Tuesday, September 13, 2016

Lessons of the Last Four Years

Wow, it has been a long time - four months - since I last posted. Well, no, I haven't stopped blogging but I have definitely slowed down. I have been busy with work while my investment activity has virtually halted until recently. Besides, I probably needed a break as I have been blogging for four years.


During the last few months, I have reflected on what I've learned in the last four years. For one thing, I am still learning new aspects of value investing. The value investing concepts seem to be straightforward, but different people can interpret the same thing differently and even the same person can interpret the same thing differently at different times.


I have heard from Peter Lynch and Walter Schloss, among others, that an investment needs about 3-5 years to play out. That is a long time to get the feedback on whether you are right. But it's the easiest way I know of to get outsized results. By now or soon from now I can see whether my investment ideas were sound.  One example is Installux. I bought it originally 3 1/2 years ago and it has more than doubled in addition to a nice dividend. Which is as good as I can expect. But I didn't believe this concept as much as I should have.  Take the case of Andrew Peller (ADW:TSX), which I bought 3 years ago at CDN$14. Today it is CDN$32.  But unfortunately, I got impatient and sold and barely eked out a gain.  This is a hard lesson learned. I will redouble my efforts to see my investments through the 3-5 year period.

A second investing concept I've genuinely learned is that buy and hold can mean forever. I read this from in Fisher's book Common Stocks and Uncommon Profits. What it means is that if a company's prospects grow with the price at any given time, then one should hold the stock until that changes. And if that doesn't change then one should hold on indefinitely. This is more of a growth investing approach but one can argue that growth is part of value. Stocks that used to undershoot can now overshoot beyond my wildest expectations. I've learned this lesson the hard way when I sold Phillip Morris (MO) after 12 years. By then this cigarette company had a PE in the low teens.  Who would have thought that cigarette companies now have PE above 20 and MO would triple in the last 4 years!


Thirdly, I often wonder what drives the market of months or years when it doesn't behave quite rationally. And from watching the market for almost 20 years, I have concluded that often there simply is no rhyme or reason for its behavior. Nobel Laureate Robert Shiller drove this point home to me in his book Irrational Exuberance. He points out example after example of long periods of mispricing in different times and different countries because it is human nature. For example, I've owned MSFT off and on for years while its PE was in the teens. Then, over the last 2 years, it expanded to over 20. This hasn't consistently happened since around 2000.  And I cannot see any significant change to the company's growth prospects.  And I cannot even see any good reason why the market changed its sentiment, other than the fact that investors feel bullish about the market.  The market is quite overpriced but I don't feel more money chasing yield is a good reason for a stock to go up. Or at the very least I don't think I can count on excessive multiple expansion for my gains.

The same anomaly can occur in the negative direction. Entire markets can be depressed for as long as a decade. I am not referring to Japan, which one can argue is depressed for good reason. But the Hong Kong market should be much higher because it's price to book ratios are extremely low. And Hong Kong does not have the demographic problems that plague Japan. That gives the Hong Kong investor like me a huge margin of safety.  And I hope this margin of safety will give an edge over other investors who may not be inclined to invest in such markets.  I am also buying and waiting for multiples to revert to more normal values in other markets like Russia.


Fourthly, while concentration is needed to maximize gains, don't overdo it! The concentration argument is that one should bet big when one has conviction. Extreme concentration is warranted only in a few types of situations. For example when Charlie Munger levered to buy BCP, or when Warren Buffett bought the Washington Post.  In the first example, Munger was waiting for the outcome of an impending court decision which would either determine if he breaks even or makes a profit. In the second, the Washinging Post was a diversified media company with many assets which are spread out in different media and different locations. And he knew he could get an offer on those properties if they were for sale. And the Washington Post was selling for a fraction of book.

However, very often people have more conviction than they should. When a person concentrates like this investing becomes gambling because a few events can make or break a portfolio.  The purpose of diversification is to prevent catastrophic loss of the entire portfolio. And often even successful investors make this mistake. And when that happens it isn't just bad luck, it is because they've been playing Russian roulette one too many times.  They may have been lucky for many years but eventually the odds catch up to them.  Earlier I said value investing gives feedback in 3-5 years, so a few feedback cycles can take over a decade, and maybe over that time they may have been lucky.

Recently, the internet chatter has been buzzing with two big disasters: Valeant and Horsehead Holdings. Both were companies with big stories of potential gains. But Horsehead was betting on one plant coming online as the low-cost producer. If that did not happen, well it's complete equity wipeout. And that's exactly what happened.  Valeant was a company with a suspicious business model and it also came crumbling down with a 90% loss of shareholder value.  Those two situations wouldn't have been so bad except that some big fund managers put 20% or more into these stocks! And they threw in new money after the companies started to stink! I think putting in new money was an obvious case of denial.  This was a timely reminder to me that no matter how long I can have success, I should stay diversified.  Bad things happen at the most inopportune times.


I don't know whether my investing strategy will ultimately succeed. However, I will keep learning and relearning value investing concepts. I will also learn the mistakes of others and stay vigilant


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