Confessions of a Business Student
So here I am. My first year into what is about to be a great learning journey through one of the top business schools in the world. I am not alone. In America, about 1 million students choose to study business at the undergraduate level every year. I was told that I was about to have the best time of my life.
Well, it’s all a matter of perspective.
But I can see why so many people told me that. Some students are definitely living the dream. No need to watch American Pie anymore.
On a more academic note, since I am passionate about investments, I decided to apply for a spot on the committee that manages the student investment fund. I first had to go through an interview during which I was asked how many condoms are consumed every year in China (there were other finance-related questions too, but this is the one I remember most). I came to an approximation after a couple of minutes of mental math. Obviously I was way off the track. There are approximately 10 billion condoms produced each year in China. My answer was 90 billion. In any case, it didn’t seem to bother my interviewers that I overestimated the frequency of sexual relations in Asia. I advanced to the second round.
The second step was a little more concrete. We had 36 hours to analyze a company and present it in front of the whole committee. Oh, and we did not get to choose the company. So I locked myself in my room and started grinding through the annual reports of Intel Corp.(INTC). I actually managed to do a pretty good job in such a short time frame. Once in front of the committee, I started to recite everything I could remember from what I had read about the company. Everyone seemed to follow until I mentioned a word (or a name, I must say) that seemed to leave everyone puzzled. I tried repeating the name for a second time to make sure everyone understood. Now my audience was not just puzzled anymore, they were completely lost.
-Ben Graham used a formula in Security Analysis…
–Benjamin Graham, nobody has heard about him?
–Yeah, isn’t that guy a teacher in Harvard or something?
That’s when I realized that I was not in the same world as these people in front of me. Even though they could recite every corporate finance textbook, nobody knew who was Benjamin Graham. So I kept talking anyway. In the last part of my speech I made several references to Bruce Greenwald’s method of calculating the reproduction value of a business as well as toWarren Buffett (Trades, Portfolio)’s letters to shareholders. I kept having the same puzzled look, like I was coming from a world where 2+2=5.
It seems they liked my presentation anyway, because I was one of the few selected to fill the available spots in the club.
Once the new committee was formed, we had our first meeting in which the older students showed us how to calculate the value of a company using a DCF model. The majority of the rookies don’t even know what free cash flow means, and we are shown how to discount them. They told us that from now on, when we analyze a company, we ought to use a DCF. That’s the way to do it. Then they started to talk about betas and EBITDAs and all that kind of stuff.
I was just astonished.
I am not saying that DCF models are bad. It’s just that they are like chemical compounds in a laboratory. If you don’t have the required knowledge and experience to mix them, they just blow off your face. I don’t pretend to have any special knowledge. That’s why I don’t use DCFs. I found several useful tools to value a company, tools that are much simpler, and that I understand pretty well. I stay in my circle of competence. I can say with certainty that nobody in this group masters the use of a DCF model. But they use it anyway to make decisions on which they will bet several thousand dollars.
Fast forward later that night and we are all together in a bar (I’m Canadian, so yeah, we are old enough to drink legally), chatting about finance and about our personal investing prowesses. At some point, the subject of discussion turns to internships. Now everybody is talking about how much they want to go into investment banking or consulting. Some are actually summer interns in different investment banks, and they are just complaining about how hard it is and how little sleep you get.
Then it hit me. That was not my place. Not at all.
It became worse later that night when my turn came to talk about the biggest position in my personal portfolio.
“Yellow Media,” I answered.
Their faces. You should have seen their faces. I think they felt sorry for me. They looked at me like I had just lost all my loved ones, at the same time, in a fire, or something as serious as that. I even felt like they started reconsidering if they would let me manage the school’s money.
“Poor you, how did you end up with that? They’re just getting out of bankruptcy. The business is not going well at all. The stock just keeps dropping. What a bad move!”
Yeah, but none of this really matters if I paid a price low enough. First, the business is reviving; it’s not going bad at all. Second, some people made millions investing in bankrupt companies. It’s all about what you get for the price you pay. But nobody would listen to me. For them, price and value are two vague concepts from outer space (except when it fits perfectly in their DCF models).
Here’s another one. A little later I ended up talking with a smart young student and one of the only two girls in the group (which by the way has enough brain power to blow up any of your conceptions of a genius). The young man was then talking about a stock that he thinks will double in two or three years. When he stopped, I asked him what was the worst investment he had ever made. He answered with the same stock he was just talking about. The one that he thinks will double. His rationale was that since he bought the stock, it went down 20%, so he should have waited to buy it.
Finally, the (incredibly) smart girl (also incredibly attractive) really killed every bit of remaining doubt in my mind that I was not in the right place. She’s actually going into investment banking after having received an offer last week. Talking about a particular stock, she said that she couldn’t get herself to buy because every time the company reported its quarterly results, the stock went up, and then down. “I’ll wait until it goes up and doesn’t come back down, I will feel safer buying it.” I challenge you to find a logic behind this statement.
Those are the same people who are going to run our financial industry in the future. They are not dumb. They are incredibly smart. Like computer smart. The average GPA of the group is probably around 4.15. They’re just human. Investing requires counterintuitive behavior. Nobody can blame them.
It’s just that nobody shows us how to think. We learn how to discount future cash flows and compute financial ratios, but we don’t know how to think about them.
We are wired to feel comfortable acting the same way as the herd does. That’s why those students I’m talking about all want to get the same jobs. They all want to buy the stocks that other people buy. They can’t stand being different. They can’t stand the risk of being wrong and being the only one. What they don’t realize is that by reverting to the mean, they will never stand out as exceptional investors. By definition, if you want to beat the average, you need to differ from the average. In your thinking, and in your actions.
And me? I just can’t pronounce the word Net-Net. Good thing they don’t know what it is. I would probably get kicked out of the group for real.
All of a sudden, I realized the real meaning of this word. It must incredibly hard to be contrarian in the huge jungle that is the world of finance. I was in a bar with a dozen students, and I had hard time simply handling their reactions when I told them about my investment philosophy. I felt alone. I felt rejected. I just can’t imagine on Wall Street. It seems easy when you’re reading Buffett’s letters in your basement, but in the real life, the human instinct is powerful. It is easy to get caught.