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learning from your mistakes

12/4/2018

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“Experience is simply the name we give our mistakes.”        -   Oscar Wilde

“A man must be big enough to admit his mistakes, smart enough to profit from them, and strong enough to correct them.”        -  John C. Maxwell

Over the course of my twenty odd-year investing career, I blanch sometimes when I think about the mistakes I made. Overpaying, not understanding value, making rash/emotional decisions, and not understanding competitive strength. The list could go on and on. Some have worked out okay in the long run – such as when a competitor swooped in and snatched victory from the jaws of defeat by paying triple the closing price of an investment where I was down 35% and likely headed lower. There were others where no white knight could save me from my own imbecility. After each failure, I have tried to go back to the very beginning and analyze the process from moment one. I generally find these mistakes can be broken into one of several buckets. The more buckets each individual fiasco touches, the greater the losses. 

Inadequate Research on the Investment, Competition, or Market Tends
One investment that sticks out instantly when I think of this type of mistake is Thompson Creek Minerals (now owned by Centerra Gold TSX: CG). I first purchased the stock when molybdenum was selling at a premium and China was peaking in its infrastructure build up. After holding the stock for about 6 months it occurred I knew nothing about the China government’s industrial policy, mining technology, import/export regulations, or metals pricing and markets. My ignorance went on to a remarkable extent. I was down 3% when I sold it and realized I was lucky to come out of it with anything at all.  

Making the Investment Case Fit…Facts Be Damned
The older I get, the less this is a problem. Certainly, in my younger days I would play with free cash flow numbers to such an extent to make my estimated values worthless for investment decisions. It starts with bumping revenue by 1% to meet the discounted value that meets your purchase price and goes down hill from there. If the number I use comes in over 75% of the previous ten-year growth rate, I simply don’t invest these days. Underestimating protects me on the downside, overestimating almost always takes on risk with few rewards.   


No…Really. I Do Know More than the Markets! 
Over time one begins to recognize there is a tremendous dichotomy in the markets. The first is that – in general – markets have a great deal of wisdom to impart. For instance, when bond yields invert (meaning that short-term interest rates are higher than long-term rates), it is generally a strong indicator of the potential of an oncoming recession. This information can be of tremendous value as an investor looks into the future for market trends. On the other hand (and hence the dichotomy) markets can get pricing on individual stocks terribly wrong. For instance, in 2000 there was a plethora of stocks pricing 50% revenue growth for the next 25-50 years. (You can do the math yourself, but suffice it to say this leads to companies of truly biblical scale). So - dependent on the day and your mood - it’s easy to sometimes think you can outsmart the markets with one hand tied behind your back. One piece of advice – never, ever think that. 

Why This Matters

I bring these tales of woe up because there has been in the past few months, investors have been whipsawed between new market heights and sickening 2-3% drops on what seems like a weekly basis. During these times of emotional high and lows, all of us can let our hearts rule our brains – usually to our detriment. Wall Street and its vast marketing machine doesn’t make it any easier. Preying on investors’ uncertainty and greed, we have seen an explosion in the amount of advertisements and articles that talk about generating nearly impossible returns, how to double your income, or any other such bogus claims. In a study completed at my old firm Nintai Partners, we estimated for every percent the market exceeded our estimated fair value, the amount of misleading or generally false adds increased by 12.5%. For instance, in 2000 we estimated that nearly 87% of all financial industry commercials were fundamentally flawed/false claims, or not based in any market reality. An example was one where an individual discussed he made enough money to buy two yachts by trading in penny stocks based in Hong Kong. Incredibly you could as well by simply sending in a check for $395 or just call in a credit card right now.  

Somebody once said the real losses weren’t made in down markets, but rather the up markets just before the down markets. I actually buy into that theory. I think after long bull markets we all get a little more complacent and a little more indolent in our analysis.  So, what can you do starting today to prevent falling victim to both your internal weaknesses and marketing ploys of Wall Street? I suggest two actions.

Hasty Decisions are Generally Poor Decisions
At Nintai investments, I run a very focused portfolio of roughly 20-25 stocks. I don’t short, use derivatives, or develop esoteric trading programs. I own small pieces of great companies that I know intimately – from balance sheet strength to free cash flow drivers to main competitive strategies and product development. Decisions I make on each holding can take months before I pull the trigger. Adding or removing a holding can take even longer. In these days when we new highs followed by huge drops in individual stocks, it’s vital you know everything possible about your companies. More importantly, know exactly when and why you think you should pull the trigger. Don’t make decisions based on a whim, but well thought out fact-based reasoning. Every decision to allocate capital can make or break your long-term returns.     

Lost “Opportunities” Can Sometimes Add Positive Returns
If I had a dime for every time I heard “I bought it on Monday and Tuesday it was up 11%”, I would be a very rich man. Hasty decisions made on newly acquired data – such as a suggestion you heard from a broker or read in an investment newsletter – supposedly offset the risk of lost opportunity costs. It’s important to realize that lost opportunities are just as likely to be losses as gains. When Wall Street says that cash returns nothing, I take exception. Making a hasty investment decision and avoiding idea of the lost opportunity can sometimes be offset by simply holding cash. A flat return can be a real improvement over a 20% loss. Losing that opportunity to invest in the latest and greatest stock might just be the best investment decision you ever made. 

Conclusions

I’ve found over my investing career, the better my performance, the worse my efforts are at reducing risk. Since just about every decision has paid off, I make choices faster, with less data, and less discernment. These are all the marks of an investment disaster waiting to happen. In these times of emotional highs and lows, its critical to slow your evaluation process down, check and double check your data, and make mindful and deliberate choices. 
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    Mr. Macpherson is the Chief Investment Officer and Managing Director of Nintai Investments LLC. 

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