Sep 24, 2007

business book reviews

So after my last book post I mentioned moving onto lighter fare. And nothing is lighter or fluffier than business books. I have a favorite spot in hell picked out for most business books. They are on the whole, atrocious. When I worked at McKinsey there was actually a service we were subscribed to that would summarize new business books out that week in a single page. Even then it was painful to waste the 5 minutes reading that page.

So it would seem strange that I would pick up quite a few business books to read next. Well some of them are peripherally related to my job so I thought it was my duty to do it. Some of them I've read before and enjoyed, and some came with extremely high praise and I thought I'd give them a shot.

The first book, one that came with high praise, is Nassim Taleb's Fooled by Randomness. An interesting topic. That humans have a propensity to see patterns where there is nothing but randomness. For example, are a particular hedge fund's fantastic returns from the past 5 years pure luck or do they have something to do with talent. Let me get to the point on this book. It is atrocious. It should never have been published. I refuse to link to it or his latest book. And rather than having me waste my time reviewing this garbage, read Amazon's 1 star ratings because they've nailed this book. Notice the similarities in the reviews. An astute example
This is a painfully bad book. Nassim Nicholas Taleb's observations are completely trivial, lacking any depth and conclusion whatsoever, and it takes you a while to understand that this book is not about randomness and the way the human brain is easily fooled when interpreting information.

This book is about Taleb himself - one huge ego trip and at the end impossible to read.

The second book I read was The Little Book That Beats the Market by Joel Greenblatt. I really liked this book. At some point in the future I need to write about why investing your money without a professional's help can be a recipe for disaster. But if you are going to do it yourself then I would recommend some variation on this guy's approach. In a nutshell he advocates buying good companies that are cheap. Well duh? But Greenblatt tells you how to systematically do this. And this is where most investors (amateur and professional) screw up. He does this with numbers and equations and so forth. And it makes sense. We use highly sophisticated stock screening tools at our firm but at the core of those tools is something similar to what Greenblatt is showing you here. It's a quick read. I would recommend diversifying more than he suggests but the principles are sound.

Next I read Against the Gods: The Remarkable Story of Risk. In essence it is a history book about how civilization warmed up to the ideas relating to probability and statistics and their use in assessing risks. It's hard to imagine a time when this wasn't the case. But at one time 'insurance' companies were operating mostly on hunch. This isn't a statistics book; it is a history book. Those interested in mathematics will find many familiar names but don't expect to learn how to apply statistics or risk assessments. It also delves into modern statistics as they play out in the markets (e.g., derivatives). You won't learn much of practical use but it may make you assess risks slightly differently and it might make you interested in learning more about statistics. It might be a tad on the slow side for some though. He isn't a riveting writer.

Deep Survival isn't a business book in the traditional sense. But neither is the The Art of War and everyone associates that with business. Deep Survival is about how we can get ourselves into dangerous situations and why some of us die in those situations while others live. While it was a tad long on words, it actually was quite a riveting book. Not exactly an Into Thin Air, but it shares some of the same appeal. I'm terribly fascinated by this subject. How to avoid unnecessary risks and how to get out of them once you are committed.

The basic solution is on the cover of the Hitchhikers Guide to the Galaxy. Don't Panic. But there are other nuances; some expected and some surprising. Did you know a 6 year old has a better chance of surviving in the wilderness than a 12 year old? The risky situations presented here are all man against nature. People capsizing in boats, getting stuck on mountain tops, getting lost in the wilderness. But you can see how the same rules apply to any risk situation which is why some view this as a business book. Or specifically a asset management handbook.

I consider myself extremely low risk when it comes to my life. I have no desire to get on a motorcycle. No desire to go skydiving. But having read this book there are a few times where I probably took some unnecessary risk. Mainly involving wilderness outings. Part of the message here is people get into these risky situations very innocently. It's hard to assess the risk of something you are not familiar with. And therefore survivors generally become hyper aware when outside their comfort zone. Recommended reading.

When Genius Failed is a book about the Long Term Capital Management crisis back in 1998. LTCM was a hedge fund that eventually blew up when it made a number of highly leveraged bets on fixed income and equity vehicles that went the wrong way on them. It's largely a story of hubris. Before things turned bad, things went very very well. This led to a feeling of invincibility regarding the funds activities.

What is particularly interesting about this book is that it is a good primer on what happened recently. In fact both events took place in August. The anatomy of a credit crunch involves a number of ingredients but the events are generally the same. Leverage, a belief that past events foretell future events, and a transition from one market environment to another (in both cases one of low volatility transitioning to one of high volatility). One other ingredient for this kind of failure is the asymmetric rewards offered by Wall Street. If you knock the ball out of the park you can become rich. If you don't you will be viewed as a laggard but you own't lose your own money. It makes sense to go for the home run because even if you eventually go belly up, you've made your money. You get rewarded for good performance but you aren't penalized (monetarily) for bad performance. Even the partners of LTCM quickly created and funded new funds.

I then dipped into my bookshelf for some books I'd already read once but that I thought a second reading might be interesting given my change in industries. The first was Peter Lynch's One Up on Wall Street. I found this a particularly dangerous book for the average investor. He lays out the right basics and there's no denying that he was one of the more successful managers from a long term perspective. But his heuristics to narrow down stock winners is too simplistic. And remember he invested through a largely bull phase of the stock market so he has what I would call a growth perspective on investing. At many times that is one dangerous approach (2000 anyone?).

The other problem I have is that his approach is 'fundamental' or that it is based on researching the business behind a stock. How it makes money, etc. I find this dangerous compared to the Little Book (above) approach because you can really get hammered using this approach if you are not really really careful. Enron looked like a great stock. Is the average investor savvy enough to go through the 10K to understand what SPEs are? Most of Wall Street wasn't. But some were. What about something as simple as understanding movements in deferred revenue and accounts receivable? Identifying the potential of 'channel stuffing'? Changes in Allowance for Doubtful Accounts? NOLs rolling off which changes the tax structure? If you don't know what I'm talking about then be very skeptical about your ability to pick stocks. The Little Book is prescriptive and intuitively appealing. Ultimately if I wasn't getting free financial planning I would either hire someone or focus purely on allocation and rebalancing via ETFs or index funds.

A Random Walk Down Wall Street is still one of the better books on investing out there. And required reading for anyone with too much hubris about their stock picking ability. The great thing about this book is it largely focuses on actual research on the ability of Wall Street to beat the market averages. It doesn't paint a pretty picture.

But the gist of the book is this. To identify a good fund requires time. Because there are so many funds it is highly likely over the course of a short time period that many funds will do better than the market. So you need 10 years or so before you can identify a consistent winner like Peter Lynch. But by the time that has occurred Peter Lynch may not be with the fund anymore. Or other things have changed like the aspect that made the fund successful is copied by many others (this kind of happened with LTCM). Or the market dynamics have changed from a period of growth to a period of value. So by the time you identify a good fund it may be too late.

Barbarians at the Gate is another story of hubris. It focuses on the leveraged buyout (LBO) of RJR Nabisco by a number of players. I guess the thing that surprised me most about this story and the one I can't quite get my head around still, is how utterly unsystematic the purchase of RJR was. KKR ultimately won the bid and I had some image in my head of them being really smart guys. But they aren't. They've just taken risks and in general come out ahead. KKR really had no clue what the hell they were buying.

There's a part of me that refuses to believe this story has an bearing to reality. I just can't believe that many people on Wall Street are that dumb and that driven by ego and emotion. I think people from the outside would expect that behavior from Wall Street but there are clearly smart people here. If this is the way the KKR deal went down I hope that isn't how things happen nowadays. But perhaps it is. Whenever someone out bids someone else for a companym the media portrays that bidder is the 'winner'. Shit I could go buy some piece of junk company right now and pay $100B and I would 'win'. How does that make me a winner? I just lost. And lost big. Maybe this is how deals go down now, but it's scary if it is this way.

The second thing about this book that is slightly annoying is the persistent moral high ground the authors espouse: "deals are bad", "breaking up companies is bad", "LBOs with junk bond financing are sketchy". A lot of weird views that you wouldn't expect from a pair of Wall Street writers. Basically RJR was about as fat as a company could be. Tons of corporate jets and lavish spending on the most ridiculous promotional events. Shareholders were getting hosed. Someone buying them out and firing the workers (especially the CEO) was the best thing to happen to that company. It's amazing they didn't go bankrupt. Good book but scary at the same time.

Den of Thieves is yet another story of hubris (see a lesson here?). This time focusing on Drexel Burnham Lambert and Mike Milken and the junk bond empire they built. Junk bonds are what KKR used to finance the RJR deal. They get a bad name but they are what they are. A good source of financing for some people.

I was just out in San Francisco and had the opportunity to chat with a guy who worked at Drexel just before they went belly up. He said they each had their own supermodel assistant that would take their dry cleaning in and pay their bills and do their grocery shopping. This was to remove all errands in the average employees day, so they could focus on work. They were writing $1 billion of junk bonds every day and getting paid a huge commissions. Every senior partner in that firm is a billionaire according to him. It was, as he said, "Disneyland for adults".

What isn't good is insider trading. Which is really what the problem with Drexel and Milken is all about. The junk bond business was basically brilliant. For all practical purposes they held a monopoly on junk bond trading. They were smart. But not smart enough to get away with activities the SEC views as criminal.

This is one of the better business books I've read. It doesn't get caught up in emotion or prosthelitizing. It's also interesting to see Rudy Guiliani earn his chops as US Attorney, the prosecutor for Milken and Boesky. I still love this book.

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