Avoiding hubris

We can’t control what the stock-market does day-to-day, but we have some control how we behave and feel about it. With some decent performance behind us I’ve spent some time considering one of the key risks for any investor.

Confidence is a dangerous emotion for investors — I’ve seen hubris ruin many a good track record and I’m determined to avoid that same fate.

I try hard to be sceptical in my thinking, reasoned in my judgement, and measured in my decisions. Controlling my environment and being selective with my close colleagues are also important elements.

Don’t rely on the experts

“Stocks aren’t cheap and popular at the same time” (title of Actuaries Digital article).

It is intuitive for investors to make decisions based on their economic view but share prices are more heavily influenced by people’s emotions (in the short term) and don’t move perfectly in line with economic indicators.

One of the problems with economic forecasts is that they are made by fallible humans, usually salaried economists and strategists with a desire to keep their jobs. This means they play it safe and so have very little incentive to put forward a view that is different to their peers.

Another consideration is that most of these economists work for investments banks (Wall St) whose opinion on the economy is heavily influenced by the stock market. These ‘experts;’ are sitting inside of fancy city offices, often far away from the pulse of the real businesses they are supposed to be measuring.

Because of the above, forecasts, data, and share prices are often disconnected and so joining the dots between them for investment decisions is near impossible. Waiting for the experts or the data to improve before making an investment can be a mistake as the share prices often move well before the forecasters do.

18 months ago when the share market was flying high, it was difficult to find a negative view. Now that the market has fallen significantly, it’s near impossible to find an optimistic one. Here’s my bold forecast… consensus won’t return to positive until well after share prices have risen again.

Buying. Now.

For us, risk is mitigated via a low price which provides us a margin of safety. We are much more comfortable paying a low price during times of high uncertainty vs a high price during times when sentiment is very high.

Risk to us is the potential for capital loss. Uncertainty is the wide range of possible outcomes.

I’ve noted before Mohnish Pabrai’s description of that moment when the market gets confused between uncertainty and risk. Sure, there are a wide range of possible of outcomes, but regarding the companies we are buying, we are confident none of them ends up in a substantial capital loss.

Now is the time for buying. Many of the stocks which we monitor have fallen +30% in less than 12 months. We are much more inclined to buy during these times.

Ultimately, we have NO control over what a share price does. We spend very little time thinking about the ‘stock market’ instead, we have tried to focus our investment process on tasks within our control.

“The chief task in life is simply this: to identify and separate matters so that I can say clearly to myself which are externals not under my control, and which have to do with the choices I actually control.” Epictetus

We identify businesses we feel we understand. We conservatively value that business. When/if that value is significantly above the current share price, we invest with the confidence that some point in the future, the share price will reflect our valuation of the business.

“The market’s very emotional but over time, doing something logical and systematic does work. The market eventually gets it right” Joel Greenblatt

We choose to be bottom-up investors. This means that our focus is on the quality and margin of safety of the underlying investment we are considering.

We give very little credence to (top-down) economic considerations — a good business and a good price should take care of any economic factors in time.

Often, bad economic conditions are coupled with good (cheap) prices. Bad news today portends to good news tomorrow so it’s often a mistake to sit on the sidelines when economic news is poor.

We are happy to buy relatively early in a correction, but we counter the risk of further declines by purchasing small parcels regularly.

“When it comes to so-called market timing there are only two sorts of people: those who can’t do it, and those who know they can’t do it. It’s safer and more profitable to be in the latter camp”. Terry Smith

I firmly believe that our ability to think and act with a very long-term orientation is our most under-appreciated advantage. The investments we are making for you today are coupled with a willingness to hold-on for as long as it takes for our thesis to play-out.

Managing emotions — especially through adversity.

Analysis is the easy part of the investment process. Most people know what constitutes a good company, and whether an asset is worth $1 or more. What many struggle with is buying and holding an investment when the crowd around us is freaking out.

“When it comes to long-term investing, doing ‘less’ is often ‘more’” Joel Greenblatt

In a recent interview, Guy Spier compared investing to golf. They are both games of resilience. They both look easy and everyone can get lucky with a good shot or two. But the real challenge is consistently implementing the art form overtime. Especially though adversity.

In the face of falling prices and negative sentiment, it’s extremely difficult to keep our emotions in check. As with golf — emotions lead to poor decision making and poor performance.

“We don’t have to be smarter than the rest. We have to be more disciplined than the rest” Warren Buffett

I work hard to be self-aware and in-tune with my emotions (yes — I said that!). Successfully managing emotions is the most important ingredient to making rational decisions over time.

Our Superbowl

Periods like this are most akin to our Superbowl. I take this job very seriously. Even more so in the turbulent times like this when our day-to-day decisions really move the dial and make a significant impact on you — our investors.

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Acknowledgements: Warren Buffett, Actuaries Digital, Joel Greenblatt, Terry Smith, Epictetus.