RANDOM MUSSINGS (ii)

Hugh Hendry issued a new piece. He is always an entertaining and highly recommended read. Especially, if his last opus was almost 2 years ago (he did not have what to say). One of the greatest contrarian thinkers at the moment.

What puzzled me is his love for “stop loss” (which also connects with my recent piece about “sell your losers and ride you winners”). I do not understand it. He gives as an example tragic death of Jesse Livermore, who was right on his macro call but market remained irrational longer than he remained solvent. Volatility killed him (by the way he was shorting the market around 1930) and his panacea could have been stop losses.

I would say that, from what I understood (disclaimer: apart of this article, I know nothing about Jesse Livermore), he was killed not by volatility but by leverage or maybe also asymmetric nature of shorting individual names.

Stop loss is a practical thing to say that I do not understand what I am doing.

If one operates with sufficient margin of safety, even considerable volatility should not scare. It is always advisable to have low expectations. You cannot time the market so that you will always buy in the lowest point. That is impossible. It should be comforting that premature accumulation is a sin of all the greatest value investors.

It takes time for intrinsic value and price to converge. I follow a general rule of 3 years (I took it from Pabrai’s “Dhandho Investor”), which should be enough for your story to play out and admit a mistake. Intrinsic value in most cases is changing slowly – definitely not like when you watch big daily plunges on the stock market.

Lehman produced many stories of 50% plunges and 200-300% recoveries in less than 3 years. I do not know how to be that smart and sell it after e.g. 20% drop, then buy back after 50% down (total) and ride it up 3 or 4x. I do not know people who bet the entire farm back in March of 2009. You are fooling yourself if you think that you will dare to move in the darkest hour.

RANDOM MUSSINGS (i)

“Sell your losers and ride your winners” – that’s what James Montier was proposing in 2002 and probably now would recommend, too. (This is, by the way, a great place of his highly recommended writings – Link).

This dilemma tortured me for a long time and I wanted to share my thoughts.  Losers are not always bad investments. Actually, they are one of the best. Nobody likes them, i.e. there are clear willing sellers and for all kind of reasons, psychological and economic.

As it’s written, it has a very absolute meaning, very undemocratic.

Averaging down is a good thing and I am doing it routinely. As per his most recent annual review, Prem Watsa also likes it and calls it “long term value investing approach”. (Link, btw, his liking of RIM still puzzles me – I admit that I do not understand the odds in this particular case). You just have to practice it deliberately. Know the misjudgment and make conscious decision.

New facts (not emotion, not mood, not liking/disliking) and intrinsic value should guide you and not your brain’s asymmetric treatment of pains of loss and pleasures of gain. Each stock has a price and value. When discrepancy is big enough, you can strike.

INVESTMENT PHILOSOPHY

In 10 words: Margin of safety. Circle of competence. Preparation. Discipline. Judgement. Patience.

I read a lot for the last couple of years (approaching 10,000 hours) and mainly value investing literature and various investor market commentaries. Below is the list of tenets which stayed on in my mind and keep on coming back.

Not ranked, numbered for future reference: 

1. Model – Mr. Market metaphor is simple and powerful. You are dealing with an ever evolving crowd system. (HT Ben Graham)

2.  Circle of competence - lean towards simple, expand and know it. (HT Buffett)

3. 50c dollars - you need margin of safety because you do not really know much. Value and price are different things and opportunity arises when they diverge. (HT Buffett, Klarman)

4. Activity bias - you must be a gentleman of leisure as you do not have to do anything on any given day and feel great about that. (HT Buffett, Pabrai)

5. Duration (long term) - synchronize expectations with pace of life - business does not change in a day or even in a month. Three years is enough but not universal. Patience is a great, unappreciated and unrecognized edge. (HT Pabrai)

6. Duration (short term) - nobody went bankrupt by taking quick 30% gains, especially when you have offsetting short term losses. This depends on your conviction, though, and is a good test.

7. Volatility is your friend because provides opportunity to enter and exit. (HT Buffett)

8. Beta is nonsense because 50% down stock is twice cheaper, i.e. less risky also twice. (HT Buffett)

9. 52 week highs and buy & hold are for Buffett because he has too much money and lack of time. He was much much more active 60 years ago and he admitted publicly that he would behave differently with only $1m in capital. 

10. Macro - follow the macro situation and FMV of the market, which consists of a set of micro. 

11. Discounting - think what market knows (discounts) (HT Ken Fisher)

12. Big is VERY rarely mispriced. (HT Buffett)

13. Mispricing - it always depends on supply and demand - forced sellers is a good sign but how to know that. Why security is cheap? What is a bear story? (HT Klarman)

14. Risks - try to kill the business and first discuss bad things rather than merits. (HT Berkowitz)

15. Shorting - yes, it is an asymmetrical bet but index short is safer. You can profit on both ways: up and down, which is the essence of absolute returns but always remember that Mr. Market can remain irrational a lot longer than you can stay solvent. 
16. News - beware the writer's bias to attract audience. (HT Mark Sellers)

17. Get a sense of proportions and context in any numbers - billion is not always huge, a 5% miss may not justify EV drop of 25%. (HT Ken Fisher)

18. Diversification - size of bets is proportional to your edge, conviction and expertise. Normal position is 10% of investable assets and do not expect to initiate more than 1 or 2 in a normal year (vs. market crash year).

19. Cash - I always feel better with 20-30% of investable assets in cash. Index shorts are also future cash for cheap stocks when markets are reasonably priced (as if that would be so easy – this topic probably deserves a separate post).

20. Sustainable competitive advantage - study moats and look for lollapaloozas, identify headwinds and tailwinds, invert. (HT Munger)

21. Know yourself well (misjudgments and mental capacity). Psychological awareness and stability can be your edge. Maintain stock lists and document your process - it is guaranteed that you will forget important things. (HT Munger)

22. Reading  –  it is an easy test to determine if you can invest on your own. In this business you can earn more money reading and thinking rather than meeting and talking. (HT Buffett)

23. Numbers – you have to love numbers, which is another easy test.

24. Gold – silver is better because it has more practical uses. If India (1/4 of annual gold demand vs. closer to 1/8 for silver’s global jewelry demand) suddenly changes its preference, gold will tank. This article provides a very good perspective on the subject.