How to make money

People in the finance industry are very good at making money – for themselves.

Take a look at the hedge funds, which have a fee structure called “two and twenty”. The two is 2% of the capital invested, and the twenty is 20% of the profits. When one does the maths, it works out that, as a client, it’s quite difficult to make money. If the return on investment is 5%, then the “twenty” gives the hedge fund 1 of the 5% and the “two” gives them another 2 of the five, which is 60% of the return. And it appears that’s a generous example. An insider, with access to the data, calculates that hedge fund managers have kept 84% of the returns, and their clients have got the other 16%. It’s a good deal for the managers.

Of course, it’s the clients who carry all the risk. It’s really not a very good deal for the clients.

Now the funny thing is that it’s not really all that complicated making money on the stock market. One of the best books on the subject “Security Analysis” has been around since 1934. Its most successful proponents is Warren Buffett. Another is Seth Klarman who, like Buffett, has made extraordinary returns for his investors. Klarman is also the author of the book “Margin of Safety: Risk-Averse Value Investing Strategies for the Thoughtful Investor” which is now also considered to be an investment classic.

Value investment is the term given to the strategy. Briefly summarized, it’s proponents argue that it makes sense to buy something worth a dollar, if you can find it at 40 cents. They argue that the markets often react emotionally, and then sometimes going against the market makes sense, especially if you know that there is something special about the business. That’s how one finds the dollar for 40 cents.

Let’s use the example of Olympus. Last year there was a lot of bad news about the company. It had been hiding losses, and the share price crashed from a peak of ¥2,773 on 08/1/2011 to a low of ¥424.00 on 11/11/2011.

Olympus makes cameras. The camera market has become quite challenging as phones have captured the point and shoot market. So the market is shrinking to the professionals and dedicated amateurs.

Olympus has just introduced a new model that is changing that market. The new model replaces it’s clunky SLR predecessors. The new camera matched to similarly svelte high quality lenses is going to give the dominant players, Nikon and Canon, something to worry about.

If Olympus was only about cameras, buying their shares would be a great value investment, even with the market as it is. Unfortunately, they make a lot of other products, and not knowing enough about those makes the investment less certain.

Certainly worth investigating though.

Legal note: This article does not constitute financial advice. If you follow any of the suggestions contained herein, losses are for your own account. Profits are to be shared on 1% and 20% basis.

More at:
Olympus Corp (7733:Tokyo)
The Superinvestors of Graham and Doddsville
Notes to Ben Graham’s Security Analysis
Security Analysis – What did Benjamin Graham really say?
Margin of Safety: Risk-Averse Value Investing Strategies for the Thoughtful Investor
Security Analysis: Sixth Edition, Foreword by Warren Buffett
Margin of Safety: Risk-Averse Value Investing Strategies for the Thoughtful Investor
Hedge funds
Mastered by the universe
The Oracle of Boston
Figuring it out