Novel Investor https://novelinvestor.com/ Compounding investing wisdom... Fri, 26 Aug 2022 15:31:19 +0000 en-US hourly 1 https://novelinvestor.com/wp-content/uploads/2018/10/favicon.png Novel Investor https://novelinvestor.com/ 32 32 25613926 Wise Words from Charlie Munger https://novelinvestor.com/wise-words-from-charlie-munger/ Fri, 26 Aug 2022 14:39:24 +0000 https://novelinvestor.com/?p=512955 Charlie Munger is the lessor known half of the partnership team that built Berkshire Hathaway. Prior to that, he was a lawyer, before giving up law to run his own investment partnership. He started Wheeler, Munger & Company in 1962. The partnership was wound up in 1975. Back-to-back 31% losses in 1973 and 1974 made […]

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Charlie Munger is the lessor known half of the partnership team that built Berkshire Hathaway. Prior to that, he was a lawyer, before giving up law to run his own investment partnership.

He started Wheeler, Munger & Company in 1962. The partnership was wound up in 1975. Back-to-back 31% losses in 1973 and 1974 made investors squeamish and in need of capital. Yet, despite the losses, Munger outperformed the market, earning a 19.8% annual return over the 14-year period (compared to 5% for the Dow).

Munger teamed up with Warren Buffett three years later (1978) as vice chairman of Berkshire. In his spare time, he chairs the Daily Journal, designs buildings, and plays the part of a walking, talking encyclopedia. He’s a learning machine who built his own system of mental models to reduce errors in this complex world. His unique view of uncommon sense, as he calls it, can be seen in how he invests.

Extreme concentration and inaction best describe Munger’s approach. He’s comfortable with only three or four wonder businesses in his portfolio. That’s far short of the popular broad diversification strategies recommended today.

Except, extreme concentration is not for everyone. First, finding a handful of wonderful companies worth owning is never as easy as it sounds. Someone not skilled in the art is likely to find awful companies more often than wonderful ones.

Second, it takes a particular mindset to own a handful of stocks and do nothing because the byproduct of concentrated portfolios is higher volatility. Most people are driven to act when the market gets crazy. Munger, however, does nothing and accepts it.

The good news is that you don’t need to invest exactly like Munger to be successful. The best part of investing is the ability to learn how the greats did it. You can learn from their successes and failures, borrow their ideas, and make them your own.

On Traits of a Great Investor

I think great investors to some extent are like great chess players. They’re almost born to be investors… Obviously you have to know a lot. But partly it’s temperament. Partly it’s deferred gratification. You got to be willing to wait. Good investing requires a weird combination of patience and aggression. And not many people have it. It requires a big amount of self-awareness and how much you know and how much you don’t know. You have to know the edge of your own competency.

On His Investment Philosophy

Understanding both the power of compound return and the difficulty getting it is the heart and soul of understanding a lot of things.

***

Value investing, the way I conceive it, is always wanting to get more value than you pay for when you buy a stock and that approach will never go out of style… I think all good investing is value investing, and it’s just that some people look for values in strong companies and some look for values in weak companies, but every value investor tries to get more value than he pays for.

***

We want to buy something that’s intrinsically a very good business, meaning that an idiot could run it and it would do all right. Then we want that business, which an idiot could run successfully, to have a wonderful person in it running it. If we have a wonderful business with a wonderful person running it, that really turns us on, and it works very well. Now, we do make exceptions, but not many. It’s a pretty simple philosophy.

***

I had a friend when I practiced law and he said, “If it won’t stand a little mismanagement, it’s not much of a business.” We like businesses that stand a lot of mismanagement but don’t get it. That’s our formula.

***

If you have a pharmaceutical company and you’re trying to guess what new drug is going to be invented, I’ve got no advantage. Other people are better in that than I am. I don’t play in a game where the other people are wise and I am stupid. I look for a place where I’m wise and they’re stupid. And believe me, it works better… That’s my philosophy, and I think you have to know the edge of your own competency. You have to kind of know “This is too tough for me. I’ll never figure this out.” I’m very good at knowing when I can’t handle something.

***

A place like Berkshire Hathaway or even the Daily Journal, we’ve done better than average. And now there’s a question. Why has that happen? And the answer is pretty simple. We tried to do less. We never had the illusion we could just hire a bunch of bright young people and they would know more than anybody about canned soup and aerospace and utilities and so on and so on and so on. We never had that dream. We never thought we could get really useful information on all subjects like Jim Cramer pretends to have. And we always realized that if we worked very hard, we can find a few things where we were right. And the few things were enough. And that that was a reasonable expectation. That is a very different way to approach the process.

***

There are huge advantages for an individual to get into a position where you make a few great investments and just sit back and wait: You’re paying less to brokers. You’re listening to less nonsense. And if it works, the governmental tax system gives you an extra 1, 2, or 3 percentage points per annum compounded.

***

It’s not given to human beings to have such talent that they can just know everything about everything all the time. But it is given to human beings who work hard at it — who look and sift the world for a mispriced bet that they can occasionally find one. And the wise ones bet heavily when the world offers them that opportunity. They bet big when they have the odds. And the rest of the time, they don’t. It’s just that simple.

***

You’re not talking to a great exiter. My Berkshire, I bought in 1966… I’ve been a good picker. But other people know more about exiting. I’m trying never to have to exit… I think there’s working styles of investments that work well with constant exits. It just hasn’t happened to been my forte. So I’m no good at exits. I don’t like even looking for exits. I’m looking for holds.

***

Over the long term, it’s hard for a stock to earn a much better return than the business which underlies it earns. If the business earns 6% on capital over 40 years and you hold it for that 40 years, you’re not going to make much different than a 6% return even if you originally buy it at a huge discount. Conversely, if a business earns 18% on capital over 20 or 30 years, even if you pay an expensive looking price, you’ll end up with a fine result. So the trick is getting into better businesses. And that involves all of these advantages of scale that you could consider momentum effects.

On the Stock Market as a Pari-Mutuel System

The model I like to sort of simplify the notion of what goes on in a market for common stocks is the pari-mutuel system at the racetrack. If you stop to think about it, a pari-mutuel system is a market. Everybody goes there and bets and the odds change based on what’s bet. That’s what happens in the stock market.

Any damn fool can see that a horse carrying a light weight with a wonderful win rate and a good post position etc., etc. is way more likely to win than a horse with a terrible record and extra weight and so on and so on. But if you look at the odds, the bad horse pays 100 to 1, whereas the good horse pays 3 to 2. Then it’s not clear which is statistically the best bet using the mathematics of Fermat and Pascal. The prices have changed in such a way that it’s very hard to beat the system…

In the stock market, some railroad that’s beset by better competitors and tough unions may be available at one-third of its book value. In contrast, IBM in its heyday might be selling at 6 times book value. So it’s just like the pari-mutuel system. Any damn fool could plainly see that IBM had better business prospects than the railroad. But once you put the price into the formula, it wasn’t so clear anymore what was going to work best for a buyer choosing between the stocks. So it’s a lot like a pari-mutuel system. And, therefore, it gets very hard to beat.

On Handling Booms and Busts

I’ve had my Berkshire stock decline by 50% three times. It doesn’t bother me that much. That’s just a natural consequence of adult life, properly lived. If you have my attitude, it doesn’t really matter. I always liked Kipling’s expression in that poem called If. And he said, “Success and failure.” He says, “Treat those two imposters just the same.” You just roll with it.

***

You get crazy booms. Remember the Dotcom boom? When every little building in Silicon Valley rented at a huge price and a few months later, about a third of them were vacant. There are these periods in capitalism and I’ve been around for a long time and my policy has always been to just ride them out… What shareholders actually do is a lot of them crowd into buying stocks on frenzy, frequently on credit because they see that they’re going up, and of course that’s a very dangerous way to invest. I think that shareholders should be more sensible and not crowd into stocks and just buy them just because they’re going up and they like to gamble.

***

Everything in life has dangers. Since it’s so obvious that investing in great companies works, it gets horribly overdone from time to time. In the “Nifty-Fifty” days, everybody could tell which companies were the great ones. So they got up to 50, 60, and 70 times earnings. And just as IBM fell off the wave, other companies did, too. Thus, a large investment disaster resulted from too high prices. And you’ve got to be aware of that danger.

***

I didn’t get rich by buying stocks at a high price earnings multiples in the midst of crazy speculative booms, and I’m not going to change.

On Creative Destruction

The Harvard Business School, when it started out way early, they started out with a history of business and they’d take you through the building of the canals and the building of the railroads and so on and so on and you saw the ebb and flow of industry and the creative destruction of economic changes and so on and so on. It was a background which helped everybody. Of course, what I’m saying is that if I were teaching business, I would start the way Harvard Business School did a long time ago…

If you stop to think about it, business success long-term is a lot like biology and in biology, what happens is the individuals all die and eventually so do all the species and capitalism is almost as brutal as that. Think of what’s died in my lifetime. Just think of the things that were once prosperous that are now in failure or gone. Whoever dreamed when I was young that Kodak and General Motors would go bankrupt? It’s incredible what’s happened in terms of the destruction. Of course, that history is useful to know.

***

My first investment with my pitiful savings of a venturesome sort, I invested in a company right in Pasadena. And it was called William Miller Instruments. And I damn near lost all my money. It was hell on earth. We just barely squeaked out with a substantial outcome. But what did us in was the oscillograph that we’d invented, and we were so proud of, and we thought it was going to knock the world flat. Somebody invented magnetic tape without telling me and by the time we got the oscillograph ready to go to market, we sold three. Three total, in the whole country. So technology is a killer as well as an opportunity. And my first experience had damn near killed me…

Over the long-term, big companies of America behave more like biology than they do anything else. In biology, all the individuals die and so do all the species. It’s just a question of time. And that’s pretty well what happens in the economy too. All the things that were really great when I was young have receded enormously. And new things have come up and some of them started to die. And that is what the long-term investment climate is and it does make it very interesting. Look at what’s died — all of the department stores, all the newspapers, U.S. Steel. John D Rockefeller’s Standard Oil is a pale shadow of its former self. It’s just like biology. They have their little time and then they get clobbered…

Some people try to get on the cutting edge of change. So they’re destroying other people instead of being destroyed themselves… Other people, like me, do some of that, joining things like Apple. And in some ways, we just try to avoid big change we think is likely to hurt us.

On Mistakes

I’m constantly making mistakes where I can, in retrospect, realize that I should have decided differently. And I think that that is inevitable because it’s difficult to be a good investor. I’m pretty easy on myself these days. I’m satisfied with the way things have worked out and I’m not gnashing my teeth that other people are doing better. I think that the methods that I’ve used, including the checklist, are the correct methods.

***

I have made bad business decisions. You can’t live a successful life without doing some difficult things that go wrong. That’s just the nature of the game. And you wouldn’t be sufficiently courageous if you tried to avoid every single reverse.

***

I’m a very blocking and tackling kind of a thinker. I just try and avoid being stupid. And I have a way of handling a lot of problems. I put them on what I call my “too hard pile” and I just leave them there. I’m not trying to succeed in my too hard pile… I sometimes get into things that are too hard, and when that happens, I fail.

***

A good bit of the Munger fortune came from liquidating things we originally purchased because we were wrong. Of course, you have to learn to change your mind when you’re wrong. And I actually work at trying to discard beliefs. And most people try and cherish whatever idiotic notion they already have, because they think if it’s their notion, it must be good. And I think, of course you want to be re-examining what you previously thought, particularly when disconfirming evidence comes through. And there’s hardly anything more important than being rational and objective.

***

How do you scramble out of your mistakes without them costing too much? And we’ve done some of that too. If you look at Berkshire Hathaway, think of its founding businesses. A doomed department store, a doomed New England textile company, and a doomed trading stamp company. Out of that came Berkshire Hathaway. Now, we handled those losing hands pretty well when we bought into them very cheaply. But of course, the success came from changing our ways and getting into the better businesses. It isn’t that we were so good at doing things that were difficult. We were good at avoiding things that were difficult. Finding things that are easy.

Sources:
A Conversation with Distinguished Alumnus Charles T. Munger
The Not-So-Silent Partner
Redlands Forum Transcript
2021 Daily Journal Annual Meeting
2020 Daily Journal Annual Meeting
2019 Daily Journal Annual Meeting
The Art of Stock Picking

Last Call

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Skill vs. Luck: Failing to Lose https://novelinvestor.com/skill-vs-luck-failing-to-lose/ Wed, 24 Aug 2022 20:56:24 +0000 https://novelinvestor.com/?p=512923 Purposely losing money in the stock market seems like it should be an easy task. It turns out it takes some luck to lose money in the market. The same goes for making it. Michael Mauboussin defines pure skill-based activities as those where you can lose on purpose. Chess is pure skill. It takes years […]

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Purposely losing money in the stock market seems like it should be an easy task. It turns out it takes some luck to lose money in the market. The same goes for making it.

Michael Mauboussin defines pure skill-based activities as those where you can lose on purpose. Chess is pure skill. It takes years of learning and practice to become just good at chess. However, a master chess player can lose on purpose to anyone.

Whereas the lottery is pure luck. It’s a random draw. You can pick a series of numbers and hope to lose but there’s always a chance you get lucky and win.

Investing falls somewhere in between pure skill and pure luck because the amount of noise in the system makes it hard to lose (or win) on purpose in the short run.

A good example of this is an interesting experiment run by John Rogers and his team several years ago:

We had some fun with this notion at Ariel this summer. I asked 71 of my associates to pick ten stocks that would underperform the market in the second quarter. Only 19 of them succeeded, meaning 73% of them tried to lose on purpose but couldn’t. Indeed, the average return on the try-to-lose portfolios was 30%, double the market’s return. The lesson: Short-term stock movements are more a function of luck than skill.

There are a number of fundamental characteristics we can look for in companies that are known to produce poor returns. For example, companies trading at excessively high valuation multiples, on average, tend to perform horribly. Companies with declining sales, no earnings, burning through cash, laden with debt, and static to shrinking market share should lose you money too.

Yet, on average is not absolute. Improbable things happen. The market can defy common sense in the short run.

The risk: investors who don’t understand probabilities learn the wrong lesson. It’s like the guy playing blackjack who hits on 19 and the dealer turns over a two! Then forever hits on 19 because he confused an unlikely outcome with a smart decision. Investors tend to attach skill to positive outcomes even when luck is involved.

It’s important that investors separate process from outcome because a good investment process, may have setbacks, but it will produce good outcomes, on average, over time. A bad investment process, may produce a few lucky breaks, but will ultimately lead to ruin.

The problem investors face is that it’s hard to tell the difference between a good and bad process in the short run if you don’t know the difference between a setback and a lucky break. So what makes a good process?

First, a good process is long-term oriented. The shorter the focus the more good or bad luck plays a role, as Roger’s experiment showed.

Second, a good process has a history of past success and makes sense. For example, a process built on mean reversion through stocks with low valuation multiples has performed well over multiple decades. Combining it with other factors with a similar history can improve the odds of success. And there are sound behavioral reasons behind why it works.

Finally, a good process should mitigate behavioral mistakes. It could be a simple checklist. It could be rules-based to eliminate behavioral biases entirely. Whatever your tendencies are, having a set of rules or checks to balance them out builds discipline into your investment process.

Investing is a game of probabilities. A disciplined investment process tilts the odds in your favor. That’s what successful long-term investing is about.

Source:
Briefing Book: John Rogers Jr.

Related Reading:
On Process: Moneyball, Casinos, and You
Steven Crist: Second Level Thinking at the Racetrack

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Edwin Lefevre: Investor, Speculator, or Gambler? https://novelinvestor.com/edwin-lefevre-investor-speculator-or-gambler/ Fri, 19 Aug 2022 13:22:34 +0000 https://novelinvestor.com/?p=512730 Ben Graham often explained the difference between investors and speculators. An investor looks for investments that provide safety and a solid return. A speculator tries to profit off market moves. Edwin Lefevre had a similar view. Though, he added a third option for good reason. He separated gamblers from speculators because he saw a pattern […]

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Ben Graham often explained the difference between investors and speculators.

An investor looks for investments that provide safety and a solid return. A speculator tries to profit off market moves.

Edwin Lefevre had a similar view. Though, he added a third option for good reason. He separated gamblers from speculators because he saw a pattern of gambling emerge during bull markets.

Here’s how he defined each following the 1929 crash:

The Investor

The careful investor should seek expert advice, for he must subordinate income to safety… No living man can, vision what effect unpredictable changes in politics, in social readjustments or in technological processes may have on any business or on any government. It follows that even the most careful of investors cannot altogether eliminate the element of chance or the peril of change from his operations. At best, he reduces them to a reasonable minimum.

It behooves him and no one else to do his own studying and to pick the right adviser with the same care he uses to pick his lawyer or his physician. Going to the wrong investment banker is one of the risks he runs. Remarks about careless or dishonest or ignorant bankers and about dangerous demagogues may be justified, but the same holds true of shysters and quacks.

The investor today is better protected than ever before in our history, and he should have learned something from the depression. But nobody can guarantee him against loss, nor is he freed from the responsibility of studying his own problem instead of leaving it to a dealer’s say-so. It has never been easy to be a wise investor, but it has always been easy to be careful.

The Speculator

A speculator bets on probabilities. His decision to buy or sell securities is apt to be based on his knowledge of his own business or on his judgment of such conditions, political, industrial, financial or commercial, as normally affect market values. It makes him willing to take greater chances than the true investor, because he is looking not for an assured income but for a profit. He is backing with dollars the accuracy of his observation and the soundness of his deductions. He does not overlook possible accidents. He considers both trade statistics and human nature.

In the last bull market, more than one speculator who knew that prices were much too high, nevertheless carried stocks past the initial danger points — not because of earnings or past records but because of his reading of the bull-fever thermometer. Other equally clear-sighted men sold stocks short in 1928 or 1929 because prices were dangerously inflated. They also were right, but they went broke because they were right as to facts and wrong as to time; and being right too soon is as unprofitable as being right too late or being wrong at any time.

The Gambler

There remains the third class: The gamblers — the margin traders during bull markets, chiefly the general public. They are the most numerous and the most reckless. No matter what laws are passed, or what safeguards are provided, or how the game is played, they are bound to lose, because their motive is wrong. They buy stocks for one reason only — to sell at a profit. They are not true speculators — or professionals, like the floor traders — because their hope is not the result of study or experience but of wishful thinking, of listening to customers’ men or to lucky friends. Their reasons for buying are apt to be excuses for gambling. They think that taking big risks entitles them to big profits.

What contributed to the huge losses of thousands of Americans during the crash? For one thing, they were playing another man’s game. They were bent on getting something for nothing. Then again, they overtraded. The bait has always been easy money…

Knowing which of the three above you fit into is a good start. The difficulty is in staying the course.

Graham repeated the differences between investors and speculators often because he knew that people confuse the two during bull markets. They become risk-seeking rather than risk-averse. Any price will do.

Investors act more like speculators — or worse, investors and speculators act like gamblers. Disaster follows those who claim to be something they’re not.

The risk that investors act like speculators or both act like gamblers is ever-present in bull markets. Of course, it’s human nature to chase easy money. And it’s easy to slip from investor to speculator or gambler and believe nothing has changed simply because you’re making money. In the end, it rarely pays off. You trade long-term plans for easy short-term gains, which turn into losses in the ensuing collapse.

The lesson is to stay in your lane. Stay disciplined. Investors should stick to investing, speculators to intelligent speculation, and gamblers should stick to the casino.

Source:
The Newest Era in Wall Street, Saturday Evening Post

Last Call

  • You Can Make Any Piece of Data Look Bad if You Try – TKer
  • 4 Things Poker Taught Me About Investing – CityWire
  • Hypertakeflation and the Sportification of the Fed – Kyla’s Newsletter
  • A Conversation with Josh Wolfe: Macro, Mentors, Motivation – The Manual
  • Edward Chancellor: Interest, Capitalism, and the Curse of Easy Money (podcast) – M. Faber
  • Family Fortunes – Net Interest
  • We Don’t Have a Hundred Biases, We Have the Wrong Model – Works in Progress
  • History Rhymes: Nobody Wants to Work Anymore – Klement on Investing
  • An Oral History of SuperbadVanity Fair

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Learning the Wrong Lessons https://novelinvestor.com/learning-the-wrong-lessons/ Wed, 17 Aug 2022 21:26:02 +0000 https://novelinvestor.com/?p=512652 There’s a risk that investors learn the wrong lessons from recent market cycles. One of the biggest wrong lessons is that the market always quickly recovers. Of course, quick recoveries have defined the stock market since the 2008 financial crisis. The 2009 bottom led to the longest bull market ever and the buy the dip […]

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There’s a risk that investors learn the wrong lessons from recent market cycles. One of the biggest wrong lessons is that the market always quickly recovers.

Of course, quick recoveries have defined the stock market since the 2008 financial crisis. The 2009 bottom led to the longest bull market ever and the buy the dip mantra (BTFD) grew from that period. The 2020 crash solidified it.

It would come as no surprise if investors expected recent history to repeat itself. Of course, investors often mistakenly rely on recent history or lived experience to make decisions, as if it’s the only history that matters.

In fact, Seth Klarman noted this specific false lesson in 2010:

Bad things happen, but really bad things do not. Do buy the dips, especially the lowest quality securities when they come under pressure, because declines will quickly be reversed.

Howard Marks shared a similar thought in his book Mastering the Market Cycle:

I fear that people may look back at the decline of 2008 and the recovery that followed and conclude that declines can always be depended on to be recouped promptly and easily, and thus there’s nothing to worry about from down-cycles. But I think those are the wrong lessons from the Crisis, since the outcome that actually occurred was so much better than some of the “alternative histories” (as Nassim Nicholas Taleb calls them) that could have occurred instead. And if those incorrect lessons are the ones that are learned, as I believe they may have been, then they’re likely to bring on behavior that increases the amplitude of another dramatic boom/bust cycle someday, maybe one with more serious and long-lasting ramifications for investors and for all of society.

A quick market recovery is one possibility in a wide range of outcomes after every bear market. Had events played out differently, the 2008 financial crisis could have been significantly worse than it was. The same is true of the 2020 crash. An alternate history exists where BTFD never becomes popular.

Except, that’s not what happened. The bull market lasted longer than anyone expected, many investors believe BTFD is a strategy (it’s not!), and the fear of missing out on the recovery will drive their decisions because they failed to look beyond 2008.

Since 1929, the average bear market (peak to trough) lasts about one year. But the average leaves out some context. The shortest bear market was in 2020, lasting 32 days. The longest was the 929-day stretch that wiped out the Dotcom Bubble. That’s 2.5 years to hit bottom. That range — 32 to 929 days — offers an idea of how long the current and future bear markets might last but they’re not limited by the past.

More importantly, not every ensuing market recovery can be defined as “quick.” In fact, the market can experience fits and starts that drag on for months or years after it bottoms before resuming its long-term upward trend.

In investing, hindsight is often the worst teacher and we’re blind to the future. Every bear market rally looks like the start of the next bull market. Every bull market dip looks like the start of the next bear. The reality is we won’t know when the bear market ends until we’re well into the next bull market.

Buying only because the market has fallen is not how to invest. Buying because the market has gotten cheap is a reason to buy. The same is true for stocks. An investor who can’t differentiate between the two is trying to time the market.

Trying to guess which rally or dip marks the turning point in the market is the wrong way to approach things. Market timing doesn’t work. You’re better off holding on the entire time than trying to jump in and out of the market.

Source:
The Forgotten Lessons of 2008
Mastering the Market Cycle
Market Briefing: S&P 500 Bull & Bear Markets & Corrections, Yardeni Research

Related Reading:
The Trouble with Timing the Bull
Notes: Mastering the Market Cycle

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Wise Words from Charley Ellis https://novelinvestor.com/wise-words-from-charley-ellis/ Fri, 12 Aug 2022 12:37:40 +0000 https://novelinvestor.com/?p=512448 Charley Ellis recognized that there were two different games being played in the stock market. The game the experts play differs from the game the amateurs play. When the amateurs try to play the experts’ game they frequently make mistakes and lose money. That’s not to say the experts are fantastic at making money. A few […]

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Charley Ellis recognized that there were two different games being played in the stock market. The game the experts play differs from the game the amateurs play.

When the amateurs try to play the experts’ game they frequently make mistakes and lose money. That’s not to say the experts are fantastic at making money. A few are but experts, on average, fail to beat the market too. So the majority of experts fall short of the market and the amateurs, emulating experts, do worse.

Ellis’s solution is to play a different game entirely. The game amateurs should play, and many experts too, is built on a foundation of avoiding errors. Essentially, not losing. Fewer errors lead to better results.

Ellis wrote this in his 1975 classic The Loser’s Game. In it, he used an analogy between tennis and investing. It turns out there are two different games in tennis too. The game the professionals play is not the same game as the one the amateurs play.

The pros can be aggressive. They have the skill, precision, and experience to place shots just outside their opponent’s reach. They play a winner’s game. The match goes to the player who earns the most wins.

Amateurs, however, often lose by trying to play like the pros, because it leads to unforced errors. It’s a loser’s game. Amateurs win in tennis by volleying until their opponent hits it into the net or out of bounds. They win by not losing.

Of course, the concept of loss avoidance has been around forever but Ellis’s analogy delivers a strong message. It’s a piece every investor should read every few years.

And many of Ellis’s teachings since then follow the concept of winning by not losing.

On the Best Investment Policy

Know your own financial situation. Know your long-­term goals. Know what your limits are. But be careful. Most people approach investments as if the right “solution” were mathematical, and their investment objectives rational. The objective factors are usually not the most important parts of the “best” investment policy. Experience teaches that the subjective and emotional factors are usually more important because the emotional errors­ — buying too high because of excessive confidence or selling too low because of excessive anxiety — ­do more harm than rational errors. So you need to know as well what is your emotional situation and what are your emotional constraints. What riskiness can you live with and live through? Can you hang on when the pressure is most intense and the data most compelling that you are clearly wrong? If not, recognize your own emotional realities ­and learn to live well within them.

***

If you are not able to sit down and write out in an hour’s time what you are trying to do with your portfolio and how you intend to do it…you should at least consider making a serious study of your objectives, your risk aversion, the nature of the capital markets, your cash inflow and outflows, and the design of an investment policy that is truly right for the long term, for you.

***

The reality is that “roughly right” is all we can ever hope for on long-term asset mix, because even the most sophisticated investors must make their judgments on the basis not of facts, but on probabilistic estimates of two great uncertainties, markets and human reactions to markets, and without knowing the consequential leads and lags that will surely be part of the real world.

***

The really hard part about investment policy is not figuring out the best feasible combination. While it takes some time and analytical discipline, this part of the problem-solving is far from advanced science. The really hard part is managing ourselves: our expectations and our interim behavior. Walt Kelly’s Pogo puts it as “we have met the enemy and he is us.” Most investors are too optimistic about the long run and much too optimistic about how well they will do compared to the averages, so they set themselves up for disappointment.

On Luck 

Every investor should recognize the powerful potential impact of luck — not good luck, but bad luck. We can all live through good luck. But bad luck — the apparently random occurrence of adversity — is equally prevalent, and its consequences can be far greater.

On Getting Excitement Out of the Market

Go to a continuous-process factory sometime — a chemical plant, a cookie manufacturer, a place that makes toothpaste. Everything is perfectly repetitive, automated, exactly in place. If you find anything interesting, you’ve found something wrong.

Investing is a continuous process too; it isn’t supposed to be interesting. It’s a responsibility. If you go to the stock market because you want excitement, then sooner or later you will lose. Everyone who thinks the stock market is a game loses — everyone, to the last man, woman, and child. So, the purpose of an investment policy is simply to ensure that your continuous process never breaks down.

On Not Losing

In investing, losing means taking decisive action at the worst possible times — being driven by your emotions precisely when you need to be the most rational.

***

All investors of course will experience uncomfortable fluctuations in the market. That’s reality — and not a major concern. The real concern is with irreversible losses caused by overreaching for speculative possibilities; by taking market risks greater than our capacity to endure turbulence and maintain consistent rationality; by reaching for managers whose best performance is behind them and who are destined or doomed to underperform — with your money; and by going into debt.

***

If, as investors, we could learn to concentrate on wisely defining our own long-term objectives and learn to focus on not losing as the most important part of each specific decision, we could all be winners over the long term.

***

While all the chatter and excitement is taking place about big stocks, big gains, and “three-baggers,” long-term investment success really depends on not losing — not taking major losses.

***

Really strong defense makes the offense easy. Most of the trouble in investment management is not because you came just a little short of having superb investment results. It’s because you made a mistake. Knowing how to be selective, you avoid the mistakes.

On Over-Confidence

In a rapidly rising market, the faster you trade, the better you’ll do — and that makes you forget that those whom the gods would destroy, they first make confident. The more you know, the higher the odds that you’ll make a serious mistake. That’s why it’s not the beginners who tend to die at skydiving and why most car accidents happen within a few miles of home. There’s a saying in the British Royal Air Force that investors need to remember: “There are old pilots, and there are bold pilots, but there are no old, bold pilots.”

***

As human beings, particularly if we are successful in other parts of our lives, we are notoriously unable to accept the obvious reality that, on average, we are average, and that our normal experiences will usually be about average because we are, as a group, captives of the normal distribution of the bell curve. It amuses us that Lake Wobegon’s children are all above average, yet studies all the time show we think we are above-average drivers, above-average parents — and above-average investors. And we do tend to take it personally when our stocks go way up or go way down, even though, as Adam Smith admonishes, “The stock doesn’t know you own it.”

Sources:
Investment Policy and the Competent Stranger
The Winner’s Game
Wall Street’s Wisest Man
Investing Success in Two Easy Lessons
Words from the Wise Charles Ellis

Last Call

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Phil Fisher: The Art of Holding On https://novelinvestor.com/phil-fisher-the-art-of-holding-on/ Wed, 10 Aug 2022 17:53:33 +0000 https://novelinvestor.com/?p=504158 Selling is the more difficult part of investing than buying. Holding on is even harder. Phil Fisher had a philosophy around selling — or rather, not selling — that may be helpful to more than his stock-picking fans. But first, a little background. Fisher was the original long-term investor. He just did it in a […]

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Selling is the more difficult part of investing than buying. Holding on is even harder.

Phil Fisher had a philosophy around selling — or rather, not selling — that may be helpful to more than his stock-picking fans. But first, a little background.

Fisher was the original long-term investor. He just did it in a very highly concentrated way, a side effect of his strategy.

He’s the guy that influenced Warren Buffett’s transition from Ben Graham’s buying companies at a wonderful price to Buffett’s wonderful companies at a fair price. The key change was essentially paying a higher multiple (but still undervalued price) in exchange for a longer runway.

That last bit is key.

Fisher’s philosophy is built on finding the handful of companies that can grow at a sustainably high rate over long periods of time. While the typical Graham investment might have a holding period of one to three years, Fisher’s was decades.

The difference in holding periods hints at the prevalence of opportunities for each strategy. Graham had a small steady supply. Fisher’s were rare.

So when it came time to sell, Fisher’s response was hopefully never. Not even if the stock gets “expensive.” His investment in Motorola is a great example:

If you are in the right companies, the potential rise can be so enormous that everything else is secondary. Every $1,000 I and my clients put into Motorola in 1957 is now worth $1,993,846 — after all the ups and downs of the stock and of the market…

If I’d sold Motorola because I thought it was overpriced 10 or 15 years ago, chances are I would not have known when to get back in, and I would have missed a tremendous profit. If one of my stocks gets overpriced, I warn my clients that things may be unpleasant for a little while but it will rise to a new peak later.

That’s over a 20% annual return on his Motorola purchase.

And there’s the rub. Companies that grow at a high rate of return, have stocks that earn a high rate of return.

Great companies, that can sustain high growth rates, trade at a premium. They’re rare. The demand for high future growth commands a higher multiple.

However, sometimes shifts in demand can throw prices out of wack but because high compounders are so rare, there are only a few reasons to sell:

If I have a deep conviction about a stock but it has not performed after three years, I will sell it. If I think management or the basic situation has deteriorated, I will sell.

If the only thing that’s changed for the business is the stock price, selling a rarity makes no sense. It’s better to hold on and suffer a little bit than to sell and miss the compounding potential.

The price still matters (more so when buying than selling), but only at the extremes. Otherwise, the opportunity lost in selling a compounder is too high because the real benefits of compounding come at the tail end of a really long run. Selling Motorola “10 or 15 years” early because it’s “overpriced,” meant missing out on the compounding effect of a 20% return over the full 40 years.

Now, if it only took a rearview mirror to find these gems.

Fisher was brilliant and had patience and guts. He held a handful of stocks for 15 to 20 years (longer in some cases) despite huge swings in price. He had clients that bought in. He had an above-average ability to avoid the typical tendencies that trip up other investors. So difficult is an understatement.

The more important takeaway is that over decades, a stock will earn a similar return as the business earns. A basket of businesses with sustainable high growth rates have stocks that compound at a similar rate. And selling early can be costly.

Conveniently enough, a basket of stocks, whose businesses grow at a similar rate to the market average will earn a market return. Barring some material change in those businesses, the price swings should be ignored, aside from extremes. Long-term investors should focus on what matters: business growth not price swings.

This post was originally published on January 17, 2020.

Source:
The Money Men, Forbes 1996

Related Reading:
Philip Fisher Explains His Growth Philosophy
What Makes Great Companies Great

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