How a value investor prepares for a Europe backpacking trip

Tomorrow, I fly-out for a backpacking trip through Europe with by friends Chris and Deep. Part of our pact to "travel abroad until we get broads" -- our 1-liner to explain why we spend Xmas and NYEs abroad until we're tied-down at our home towns (either by family, kids, etc.). Just a normal-sounding bachelors' trip, except the three of us are value investors (Deep and I started Palmanik Investments together; I've been teaching Chris value investing since 2008).

So before I jumped on my American Airlines flight to London, I researched the economics of the airline industry. Here are some back of the napkin calculations and an "inside look" at how an investor prepares for a Europe backpacking trip:

• Average fuel cost per mile for airlines in Q3 2009 was $0.035/mile. Which, on my 5,500-mile flight would cost $195. (Interesting comparison: an average commuter spends about $0.10/mile on car fuel costs).
• Additional costs in Q3 2009 adds another dime, bringing operational costs to $0.14/mile. Which, on my 5,500-mile flight, would cost $770 net.
• I paid $1,200 for my 5,500-mile California-to-London flight, which means I paid $0.22/mile. But here's the catch, I paid $1,200 for a ROUND TRIP flight (so round trip, I flew 11,000-miles which drops the price I paid per mile to $0.11/mile).
• Just to break even, an airline would want to charge about $3,000 RT or $0.27/mile on my California-to-London RT flights. I paid $1,200 and $0.11/mile.
• The difference between costs/mile ($0.27) and price paid per mile ($0.11) is horrifying from an investor's standpoint. Reflective of the competitive nature of the airline industry; variable costs of fuel; fixed costs of labor, interest, maintenance, etc.; seasonality of consumer traveling; general recession environment.
• Based on these back of the napkin calculations, American Airlines is losing a ton of money per mile served. I say this with mixed thoughts -- happy as a consumer, disappointed as a potential investor.

Interesting how much you can find out about a company by just breaking down the basic economics of their product.

Time to pack for Europe.

Cheers, Miguel

Gates and Buffett on "Creative Capitalism"

Wow, it's been over three months since my last post.

Now that my schooling is done at San Diego State University, I have more free time to read and learn. Schooling is different from education -- and like I told my parents after my graduation ceremony, "now that I've graduated, I finally have free time to start my education."

Speaking of education, here's a discussion (albeit a long one) between Warren Buffett and Bill Gates on "creative capitalism." It's a topic I've never read anything about, but I think some of you will enjoy their in-depth discussion on intelligent philanthropy, how to help poor countries, the inefficiencies of capitalist economies, and Bill Gates' "annual letter" to prospective philanthropists coming out in January 2009.

Enjoy! This one is out of my ordinary postings on value investing and finance.

Investment questions from a friend and my e-mail replies

After participating in an investment simulation, one of my friends had some follow-up questions for me regarding his investment experience. My friend has minimal investment experience and is a college student. But after you read their questions, you'll probably get the sense that they're thoughtful and very analytical (and possibly a psychology major)!

They threw their questions at a "fast speed and with a dangerous curve," challenging me to dig deep into what I knew about investments and other related fields. I'd like to share with you the short e-mail conversation we had:

FRIEND: 1. Buy low sell high, right? Or is it buy low and keep high?
ME: It's buy low, sell high.

Ideally, it's buy low and never sell i.e. you want to buy a business that will keep growing in value forever. But in reality, value investors often sell their investments for various reasons. Some reasons to sell include: 1) the original analysis of the investment was incorrect, 2) you find a better investment vehicle or, 3) your investment has become grossly overpriced.

2. Does macro economics help?
Very good question and one that is arguable for some folks.

Here are my thoughts: when I evaluate information, Warren Buffett asks if a) is the information important?, and b) is it understandable? There's no doubt that macro-economics is important, but I don't understand it. To me, macro-economics is the oversimplification of a very complex system ... which is the reason why I think people who make investment decisions based on macro-economics often get things wrong.

Going further, I found that you can usually figure out what's going on in the macro level by studying micro level stuff i.e. you can typically make a semi-accurate analysis of macro level phenomenon by knowing and understanding micro level stuff. If you have any questions about what I consider "micro level stuff," please let me know -- that's a detailed conversation in itself.

3. I remember in our business plan our guest speakers used a lot of macro economics to explain why our pricing strategy didn't work. How much of stocks is psychology opposed to economics?
My oh my ... you have wonderful insight! Economics and psychology are very much intertwined -- actually, there's a field called "behavioral finance" that studies the overlap between economics and psychology. You might be interested to study that subject. I've studied it too; it's interesting stuff.

Psychology is very intertwined in stock purchasing. After all, you're talking about a market that is made-up of average investors ... these average investors have wives, children, sit in traffic after work, get mad when their cappuccino is cold, etc. And yes, economics is also involved with stocks ... but to a limited extent. Understanding the main theories of economics is very important, but it's even more important to know when economic theories don't work in investments and to know its limitations.

4. Stocks seem to be partially dependent on demand which is dictated by what people think will be profitable. Does it even make sense at times? Can something so complex be mapped? Is there a field of psychology that tracks the mental processes of investors?
The field of psychology that tracks financial mental process is behavioral finance.

Your question regarding "Can something so complex be mapped?" addresses the concepts of prediction and touches on Efficient Market Theory. In short, I don't think such a complex system such as the market can be mapped and that its behavior is not predictable. That question addresses the subject of complex systems (which the market is) and how to properly act and think in complex systems. I'm a firm believer that something so complex as the stock market cannot be mapped, but with a solid framework you can beat the market return.