Tuesday, 1 April 2008

Reading List

By Dresdner Kleinwort

Investing 101: a reading list One of the questions I am regularly asked is which books do I consider the bestinvestment reads. This is not an easy question to answer, particularly as if you omitsomeone’s personal favourite they tend to take it as a personal affront. So it is with sometrepidation that I humbly submit the below as among the key readings for investors. Ifyour favourite isn’t on my list then feel free to send me an email, I may even compile areaders favourites list as well. In order to give my choices a little structure I have created four categories of books and only allowed myself to select five books in each group, so there were many great booksthat just didn’t quite make my very restricted list


The first category is the timeless masters. The books in this group have lasted forgenerations, yet their wisdom seems often to go unheeded.

Security Analysis by Ben Graham and David Dodd I prefer the original 1934 edition of this book (available thanks to a recent reprint). Noother book covers such an immense array of investment knowledge. Whilst theaccounting standards may have altered, the very essence of investing can be foundwithin these pages. Some may prefer the easier (and more comfortable to hold) read thatis provided by Graham’s Intelligent Investor. Either or indeed both of these great booksshould be required reading for anyone serious about investing.

Chapter 12 of the General Theory of Employment, Interest and Money by John Maynard Keynes

Much of the General Theory will do little to help investors as it is concerned witheconomics. Keynes himself turned his back on trying to apply economics as an aid toinvesting as he put it “I can only say that I was the principal inventor of credit cycle investment... and I have not seen a single case of success having been made of it”.However, Chapter 12 is very different from the rest of the book; it contains a wealth ofunderstanding and analysis of the psychology and institutional constraints that bedevilinvestors as much today as they did when Keynes was writing in 1935. (For more on therelevance of both Graham and Keynes to the modern investment problem see Global Equity Strategy, 23 January 2007).

The Theory of Investment Value by John Burr Williams

A third book from the 1930s (anyone spot a pattern emerging here?). John Burr Williamspublished his book in 1938 – having written it as his PhD thesis. Williams went to Harvard to study for his doctorate. His supervisor was none other than Joseph Schumpeter, whosuggested that he looked at the question of intrinsic value of a stock. Williams actually published his book (backed in part by his own money) before he was awarded his PhD (asubject of much discussion at his viva). The book contains the essence of the discounted cash flow approach to valuation. Assuch it far predates the more widely cited Gordon papers (as in Gordon Growth Model).The book not only lays out the process and examples of DCF but also contains perhaps the first treatment of the industry lifecycle (Chapter VII). Williams opens The Theory of Investment Value with words that have been value investors’ creed ever since “Separateand distinct things not to be confused, as every thoughtful investor knows, are real worthand market price.”

Manias, Panics and Crashes by Charles Kindelberger

First published in 1978 this is almost a candidate for our modern section. But itsnumerous reprints and editions since 1978 suggest that it has earned a place amongst the classics. This book contains not only a history of most of the major bubbles infinancial markets, but also provides a framework for understanding their progress and ultimately their demise. As such it serves to remind us that although bubbles usually ariseon different assets, the pattern they follow is relatively consistent. We have often usedthe Minsky/Kindelberger paradigm when discussing the path of bubble unwinding (seeGlobal Equity Strategy, 18 July 2002 for example).

Reminiscences of a Stock Operator by Edwin Lefèvre

Originally published in book form in 1923 (although published in Saturday Evening Postas articles prior to that), Reminiscences tells the barely fictionalised biography /autobiography of Jesse Livermore. Livermore battled with depression throughout his life;he finally lost the fight in 1932 when he took his own life.

Although a perennial favourite with traders, Reminiscences contains much advice thatinvestors would do well to remember, such as “Another lesson I learned early is that there is nothing new in Wall Street. There can’t be because speculation is as old as the hills. Whatever happens in the stock market today has happened before and will happenagain. I’ve never forgotten that.” Or “There is the plain fool, who does the wrong thing at all times everywhere, but there is the Wall Street fool, who thinks he must trade all thetime. No man can always have adequate reasons for buying or selling stocks daily – orsufficient knowledge to make his play an intelligent play. I proved it.” And “The desire for constant action irrespective of underlying conditions is responsible for many losses in Wall Street even among the professionals, who feel that they must take home somemoney every day, as though they were working for regular wages.” But perhaps my favourite quotation is “A stock operator has to fight a lot of expensive enemies within himself.”


To qualify to be in this section the book must have been written within the last ten years,but have the potential to become a classic given time.

The little book that beats the market by Joel Greenblatt

Regular readers will know that I am a big fan of Joel Greenblatt’s book. Indeed we havetested Greenblatt’s formula in non-US markets and shown it is a powerful tool regardlessof the market under consideration (see Global Equity Strategy, 9 March 2006). In just 155pages Greenblatt produces a mass of evidence showing that following a quantitativevalue orientated approach to stock selection can produce exceptional performance. But the book is more than just a quantitative take on the value process; it also contains gems such as “You must understand only two basic concepts. First, buying good companies atbargain prices makes sense… Second, it can take Mr. Market several years to recognizea bargain.”

Even better than that, the book is written so that an 11 year old can understand it. But alot of professional investors could do far worse than peruse this slim volume.

The little book of value investing by Chris Browne

My second choice in the modern section is another book from the little book series. This one written by Chris Browne of Tweedy Browne – one of the greatest living embodimentsof value investing. The very essence of the value approach and all it entails (patience etc.) are explored here in 180 pages. The discussion on the margin of safety highlightsthe way in which value investors think about risk – a far cry from modern portfoliotheory’s beta concept. Browne also explores issues such as how to distinguish a valuetrap from a value opportunity. Can be read easily in an afternoon, but should berepeatedly studied by value investors as a check on their own behaviour.

Fooled by Randomness by Nassim Taleb

Taleb’s next book The Black Swan is due out shortly – I’ve had the luxury of reading a draft copy and thought it was every bit as insightful as Fooled by Randomness (althoughpersonally I miss the Nero Tulip stories). In Fooled Taleb highlights just how easy it is for us to fall victim to spotting patterns in the purely random. Every investor who has donewell in a given period should read this book as a reality check, before they start to believetheir own hype. Anyone who is vaguely interested in the role of luck, chance andrandomness will find Taleb’s book a source of much wisdom.

Contrarian Investment Strategies by David Dreman

One of my favourite books on investment. I only recently read Dreman’s book (since thenI have obtained and read his previous two books, and I gather a new book is due outlater this year). This tome is packed with deep insights into the nature of the investment problem, and practical investment strategies designed to avoid some of the behaviouralpitfalls that we all too often stumble into. Dreman is also an empirical sceptic, and offersup good statistical evidence to support his analysis – something that is far too rare in theworld of investment books. My own Seven Sins of Fund Management (November 2005)reaches many of the same conclusions as Dreman, albeit from a totally different perspective.

Speculative Contagion by Frank Martin

For my final selection in the modern category I wanted a book that represented aninvestor’s real time experience of dealing with the market. Several books could havefitted the bill; Cunningham’s edited version of Buffet’s letter was a front runner, as wasChancellor’s edited version of Marathon Asset Managements’ views (Capital Account).However, in the end I settled on Frank Martin’s Speculative Contagion. This book pulls together the annual reports that Martin had written to his clients throughout the bubbleand burst years. It is source of much investment insight. As regular readers will know Irecently used Martin’s trinity of risks as a basis of a better way of thinking about the nature of risk from an investment perspective (see Global Equity Strategy, 1 February2007). Martin’s book provides us with opportunity to see exactly how bad it feels to be onthe wrong side of a bubble, but also delivers insights into the discipline needed to stick tosensible investment process though thick and thin.


The books in this category are close to my heart. They are books on psychology. They aren’t concerned with investing per se. Instead they are all concerned with the way inwhich we think and make choices. Investing is all about making decisions and choices, and as such I think a good grip on psychology is vital for all investors’s hoping to conquertheir internal demons.

The Robots Rebellion by Keith Stanovich

The title sounds like a Sci-Fi novel. However, the robots are us. Dawkin’s selfish geneideas suggest we are effectively just a vehicle for the replication of genes. Stanovichargues that we may be the only species that have the ability to rebel against our genes.At the heart of his approach is a dual system theory of thought (system X vs. system Cfor regular readers). The X system is very much a product of genetics, the C system provides us with a way of over-riding our genetic predispositions. Stanovich explores how evolutionary psychology and the heuristics and biases literatures can be reconciled (an arena that I have tried to explore before). The book also covers how and where many ofthe major biases are likely to show up

Strangers to Ourselves by Tim Wilson

Freud introduced the concept of the unconscious (at least as it is known in the West).Sadly people seem to equate Freud with psychology. However, academic psychology has little to do with Freudian concepts thankfully. Tim Wilson’s book explores the modern concept of the unconscious (system X in many ways). He presents evidence showingthat our actions are often outside of our conscious control. He also points out that simpleintrospection is not the answer, as we are more than capable of lying to ourselves. A brilliant, if disconcerting book.

How we know what isn’t so by Thomas Gilovich

This book is one of the best introductions to error prone human reasoning that I haveever come across. Many of the biases that I have explored in the context of finance are to be found within the pages of this book. Gilovich covers such areas as ourmisperception of random events (hot-hands in basket ball), our habit of seeking out information that agrees with us (confirmatory bias), and issues surrounding group influence on decisions. Anyone interested in the pitfalls of human reasoning will find thisa treasure trove of analysis.

Stumbling on Happiness by Daniel Gilbert

This book is really a book about the folly of forecasting. However, rather than focusing on the failure of GDP forecasts or interest rate forecasts, Gilbert is more interested in our forecasts about what makes us happy. Gilbert is the leading expert in the field of affective(or emotional) forecasting. This book explores his research into why it is we don’t make decisions that would make us happy. Gilbert argues that someone else’s evaluation ofhow they feel in a given situation is a far better guide to how we will feel than our ownprediction. Not only is Gilbert’s subject fascinating, he is also an incredibly talented andfunny writer, not to mention an astute observer of human behaviour with a wicked sense of humour.

The Psychology of Intelligence Analysis by Richard Heuer, Jnr

It isn’t often that the CIA is a good source of insight! However, this book pulls togetherRichard Heuer’s papers from 1978-1986 originally written for use within the CIA. Heneatly reviews the psychology literature as it relates to the processing of information, andits application to solving intelligence problems. The overlap between intelligence analysisand investment analysis is surprisingly high. Both deal with decision making in the face ofmarked uncertainty. Heuer’s book is an easy read that more than repays its reading. Thechapter on the analysis of competing hypotheses should be mandatory reading for all financial analysts! This book may be the best value book on this list – it is free todownload at https://www.cia.gov/csi/books/19104/index.html.

Hidden Gems

The books in this section are a hodgepodge of ideas and interesting reads, some arerare, some haven’t even been published yet, but all provide some powerful insights into the investment problem.

The Halo Effect by Phil Rosenzweig

This book was recently suggested to me by a client (thank you Steve). It is an empirical sceptic’s delight and should be required for all of those involved in the analysis ofcompanies from the bottom-up. Rosenzweig takes much of what passes for analysis in the business world and shows it to be complete piffle. Too many books in the businessfield go along the lines of Company “X” did exceptionally well for the last Y years, now study what they did and learn to apply it to your business. Or CEO of Company X createda culture of excellence, read this book and you can be like him. Even the so-called data based books like ‘Good to Great’ or ‘In Search of Excellence’ arereally little more than stories masquerading as science. They are subject to the garbage in, garbage out critique, low quality data will result in low quality conclusions. My favourite section is on the halo effect – our habit of seeing one good trait and inferring lots of other good traits. It strikes me that analysts may often find themselves at the mercy of thiseffect - going and visiting a company, deciding they like the management and theninferring all sorts of desirable traits like future growth or cheapness.

Mindless Eating by Brian Wansink

Regular readers may recall that I recently used Wansink’s work as an example of theuniversality of behavioural patterns (see Global Equity Strategy, 14 February 2007). Exactly the same behavioural errors and mental pitfalls are displayed in the realm of foodconsumption and the financial markets. For those looking for an entertaining example of the wide spread nature of error prone human decision making this book is excellent. Italso provides yet more evidence of the importance of codifying rules to help overcomeour behavioural biases.

The Inefficient Stock Market by Robert Haugen

A former academic, Bob Haugen now runs Haugen Custom Financial Systems. Histrilogy of books: The New Finance, The Inefficient Stock Market and the Beast on Wall Street are all excellent. But ‘Inefficient’ is my personal favourite. Haugen explores thefailures of classical finance with his tongue firmly in his cheek. He also extols the virtuesof multifactor quantitative models, and his web site has plenty of data to show that the outof sample performance of such models has been exemplary. This book neatly combinestheory and evidence – a top read.

Margin of Safety by Seth Klarman

Perhaps the best book on value I’ve read, although not the best value book I've read since copies appear to change hands at around £700-800! I was lucky enough to findsomeone with a copy of the book who was willing to let me borrow it (Thank youWhitney). Klarman’s discussions on the nature of value investing are priceless. AsKlarman puts it “Value investing...is simply the process of determining the valueunderlying a security and then buying it at a considerable discount from that value. It isreally that simple. The greatest challenge is maintaining the requisite patience anddiscipline to buy only when prices are attractive and to sell when they are not, avoiding the short-term performance frenzy that engulfs most market participants”.

I must confess to displaying strong confirmatory bias when reading Klarman’s work. Heargues that value investors should be absolute return focused, and that the margin ofsafety is all important and central to risk management. He also explores both thebehavioural biases and institutional constraints that prevent most investors from followinga value orientated strategy.

Your Money and Your Brain by Jason Zweig

I recently returned from holiday to find Jason had very kindly sent me a pre-publicationcopy of this book. I started reading it almost immediately, and was smitten from theoutset. For those of you who don’t know him, Jason is a well respected writer on finance.He edited the latest version of Ben Graham’s Intelligent Investor. Given that I am a hugefan of Graham’s work I rarely think it can be improved. However, Jason managed thenear impossible, he added value to Graham’s great text.

In this new book, Jason explores neuroeconomics as it applies to investing (a topic Ihave touched on before, see Global Equity Strategy, 20 January 2005). The book is a pleasure to read – Jason’s writing style is second to none. For those (like me) who arefascinated by the underlying neurological correlates of decision making, this is a must read. It also hints at why we find it quite so difficult to change our behaviour, many of thebehavioural biases appear to be a hard wired function of brain architecture.

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