Monday, 17 August 2015

A Change of Strategy

Well it's safe to say it's been a long time since my last post just over a year ago. Plenty has been happening during that time - I've been too busy enjoying life and learning to put my thoughts to paper, but for some reason I felt like writing up a new piece today. A warning, it's fairly lengthy. For any of you diehards who are still following my blog, I wouldn't hold out for another post soon, but I definitely appreciate your continued patronage and will try to write up any noteworthy thoughts I have. 

One of the best things that happened over the past year was my trip to the Berkshire Hathaway Annual Meeting in late April and early May. It was an fantastic trip and something I've wanted to do for a long time. Yes, the opportunity cost of the travel expenses is probably worth millions by the time I'm old, but to me the opportunity to hear from Warren Buffett and Charlie Munger in person (and even get a selfie with Warren!) is priceless. To the right is one of the photos I took of Buffett. You can read a little bit more about my trip in a little piece I wrote for Forager. 

The main topic I wanted to write about was my change in investing approach. Don't worry, it's nothing drastic like becoming a day trader - if I do, you'll know I've lost my marbles - but it's a fairly substantial change. I now have a much greater appreciation of the power of mechanical investing strategies. This involves using a fairly simple rule or rules to pick stocks. One of the most well-known mechanical investing strategies was first outlined by Joel Greenblatt in The Little Book That Beats the Market, which he named the 'magic formula' - yes, a dodgy sounding name but the formula does actually work very well. Using just two ratios, for value of the stock and quality of the business, Greenblatt reported that a portfolio of the top 30 stocks ranked by his magic formula would have returned 23.8% p.a. from 1988 to 2009, compared to the market return of 9.6% p.a. Subsequent research and performance casts a little suspicion on the veracity of his backtesting but whichever way you cut it, the formula outperforms the market. 

Other very simple strategies that implement value investing systematically include buying stocks that have a low price in relation to book value, earnings, dividends, revenue etc. While some work better than others, it's rather astonishing to see how well such a naive strategy performs. If you're interested in reading more about this I highly suggest you take a look at Tweedy Browne's excellent paper, What Has Worked In Investing, Wesley Gray and Tobias Carlisle's book Quantitative Value, and Tobias Carlisle's book Deep Value: Why Activists and Other Contrarians Battle for Control of Losing Corporations

You may be wondering why these mechanical investing strategies work so well and why you don't see every investor/fund manager adopting them. They work so well because unlike us humans, these strategies are perfectly unbiased and ignore irrelevant information that often clouds our judgement. It doesn't matter how terrible or attractive a particular stock may look to a human, these strategies weigh up the critical information (the price in relation to value) and stick with it, allowing them to purchase really cheap businesses and stay away from expensive ones. It's value investing implemented systematically, protecting us from our own biases and allowing us to take advantage of other people's biases. As for why it isn't widely adopted, I suspect that it's hard to convince people to put their savings (and pay fees) to a fund manager that lets their computer do all the hard (or rather easy) work. Perhaps more important is what Charlie Munger refers to as Excessive Self-Regard Tendency - we think we're all above average drivers (90% of Swedish drivers think so), we tend to buy more lottery tickets if we can pick the numbers, surely we can beat a dumb formula at stock picking. Personally speaking, I can also attest that it's hard to admit that a formula is likely to outperform you, despite all the hard work I put into analysing a business. 

However, I've decided to put my wallet ahead of my pride and largely stick to a mechanical investing strategy. This is not to say that researching businesses and using expert judgement to pick stocks isn't a good approach - one only needs to look at some of the most famous investors to see that it can work extremely well - but I believe that far too many investors are fooling themselves into thinking they can pick stocks better than some of the strategies mentioned in the Tweedy Browne paper. I'll still be open to exceptional ideas that don't qualify for my mechanical investing approach, indeed I've bought one recently that I might detail in another post sometime. As for what particular approach I've decided to go with, the net-net strategy is the most appealing to me as I'll try to explain next. Many of you reading this who are value investors would have heard of the net-net strategy, but for those of you who don't, I'll try my best to explain it. 

Way back in 1934, Benjamin Graham and David Dodd described the net-net strategy in Security Analysis. The idea was that if you could buy a business for a price substantially below its liquidation value, you would do pretty well as an investor. As a rough proxy for this liquidation value, they calculated a 'net current asset value' (NCAV) as follows: current assets minus total liabilities and preferred stock. While the current assets (typically cash, receivables and inventory) would likely not be worth as much as stated on the balance sheet in an actual liquidation, the idea was that the sale of the rest of the non-current assets (mostly property, plant and equipment) would usually make up the difference. Most businesses have more total liabilities than they have in current assets so have negative NCAV and can be ignored for this strategy. Graham and Dodd's recommendation was to purchase a stock when the price of the stock (or market capitalisation) was less than two-thirds of this NCAV, or alternatively stating that, when the NCAV to price ratio was 1.5 or greater. For example, if the NCAV of a business is $30 million, you'd buy the stock if its market capitalisation is $20 million or less. This buffer between the NCAV and the price of the business is the margin of safety that value investors require. 

It's a very simple, straightforward mechanical investing strategy described over 80 years ago. I had assumed until recently that these net-nets were largely extinct due to the ability of computers to easily ferret them out in recent decades. It turns out that my assumption was wrong and surprisingly there are still hundreds of net-nets in developed markets today. In addition, I believe I had fallen under the illusion that many other value investors would have had - nowadays Warren Buffett tends to purchase high quality businesses hence many people want to emulate his current approach, but his highest returns were many decades ago when he bought these net-nets and similarly neglected, poor-performing businesses. He's even said in recent years that if he were young and working with much less money than he is today, he'd do pretty much what he did in the past again.  

So how well does this strategy perform? Benjamin Graham implemented it his Graham-Newman fund from 1930 to 1956 and reported an average return of 20% per year from buying these net-nets. That's a pretty juicy return, but how does the strategy stack up with more rigorous testing under different time periods and different markets? Luckily, a number of academic studies have fairly comprehensively answered that question. It performs unbelievably well. I'll give an overview of the findings of these papers (feel free to skip over it if you take my word for it), but for a more comprehensive review I suggest you read the actual papers. 

In one of the earlier studies, Ben Graham's Net Current Asset Values: A Performance Update, Henry Oppenheimer looked at the performance of net-nets in the US stock market over the 1970 to 1982 period. Once per year, a portfolio of net-nets was formed - that is, the NCAV to price ratio of the stocks chosen was at least 1.5. One year later, the portfolio was sold and replaced with a new one. He found these net-net portfolios compounded at 28% p.a., whereas the market as measured by the NYSE-AMEX benchmark returned just under 11% p.a. He found that the greater the ratio of NCAV to price (i.e. the cheaper the stock), the higher the return. Interestingly, he found that the stocks that had positive earnings in the last year actually underperformed those that had lost money in the previous year. In addition, he found that of those stocks that had positive earnings, those that paid a dividend significantly underperformed those that didn't. Those last two findings are pretty counterintuitive - most people, including myself, would have expected that a profitable, dividend paying net-net is more attractive than an unprofitable net-net that doesn't pay dividends, but in fact it's the exact opposite. 

In their paper, Ben Graham's Net Nets: Seventy-Five Years Old and Outperforming, Tobias Carlisle, Sunhil Mohanty and Jeffery Oxman essentially extended Oppenheimer's study to the 1984-2008 period. The results were even more impressive, net-nets overall compounded at 35% p.a. compared to the market at 11% p.a. In addition, they largely confirmed the other findings of Oppenheimer with a small exception. While the higher NCAV to price stocks tended to perform better than the more expensive ones, the very cheapest quintile of net-nets recorded a relatively disappointing 23% p.a. compared to the second cheapest quintile of 53% p.a. There's probably something not quite right about those net-nets that appear to be the very cheapest according to the net-net criterion - in my experience I've found that many of these are either in bankruptcy, delisting, their assets have disappeared since the last financial statement date, or there are substantial non-controlling interests so not all the assets belong to shareholders. Putting this aside, the researchers found confirming evidence that profitable net-nets underperform their unprofitable peers - 27% p.a. compared to 49% p.a. Likewise, the profitable, dividend paying stocks underperformed the profitable, non-dividend paying stocks 19% p.a. to 33% p.a. This is pretty powerful evidence for the performance of the net-net strategy - with 1362 net-nets over 26 years, there is strong statistical significance. Furthermore, digging down into the yearly returns shows that despite the prevalence of computers in recent years that should make such a strategy much easier to implement, net-nets have continued to outperform in the 21st century. 

What about outside of US markets you might ask? Fortunately, James Montier has us covered here in Graham’s Net Net’s: Outdated or Outstanding? where he analysed the performance of net-nets in three regions, the US, Europe and Japan. Between 1985 to 2007, he found that the global portfolio of net-nets returned 35% p.a. In the US, the result was over 40% p.a., in Europe just under 20% p.a. and in Japan 20% p.a. Keep in mind that during this period the US share market performed much more strongly than the European and Japanese markets, so this likely explains the absolute performance differential. I don't see any reason why net-nets wouldn't perform well in other developed share markets. 

I could go on and on for much longer about other studies corroborating these results but hopefully you get the idea by now. It's worth noting that the net-net strategy won't outperform the market every single year and is still subject to some gut-wrenching declines like those which occurred in the GFC. Moreover, actual returns from implementing it would likely be a few percentage points lower than stated in these studies due to transaction costs and difficulties in purchasing illiquid stocks. I'm willing to put up with that but of course it's not for everybody. On the plus side, this is a relatively simple and time efficient way to invest - you don't need an IQ of 200 nor spend all night researching stocks. All you have to do is run a stock screen to find these net-nets and purchase them - it can be done in less than an hour, although I spend much longer checking out each business. If you're really keen and would like to look at the results of some other studies, this is a good place to start (keep in mind the methodology varies a little bit across studies but the conclusion is still the same, net-nets drastically outperform). So we've established that this simple strategy works across markets and across different time periods, with some results indicating roughly 50% p.a can be achieved. But why stop there, is it possible to do even better? At risk of stuffing up a very good strategy, I think we can. 

In addition to the NCAV calculation described above, Benjamin Graham also suggested that you could be even more conservative in your calculation of liquidation value. Given that in a liquidation, you might not get all the receivables owed to you and you may have to sell inventory at a big discount, Graham came up with an alternative, which I like to call 'discounted NCAV'. You take cash + receivables x 0.75 + inventory x 0.5 - total liabilities - preferred stock. You're assuming that receivables are only worth 75% as much as stated on the balance sheet and inventories 50% of their balance sheet value. This tends to favour cash rich businesses compared to the previous formula. Once again, you purchase if the discounted NCAV to price ratio is 1.5 or greater. It's a pretty blunt approach and some people prefer to use different discount factors for receivables and inventory, but intuitively it should work better than the previous formula as you're demanding a greater margin of safety. Even fewer stocks meet this discounted NCAV criterion than the previous one but it appears that this greater conservatism leads to greater rewards.

For this we turn to a relatively hard to find paper, Dissecting the Returns on Deep Value Investing, once again conducted by Tobias Carlisle, Sunhil Mohanty and Jeffery Oxman. They investigated the performance of this 'discounted NCAV' approach over the 1975 to 2010 period. To qualify, stocks had to have a minimum price of $3 per share, and another portfolio tested performance only for stocks trading for at least $5 per share. Instead of requiring a discounted NCAV to price ratio of 1.5, they only required a ratio of 1.0, a less stringent requirement but perhaps they did it to obtain a greater sample of stocks. You'd expect if they tested it on a ratio of 1.5 and ignored the arbitrary minimum price requirement, the performance would be even better. Here's the unbelievable bit: net-nets in the minimum $5 price portfolio returned a compound 75% p.a. and those in the minimum $3 price portfolio returned 85% p.a! I've never seen anything like that before, and in the back of my mind I still doubt the validity of those numbers as they appear too good to be true. Nevertheless, at the very least I would expect such a discounted NCAV approach to do as well as the traditional NCAV approach that most papers have studied. Therefore, this is the strategy that I'm going to stick with. 

It's tempting to say, "Well that's fantastic, I'll just take that list of net-nets and pick a few that look good to me". However, this kind of cherry picking is very tricky to get right as more often than not, we tend to hamper the performance of mechanical investing strategies by using our own judgement. See James Montier's Painting By Numbers: An Ode To Quant for an excellent description of the applications of simple statistical models to improve results outside of investing and evidence that we should try to avoid interfering with the models. In addition, I highly recommend Daniel Kahneman's book, Thinking, Fast and Slow to better understand how our brains work and read about more evidence detailing the usefulness of simple statistical models for decision making. 

Even going back to Joel Greenblatt's magic formula, Greenblatt set up a website that either allowed subscribers to access the list of magic formula stocks and choose to invest from that list, or he managed the portfolios for investors by strictly adhering to the formula. From 2009 to 2011, those that self-managed their portfolios had a cumulative return of 59.4% compared to the S&P 500 of 62.7% and the professionally managed portfolios of 84.1%. Greenblatt says those that cherry picked from the magic formula list systematically avoided the best performing stocks because they looked the scariest and most ugly. In addition, they also timed the market poorly, selling stocks after poor performance and buying after good performance. This goes to show that cherry picking can eliminate all of the outperformance of a winning strategy and even lead to underperformance relative to the share market. Nevertheless, I think that very limited human intervention can improve results. In the case of this net-net strategy for example, simply checking that the stocks aren't about to go bankrupt and confirming the NCAV calculation is correct are no-brainers that I believe will improve performance.

In my personal net-net approach I've added additional filter rules based on empirical evidence, for example, as mentioned above, the unprofitable net-nets perform far better than the profitable ones so I'm filtering out any profitable net-nets. In addition, I have some extra quantitative factors that I can apply objectively and have also been proven to improve performance. For instance, if a net-net is buying back lots of shares I'll give it a few bonus points to its NCAV to price ratio, and if it's issuing tons of shares, I'll subtract a few. I won't go into detail about these extra factors as this post is already getting quite lengthy, but they generally don't make much of an impact on my decisions - the NCAV to price ratio is all important. I've decided to pick the top five stocks each quarter to eventually come up with a portfolio of 20 net-nets which should provide more than enough diversification. My first five picks were made a few weeks ago - these averaged a NCAV to price ratio at the time of purchase of 2.55, which is well above the minimum requirement of 1.5, so my margin of safety should be much higher than the studies listed above. There's no guarantee they'll do as well as the academic studies have demonstrated - I've made some adjustments with the goal of improving performance but none of the studies have explicitly tested my exact rules. While I certainly don't expect 75% p.a. returns, I'm confident the results will be good, so I'm putting my money where my mouth is. I'll keep you posted on the performance. 

The five stocks I've purchased so far are largely listed in Canada, have lots of cash and very few liabilities. The names are S i2i Limited, Africo Resources Limited, Petrofrontier Corp, INV Metals Inc and Black Iron Inc - I'll let you research them yourselves if you're interested. It seems hard to imagine that you can buy these stocks that are trading at around half their cash (after all liabilities have been deducted). There is no way in the world someone would sell you their entire business for prices like these - they'd call you crazy and tell you to get stuffed. But in the share market, small ownership stakes in companies can and do trade at ridiculously cheap prices. Proponents of the strong-form efficient market hypothesis ought to take a hard look at these examples as they're clearly inconsistent with the notion that all securities are priced rationally. 

After all this, you may be wondering why I'm willing to lay out this strategy for everyone to read and possibly implement - after all, shouldn't it create more buying and selling competition for these net-nets? Well I don't think it'll cause much, if any, competition. The obvious reason is that barely anyone reads this blog! But even assuming I had a large audience, only a very select group of people would be comfortable with such a strategy and follow through with it. First off, the vast majority of net-nets are small, illiquid stocks so it is near impossible for anyone with millions of dollars to buy them up in decent quantities. That eliminates virtually all of the smart professional investors that would no doubt love to adopt such a strategy. Once you get to a portfolio of a million dollars or so, I suspect that this net-net strategy will be difficult to implement, but it's a good problem to have too much money. Secondly, as previously discussed it goes against human nature to cede control to a simple formula or rule even though it's proven to do better than human judgement, thus this net-net strategy will appear too scary to most people. Thirdly, you need to be a value investor that understands why this method of investing works - of which we are in a minority. Finally, some people will look at these net-nets and view them as garbage as they've often been terrible businesses - but that's fine with me, as they say, one man's trash is another man's treasure. Much of the reading I've done has helped me realise that it's the ugliest, scariest businesses that outperform the most, largely due to mean reversion as business performance improves and people realise the stock isn't as crappy as they thought - the typical net-net being a good example. But that's a topic for another time. In summary, the net-net secret has been out for more than 80 years, I doubt people are suddenly going to start paying attention to it now. 

Sunday, 29 June 2014

Richfield International Services

On Monday I finally managed to purchase some shares in the highly illiquid Richfield International Limited (17,538 units for $0.115 each). The way in which I eventually got hold of those shares was rather serendipitous. A number of months ago I put out a buy order for RIS shares - determined to pay no more than 11 cents - but the sellers were always out of reach, usually asking for 12 or 13 cents. Eventually tiring of this stalemate, I thought to myself that if someone offers 11.5 cents I'd just take it. One day I remarked to my friend Kelvin about RIS, 'That damn seller on the other side won't budge either', which is when he laughed with amazement and told me he had just placed an order to sell at 11.5 cents. Incidentally he was thinking the same thing about the highest bidder (me), hoping that I would yield. We quickly agreed to place orders at 11.5 cents on Monday, which were executed first thing in the morning. Initially I was rather concerned to find out that he was selling while I was buying but having made a decent profit he simply wanted to reduce his weighting in RIS. At least that's what he tells me...

I suspect most readers have never heard of the $7.2 million business called Richfield International, which is probably why diligent value investors can come across these opportunities. Having suspended its loss making container ship operation, RIS provides port, shipping and chartering services for foreign-vessels. Although listed on the Australian Securities Exchange, RIS primarily operates in countries such as Singapore, Vietnam, Bangladesh, Indonesia and Thailand. The company's main subsidiary was founded in 1984 by Chak Chew Tan, who has been managing the business ever since. If he's stuck around for that long, Tan probably views RIS as his baby and is more likely to put the long-term interests of the company ahead of any short-term focus. It's also great to see that he holds 23.4 million shares, making him the largest shareholder and therefore has his interests aligned with mine. 

Recent years have been tough for the shipping industry with sustained depression in shipping freight rates while operating costs have been increasing due to higher bunker fuel costs. This has had a flow-on effect for RIS since it provides services to these shipping companies, but its financial results have been improving over the past few years. This is rather interesting as I can't identify any competitive advantages that RIS can provide in its highly competitive sector other than the long-term relationships it has established with customers over the decades its been around. Anyhow, should the shipping industry recover sometime in the future, RIS is very likely to further increase its profitability. For what its worth, in its 2013 annual report management needed to perform a goodwill impairment test and used a forecast revenue growth rate of 3% p.a which they considered 'ultra-conservative as there is an expectation of a rebound in the global shipping sector over the next four years'.

Fortunately, my investment thesis doesn't rely on conditions improving as RIS already produces earnings that can easily justify its current market price. In the financial year ended December 2013, RIS reported a net profit of $964,725 but adjusting for foreign currency gains and the discontinued container ship subsidiary, I estimate its normalised earnings were around $850,000. This puts RIS on a P/E ratio of around 8.5x, far from expensive. Margins were very high, with a gross margin in 2013 of 87.4% and a normalised NPAT margin of around 23% so any sudden increase in costs shouldn't cause RIS to start making losses. It's also a very capital light business which is generally a good thing but with negligible capital expenditure I'm slightly concerned that RIS is underinvesting in itself. However, as a service business it relies more on its people than property, plant and equipment which may excuse the low investing cash flows. As a result, the great operating cash flow of $1.7 million goes almost straight to its bank account.

This brings me to the final, and most significant reason why I invested in RIS - its cash pile. This is one of those rare instances in the share market where you find a profitable company trading below its net cash: $11.4 million vs a market capitalisation of $7.2 million. Even if RIS decided to pay off all its liabilities (primarily payables), it would have $8.4 million in cash. If you include receivables of $700,078 RIS could have up to $9.1 million in excess cash. In other words, the market is offering a situation in which a sole owner of the business could buy it for $7.2 million, pay himself at least $8.4 million in cash and be left with a business earning around $800,000 a year (adjusting for the loss of interest revenue). And with every quarterly report RIS is building up more cash: in the first quarter of 2014 operating cash flows were an excellent $461,547, bringing the cash balance to $11.9 million. Although that operating cash flow could be distorted by a reduction in working capital or other one-off factors, it's a very encouraging start to the year.

This is primarily a statistical bet for me - it is unlikely to shoot the lights out in terms of returns and may take quite some time to play out but with the large amount of cash on the balance sheet, it seems hard to envision this investment being a terrible one either. Nevertheless, there are of course a few risks to keep an eye on. The shipping industry is obviously one, blowing the cash on an overpriced acquisition or diluting shareholders unnecessarily for a large acquisition are others (Chak Chew Tan got approval from shareholders for the ability to issue an additional 10% of the shares on issue and has mentioned he's on the lookout for mergers/acquisitions). Regrettably, as good as this investment appears now I passed on it when it was around 7 or 8 cents. Ah well, better late than never.

P.S You might want to take a look at their very retro website. Rather concerning how 1990s it is, but if it's a reflection of the tight cost control at RIS, I'm all for it. After all, the $300+ billion Berkshire Hathaway isn't too different.

Friday, 20 June 2014

Random Thoughts About Randomness and Black Swans

Nassim Nicholas Taleb reminds me of the venerable Charlie Munger in many respects: they are both experienced (and successful) in finance, multidisciplinary, iconoclastic, unwilling to mince words and voracious readers. After hearing his name crop up many times with regards to investing, I knew that I had to get around to seeing what all the fuss is about, and I'm glad I eventually did. 

In Fooled By Randomness: The Hidden Role of Chance in Life and in the Markets and The Black Swan: The Impact of the Highly Improbable, Taleb argues that the world we live in is subject to considerably more randomness and extreme events (Black Swans) than we usually realise. I think they're both great reads, not just for investors but anyone who needs to make decisions under uncertainty (i.e. everyone). 

One of my favourite examples from The Black Swan is his idea of the turkey problem. Imagine a turkey that is fed every day for 1000 days. From its point of view, with each passing day and each meal, it gains increasing confidence that humans are acting in its best interests. That is until day 1001 which turns out to be the Wednesday before Thanksgiving... This event is a Black Swan for the turkey, but not for the butcher who knew it would eventually happen. Extend this problem to any patterns that humans interpret - even with 1000 years of evidence to suggest something will continue, it is impossible to predict a Black Swan type event that has never occurred before and we could find ourselves helpless as a turkey in the face of the unforeseen event. 

What does this mean for us then? It means that we need to be very wary of relying on past data to predict the future and individuals should try to make themselves robust to Black Swans. In financial terms, that might mean reducing debt or eliminating leverage from your life altogether, taking out more insurance protection, or it might mean that you need to diversify your investments more. It makes me wonder whether it is reasonable to assume that share markets will continue to outperform all other asset classes over the long term. Despite over a century of information indicating share markets return around 10% per annum, the next century could severely disappoint - Taleb reminds us that Black Swans aren't just completely unexpected events, events that are widely expected but do not materialise are also Black Swans. It is impossible to determine with precision the likelihood of this Black Swan. 

Perhaps we need to look deeper and try to determine the cause/s of the pattern we see in order to establish whether it is truly sustainable and to find out what could disrupt its continuation. For instance, one could argue that because share markets are more volatile in the short term, they deserve to be priced at a discount to less volatile asset classes (in finance speak, shares require an equity risk premium). A 5% p.a. return from the share market that could vary wildly year to year is not as desirable as a smooth 5% p.a. return from your bank account, so shares should be priced to give a higher return. Therefore, one would need to figure out what if and what could disrupt this driver of returns. Is it possible that shares become less volatile in the future? Is it possible that corporate earnings (another driver of the excess returns from share markets) could grow at a much slower rate in the future or be hit negatively by a Black Swan? Is it possible that interest rates will be permanently lower (and therefore all investors receive a lower return)? The answer is yes, they are all possible, but I would guess improbable. Therefore, with an awareness that 10% returns are not set in stone, I come to the conclusion that investing in the share market over the long term is still the best course of action - others may disagree and they would be perfectly justified in doing so as the answers are too unclear. 

Speaking of the best course of action, I recently wrote about my loss on Antares Energy: "I think that the initial reason for purchasing was still valid, as it appeared more likely than not that the deal would go ahead, in which case the net cash per share would have been almost double my buy price. Unfortunately, chance has an annoying habit of making rational decisions look silly from time to time, but that's just a part of investing you have to deal with." I was trying to communicate the rather counterintuitive idea that even though I made a loss, it was the right decision to invest in Antares. 

Fortunately, I'm not the only who thinks this way and Taleb is more eloquent in explaining it than I am: "I will repeat this point until I get hoarse: A mistake is not something to be determined after the fact, but in the light of the information until that point." If that still doesn't make sense, consider a situation where if you roll a six-sided die and land a three, you have to pay me $5 but if you roll anything else, I'll pay you $5. Clearly, the odds are skewed in your favour - the rational thing to do would be to grab the die and roll it as many times as you can before I realise my idiocy. But what happens if I only gave you one roll and you happened to roll a three? Sure, you lost money but your decision to roll the die was not a mistake. In light of the information that you were provided, you made the rational choice but the outcome was obscured by randomness. The exact opposite occurs in a casino. 

Taleb expands on this concept a little more, stating that, "One cannot judge a performance in any given field (war, politics, medicine, investments) by the results, but by the costs of the alternative (i.e., if history played out in a different way). Such substitute courses of events are called alternative histories. Clearly, the quality of a decision cannot be solely judged based on its outcome, but such a point seems to be voiced only by people who fail (those who succeed attribute their success to the quality of their decision)." He applies this alternative history idea to the choice of a career. For example, if you decide to become a dentist, your future financial position is far easier to predict than one in which you become a writer (where only a very small minority claim the majority of money to be made in the writing industry). Therefore, even if you made it big time as a writer and became a billionaire like J.K Rowling, you made the irrational decision financially. If you lived your life as a writer another thousand times, in the majority of those lives you would be pretty poor. Although it is very unlikely you'll ever become a billionaire in your thousand dentist lives, it is also unlikely you'll be struggling financially. Performance should be evaluated using this logic - despite a favourable or unfavourable outcome having occurred, what were the alternatives that could have happened? Unfortunately, it seems humans are wired to take outcomes at face value and ignore these alternative histories. 

A corollary of this alternative history idea is that the financial success of many billionaires or the fame of many celebrities is simply due to luck. There will always be a few lucky fools that were simply in the right place at the right time, but they are usually admired all the same as those who succeeded due to inordinate skill or effort. Equally, it is an unfortunate truth that there are many extraordinary individuals deserving of success that the world will never know of because they were unlucky in some way or another. I suppose the lesson to learn here is not to simply judge people on where they ended up, but rather to look at the alternative histories that would have occurred if they lived their lives many times over. Or in Taleb's more profound words, "Heroes are heroes because they are heroic in behavior, not because they won or lost."

Although I have doubts about some of Taleb's other ideas such as his 'barbell strategy' and found him to criticise a little too much for my liking, I wholeheartedly recommend you read Fooled by Randomness and The Black Swan. In this blog post I've only scraped the surface of what he writes about in those two books, as it is difficult to compress his ideas - a compliment to Taleb. I haven't got around to reading his most recent book, Antifragile, but I'm expecting it to be similarly thought-provoking. 

Finally, I thought I'd pass on a great piece written by Tony Hansen, who runs Eternal Growth Partners. More interesting thoughts abound here

Wednesday, 7 May 2014

Vision Eye Institute and a Portfolio Shakeup

I'm happy to report that on Monday I went on a bit of a shopping spree (on stocks of course), adding some Vision Eye Institute (ASX:VEI) and topping up on my existing holdings, which I'll talk about later. Many Australians in New South Wales, Queensland or Victoria will have either heard about Vision Eye Institute or have utilised their ophthalmic services. These eye related services are broken down into three categories: consultations, refractive surgery (better known as laser eye surgery), and other surgical procedures performed in a day surgery. In the last decade, the company experienced rapid growth as it bought more clinics and attracted ophthalmologists on the east coast, but poorly structured deals eventually led to an exodus of ophthalmologists. In combination with a high debt load, the company was brought to the brink of bankruptcy but has fortunately managed to stage a recovery recently. 

Instead of rambling on for many paragraphs about why I believe VEI is an attractive investment, I thought I'd try to keep my reasoning as concise as possible this time. Many of the most successful investors such as Peter Lynch and Warren Buffett suggest that investors be must able explain why they are purchasing a stock in a succinct manner, which makes perfect sense to me. It focuses your attention on the most important factors, encourages you to be rational, and ensures that you clearly understand the rationale. Alright, here we go!

Around 90% of VEI's revenues are non-discretionary due to the essential nature of its services to its customers. This stability in revenue was demonstrated throughout the global financial crisis and the years afterward which were spent addressing the decline in ophthalmologist numbers. Better still, with the ageing population, demand for VEI's services should continue to grow at a nice 5%+ p.a over the foreseeable future. The past issues of ophthalmologists leaving appear to be largely resolved, with the number of doctors increasing from 68 in October 2013 to 77 doctors currently. With management indicating that they will recommence the search for organic growth by expanding the number of clinics/ophthalmologists, economies of scale should help boost margins and build its competitive position. The cost of interest payments has also been dramatically cut in the most recent half, which will boost profits and reduce risk. Regarding the all important price, I estimate that VEI is trading on 7x to 8x its FY14 earnings and a DCF calculation confirms that it seems cheap enough for me. Finally, with a 20% stake in VEI, Primary Healthcare (ASX:PRY) may look to acquire the whole business, perhaps providing a nice catalyst for a re-rating in VEI's share price. 

On the flip-side, I think it's also a good idea to balance out that optimism by writing down the main risks which could result in a poor investment. To my mind, the main two are the bargaining power of ophthalmologists which is putting pressure on gross margins, and the gearing level. As the most important assets of VEI's business, the ophthalmologists have been able to push for an increasingly higher share of profits. Although gross margins have fallen from more than 50% to 43% in the first half of 2014, management have warned that this margin compression will continue. Although I believe that this trend will come to a stop in the next couple of years to balance with the benefits of VEI's business model to the ophthalmologists, I could be completely wrong, in which case the earning power of VEI may not be able to justify its current valuation. Despite reductions in net debt from $105 million in 2008 to $30 million today, this is still a relatively high 40% net debt/equity ratio. Furthermore, there are very few tangible assets to back its borrowings, so shareholders and creditors are solely reliant on the continued cash flow generation of VEI to sustain that $30 million of debt. Given the banks require $3 million to be repaid this year, management need to be careful with balancing their growth and dividend intentions in order to avoid another debt debacle. 

Although I don't think VEI is going to shoot the lights out in terms of share price performance from its current level and the risks outlined above are concerning, the case for investment was still tempting enough for me to purchase 2,786 shares at $0.61 on Monday. Speaking of temptations, it was difficult to resist making one of the endless lame puns on 'vision' that I was thinking of, but if that's your thing, take a look at the VEI attempts in their older annual reports (how about the 2005 line: 'focused on the future'). 

On a less positive note, I decided to finally exit my position in Antares Energy (ASX:AZZ) at a loss of around 23% on Monday after the proposed takeover offer of US$300 million fell through. Even though a number of investors I highly respect either recommend or hold Antares, holding onto this kind of business for the medium to long term is simply outside my circle of competence and I don't feel comfortable relying on the opinions of others. I think that the initial reason for purchasing was still valid, as it appeared more likely than not that the deal would go ahead, in which case the net cash per share would have been almost double my buy price. Unfortunately, chance has an annoying habit of making rational decisions look silly from time to time, but that's just a part of investing you have to deal with. 

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In addition to the above transactions, I added $6,600 to my portfolio and used most of it to purchase existing shares so their weighting in the portfolio stayed in line with what I think is reasonable. These purchases were 331 TGA at $2.11, 482 IMF at $1.86, 7,096 BOL at $0.155, and 12,000 ACG at $0.125. Consequently, my portfolio value currently stands at just over $16,000 with around $2,000 in cash that will hopefully be invested in a new stock if my buy order gets executed soon. This means that I've more than doubled the size of my portfolio in less than a month, and to account for my additional contributions, I'll be calculating a time-weighted return (the measure used by professional fund managers to adjust for inflows and outflows). Although portfolio performance over the past few months has been disappointing, I feel much more comfortable going forward with AZZ gone and the additions of ACG, BOL, NOD and VEI. It is probably for the best that my investing ego isn't inflated so early on by excellent portfolio performance, and it's also a good reminder that the index (All Ordinaries Total Return) is a tougher benchmark to beat than most people expect. To the right are the full gory details of my portfolio. 

For those of you seeking more detailed analysis of VEI, I can once again highly recommend The 8th Wonder - who incidentally posted just after I bought shares - and Intelligent Investor Share Advisor. After completing a six week internship at Intelligent Investor Funds Management (who are the second largest shareholders of VEI according to the 2013 annual report) and the guys at Share Advisor, I can definitely vouch for their ability and integrity. And no, unfortunately I was not paid to say all that. 

Wednesday, 16 April 2014

Nomad Building Solutions

Today I purchased 33,333 shares in Nomad Building Solutions (ASX:NOD) at a price of $0.051 each. Like Boom Logistics, this is another stock that was brought to my attention by Alex over on The 8th Wonder. Their main business now is a subsidiary called McGrath Homes that builds and sells modular homes in Western Australia. Unfortunately, because I'm very snowed under with university work at the moment, once again I'm going to refer readers to Alex's summary of why NOD looks cheap, which I substantially agree with. Besides, after that long post on Atcor Medical, I think both you and I could do with a shorter post.

I'll just point out one important piece of the puzzle that Alex didn't mention in his post, and the one that concerns me the most - while NOD has wound down the Nomad Eastern States segment, they had a non-cancellable lease over a premises in Wacol, Queensland. If you look at the annual report under note 29, you'll find that Nomad is required to pay more than $3 million in FY14 for non-cancellable leases, almost $10.6 million in the four years afterward (an average $2.6 per year), and $2.3 million thereafter. I'm assuming that the entirety of these amounts refer to the Wacol lease, as the $3 million figure roughly lines up with the $1.4 million loss from operating activities in Nomad Eastern States for the first half of FY14. This is very significant in relation to the group's profits and will continue to drain cash until management is able to sub lease this property, which is understandably one of their highest priorities at the moment. When and on what terms this sub lease is established is an important risk, and one investors should watch closely.

Thursday, 10 April 2014

AtCor Medical

Since its invention in 1881, doctors, specialists, researchers, hospitals and pharmaceutical companies have been utilising the sphygmomanometer. Sph-what? Don't worry it's just the inflatable cuff that your doctor may have placed around your arm that is used to measure blood pressure. It's proven to be a very useful device for predicting and preventing cardiovascular disease, strokes, diabetes, kidney failure, eye disease etc. However, while it measures the blood pressure in your arm, known as brachial blood pressure in medical parlance, what we really want to know is the blood pressure around your heart, or your aortic central blood pressure. Until recently, the only way to find that out was to use an invasive catheter - basically a tube they stick into your body to reach the heart - and as such, this was typically done in a hospital. 

The SphygmoCor XCEL
However, in 1992, a company was co-founded by two clever guys and in 1994 they developed a device called SphygmoCor. It was able to take your brachial blood pressure (blood pressure in your arm) and mathematically derive your central blood pressure with a good degree of accuracy compared to the invasive catheter, in addition to a host of other useful measurements. The newest iteration of that technology called the SphygmoCor XCEL is in the cuff based form that GPs and patients are used to. The operator simply presses start, waits 60 seconds and all the data is fed to a computer.

As you might have guessed, I'm writing about all this because the device and its 8 patents are owned by AtCor Medical (ASX:ACG), which designs, manufactures and sells the SphygmoCor products all over the world with the help of distributors. Although I typically stay away from emerging biotech companies because they are often too speculative and too hard to understand, the risk/reward appeared compelling enough for me to buy 14,530 shares at $0.12 yesterday. I've actually been following this company since June or July last year, when shares traded at around $0.07 and I was very tempted to dip my toes in and buy some shares. My more intelligent friend purchased shares but regrettably I didn't, and I watched as the shares rocketed up to a high of $0.21 in October, before gradually dropping back to its current level. At a market capitalisation of $18.9 million, or $21.3 million assuming all options are exercised, I believe that this business could be significantly undervalued and will try to explain why. 

In the last decade, study after study has come out showing that central blood pressure provides more useful information than brachial blood pressure. Even though two people could have the same brachial blood pressure, their cardiovascular risk as measured by central blood pressure can differ significantly. Using central blood pressure helps doctors to diagnose people better, and a study has shown that it improves treatment too, since the better diagnosis allows them to prescribe fewer drugs to patients. In addition, pharmaceutical companies are able to develop more effective drugs with fewer side effects, cardiologists are able to better treat complex cases of hypertension (high blood pressure), renal physicians can improve treatment of kidney problems, and researchers are able to draw better conclusions in their studies. The list goes on. 

The body of evidence in support of using central blood pressure is growing every year, with over 100 new peer reviewed journals being published each year. At the forefront of this trend is ACG with its SphygmoCor technology, having been mentioned in over 700 per reviewed journals to date. As the first device to measure central blood pressure through a noninvasive method, it's been subject to a lot of scrutiny, and has held up quite well. So much so, that new devices are regularly compared to the SphygmoCor in academic papers to determine accuracy, and the management of Atcor labels its device the 'gold standard'. I am quite confident that this technology will eventually replace the old sphygmomanometers that only measure brachial blood pressure, but what I'm much less sure of is how long it will take. Some other important measures a SphygmoCor device can take include pulse wave velocity, heart rate variability and arterial stiffness, but I won't get into these (mainly because I don't understand myself)

Reflecting their usefulness, these machines do not come cheap, and although I am not sure about the latest figures, I believe they were being sold for $15,000 to $20,000 before. This is obviously why ACG has stunningly high gross margins of over 80%. Assuming they sell for $15,000, that means it only costs ACG $3000 to manufacture it. However, as a small company, administrative expenses, marketing and sales expenses, and research and development each away at a large portion of that gross profit. With a substantial amount of relatively fixed costs, ACG has a lot of operating leverage, which will supercharge profits when revenue increases, and vice versa. Only last year AtCor managed to report its first profit after many years of losses, and has had positive cash flow from operating activities for the last 6 quarters. Bear in mind however, that ACG has been receiving financial support from the government through grants and R&D tax concessions, and this will not continue indefinitely. Recent performance has meant the balance sheet is in much better shape than it has been in the past, with cash of $4.1 million and no debt. 

ACG's head office is based in Sydney, but it is in their American office that the CEO Duncan Ross resides. Why? Because for many years ACG has been focusing on driving penetration in the US market. Rich, developed nations that seek out the best technology are the perfect target for ACG, and America falls into that category. In addition, the majority of big pharmaceutical companies are based in America, and around 60-70% of ACG's sales come from selling devices to these companies for their trials. Astonishingly, as of late 2012, SphygmoCor had a 95% share of the market in this pharmaceutical trials sector and speaking with management on the phone, it seems Atcor's position may have even turned into true monopoly. Aside from providing higher quality data, one of the reasons for this is because ACG adds further value by offering data management services to pharmaceutical companies, which can be quite a hassle for these companies if they are running big trials. AtCor's exceptional service has led to a 100% retention rate in this market. Apparently one pharmaceutical company tried a competing product, in the end coming to ACG and saying that they regretted it. Management reckons that the market for selling these devices to pharmaceutical companies is US$110 million annually. With only single digit penetration so far, ACG would be hugely successful if it could continue to maintain that monopoly whilst take up within the industry heads higher, given its total sales were just $9.1 million last year. 

Unfortunately, the pharmaceutical trials market is quite lumpy, and delays in contracts has led to ACG's sales dropping 51% in their most recent half (56% on a constant currency basis), knocking the share price down a fair bit. Nevertheless, I believe that this is only a temporary hiccup that the market is too impatient to look past. Encouragingly, sales to US clinicians grew 77% in spite of uncertain market conditions. One major short term risk is that in FY13, $5.3 million out of AtCor's $9.1 million in sales were from just two customers (which I presume are pharmaceutical customers). This helps to illustrate how ACG's revenue could easily fall dramatically, as it did in the first half of FY14. Fortunately, results are expected to improve in the second half, and the pipeline of potential new pharmaceutical business is quite strong at more than US$16 million. 

The other three markets that ACG is targeting are the clinical specialists (such as cardiologists, nephrologists and endocrinologists), researchers (universities and affiliated hospitals), and the clinical - primary care market (GPs, internists, executive health, wellness centres). The research market has the smallest potential at US$22 million annually, followed by clinical specialists at US$100 million, pharmaceutical trials at US$110 million, and finally the clinical - primary care market at US$268 million. In total, the global market potential is around US$500 million annually. Penetration in the research market is 11%, while the other three categories are in the low single digits. As you can imagine, with its current margins, even if ACG manages to capture even 10% of that $500 million total, shareholders at the current price will do very well. Driving adoption in the specialists is particularly important, because general practitioners want to see that the specialists are using a procedure before they adopt it themselves. 

For years ACG has been trying to get the CPT code I, which means that Medicare in the US will reimburse clinicians every time they take someone's central blood pressure. Private payers, such as insurance companies, generally follow Medicare's lead on what they will reimburse for and how much. While AtCor managed to obtain a CPT code III for their technology a couple of years ago, this is a temporary code reserved for emerging technology/processes and is generally not reimbursed. I was told that the reimbursement rate for ECG, which is around $50 per test, would be quite a reasonable amount in the event that ACG gets the CPT I code (keep in mind there are variations based on geographical regions). At this level, the payback for doctors would be around 6-9 months, while the device can be expected to last around 4-5 years. I agree with management that these are very compelling economics, and one could expect sales to increase quite rapidly if this does eventuate. Although I am no expert on the approval criteria, it seems to me that success is more likely than not as almost all of the boxes have been ticked, and for what it's worth, management has a 'good degree of confidence'. ACG is expecting to file for a CPT I code later this calendar year with the backing of the Renal Physicians Association (who also played the same role for the CPT III) but even if it is approved, the earliest it could come into effect is 1 January 2016, so patience is required on this front. The existing CPT III code and the CPT I code will only apply to FDA approved products, of which there are only four, and only products that utilise the central waveform. Most competing devices that spit out numbers don't actually use the central waveform and therefore won't be covered by the CPT code. 

At the moment, there is very little competition in the US for ACG as most of its competitors are based in Europe and focus on selling their products into European countries, potentially allowing ACG to build up a decent first mover advantage in the US. This is partly due to the regulatory environment in Europe, which has a simpler regulatory regime than the US and therefore has lower barriers to entry. However, the European market for these devices is more reliant on the government than private payers, and as we all know, the government budgets for European countries are generally not too great at the moment. In addition, most of the European sales are made to researchers, which is the smallest market for central blood pressure devices. These factors help explain why AtCor hasn't been very profitable in Europe. Asia doesn't yet have a culture of funding healthcare and new technology, although this is gradually changing as the middle class grows. Recent regulatory approvals in China, Canada, Mexico and Korea should help boost sales, although are unlikely to be very significant in the short term. Excluding pharmaceutical sales (which are grouped in the Americas segment even though they are increasingly globalised), sales between Americas, Europe and Asia Pacific are fairly even, with America a little bigger than the other two. Over time, I believe governments will recognise that it is in their economic and social interests to adopt this technology. As Benjamin Franklin said, 'An ounce of prevention is worth a pound of cure', and this is very true of central blood pressure measuring devices. It is cheaper for governments and insurance companies to prevent people from developing serious complications by funding these devices than to spend years trying to treat people.

My main concern with ACG is its competition - if AtCor is unable to differentiate its product, it is quite likely that its gross margins will get crunched, or sales will simply stall. Regardless of competition, management expects gross margins to contract as clinical sales become more important as clinicians don't require all the extra features that researchers and pharmaceutical companies purchase. The bigger problem is that even though ACG markets itself as the gold standard, and has had its technology validated through many studies, the competition is catching up and may even be better than the SphygmoCor technology. Indeed, another listed competitor, Uscom (ASX:UCM) has recently started calling its central blood pressure measuring device the gold standard. This was in response to a study that rated UCM's Cardioscope II product as having more 'clinical applicability' than SphygmoCor. Bearing in mind that this study was only conducted by one researcher, who acknowledged the ratings were entirely subjective, and who did not refer to the product comparison at all in the rest of the paper, I was quite sceptical as to how much reliance should be put on this piece of information. Nevertheless, I quizzed management about it, who aside from pointing out the above, said that the main reason why the Cardioscope II and the Centron cBP301 were rated higher was because unlike the SphygmoCor they do not require a computer for data to be fed into. The requirement for a PC enables clinicians to keep a patient history and connect to AtCor's proprietary data management system, which is why AtCor believes it is actually an advantage rather than a disadvantage. 

Although that study may not be the best source of information to draw conclusions about the relative merits of each product, after reading dozens of other academic comparisons, I get the impression that while AtCor still provides more metrics than its competitors and has the overall technological edge, the accuracy of the data that its competitors do measure is quite close to the SphygmoCor. Another issue is the expiry of patents, some of which AtCor has had for a long time (patents generally last to a maximum of 20 years). Encouragingly, even though an important patent - the generalised transfer function (the mathematical model used to derive central blood pressure) - had expired three years ago, management says that the competition has so far been unable to fully replicate it. They also interestingly mentioned that one patent that ACG holds is unlawfully being used by a Japanese competitor called Omron Corporation, but since Omron is quite large, ACG has decided not to pursue a costly legal battle with them at the moment. Fortunately, most of AtCor's competitors are very small and are in a weak financial state (take a look at Uscom, which had sales of only $387,119 in their most recent half and will be out of cash in the next 6 months if they continue their performance). I was told by management that 'AtCor is well and truly the largest player', which is a little surprising given ACG is still a very small company itself. 

As you would expect, ACG isn't resting on its laurels and is developing new versions of its SphygmoCor technology that is tailored to each market (eg. one for researchers, another for clinicians etc). In addition, it has formed alliances with three other companies to either develop new products (one of which is due to be launched in July this year) or to help market the SphygmoCor XCEL to new segments such as urologists. AtCor is investigating complementary technologies, such as optimising pacemakers using central blood pressure and are also working on applications in cerebral vascular and intensive care medicine. I view all of these additional opportunities as an extra bonus if they do turn out to be successful, but in the short to medium term, all eyes will be on how well SphygmoCor goes. 

In terms of the people running the business, I don't have strong views one way or another. Duncan Ross has been CEO since 2006, when he replaced co-founder Ross Harricks, while the other co-founder, Dr Michael O'Rourke remains as a non executive director. Directors and executives hold a modest number of shares, and their compensation seems sensible to me. While progress since the IPO in 2005 has been slow, I think management have largely done as good a job as they could have, and am comfortable with them continuing to manage the business. Peter Manley, the CFO, was very generous with his time in answering the numerous questions I had by phone and email, so one might infer that the company's attitude towards shareholders is quite positive. Either that, or they've got too much time on their hands. 

To summarise this post before it drags on any longer, although there are most certainly substantial risks to investing in ACG, and it is definitely not a stock for everyone, I believe that the potential upside more than compensates for the risk. I won't present any singular valuation because the probabilities of various scenarios are too difficult to estimate with any reasonable degree of accuracy, but I'm confident that with even modest success in growing sales, AtCor will be rewarding shareholders quite handsomely. 

Thursday, 20 March 2014

Influence: The Psychology of Persuasion

As I've previously mentioned, in his speech titled The Psychology of Human Misjudgement, Charlie Munger discusses 25 tendencies that lead to irrational behaviour. He acknowledges that many of these ideas and examples in the speech came from a book called Influence: The Psychology of Persuasion, written by Robert Cialdini. After reading that Munger immediately sent copies of this book to all his children, and gave Cialdini a share of Berkshare Hathaway Class A stock as thanks, I knew that it must be something special.

Indeed, although this is a blog primarily about investing, I was so impressed by the book that I'm persuaded to recommend it here (pun intended). It is not entirely unrelated however, as some of the lessons it contains such as the consistency and scarcity principles are quite applicable to investment decisions, and it is curiously part of the Collins Business Essentials. Originally published in 1984, the 2006 revised edition is updated to reflect new findings about the process of influence, and at the end of each chapter, Cialdini discloses letters that readers have written to him about their personal experiences. 

Like many people, Cialdini admits that 'All my life I've been a patsy', so as an experimental social psychologist, he spent 35 years conducting experiments into how people think and what makes them likely to be persuaded. In addition, he spent three years going undercover by applying for jobs in fields such as real estate, user car dealerships, advertising, public-relations, fund-raising, telemarketing and restaurants. These insights into how the professionals get us to say 'yes' provide a nice demonstration that what works in experiments applies equally well to the real world. Cialdini's writing style is easily understandable and humorous, but fortunately doesn't patronise readers by oversimplifying. My only criticism is that he tends to be a little repetitive in drilling home the results of an example or the message he's trying to convey, but overall the book is a pleasure to go through. 

Influence: The Psychology of Persuasion details six very powerful principles, one per chapter:
1. Reciprocation
2. Commitment and Consistency
3. Social Proof
4. Liking
5. Authority
6. Scarcity

These principles usually work to our great benefit, but our regular reliance on them may cause lapses in judgement, especially when someone is intentionally exploiting them. Although some may seem obvious, I think you'll be surprised how powerful they are once you read example after example of their applications. By understanding how these principles work, you can use them yourself to help persuade others (hopefully with good intentions), or you can avoid being led into unwanted situations (Cialdini explains 'How to say no' at the end of each chapter). Interestingly enough, even though I'm planning on pursuing a major in psychology - as well as finance and accounting - my first few weeks of social psychology have made no mention of any of these principles. 

Using these principles, Cialdini explains why a woman in New York was chased and stabbed to death while 38 of her neighbours watched on without calling the police or intervening, why the number of airplane crashes and automobile fatalities shoots up after a highly publicised suicide story, and how a cult leader got more than 900 people to kill themselves in an orderly fashion by passing around a vat of poison. To find out the tragic and disturbing reasons for these extreme examples, you'll have to read the book! 

In summary, if this was a broker report, my recommendation would be BUY.