schools in Canada. The investment thesis accounted for 50% of the score, and the actual portfolio return was the other half. I needed luck to be on my side to do well in the second category. Success is a combination of skill, luck, and opportunity, and I managed to get a perfect score on my investment thesis (skill) and 23rd place in returns overall (luck). Taking a step back, I can humbly say that luck played a major factor in this result. I could control the investment thesis write-up, but I could not control the performance of the stocks in my portfolio, which realized their value within 4 months.
Your author, being a conservative individual, can admit that I cannot prove that I am currently capable of beating the market. What I can say is that, although I cannot prove that I can beat the market, I follow, replicate, and learn the best techniques, principles, and philosophies of those who can. I take what is useful and discard what is not.
As a poker player, I can tell if a poker player is good based on their ability to analyze a hand. Poker players often talk hands with each other. I am well versed in what poker strategies and theories are applicable in a hand; hence, when I hear someone explain how they analyzed a hand, I can pinpoint whether a player is applying the right theories or simply factoring variables that aren’t important. In poker and stock investing, the long-term outcome is dictated by the quality of the analysis and having the conviction to follow it. In poker, you can have the right analysis and make the correct decision but end up with an unfavourable result. If you consistently make the right analysis and decisions, then over the long run, you will be profitable. On the contrary, if you make the wrong decision, over the short run you may win, but over the long run you will eventually lose. What matters in poker and stock investing is correct reasoning and decision-making, regardless of short-term results. Long-run investment returns that beat the market are a function of 1) correct investment analysis, 2) intrinsic value surpassing market value by an amount that provides a market outperforming return (margin of safety), and 3) being right more times than you are wrong (the market agreeing with you). If these factors align, then over the long run, you should come out a winner. Factor 3 is usually the nail in the coffin for most capable investors. If the market takes too long or never agrees with you, despite being correct on your analysis, you may underperform the market. Or your investors withdraw their funds before your investments realize their full potential. Hence, as the author, I hope that you, the reader, will assess me based on primarily factors 1 and 2, and give me a long enough time frame for factor 3.
As an anecdote of what I’m referring to. I haven’t looked at this stock in a while, so take the exact numbers with a grain of salt. The main point is the story. In late 2021, when PTLO IPOed at $20, the stock quickly rose in price. A novice investor friend told me they had bought shares at $35. The stock was now trading at $45 so they asked me whether they should sell. I analyzed the stock, and the promise from management was to open 200+ stores over the next decade. I looked at the company’s track record of opening stores. In the 60+ years of their operational history, the company has opened just over 60 stores, or on average 1 store a year. I looked at the geographic distribution of stores. The company had many states where it only had 1 store. If a company is profitable in 1 state and has built up a track record there, why not focus and expand in that state first? Why would it not leverage economies of scale to its benefit? I looked at the store layout and design, and each store is different and unique. Meaning the speed at which stores could be opened would not be as rapid as a McDonald’s. At $45 dollars, the market price required management to keep its promise and open a significant amount of stores each year at rates significantly higher than it has ever done before. I told my friend that, conservatively, I would take the 200+ store with a grain of salt. I said I prefer to be conservative and expect management to do what they’ve been doing or to perform slightly above what they have been doing. I told him Buffett got in at $18, which is a terrific price because it allows management to heavily miss its targets and the investment will still perform. At Buffett’s price, the company can open 5-10 stores a year, and Buffett would be happy. I told the friend the stock was worth between $20-30 and that I wouldn’t personally own the stock at any price above $25. Within a week, the stock rose to $60, and my friend questioned my analysis and started spouting rosy qualitative reasons noted in an online article that was a regurgitation of the IPO documents. I could see the profitability per store and the rate at which they were opening stores. I told my friend that, at $60, the management has to open 20-30 stores a year. Management execution has to be fantastic for $60 to be worth it. 2022 came around, and interest rates were expected to increase. I told my friend who owned shares at $35 to sell their stake at $45. The friend didn’t listen, and the stock proceeded to drop to a low of around $15 and now trades in the $20-25 range. As a reader, I ask that you judge me on my long-term results. I make decisions with reason, logic, and a conservative estimate of what I believe economic reality to be.
How I approach each factor:
Factor 1: Correct investment analysis
-Fully understand the business model (circle of competence)
-Fully understand the business economics
-Determine the quality of management
-Creating a full financial model. Forecast using conservative estimates
Factor 2: Market outperforming return potential
-The stock, based on conservative estimates and assumptions, provides a return that outperforms 10%. My goal is to find stocks that return at least 15% CAGR per year or more.
-Sufficient margin of safety. Market value is trading at a large discount to intrinsic value.
Factor 3: The market agreeing with you
-Analyze the catalysts of the company. When will the catalysts come into play? How long until the market agrees with you?
-Long-term arbitrage. Is this a stock that rewards the long-term investor? Will I be rewarded, given a long enough time frame?
-Sometimes the market is forced to agree with you. $1 in cash is worth $1. If the company is highly cash flow generative and uses its cash flow to purchase further cash flow-generating businesses, the market will eventually have to agree. i.e. Consider a highly lucrative hot dog stand that generates enough cash flow to open a new stand annually. During the transition, the public might not grasp its income potential. However, after a year, when the second stand is operational and the income statement shows the earnings from both, the market should accept this reality.
As the author of this newsletter, my goal is to prove to you that I can beat the market. As investing is my passion and my life’s goal is to become a portfolio manager of my own fund, I am staking everything I have to prove my worth. Given that I will invest in every undervalued opportunity I identify that can beat the market, my interests are aligned with yours, the reader.
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