DAN DAVIES ON THE SMART MONEY METHOD
“Although we tend to hear more about big swinging macro funds or quant rocket scientists, it’s still the case that the majority of the money made in financial markets is through old fashioned stock picking. And within the world of stock picking, consistently the most profitable thing to do – if you are good at it – is to find “special situations” where a 50% profit can be picked up on the long or short side. This is the subject of “The Smart Money Method”. It’s a book about how to pit your wits against the finest minds of the market and find stocks where the consensus view is badly wrong.
The interesting thing is that there are a lot more such situations than anyone cares to admit, even the finance professors. Fisher Black, of the Black-Scholes option valuation model, used to say that a reasonable definition of an “efficient market” would be one in which it was difficult for a security to trade for less than half or more than double its true value. Obviously, in a “factor of two efficient” market like this, there’s a lot of free money available for anyone who can spot even a couple of dozen of the really cheap stocks.
So why don’t more people do it?
Well, the answer is that it’s difficult, and it’s hard work. Not by any means impossible – I once suggested to a friend that to be a successful equity stockpicker, you would need to put in roughly as much time and effort as a really serious birdwatcher puts into birdwatching. That shouldn’t be too demanding a thing to ask. Companies aren’t as nice to look at as birds, but they often act in more interesting ways, and for many people the money itself is an attraction.
Unlike birdwatching, though, it is not easy to find someone who will teach you how to pick stocks. There are a hell of a lot books, but – and I have read dozens of them – they tend to be disappointing in a lot of the same ways. About half of them are dumbed down summaries of 1920s textbooks on value investing. Half of the remaining half are just lists of someone’s best ever stock picks. The only one that professionals really rate is “Accounting for Growth” by Terry Smith, but that is now nearly thirty years old. (It’s still worth reading, even though nearly all the accounting standards it refers to have been revised). So a good new book like this one which actually explains how the thing is done is extremely interesting.
Where “The Smart Money Method” stands out is that it gives actual, specific advice. It doesn’t start by telling you “once you have found your idea …”, it tells you how to generate workable candidates. Before getting into the weeds of financial analysis, it takes you through a due diligence process that will help to decide whether it’s worth cracking the spine on a set of accounts. When it gets in to the accounts reading section, it doesn’t bury you in ratios or fascinating facts about individual industries – it takes you through the way in which a set of financial statements tells a story about the underlying business, and how to ask questions about that story and answer them. It explains how to handle management meetings and how to develop the right kinds of industry contacts. These are all tricks of the trade that people usually have to learn by apprenticeship on trading floors; you would have to fetch a hell of a lot of coffee to have some of these nuances explained to you.
In many ways, I’d put this book in a similar category to the dozen or so instructional manuals I have sitting next to my guitar case at home. None of them have, so far, enabled me to immediately and effortlessly play bebop solos at 200 beats per minute. But they all set out information, from people who knew what they were doing, in a way that tells you how to practice things which will make you play better. Investing is at least as frustrating as playing a musical instrument – and Steve Clapham is unusual as an author in being honest enough to include some of his mistakes along with the greatest hits – but it’s a lot easier to get better if you know what you’re trying to achieve. “