SIMPLE IS BETTER – ISSUE -17 – NUMBERS TELLS YOU EVERYTHING – 2

In the previous article (SIB-16) of the same series, I have explained needs for checking a management quality. And also explained what if we invest in the company which has troublesome management. Now, I am going to explain how we can judge the management through accounting and protect our wealth.

Entire series of “Numbers tells you everything” is based on the books –

• Financial Shenanigans – Howard Schilit
• Quality of Earnings – Thornton L. O’glove
• The Financial Numbers Game – Charles W. Mulford
• Creative Cash Flow Reporting – Charles W. Mulford

I have tried to cover up concepts available with the above books.

For Detail Issue, Click here —> SIMPLE IS BETTER – ISSUE -17 – Numbers tells you everything – 2

Avengers: Endgame and Investment

Previously I have written a post on learning investment lessons from movies such as “Chal Man Jeetva Jaiye”, “Dangal”, “3 Idiots”, “Rajneeti”, “Sanju“ and “Badla“. Now, I am going to write a few investment lessons from another movie Avengers: Endgame. Avengers: Endgame is not only a movie but it’s an emotion.

• Accept the reality and don’t lose temperament

Extract from the movie – At the starts of the movie, we have seen that Tony Stark stuck in a space and going to die. During the time, he has accepted death and didn’t lose his temperament. He has keep environment live.

Co-relation in real life – We face similar kind of events in our life and investment journey where we do not get any clue about what to do. We should not lose temperament and work on the acceptance of reality.

• Don’t lose hope and identity due to failure

Extract from the movie – We have seen that initially, Tony has denied helping Ant-man and Cap for time travel. But later on, he has worked on the time travel mission. He has made it possible to do a time travel.

Co-relation in real life – Similar way in our life and investment, if we faced failure then we should not stay away from our actual identity. Rather we should work on it and turn out our failure into success. If we lose our identity then we cannot get back success and we stuck with the failure for a lifetime. It is obvious that we face failures in our life, our assumptions go wrong, the market takes more time than we have assumed to recognize the value of our investment.

• Wait for the opportunity

Extract from the movie – We have seen that Avengers got an opportunity after the 5 years also. They had never think about it. But when the opportunity comes they have captured it and take benefits of it.

Co-relation in real life – In the investment field, we get very limited opportunities to make an investment. We need to wait for the opportunity while we are not getting it. We should not accept failure if we do not get an opportunity for a huge time. We should always wait for the opportunity.

• Accept the failure but do not give up

Extract from the movie – We have seen that Thor was not able to accept his failure and he slipped into the depression. He was not ready initially for help to the Hulk but later on, get ready.

Co-relation in real life – Similarly, we should not slip into the depression when we face any failure but we should accept it and work on the turnout our weakness into the strength. If we slip into the depression then we cannot able to capture an opportunity when we get it.

• Accept the uncertainty which can change all the scenario

Extract from the movie – Thanos got aware of the plan of the Avengers and he came from past to the future for capturing all stones from Avengers. Avengers has believed that they collect all the stones and provide lives of those who lose life due to Thanos in infinity war. But Thanos also came to the future and he had attacked the Avengers.

Co-relation in real life – Similarly, we should accept the uncertainty while we make investment decisions. Anything can happen into the investment journey which we do not have assumed. Uncertainty is only certain to happen.

• Accept that we cannot control fortune

Extract from the movie – We have seen in infinity war that Avengers cannot able to stop Thanos and Thanos has completed his task. Avengers has made a huge effort to stop to Thanos but Thanos has given death to half of the population of the earth with few of Avengers also. This proves that we only can put efforts but cannot control the fortune.

Co-relation in real life – In the investment field also, we can just work on the company identifying, analyzing, allocation, risk management, etc. But we cannot control our return. The return will be not into our control. It’s just our fortune which we cannot control.

• Put entire efforts when the opportunity comes

Extract from the movie – When the opportunity comes to bring back the life of half of the world then Avengers has put entire efforts. Also, when it comes to again protect the entire world by Thanos, they have put their entire efforts and in which we have seen that Tony has lost his life. Hulk got injured and the black widow had sacrificed her life.

Co-relation in real life – We does not know that when the opportunity comes to us. But we have to be ready for the opportunity and when it comes, we must have to put our entire efforts. We do not get investment opportunities on a daily basis so till the time, we are not getting an opportunity, and we should start working on making us stronger and stronger. And when the opportunity comes to have to build up a position.

• Accept the disconfirming evidence

Extract from the movie – During the infinity war, we have seen that Dr. Strange had mentioned that they have one chance to win from the 14 million chances. Same into the Age of Ultron, when Tony wants to build a protection shield, then nobody got agreed with him. They said they fight for any uncertainty and either win or lose but that will be together.

Co-relation in real life – We should not think that if we have a good track record of making an investment then we will win the game. But we have to accept the disconfirming evidence and be prepared according to it. We should not negate the disconfirming evidence and prepare for upcoming uncertainty.

• Fight with own emotions to win

Extract from the movie – Tony was not ready to help for time travel when Captain America has approached him. He was fearing for losing togetherness of family. He feared because he has faced death very closely. He knows that he can help with the time travel but his fear was stopping him. When Pepper Potts had explained to him that he can help others and he should then Tony got ready to help for time traveling.

Co-relation in real life – Similarly, we also have a fear of losing what we are currently holding or what we can lose from our past failures. We should not keep our past memories to hold us and keep on drain us. We should control the emotion and fight with it. Otherwise, we cannot able to achieve what we want. If we have made an investment mistake in past and those memories holding us and stop us from making a new investment or we are holding an investment which we do not want to lose then we may not able to perform a task which is the demand of time.

John Maynard Keynes The Most Addictive Game

Every minute market is putting new information, fun, clues, etc. which can be excited and addictive to us. It is a game which always excites us with its nature and it is never ending game so that slowly, we become addictive of it.

In investing, odds are decided by the human, investor’s expectation. Odds cannot be quantifiable. We all have information but users of that information are human so that human sets prices for the odds which have emotional biases also.

Mr. Keynes has started managing fund of family and friends with $30,000 in the year 1920 which was turned out to be $80,000 in April 1920. But after that, he made a huge loss which has wiped out entire capital and his father has to help him. Mr. Keynes has started speculating and build the capital worth of $120000 till the end of the year 1922. This success has encouraged him to make speculation into the commodities. Here also, Mr. Keynes lost 80% of his net worth.

Mr. Keynes has worked on to the evolving his investment style.

He stops focusing on the macroeconomic, currencies, interest rate forecasting, etc. and made the transition of his focus to the cash flow, earning the power of the companies which are selling below the intrinsic value. He put aside his ego and created fortune with the bottom-up approach rather than a top-down approach.

As we have seen in my article on Howard Marks that no investment strategy works forever. It’s cyclical, sometimes growth works, sometimes value works and sometimes momentum works, etc. Mr. Keynes was successful as a value investor but during the year 1936 to 1938, his strategy was failed and he lost around 2/3^rd of his wealth.

Mr. Keynes has explained his strategy to his clients – we need to look at the discount from the probable and potential intrinsic value, need to hold large quantity for a longer period of time.

Mr. Keynes has shifted from macro to company-specific matrix and short-term to the long-term focused investor. During the year 1928 to 1931, the value of his assets fall by 50% v/s US market fall by 30% but during the year 1932 to 1945, the value of his assets grew by 869% v/s US market rise by 23%. Additionally, his portfolio turnover reduced from 56% to 14%. He has truly focused on the long term investing and due to his long-term thinking, he has delivered a remarkable result during the 1929 great depression and also during World War II.

We always need to focus on the investing strategy which is suitable to us rather focusing on identifying a perfect strategy and following it. No strategy is perfect in all the market cycle. I like to build a portfolio of bargain stocks which badly fail during the last 2 year were no huge bargain available into the broader market level. But staying with the pre-decided strategy has helped a lot and I can able to outperformed benchmark with decent margins. So we need to select a strategy which suits our temperament and need to stick on it.

Read for more detail: Big Mistakes: The Best Investors and Their Worst Investments by Michael Batnick

Sequoia The Risks of Concentrated Investing

One of the wise advice given on risk management is we don’t have put all your money into one basket. If we have 100 stocks of a portfolio and equal 1% allocation to each company then erosion into any company will affect the entire portfolio by 1%. Whereas if we have a 10% allocation to the 10 companies then erosion to any one company will affect the entire portfolio by 10%.

When we have concentrated our portfolio to the winning businesses then we will be a winner and if we have concentrated our portfolio to the losers then we also are losers.

Sequoia fund which has done a concentrated investing, they are not interested in the short term profit making, also not interested in the low allocation to the portfolio and which is known as –

Mr. Buffett has closed his partnership in the year 1969 and suggested Mr. Bill Ruane manage the capital of partners so that Mr. Bill Ruane has set up the Sequoia fund. During the dot-com bubble, Sequoia fund has lost ~16.50% whereas the S&P 500 gained 21% and NASDAQ gained 86%. But after the dot-com bubble in the year 2002-2002, Sequoia fund has gained by 29% whereas the S&P 500 lost value by 38%.

In the year 2010, Sequoia fund has started acquiring a position to the Valeant Pharmaceuticals which becomes the second largest position. And in the year 2011, it becomes the largest position of the fund which has overtaken Berkshire Hathway which was the largest position in the 20 years.

In the year 2015, many consider Valeant business practice as an unethical and after that, it caught under accounting fraud. As Valeant was the largest position of the Sequoia fund, the fund lost 9.03% whereas S&P500 gained by 8.44%. Sequoia fund has bought again when Valeant fall by 50% and Sequoia fund becomes the largest shareholder of Valeant. But Valeant fall by 90% and Sequoia fund has to sell the entire position of the Valeant. Sequoia fund’s assets have fallen from around $9million+ to $5million. A single stock becomes a reason for the fall of their asset massively.

For avoiding such impact, we need to write down our assumption for buying a business so that we can take an exit when our assumption started getting wrong. This practice helps us to reduce the effect of endowment bias towards the stock which we hold. This also reduces the emotional bias towards the stock and help us to protect our capital. I always make a write up of the entry and exit reasons for the investment which help me for making a better decision and reduce my emotional bias. After all such activities, we need to be thankful for the role of luck which can support us. Concentration is good till we stay within our predefined process, assumptions, rules, etc. When we go out of any of the mentioned, we need to pay huge tuition fees for the concentration.

Read for more detail: Big Mistakes: The Best Investors and Their Worst Investments by Michael Batnick