Keynes and the Market by Justyn Walsh

Inspectional Read

The book’s key chapters include: Chapters 7, 8, 9, 10, 12. The main thesis of the book is that Keynes’ investment philosophy can be boiled down to 6 key principles:

  • Focus on the estimated intrinsic value of a stock – as represented by the projected earnings of a particular security – rather than attempt to divine market trends
  • Ensure that a sufficiently large margin of safety – the difference between the stock’s assessed intrinsic value and price – exists in respect of purchased stocks
  • Apply independent judgement in valuing stocks, which may often imply a contrarian investment policy
  • Limit transaction costs and ignore the distractions of constant price quotation by maintaining a steadfast holding of stocks
  • Practice a policy of portfolio concentration by committing relatively large sums of capital to stock market “stunners”
  • Maintain the appropriate temperament by balancing “equanimity and patience” with the ability to act decisively

Keynes’ investment philosophy is very simple. Value investing does not rely on academic esoterica – rather, it focuses on just two variables: price and intrinsic value. As Warren Buffet has remarked, “It’s a little like spending eight years in divinity school and having somebody tell you that the ten commandments were all that counted”

Keynes Quotes

  • Man has “a peculiar zest in making money quickly” (p. 32)
  • Keynes on the mindset of speculating: “most of these persons are, in fact, largely concerned, not with making superior long-term forecasts of the probable yield of an investment over its whole life, but with forecasting changes in the conventional basis of valuation a short time ahead of the general public. They are concernt, not with what the investment is really worth to a man who buys it “for keeps”, but with what the market will value it at, under the influence of mass psychology, three months or a year hence (p.34)
  • “Half of the copybook wisdom of our statesmen is based upon assumptions that were at one time true, or partly true, but are now less true by the day. We have to invent new wisdom for a new age” (p.52)
  • A central conclusion in The General Thoery – informed by Keynes’ own experience as a speculator – was that the pscyhology of uncertainty impaired the efficient operation of the market. The existence of uncertainty would periodically result in bouts of underinvestment and oversaving, leading to underutilization of an economy’s resources. (p.56)
  • “How sensitive – over-sensitive if you like – to the near term future, about which we may think we know a little, even the best-informed must be, because, in truth, we know almost nothing about the more remote future” (p. 65)
  • “The facts of the existing situations enter, in a sense disproportionately, into the formation of our long-term expectations; our usual practice being to take the existing situation and to project it into the future, modified only to the extent that we have more or less definite reasons for expecting a change” (p. 66)
  • “Day-to-day fluctuations in the profits of existing investments, which are obviously of an ephemeral and non-significant character, tend to have an altogether excessive, and even an absurd, influence on the market” (p. 66)
  • “Faced with the perplexities and uncertainties of the modern world, market values will fluctuate much more widely than will seem reasonable in light of after-events” (p.66)
  • As keynes pointed out, due to the inescapable fact of uncertainty, “all sorts of considerations enter into the market valuation which are in no way relevant to the prospective yield” (p. 67)
  • Keynes also lamented that the financial exchanges – with their constant price quotations and potential to readily monetize investments – gave: “a frequent opportunity to the individual…to revise his commitments. It is as though a farmer, having tapped his barometer after breakfast, could decide to remove his capital from the farming business between 10 and 11 in the mornings and reconsider whether he should return to it later in the week” (p. 73)
  • As Keynes noted, there is overwhelming institutional pressures to conform, even among allegedly sophisticated investors: “…it is the long-term investor, he who most promotes the public interest, who will in practice come in for most criticism, wherever investment funds are managed by committees or boards or banks. For it is in the essence of his behavior that he should be eccentric, unconventional and rash in the eyes of average opinion. If he is successful, that will only confirm the general belief in his rashness; and if in the short run he is unsuccessful, which is very likely, he will not receive much mercy.” (p. 75)
  • “Enterprise, or true investment, involves forecasting the prospective yield of assets over their whole life. The investor focuses on the income that a security is expected to produce, not the possible sale price of that security in the near term” Or, to employ Keynes’ terminology, the true investor is concerned more with “ultimate values” than “exchange values” (p. 79)
  • Only when the pendulum of investor sentiment had swung too far in respect of a given stock – such that the quoted price veered significantly from assessed fundamental value – would Keynes consider buying or selling that security. (p. 80)
  • “It is largely the fluctuations which throw up the bargains and the uncertainty due to fluctuations which prevents other people from taking advantage of them” (p. 80)
  • The intrinsic or fundamental value of a stock is simply the sum of expected cash flows from a given security, appropriately discounted for the effects of time. Other measures commonly thought to satisfy value investment precepts – such as low price to earnings ratios, low price to book value, and a high dividend yield – are, at best, tools for identifying possibly underpriced stocks. Ultimately, however, it is expected earning power of a stock that counts (p. 91)
  • “I am still convinced that one is doing a fundamentally sound thing, that is to say, backing intrinsic values, enormously in excess of the market price, which at some utterly unpredictable date will in due course bring the ship home” (p. 92)
  • “It is a much safer and easier way in the long run by which to make investment profits to buy £1 notes at 15s. than to sell £1 notes at 15s. in hope of repurchasing them at 12s. 6d” (p. 93)
  • “I would rather be vaguely right, than precisely wrong” (p. 95)
  • He realized that not only does an overemphasis on quantitative factors downplay non-numerical elements that may impact on the value of a stock, but – due to uncertainty – any stock valuation must of necessity be inexact, lying at best within a range of possible values. Keynes tried to avoid a sitaution “where the fall in value is due not merely to fluctuations, but to an intrinsic loss of capital” (p. 96)
  • “When statistics do not seem to make sense, I find it is generally wiser to prefer sense to statistics” (p. 97)
  • The benefit of intrinsic value calculations lies as much in providing a checklist to ensure that the investor has turned on his or her mind to all major factors potentially impacting the price of a security as in ascertaining an actual range of values (p. 101)
  • Value investing is, in essence, a “glass half-empty” rather than “glass half-full” approach – it focuses on downside risks rather than those on the upside. (p. 102)
  • “Economics is essentially a moral science and not a natural science” (p. 106)
  • They key to success in both these arenas, therefore, is to identify the radically mis-priced bet – the horse of stock that offers good odds and has a strong chance of performing. (p. 112)
  • “The art of investing, if there is such an art, is that of taking advantage of the consequences of a mistaken opinion which is widespread” (p. 113)
  • “It is because particular individuals, fortunate is situation or in abilities, are able to take advantage of uncertainty and ignorance…that great inequalities of wealth come about” (p. 114)

Non-Keynes Quotes

  • “All people are most credulous when they are most happy” – Walter Bagehot (p. 25)
  • “If everyone is thinking alike then somebody isn’t thinking” – General George S. Patton (p. 27)
  • “One dog barks at something, and a hundred bark at the bark” – Chinese Proverb (p. 31)
  • “When stock prices are rising, it’s called “momentum investing”; when they are falling, it’s called “panic” – Paul Krugman (p. 36)
  • “All truth passes through three states. First, it is ridiculed. Second, it is violently opposed. Third, it is accepted as being self-evident” – Arthur Schopenhauer (p. 59)
  • “Under certain circumstances…an agglomeration of men presents new characteristics very different from those of the individuals comprising it” – Gustave Le Bon (p. 67)
  • “Don’t try to buy at the bottom and sell at the top. This cannot be done – except by liars” – Bernard Baruch (p. 69)
  • “There are two times in a man’s life when he should not speculate: when he can’t afford it, and when he can” – Mark Twain (p. 80)
  • “Search for discrepancies between the value of a business and the price of small pieces of that business in the market. The investors simply focus on two variables: price and value (p. 90)
  • “The future ain’t what is used to be” – Yogi Berra (p. 91)
  • “Life is the art of drawing sufficient conclusions from insufficient premises” – Samuel Butler (p. 96)
  • “Practically everybody (1) overweighs the stuff that can be numbered, because it yields to the statistical technical techniques they’re taught in academia, and (2) doesn’t mix the hard-to-measure stuff that may be more important’ – Charlie Munger (p. 97)
  • “The combination of precise formulas with highly imprecise assumptions can be used to establish, or rather to justify, practically any value one wishes…in the stock market the more elaborate and abstruse the mathematics the more uncertain and speculative are the conclusions we draw therefrom” – Benjamin Graham(p. 99)
  • “Not everything that counts can be counted, and not everything that can be counted counts” – Albert Einstein (p. 99)
  • “If you buy a bond, you know exactly what’s going to happen, assuming it’s a good bond. If it says 9 percent, you know what the coupons are going to be for maybe thirty years. Now, when you buy a business, you’re buying something with coupons on it, too, except, the only problem is, they don’t print the amount. And it’s my job to print in the amount on the coupon” – Warren Buffet (p. 100)
  • Graham observed, he had never “seen dependable calculations made about common-stock values…that went beyond simple arithmetic or the most elementary algebra” – Benjamin Graham (p. 101)
  • “Fish see the bait, but not the hook; men see the profit, but not the peril” – Chinese Proverb (p. 101)
  • “To use a homely simile, it is quote possible to decide by inspection that a woman is old enough to vote without knowing her age or that a man is heavier than he should be without knowing his exact weight” – David Dodd (p. 102)
  • “The key to investing is not assessing how much an industry is going to affect society, or how much it will grow, but rather determining the competitive advantage of any given company and, above all, the durability of that advantage” – Warren Buffet (p. 105)
  • “Necessity never made a good bargain” – Benjamin Franklin (p. 107)
  • “If fifty million people say a foolish thing, it is still a foolish thing” – Anatole france (p. 110)
  • “People always clap for the wrong things” – Holden Caulfield” (p. 114)
  • “Better a diamond with a flaw than a pebble without” – Confucius (p. 117)
  • “Too much of a good thing can be wonderful” – Mae West (p. 135)
  • “A man must consiuder what a rich realm he abdicates when he becomes a conformist” – Ralph Waldo Emerson (p. 137)
  • “The art of being wise is the art of knowing what to overlook” – William James (p. 139)
  • “Put all your eggs in the one basket and – watch that basket” – Mark Twain (p. 140)
  • “Investing should be more like watching paint dry or watching grass grow. If you want excitement, take $800 and go to Las Vegas” – Paul Samuelson (p. 149)
  • “While enthusiasm may be necessary for great accomplishments elsewhere, on Wall Street it almost invariably leads to disaster” – Ben Graham (p. 157)
  • “The way is to avoid what is strong and to strike what is weak” – Sun Tzu (p. 162)
  • “Rule No. 1: Never lose money. Rule No. 2: Never forget rule 1” – Warren Buffet (p. 167)
  • “I made my money by selling too soon” – Bernard Baruch (p. 167)

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