As an experiment, We prepare different chits and write down different stocks name on those piece of paper. Then we give it to different monkeys to pick it for a week. Few come out as a winner and few as losers. We continue playing the same with winners only. Over some time, one monkey comes as a right in all the time. The media calls that monkey a successful monkey and call everyone to understand his success mantra.
This is an outcome bias; we tend to evaluate decisions based on the result rather than on the decision process. When a person has a good performance track record of stocks picking then we consider him as a good stock picker or an expert rather than knowing the process or it can be possible that past results can be due to pure luck. I met few fund managers who do not read books or annual reports thoroughly but they have survived for 10-12 years so people call them successful and an expert.
In conclusion: never judge a decision purely by its result, especially when randomness or ‘external factors’ play a role. A bad result does not automatically indicate a bad decision and vice versa. So rather than tearing your hair out about a wrong decision, or applauding yourself for one that may have only coincidentally led to success, remember why you chose? what you did?. When we start understanding the process behind success, then we can easily recognize success as a part of luck or efforts.
We have seen the defensive investors in the last article of the same series. Now, Mr. Graham has explained what not to do for the defensive as well as aggressive investors.
Mr. Graham has explained what not to do for aggressive investors such as –
Aggressive investors also have to start with deciding an allocation between common stocks and bonds. Also, they have to be ready with more analytical work compared to defensive investors. When second-grade bonds are available at the substantial discount to the principal value and also, having a prospect then it will be more attractive compared to high-grade bonds. Aggressive investors have to compare a discount available to the high-grade bonds and the second-grade bonds. We need not forget the rule of the safety of principal while investing in the bonds. We need to check the adequate cover to the interest charge on pre-tax earnings. If such cover is not available then we should avoid bonds though they having a higher yield.
Mr. Graham has mentioned regarding foreign bonds that we do not properly know the future of foreign bonds. If any troublesome times come then we do not have a legal means of enforcing claims. So, we should avoid such opportunities though we get interested rate benefits.
Day trading – Mr. Graham has mentioned that day trading is a weapon invented for committing financial suicide. Buying and selling a stock for a few hours also bringing down your profit. The more we trade; we keep less with us which also affects our long-term profitability. Luck can provide us a benefit for a few times, but for getting consistent benefits from trading, we require great attention. Someone who can’t hold on to stocks for more than a few months at a time is doomed to end up not as a victor but as a victim.
New issues – we need to be very careful before purchasing a new issue because the majority of the times new issues comes during favorable market conditions for the seller of the new issues which means not purely favorable to the buyers of the new issues. Majority of the time, prices of new issues get collapsed. We have seen very few winners which have given a good return by investing in the IPOs such as Infosys, Wipro, Eicher Motors, etc. but there is a huge list of losers also.
So that does not jump to the IPOs at higher valuations, lets company to work for justifying such a higher valuation.
Disclosure – Companies mentioned in the article is just for an example & educational purpose. It is not a buy/sell/ hold recommendation.
Luck is not always going to support us if we do not have the proper skill to make appropriate decisions. If we won by help of luck but make the wrong decisions thereafter then we end up with the losing a game. And for making an appropriate decision, we need to work on developing our skills. If we get success by using a stroke of luck then we cannot say that failure will not come to our way. Actually, success and failure is a cycle so that if we meet success then failure will come to meet us next. By developing a skill, we can reduce the intensity of the failure.
John Paulson has started a hedge fund company with $2 million of own fund in the year 1994. His firm is specialized into the merger arbitrage. But during the year 2005, one of his analyst Mr. Paolo Pellegrini suggested him that US housing market is into the bubble territory. And after reviewing facts presented by Mr. Paolo Pellegrini, Mr. Paulson convinced to go against the housing price. He started acquiring credit default swaps. As he got a confirmation for his idea, he has started acquiring more swaps. The largest mortgage guys of the country were positive on the sub-prime during the year 2005. But outside of his team called him a crazy. He has earned during a fall of subprime in the year 2007 worth of $15 billion for the fund and $4 billion for personal.
After the big success, he started searching for a similar big winning idea. When we get a huge success then we need to save ourselves from the trap of ego. This is a very crucial emotional bias which enters to us and we remain unknowable about it.
Mr. Paulson has an idea to buy more valuable asset compared to inflation during the year 2010. So that he bought gold and gold-related investment worth of $5 billion, he became the largest owner of gold in the world. He could not able to repeat his past success and lost 30%+ value in a year and after that, he lost value for consecutive three years. Mr. Paulson other funds also lost in value and also merger fund where he has an expertise that also falls.
We cannot able to hit winning shot every-time but when we hit a winning shot, we need to keep those value which we received. But generally, we try to repeat those winning shot again and again which create destruction of wealth for us. I learn from my Guru – Mr. Neeraj Marathe Sir, from Howard Marks and Mr. Ben Graham, that protection of wealth must be our priority. Neeraj Sir always mentioned that if we focus on avoiding mistakes then we won half of the battle. So that we should focus on not to hit a winning shot but rather focus on not to lose money. If we survive into the game then we may have a chance to hit winning shot again. But if we do not survive into the game then there will not be any probability to hit a winning shot again. If we keep our focus on hitting a winning shot then we compromise with the capital protection which is an essential part of the game. And we should not forget it ever.
When the market is into the bull phase, each and every stock in upward momentum. So that everyone who has made an investment is shining and looks like a genius. But we should understand that earning during a bull phase is not our skill, it’s has a role of luck also which has supported us. Our actual skill comes during a bear phase, while we protect our wealth or fall less. But we get confuse and does not appreciate the role of luck during the bull market and make blame to the luck, market, other external factors during the bear market. Such behavior stops us from growing into the investment field.
If we could not survive during a bear phase then we definitely going to wipe out or end up with the lower return. But bull phase of the market makes us tempting and overconfidence to our skill rather make an appreciation of luck which has actually perform a role.
Jerry Tsai was run Fidelity Capital Fund by the year 1957 and he was one of the celebrity fund managers during that time. And everyone eager to observe what he was doing.
Mr. Jerry style of managing fund-
Mr. Jerry has earned a return of 296% in the year 1958-1965 compared to 166% return of conservative equity funds. In the year 1965, Mr. Jerry has sold his ownership stake of Fidelity back to the Fidelity for $2.20 million and launched Manhattan Fund.
Mr. Jerry holds a few of the stocks during the year 1968-69 was Polaroid, Xerox, and IBM. These stocks were traded more than 50 times P/E ratio due to the high growth of earning. And University Computing, Mohawk Data, and Fairchild Camera traded at several‐hundred times their trailing 12‐month earnings.
We should be always prepared for the bear phase of the market. And also should avoid hot stocks during a time. Whenever I make any investment decision, I keep the year 1929 – great depression to my mind. So that I can survive and stay prepared for a bear phase of the market. When the market is into the bull phase, everyone talks about the return and focus only on earning a return, they do not like to talk about the risk and also do not focus on the risk. Such behavior has proven as a danger for us. And our behavior also responsible for inviting a bear phase from the bull phase.
The game which is played by Mr. Jerry was not a long term surviving but he believes that he can survive for the long term because he has huge insights for the market moves. And he was overstated for his own skills. We need to understand that everyone can earn during a bull market but survival during the bear market is essential. If things do not fall under the criterion then we should avoid it rather chase for it. Not great company will be a great investment at any price. If we are not able to understand it, then does not able to survive for the long term.
If someone has bought this company during the March-2000, at the high price of around Rs.215 then after the 19 years of the period, he gets returned at 7% CAGR. And if enter to the similar company at the low price of around Rs.138 during the March-2000 then after the 19 years of the period, he gets a returned of 9% CAGR (*Considering recent all-time high price for calculating returns). Though revenue has grown at 26% CAGR, Operating profit grown at 23% CAGR and Net profit also grown at 23% CAGR during the same period. The company is supported by a good management team, good business, leadership position into the industry. During March-2000, the company was traded at 64x P/E at the low price of Rs.138 and this multiple are common nowadays and we consider it as a quality company ask for the premium. We cannot estimate which valuation multiple is high or low but we can understand that what is reasonable and what is not.