No. of Recommendations: 43
Earlier at the Halls of Shrewd'm:
Chapters 1-3 - Covers the basics of investing, including the wonders of compounding.
https://www.shrewdm.com/MB?pid=633883465Chapters 4-6 - Cover how to get started with investing, and the advantages of index funds.
https://www.shrewdm.com/MB?pid=235547419In this final instalment (Chapters 7-10) of the "How to Invest Shrewd'm style" series–––brought to you exclusively for shrewdm.com–––we cover individual stock selection.
Chapter 7: RiskBeginning investors, along with Wall Street, frequently view investment risk as stock price volatility—in particular the possibility of the stock price significantly declining. Shrewd investors view stock price and intrinsic value as independent, either able to rise and fall without the other following along. For shrewd investors, the risk is only one of two things: (1) The possibility of the price paid having been too high, and (2) the risk of the intrinsic value collapsing.
The stock price can, and will, occasionally decline—even when there is no important change in the intrinsic value.
To avoid risk, we want to make sure we are buying companies with durable earnings, and that we are not paying a price too high. In the next chapter we look at how to not overpay, but in this chapter we concentrate on avoiding risk. For investors, this should be the first test that is passed even before moving on to valuation.
Making sure a company has
durable earnings, and simply skipping those that don't, serves three vital purposes:
Durable earnings purpose 1: It prevents the permanent loss of capital.
Durable earnings purpose 2: It powerfully mitigates psychological biases that lead to "buying high and selling low".
Durable earnings purpose 3: It protects the terminal value of an investment in its distant future, owing to investors continuing to assign a relatively high earnings multiple much further down the track. (NB: Many investors miss the importance of this one.)
Ultimately, the shrewd investor utilizes the "optionality of skipping" to bypass unpredictable businesses in favor of those rare, assets that offer high conviction and long-term robustness.
Durable earnings come in two flavors: the 'autopilot' variety, like a debt-free house quietly collecting rent, or the 'fortified' variety—businesses that face margin pressure but hide behind a formidable Economic Moat. There is no magic formula for durability; the secret is staying deep within your circle of competence so you can spot the real-world risks before they spot you.
When hunting for earnings that last, look for a 'triple-win'—at least 2 or 3 of these protective layers:
High Switching Costs: Look for products that are 'sticky.' It isn't just about contracts; it's the massive headache of moving. Think of Gmail: it's free, but abandoning a decade of searchable digital history is a price most users won't pay.
Network Effect (User Value): Gravity in numbers. The more people use the platform (like YouTube or Instagram), the more valuable it becomes for everyone else, making hard (to impossible) form a competing service.
Network Effect (Industry Integration): Industry participants heavily involved with the service, creating value for customers or industry. Example 1: So many merchants have signed up to integrate Paypal that customers deem it worthwhile to use it, and vice versa (with so many customers, merchants deem it necessary to integrate). Example 2: Apple's developer community invests years mastering specific tools to earn a living; their expertise draws in customers, which in turn draws in more developers, creating a self-amplifying cycle.
Income Diversification: Don't put all your eggs in one basket. Alphabet's spread of revenue streams offers a sturdier floor than Meta's, even though both boast powerful network effects.
Obsolecense Diversification: Could there be some industry change that makes the whole business model obsolete? Example: Specialty insurers, with policies having mutually exclusive risk, such as Markel or W. R. Berkley, face less systemic 'clash' risk than automotive insurers.
Scale Efficiency: Being the biggest kid on the block allows for cost-cutting that smaller peers can't match. It's less powerful than network effects, but it help.
Structural Dominance: A moat that can't be bridged. Coca-Cola pairs massive distribution with a legendary brand, giving them the 'weaponry' to drop prices to low margins, and competitors forced to go even lower until they disappear.
Pricing Power: A telling litmus test. Can the company hike prices without losing customers? If people love or truly need the product, the company owns the thermostat.
The Debt Stress-Test: If there is high corporate debt (individual project-level non-recourse debt doesn't count) then don't guess: Ensure the company has a rock-solid history of positive earnings and the raw firepower to wipe that debt out (if they chose to) in just a few years using their cash flow.
The 'Nature' of the Earnings: So many investors miss this one. It is easy to get complicated trying to find something profound about the firm's competitive position, whilst missing this simplier but powerful one — some earnings are
durable by their very nature — durable by design, such as being near-necessary. Example: 'Real Assets'—infrastructure, wind farms, or real estate—provide a relentless, necessary stream of cash flow that ignores market whims. Provided the above Debt Stress-Test passes, the 'Nature' of the earnings can sometimes render them durable alone, even without any of the other features above.
The ROE 'Smoke Test': A persistently higher Return on Equity than peers. This isn't what causes durability—it's the evidence that durability exists.
Shrewd investors rarely purchase smaller companies (below $1 billion in market cap) despite often having valuations that seem compelling, such as having grown rapidly and still carrying a PE ratio below 10. They may be purchased, but require a much higher category of knowledge of the individuals in management, coupled with a particularly deep understanding of the industry.
Chapter 8: Valuing CompaniesBefore valuing a company, double check that found a wonderful business within your circle of competence with moat-surrounded durable earnings as discussed in the previous chapter.
In the S&P 500, a company with average growth prospects typically gravitates around a P/E of 15. A higher multiple is only commanded by companies expected to grow at a superior rate. Whilst buying firms with a low P / E ratio gets to the essence of investing (paying a little as possible for each dollar of continuing earnings) it the word 'continuing' that matters - isn't just the earnings this year that we care about, but how the earnings continue very far into the future. For example, if the earnings are set to halve over the next 5 years, then you'd want to be paying an multiple of today's earnings of only about 7.5 so that in 5 years, for the same share price, the multiple of the halved earnings will be back at 15 (an average stock valuation). It's worse than this, though, as after 5 years and looking out to the 10th year, if the earnings continues to fall then the multiple assigned at year 5 will again be lower than 15. It is for this reason that we want to look further out than most other investors are looking.
The trick to outperforming the market is buying companies priced at the lowest multiple of Earnings 5 or 10 years into the future.
3 Steadfastness TestsTest 1 of 3: The first step is to continue the business into the future, 10 years away, and come up with how you expect the business to be appraised by the market at that time, plus any dividends given off. In other words, work out the value produced by the business 10 years into the future. Different firms are valued in different ways, but most comonly you'll need to come up with an earnings per share (EPS) figure for that point in time, and an earnings multiple, multiply the two together and the 10 years of per-share dividends. This will be
impossible to do if you didn't find a company with durable earnings, but with great businesses it can be surprisingly reliable to do. Imporantly, we are not wanting to identify the central estimate for the EPS, but rather a
lower bound that you are certain the EPS will exceeed. If you aren't sure, skip the investment. If you see a large range for the EPS, or the multiple, use the
lowest values in that range. You want to come up with the intrinsic value that you are
certain the business can exceed 10 years away.
Test 2 of 3: Secondly make sure there is litle to no risk of permanent intrinsic value loss over the extreme long-term (such as 30+ years). This throws out many more businesses off the list that may have passed test 1. The purpose of this second test is to ensure the business is still viewed favourably 10 years into the future, when looking out to year 20 from year 10. We want the truly-long-term future to remain bright for the business, prevening the earnings multiple from collapsing 5 or 10 years out.
Test 3 of 3: You determined 1-2 above yourself. Sorry.. what was that? Yes,
that was the 3rd test. If you didn't, then you'll be susceptible to selling out as the quote falls and you start second guessing whether earnings are durable.
Once again, if you are not confident about either of these 3 steps, no problems—simply skip the investment and no harm has been caused. Shrewd investors do a lot of skipping.
But be cautious at this point: If you aren't entirely sure about how the business makes money and the long-term resilience of its market position, shrewd investors simply skip the investment here. It does not matter what price you pay for a business set to fail at some point in the future, and even the virtue of great patience won't help at all when things go south.
Ranking OpportunitiesUnshrewd investors, such as trained economists, corporate finance departments and spreadsheet addicts, like to calculate the value of a company as: The sum of all the actual cash a company will generate over its entire life, with each future dollar adjusted (discounted) to what it is worth in today's money. That's a mouthful to take in, but perhaps fortunately, even when you deeply understand the concept, it has almost no use. The trouble with discounting the future earnings is that the Discount Rate varies between companies according to how risky the respective earnings are, and by modifying the Discount Rate, it allows you to arrive at almost any number of the intrinsic value, making the more important of predicing future earnings as inconsequential.
Shrewd investors much prefer the common-sense concept of opportunity cost is applied by evaluating a range of companies' Intrinsic Value Tomorrow ÷ Price Today, and buying those with the highest ratio. We also add all dividends received to our Intrinsic Value Tomorrow calculation, and denote it as IV0 when looking at the value now, IV5 when looking at the value 5 years away, and so on.
Makes sense, doesn't it? To invest successfully you want to know what the value is in the future, compare that to the price today, and own the companies for which the difference (the ratio between the two) is as large as possible. That's about as simple as it gets, and about as shrewd as it gets.
Comparing IV5 to the price today is generally looking far enough into the future to find value disconnected with price, but sometimes greater market inefficiencies can be found by looking even further out—as much as 10 years—to IV10.
Example: AlphabetRisk Phase: Does Alphabet pass the durable earnings (Steadfastness Test) as calculated 28 July 2025?Steadfast Test 1: Will earnings by extremely likely above some minimum baseline in 10 years?
Answer: Yes. Advertising market share may decline but people will be performing much more product/service searches in 10 years so the total pie will be substantially larger than today; furthermore there is a large runway for advertising auction rates to increase with ever-improving targeting as more behaviour data is collected.
Steadfast Test 2: Extremely long-term test - is there any chance of catastrophic earnings loss after 20 years?
Answer: No. It's a legal monopoly with insane network effects, and if broken up (unlikely substantially) constituent parts will continue to operate well.
Value Phase: Calculate IV10 / priceEPS gains over 10 years = 14% per year, with cloud services comprising 20%+ of earnings at year 10.
This requires a thesis, which is too long for this article.
Gain or loss from normalizing the earnings multiple = 26 (typical P/E) ÷ 21 (present P/E)
= 24% above what the present quote gives
Dividend = ~8% additional gain over 10 years assuming reinvestment (~5% without reinvestment)
Finally work out IV10 / price:
NB1: Normally IV10 is calculated as lower bound EPS in the 10th year × an earnings multiple likely by investors looking from the 10th year out to the 15th year + re-invested dividends. Then divide IV10 by price today.
NB2: We can alternatively view IV10 / price as: The multiple over the price today to reach the normalized value (plus dividends) 10 years into the future, as below.
IV10 / price = 10 years of 14% return, adjusted down to end the 10 years with a normal P/E, and adding 8% for the dividends
= (1.14)^10 × (26 ÷ 21) × 1.08
=
5.0As published 28 July 2025 that's a really high IV10/price ratio.
https://www.shrewdm.com/MB?pid=896730329Holding Only The BestWith a collection of companies passing the above tests of durable earnings, and for the even shorter list for which you can confidently calculate the IV10, the final step is to compare the IV10 / Price ratio across each of them (with 2.0 a rather typical opportunity, and 4.0 or higher an excellent opportunity). Then purchase just top 3-5 companies with the very highest IV10 / price ratio.
When you find a new investment opportunity that is better than anything you own (the IV10 / price ratio is higher than everything else), you can sell the company with the lowest IV10 / price ratio, and replace it with the new opportunity. This approach will encourage you to hold some firms almost 'forever', and in rare cases that you sell it will usually be owing to the price becoming euphorically high such that the IV10 / price ratio has declined, prompting you to replace it with another opportunity (or your already-held highest ranked opportunity at the time). The approach causes you assume an ownership mentality, but to the extent that there is any selling, you are generally always buying low and selling high.
The Shrewd Shortcut: For Those Without Endless TimeFortunately, you don't have to pick individual stocks to stay shrewd. An index ETF will do the heavy lifting just fine! In the long run, the discipline of staying invested with an index ETF such as 'SPY' or 'RSP' and only managing our own psychological devils will be far more life-changing than the marginal gain you might scrape from outperforming the market.
Let's be honest: identifying truly 'Steadfast' opportunities requires a massive time commitment both to the individual firm analysis, and to continually keep up to date and deepen (arguably more important than to 'widen', as relates to investing) your Circle of Competence. If you haven't done that deep-dive legwork, you will be far more likely to succumb to cognitive biases and panic-sell during some future temporary price dip. By holding an index-tracking ETF, you trade the stress of the 'analyst' for the peace of the 'owner'—allowing you to truly set and forget.You can also evolve into a stock-picker over time. Start with an index ETF as your foundation, then gradually layer in individual companies as your Circle of Competence deepens. This hybrid path offers the reliable safety net of an ETF and the intellectual challenge of hand-picking winners—a lifelong hobby that, for the shrewd, is far more rewarding than any crossword puzzle can offer.
Chapter 9: The Psychology of ShrewdnessAs the late Charlie Munger, the billionaire partner of Warren Buffett, famously observed: 'A lot of people with high IQs are terrible investors because they have terrible temperaments.' To be shrewd, you must realize that your greatest enemy isn't the market; it is the evolutionary wiring of your own brain - great for escaping imminent wins, but often working against us in our strange modern world.
The Munger Mindset: Avoiding Standard MisjudgmentsLoss Aversion: Our brains feel the pain of a loss twice as intensely as the joy of a gain. Shrewd investors train themselves to see a market dip not as a tragedy, but as a clearance sale on future wealth.
Social Proof (The Herd): Young investors often feel a biological urge to increase stock exposure when their friends are, reinforced with positive media messages, and sell when their friends are selling, reinforced by Blood on Street! articles. Shrewdness is the ability to be 'fearful when others are greedy, and greedy when others are fearful.'
Sunk Cost Fallacy: When you start to understand that you were wrong about the business, but refuse to admit it because of the money lost, and time invested, towards it.
The Commitment & Consistency Bias: Once we publicly announce we love a stock, we find it almost impossible to admit we were wrong. Munger suggests we should 'try to destroy our best-loved ideas' every year to stay objective.
Start some conversations on the venerable Berkshire Hathaway board about these, and more of Charlie's insights:
https://www.shrewdm.com/MB?bid=1This is but a brief taste of the fascinating world of investing psychology. The main message is that just knowing how to invest is perhaps half of what makes us shrewd, and the other half is overcoming our lack of patience and emotional biases, such as responding to fear or greed, to make change-of-strategy decisions at the worst times. This is where having like-minded companions around you at Shrewd'm can really help to keep you on the right track, which is a lovely compounding curve when looked at from afar.
Chapter 10: The Shrewd GlossaryAmplification Feedback: (Relating to stock prices): The phenomenon of investors observing recent stock price declines, producing fear, leading to more selling and thus further price declines. These new declines are again observed, and so on in a loop. The Amplification Feedback also occurs in the opposite direction—investors observe recent price rises, become either enthusiastic or fear missing out, causing on aggregate more buying, which is then observed, leading to more buying, and so on in a loop. In either direction, price momentum becomes a real phenomenon, however when it ends is unpredictable. (Relating to news): Negative (or positive) news can be distributed to a very wide audience, which causes journalists to re-publish similar stories, creating other journalists to re-report, and so on, creating another amplification feedback loop. This is sometimes called an Information Cascade and can work in conjuction with stock price momentum to create a enhanced-amplification-feedback effect.
Basis Points (BPS): One-hundredth of one percent.
CAGR (Compound Annual Growth Rate): The average growth rate of an investment. To calculate, the CAGR over 4 years with 35%, -10%, 20% and 15% annual returns, CAGR = (1.35 × 0.9 × 1.20 × 1.15) ^ (1 / 4) = 13.8%. Comparing the CAGR of your equity over 7+ years to the CAGR of the S&P500 index, over the same period, is the metric by which shrewdness is measured.
Capital Gain: Simply the "profit" you make when your stock price climbs—like buying 1,000 shares at $10 and watching them hit $11 for a $1,000 win. While the taxman usually wants a slice of that profit the moment you sell, a shrewd investor avoids that "haircut" by simply holding onto the stock, allowing the tax-deferred gains to stay invested and compound like crazy. By sitting tight, you're essentially using the government's future tax money to make yourself even more money, ending up with a much fatter wallet than the Wall Street "pros" who sell-and-buy far more excitedly, paying tax along the way.
Circle of Competence: Investing only in areas of knowledge where your shrewdness is highest. It applies to all life ventures, but investing especially—knowing the boundary of this circle is more important than having a larger circle.
Book Value: Also often called 'Equity', sometimes 'Liquidation Value', but best to think of it as the "Carcass Value." It is the company's total assets minus total liabilities, and what shareholders would supposedly get if the company sold all assets and paid all debts. But if you're leaning on Book Value for a tech or service company, you're looking at the tombstone instead of the engine. It can be useful, though, for valuying asset-heavy industries like banks, manufacturing, utilities, and real estate, where tangible assets (property, equipment, inventory) form a really large part of their value.
Debt-to-Equity: The 'Oxygen Supply.' It tells us how many years of profit it would take to pay off the debt. If the company is underwater for too many years, the engine stalls. Shrewds look for companies that can breathe easy.
Debt-to-Earnings: The number of years it takes to pay of all debt if earnings were to remain the same. This ratio of (Debt / Earnings) is a more immediate indicator of liquidity and default risk.
Discount Rate: A way of thinking about investing that causes you to justify, or discard, any investment regardless of its true merit.
Diversification: Spreading risk by not putting all your eggs in one basket. We don't need to be exceedingly diversified, but having at least four good ideas is far more robust than one.
Diworsification: Over-diversifying until your shrewdness is diluted to zero.
Dividend: The "rent" that you, as an owner of the company, collects. Shrewd companies pay dividends when either the shareholders favour it, or when a proportion of their earnings (called the 'Payout Ratio') cannot be re-invested back within the company (see Retained Earnings) at a sufficiently high rate of return, allowing the investor to re-invest the dividend elsewhere themselves.
Dividend Yield: The dividend as a percentage of today's stock price (dividend per share / share price).
Earnings Yield: The inverse of P/E; helps a shrewd investor compare stocks to bond yields. A typical stock (trading at a P/E of 15) will have a yield of 1/15 = 6.6%. Unlike bonds, EPS tends to keep up with inflation, so the future yield based on today's price is generally much higher over time.
Fear of Missing Out (FOMO): Observing recent price rises in assets (stocks or housing) and—expecting the trend to continue—feeling a mix of anxiety and excitement to purchase immediately. This is driven by the desire to profit and the fear of being forced to pay significantly higher prices later.
Economic Moat: An innate advantage that a shrewd business uses to keep competitors at bay. This allows a business to continue earning a higher Return on Equity than its competitors. Forms include: Intangible Assets (Brands, patents, and regulatory licenses), Switching Costs (financial or psychological costs that discourage customers from moving), Network Effects, Cost Advantages (underprice Coke and you're out of business), Efficient Scale (a weaker form of moat, but it helps).
Active Management: Attempting to pick stock winners to outperform the market or to reduce volatility, which contrasts with just buying an ETF that tracks an index passively.
Cognitive Biases: The mental glitches that sabotage rational investing. These psychological shortcuts—like following the herd or falling in love with a less than mediocre company—trick you into making emotional trades instead of shrewd ones. In a market that rewards discipline, these biases are the ultimate "hidden tax" on your returns.
Capital Compounder: A shrewd business capable of investing back within itself, fairly repeateably, with a high rate of return, leading to outstanding long-term returns.
ETF (Exchange-Traded Fund): A shrewd vehicle to have your capital match the returns of an index. It offers transparency and lower costs compared to managed funds. Examples include 'SPY' (S&P 500 market-cap weighted) or 'RSP' (S&P 500 equal-weighted).
EV/EBITDA: A valuation shortcut taking into account Enterprise Value (Market Cap + Debt - Cash) and core operational earnings (EBITDA). It is a more shrewd metric than P/E for companies with large cash or debt positions, or lumpy one-off gains or loss on investments that don't relate to core operations
Ex-Dividend Date: The date that determines who gets the dividend check. On this day the stock naturally drops by the per-share value of the dividend.
Earnings: The profit (if positive) or loss (if negative) that a company is making right now, usually measured over the trailing 12 months (the last 4 reported quarters) or just one quarter. It is the company's sales (ie. revenue) minus expenses, including the expense of tax.
Earnings Multiple: Another term for P/E, and the shrewdest way to think about the P/E; the multiple of the present earnings that the market 'believes' (rightly or wrongly) the company to be worth.
EPS: The Earnings Per Share are the company's earnings divided by the number of shares outstanding.
Expense Ratio: The fee that steals your shrewdness. Keep it low.
Executed Transaction: When the full number of shares ordered were bought or sold.
Forward P/E: Similar to P/E but using estimated EPS for the next year. It is a quick check to see if earnings are temporarily elevated or depressed.
Free Cash Flow (FCF): The cold, hard cash left over for owners that can be used for dividends, buybacks, or reinvestment without harming the business.
Geometric Return: The math that accounts for compounding; essential for shrewd modeling. If $10,000 grows at 9% over 20 years, you calculate 10,000 × 1.09 × 1.09 × 1.09 ... repeating 20 times, and denoted 10,000 * 1.0920.
Intrinsic Value (IV): What a business is really worth, contrasting with what short-term traders might think it is worth at any given moment.
Intrinsic Value (per share) / Price: Comparing the current price to the true value. Buying at intrinsic value results in ratio of 1.0, but buying at a discount (e.g., a ratio of 1.45) offers a "bonus" 45% return spread out over several months or years as the price eventually catches up to the intrinsic value.
IV10 / Price: As espoused in Manlobbi's Descent, the "North Star" of shrewd investing. It compares the expected intrinsic value ten years from now (with dividends reinvested) to the price today. By looking further out, you are able to factor in the full weight of how growth effects intrinsic value. Factoring a full 10 years of operations, you are able to exploit greater market inefficiencies that others aren't appreciating. Firms that you can't forecast the IV10 for are simply skipped, leaving only a small number of candiates.
Limit Order: The shrewd way to buy and sell shares of a company: only at your specified price, or a more favorable price, but never a less favorable price.
Liquidity: How fast you can turn an asset into cash.
Living Below Your Means (LBYM): A mindset of maintaining a significant gap between earnings and overhead, recognizing that many consumption habits are socially programmed without adding true value. By refusing to let lifestyle expenses—such as house size or vehicle price—float upward with income, you dramatically increase the annual contributions toward your compounding engine. LBYM has become a quiet but global movement against the status quo: a commitment to buying back your future autonomy rather than chasing present self-perceived status. Far from self-deprivation, it is the ultimate flex of financial power.
Managed Fund: A pool of money with professional managers who charge fees for diversification and promotion, which reduces the investment return.
Margin of Safety: The shrewd investor's insurance policy. If you think you will get an adequate return when buying a stock at $20 per share, you'll be more shrewd buying it at a 30% discount ($14 per share) in case your investment thesis missed one or two important things.
Margin Call: When your stocks fall in value and are unable to support the Margin Debt issued earlier, the Broker forces you to either provide more cash, or sell stock (generally at the worst time).
Market Cap: The total market value of the company (Share Price x Shares Outstanding), which is roughly what the entire company is worth (that is, if all shareholder would be both willing and agreeable to sell at today's quote).
Margin Debt: This is the money you borrow from your broker—using your own hard-earned stocks as a hostage—just to chase a bit more action. A shrewd investor treats Margin Debt like a rigged game and avoids it entirely for four big reasons. First, it's a psychological trap: you'll be tempted to "leverage up" when the market is soaring (Buying High) and forced to liquidate when the market crashes (Selling Low), effectively automating your own failure. Second, it introduces the "Great Reset" risk; even a tiny 10% margin leaves you vulnerable to a total wipeout. In the 1930s, the market dropped 90%, and if you were leveraged by even 10%, you didn't just lose—you hit zero. And as we say in the huddle, Zero × [Your Net Equity] = Zero will always equal zero. Third, the math is surprisingly underwhelming. A $100,000 portfolio returning 10% over a decade gets you to $260,000 on your own. Adding 20% margin (at 7% interest) only nudges that to $286,000 - calculated as: (Normal Return) + (Return from the Margin Debt with a 7% Margin Rate) = (100,000 × 1.10^10) + (20,000 × (1.10 - 0.07) ^10). That extra $26k is not life-changing — it's just a "marginal" tip for the decade of bankruptcy risk you carried. Finally, look at the asymmetry: if you're a great compounder, you'll be rich anyway without the debt; if you aren't, margin just amplifies your funeral. It's a tool that grows your downside exponentially while barely moving the needle on your win.
Market Inefficiency: The capcity for the stock price and intrinsic value to sometimes differ by large or small amounts. Shrewd investors believe it to be the norm, whilst trained economists frequently come to believe the market to be efficient (price and value aligned).
Market Maker: The House. They stand in the middle of every trade, pocketing the Spread like a toll booth operator. They provide the liquidity we need, but don't think for a second they're on your team. Shrewd investors trade so infrequently, often holding firms for 7+ years, that the spread isn't a problem, but for addicted Technical Traders, the spread makes their job essentially impossible.
Market Order: Paying whatever the market asks; not shrewd for smaller firms where your trade size is significant relative to volume.
Market Outperformance: Generating a return higher than the benchmark index, accounting for both capital gains and dividends (total return). Often referred to as Alpha within flashy Wall Street articles, it is readily trumpeted over year to year cycles - owing chiefly to ever-present random stock price gyrations - but extremely seldom found over very long periods such as 20+ years, which is the only place it really matters to shrewd investors.
Market Timing: Trying to predict price changes over the short-term to buy or sell opportunistically. Shrewd investors don't do it, and believe it is impossible to do it. Instead, shrewd investors buy when the price is low relative to intrinsic value, with no opinion about the broad stock market movement over the short-term, considering it highly close to random.
Mechanical Investing: A rules-based investment approach that uses predefined criteria or algorithms to automate buy/sell decisions, aiming to remove human emotion and biases like fear and greed. Shrewd'm has the most expert and active Mechanical Investing community in the world, who will passionately help you with any question, or you can read more using the Shrewd'm Mechanical Investing FAQ.
Mr. Market: A conception that Benjamin Graham came up with, describing the market sentiment as a whole. Investors changing their mood all together, in unison, rather than each investor acting independently, owing to cognitive biases and amplification feedback effects such as the way news is distributed. Mr. Market is a hyper-emotional person, flipping betweena mania and depression. You must exploit Mr. Market, rather than fear him, in order to become shrewd. Like a drunk, he'll throw up quotes every month, sometimes far too high and sometimes far too low, and you don't have to take any of the drunk's quotes seriously—unless favourable to you as a shrewd investor.
Mutual Fund: Often an expensive, non-shrewd way to invest compared to index ETFs.
Network Effects: A positive feedback loop where a service becomes more valuable as more people use it (or there is more industry integration with the service), creating a "winner-takes-all" effect.
Nominal Total Return: The annual increase in portfolio value (capital gains plus dividends) before tax and before inflation as a percentage of starting value. This contrast the Total Return which adds in dividends, and the Total Real Return which subtracts inflation to give your true wealth increase.
Operating Margin: Efficiency in turning revenue into profit. Operating Income / Total Revenue.
Opportunity Cost: The hidden cost of not being shrewd with your capital.
P/E Ratio (Price-to-Earnings, or Earnings Multiple): The Price divided by Earnings Per Share (EPS). Shrewdness is knowing when this price is too high relative to the quality of the business.
Passive Investing (Index Investing): The shrewd default for most investors, holding an ETF that tracks an index of stocks outperforms nearly all managed funds over the long-term, owing to the low costs of running an ETF. There are no stock-pickers, far fewer offices, and less marketing that all quietly shaves dwown the investor's returns.
PEG Ratio: A shrewd way to adjust P/E for the growth rate. A PEG below 1.0 for a high-quality company can indicate a bargain.
Price-to-Book (P/B): Comparing market value to the liquidation value of assets (or comparing the stock price to the per-share liquidation value); often less useful for high-quality service or tech businesses that have their future earnings support not by the balance sheet, but by their market position and Economic Moats such as Network Effects. Until the 1970s, companies would often trade a ludicrously cheap prices - such as 20% of this 'liquidation value' so investors could scoop them up, then sell close to book value but the days of those opportunities are impossibly rare. These days the great investment opportunies come from huge disconnects between the price today and the likely intrinsic value well into the future, owing to business qualities that impatient investors are missing.
Portfolio: A list of all your liquid investments (cash position, margin debt, stocks, ETFs, etc) and their respective present market values.
Real Total Return: The Nominal Total Return adjusted downwards by subtracting inflation (CPI).
Return on Equity: Earnings divided by the Equity (Book Value); it describes how much profit is being produced relative to the size of the company. Asset-light firms often have a high Return on Equity, and if they can re-invest profits back in themselves at a high return then they make excellent compounding machines.
Recency Bias: A cognitive shortcut where people give disproportionate weight to recent events. In other words, forgetting history; an enemy of shrewdness.
Retained Earnings: Profits kept within the business to build more shrewdness and growth. Sometimes referred to as 'ploughing back' earnings, companies, in retaining their earnings, are doing just what you are doing—forfeiting a little earnings now for a lot more earnings later.
ROIC (Return on Invested Capital): The gold standard of a shrewd capital compounder. While ROE measures the return on all the equity, ROIC measures the return a company earns on new capital deployed.
Security: A broad term for any tradable financial asset representing ownership (like stocks/shares) or debt (like bonds), issued by companies or governments.
Share Buybacks: A company using its cash to buy its own shares on the open market, reducing the number of outstanding shares. This will increase Earnings Per Share but also reduces the opportunity to use the cash for even higher returns at some point in the future, so it isn't always a win. Share buy-backs are economically not different to purchasing shares of another very similar company, so whether it is a good move or not depends on the price paid. It is only shrewd and value-adding when shares are purchased below intrinsic value.
Scuttlebutt: Your secret edge. While Wall Street recycle news of the day and their geeks play with 'over-exact' formulas, you get the real insights by using products or platforms you know and grilling customers and employees. This shrewd "boots-on-the-ground" detective work reveals winning truths that spreadsheets simply can't see.
S&P500 Index: Tracks the stock price return (without dividends) of 500 large US companies. Though it uses position sizing in proportion to their market cap, resulting in high exposure to just the top few giants, it has remained the quintessential stock return benchmark for investors not only in the US but around the world.
Standard Deviation: A fancy "geek word" for how much a stock price wiggles. To a Shrewd investor, price wiggles are not risk—they are opportunity. High standard deviation just means Mr. Market is having a particularly moody day, offering us a chance to buy at a clearance price or sell during a mania peak when the long-term prospects are the lowest. Real risk is a permanent loss of capital; a squiggly line on a chart is just entertainment.
Sunk Cost Fallacy: The reluctance to abandon a strategy because of heavy past investment. Also known as "throwing good money after bad." Shrewd investors would argue that the Sunk Cost Fallacy doesn't apply to declining prices (which can make the investment even more compelling) but rather, only bites a value investor when they are wrong about the business, and refuse to admit it because they've spent so much time and money on it.
Ticker Symbol: The code under which a company, fund or other security trades on a stock exchange. To shrewd investors the ticker symbol represents real ownership of a business; to others it represents something that moves up and down triggering fear and greed impulses, akin to a casino game.
Total Return: Total Return is the overall gain or loss on an investment over time, combining both capital appreciation (price increase) and income (dividends, interest, distributions) into a single percentage to show an investment's complete performance, not just its price movement. This contrast the Nominal Return which is the return without dividends.
Spread: The difference between the buy and sell price on a stock currently on offer - this can be a difference of about 0.1% or even higher for thinly traded stocks. This is the "tax" you pay to the Market Makers for your trade.
Technical Trading: Looking at past price squiggles to try to predict what the price will do next. As the trade is so ludicrously short-term (often minutes, hours, or just a few days) they would be playing a zero-sum game, however it becomes a negative sum game owing to the Market Maker taking a fee each trade. On aggregate, these traders lose a lot of money each year, and the profession is akin an elaborate form of playing The Pokies.
Tracking Error: When a fund fails to match its index.
Volatility: Price swings based on public mood or fashion changes, usually having no relation to the change in Intrinsic Value, that provide shrewd entry and exit points.
- Manlobbi
