When I joined investing a decade back, I asked a friend what should I do to succeed, he answered wisely “Don’t get killed, because others will”. “With this, you will land in the top 95% percentile”. No complaint, but the balance 5% is where it starts.
The balance 5% honestly is the most difficult and the lonely part. There is no textbook to teach that part. Quite like other professions, the 5% defines you. I haven’t heard a surgeon say, he/she is better than others because he has done no operation and hence has zero fatalities. Unless you don’t act, you don’t act right. The balance 5% makes or breaks you as a surgeon. You are either a good surgeon or you are not one.
The point I am getting to is that, one has to decide what to do as much as what not to do. It’s like one has to invest in 5 things along with rejecting 95 things. It is easier to reject than to select. In this article, I will cover what helps us act and act wisely.
Trust how you feel after talking with an entrepreneur:
Our analytical mind is wired to find holes in an argument to taper things down. True value creators in public markets are the companies that have changed their return profile over a 5–7 year period and hence require an understanding of the founders. If you feel an entrepreneur is different in his approach and execution, it will show up in his discussions and actions. Never let a good feeling die down. Work on it, till the timing and valuation to invest is right. Companies that I have liked have a.) honest and professional management, b.) track record, c.) MOAT and longevity of the business, d) valuation. In a subtle way, they add up and follow one another. No maths here, things just add up. So talk more with entrepreneurs. The ability to stay invested for long with an entrepreneur is a mix of both subjective and objective observations. The same way, never overrule a bad feeling or vibe by valuation. That is wrong. Work on it, to convert it into an objective data or an observation.
When the outlook looks gloomy, find positive data, and vice versa:
Something I have learnt from the last two cycles, when you in the middle of a bubble or a crash, you feel rational. Whereas the baseline of our rationality is by default siding towards optimism or pessimism. During this time, it’s important to take baby steps, reduce your bite size, but don’t exit. More wealth has been left on the table by those who time the market than those who stay invested. As a Private Equity professional, in 2008, we were given instructions to be on a standby on all deals. Not do anything at all. Gladly, I didn’t follow the advice on my personal finance. Have spoken with a few friends post covid who exited the markets at the peak and entered again around the trough and were happy to make 20–30% return in 3 months. While the returns are good, two things happen when you dig deeper and reinvest in the companies you like, a.) your conviction to average up and down improves b.) you concentrate your portfolio towards your winners; both of these improve your IRRs.
The next risk in a business will be the one you would not have factored in, so relax and build some margin of safety:
It’s wrong to be in the virtuous loop of cursing yourself on not being able to predict negative/black swan events. One might lose time and money. Best to absorb it, chin up. Assess if the initial thesis on the business is still intact, if yes, average down, else exit. There are no marks for romanticizing with an idea and your constant brooding will not help a penny in recovery of a company. I was recently speaking with a MFI company, and the promoter nicely summarized his business as the first to get hit come what may, by a new factor every time. He has built his business in a manner to work in crisis every quarter. On the contrary, I also remember having invested in a steel company that couldn’t execute much over a 7 year cycle. We kept the faith in the management, whereas the learning was that between a bad sector and a good management, the sector wins.
People will show splendid returns for 100 companies, don’t feel pathetic, you can only choose a few:
With all due respect, post covid, have been seeing charts on 50 odd companies that have more than doubled since March 2020. Sometimes it makes me feel miserable to have only 2–3 names of the lot in our portfolio. I have, but learnt to ask: if there was a fund manager who had 8o percent of his/her portfolio in these multibaggers, he/she would be god’s gift to mankind. We are limited by our perception of loss (read sunk cost), risk, price and circle of competence. This limits the options and creates an in-action bias. My take: Its best to know your winners and double down on them over time. That will make you successful.
Entry price should be the last thing one should work on:
In my early days as an investor, I used to prioritize companies based on the valuation multiples. While it created inaction bias for the ones which were expensive, it created an action bias for the ones that were cheap or value traps. Dig deeper on the sector, growth opportunity and the management quality before a valuation discussion. Valuation first approach leaves out a large part of the investable universe. I believe that one only gets a really good thing cheap once in 10 years, for the balance one has to pay up.