Investing is hard. Microcap investing is even harder. Turning a small sum into your first million rarely happens in the time frames we want. No Pain No Gain. Symbolically, we would all like our stock and portfolio returns to look like this:
Unfortunately, the markets do not work this way. Nor do businesses. But you may say, “Sean, there are overnight success stories found in the news, like the break out investor who has been leaving the market and competitors in the dust or the private tech company that is receiving another round of funding pushing their valuation up another billion dollars.” Sure, but what we hear in the news is the tip of the iceberg. Individuals are lucky because they were prepared and most people do not want to prepare by experimenting and learning from mistakes.
“If you look really closely, most overnight successes took a long time.”Steve Jobs and a myriad of other successful individuals, past and present, have come to the same conclusion; success is a combination of luck, hard work, determination, smarts, and appetite for risk. There is no such thing as an overnight success. It usually takes years for a company to become successful and it can take years for an investment to bear fruit. Mark Twain might have said it best:
“Overnight success is a fallacy. It is preceded by a great deal of preparation. Ask any successful person how they came to this point in their lives, and they will have a story to tell.”The problem is that we hear next to nothing of the challenges, hard work, and dedication necessary to achieve success. Like Mark Twain said, successful individuals have a story to tell and I think not hearing these journeys toward success is a big mistake for the microcap investor.
I’ll pick on Steve Jobs for a moment. He introduced the iPod 25 years after he co-founded Apple, at which time Apple really started hitting its stride. It is easy to forget the years of mistakes Steve Jobs had endured to get to that point. The Apple III was a flop with only 65,000-75,000 units sold. His pet project the Apple Lisa and the G4 cube were blunders and, not to mention, Jobs had been kicked out 9 years after co-founding the business. Steve Jobs essentially was never afraid of failing. He talked about his mindset in this clip:
Jobs also had to encounter a number of challenges as an investor. His $10 million investment in Pixar was a dud for the first 9 years. He sunk an estimated $50 million more into the company and was close to giving up many times along the way. Eventually Pixar took off with the release of Toy Story and had an IPO in 1995. Jobs’ 80% stake in Pixar was then valued at $1.1 billion. In 2006, Disney acquired Pixar for $7.4 billion leaving Steve Jobs with 138 million shares of Disney for a $4.5 billion valuation. That was roughly a 23% compounded annual return over 21 years. Pixar was actually the investment that made Steve Jobs a billionaire, not Apple. Steve Jobs stuck to his higher calling in the face of countless challenges and failures. Each of his challenges set him up to be better prepared for opportunities that came about in the future for Apple.
As Ian has mentioned, I am working with him on The Intelligent Fanatics Project and Herb Kelleher is one of our case studies. Herb Kelleher co-founded Southwest Airlines in 1971 and led the company for many decades. The company reached profitability in 1973 and has been profitable every year since. Yes, this track record flies in the face of the worst industry capitalism has ever seen; the airline industry. Warren Buffett even got burned on airlines after losing $350 million buying debt in USAir in 1989. Buffett says, “Investors have poured their money into airlines and airline manufacturers for 100 years with terrible results.” This isn’t exactly true. Investors made a fortune betting on Herb Kelleher of Southwest Airlines. $10,000 invested in the IPO would have compounded at 19.3% for 43 years and resulting in $17,722,914 today (170,000% return).
Most people do not know that Herb Kelleher and Southwest had to endure significant challenges before the company ever flew its first flight. Competitors Braniff International Airways and Texas International operated in a regulated monopoly and did not want another competitor to enter into the market. From 1967 to 1971, the incumbents filed temporary restraining orders and other legal devices to thwart Southwest from ever flying. Herb Kelleher, acting as Southwest’s lawyer, fought against these established competitors and finally succeeded, nearly going bankrupt in the process. All of the initial challenges imbued a warrior spirit within Kelleher and within Southwest Airlines’ culture. This warrior spirit prepared the company for the many challenges they would later face.
So, success is not a line straight up and to the right. Success looks more like this:
All great companies started as small companies. Apple and Southwest started as microcap companies and endured numerous challenges before they were successful. This is an important observation for investors to remember when evaluating microcap management teams. A microcap CEO might have made numerous mistakes in the past, but if they learned their lessons it can be a powerful springboard toward success. You can think of mistakes as lessons. Writing off someone who has experienced a number of valuable lessons is a mistake. A rare number of leaders will learn from their mistakes and are likely to be better prepared for future opportunities.
Chip Maloney provides great insight on the art of interviewing management teams and my added suggestion would be to follow Warren Buffett’s advice, “Is management candid with shareholders?”. My process includes specifically asking management what mistakes they’ve made in the past. Humble managers will candidly describe one or more past failures as well as what they learned. These are the leaders who are preparing themselves for future success.
If you look at the data, intelligent fanatics are often late bloomers. Ian posted the following on Twitter:
These leaders had to experience life and many challenges to be prepared for their later success. It is inspiring to think that Sam Walton at age 44 opened his first Wal-Mart and during his lifetime dominated the industry.
The same is true with the individuals found in The Intelligent Fanatics Project. Every single one of our case studies, 10 in all, started as small companies and their leaders had at least one large mistake or challenge that they had to overcome. Many had multiple mistakes or challenges early on or in previous ventures. This means it took years before the CEO’s started the businesses that led to their ultimate success. The average age of the CEO’s in The Intelligent Fanatics Project is 35 years old, many starting in their late 30’s. Keep in mind that some intelligent fanatics, especially the youngest, experienced failure early in their business and needed to continuously learn and adapt to be successful. Below is a list of the ages of each case study:
Another important factor for companies to succeed in the long-term is for the microcap CEO to constantly adapt. Consumer preferences change, so CEO’s need to be a step ahead of those changes. And the only way for managers to stay ahead of market changes is to experiment. A by-product of trial and error is of course error, so managers need to embrace small failures. On the other hand, fear of making mistakes leads to complacency and allows smaller companies, who do not fear adapting, to innovate and siphon profits of larger companies. Large corporations, their professional CEOs, and their corporate bureaucracies despise failing and will shy away from adapting to change. Lean towards investing in founders or those who have a founder mentality and an experimental mindset to adaptation.
As investors we too are going to make mistakes and lose money. Your investment strategy is molded and shaped through these experiences. Not all your investments will work out in your anticipated time frame. Success often takes longer than we think. Learn from your mistakes and keep focusing on the long-term. The lessons you learn from your investment mistakes will stick with you forever and prepare you to handle the great opportunities that are around the corner.
I’ll leave on this quote from Scott Adams, the creator of Dilbert:
“Failure is where success likes to hide in plain sight. Everything you want out of life is in that huge, bubbling vat of failure. The trick is to get the good stuff out.”
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Barbara Corcoran did a Ted Talk on rethinking failure which is a great supplement to this post.
Great article Sean. Jeff Bezos agrees.
Jeff Bezos Calls Amazon ‘Best Place In The World To Fail’ In Shareholder Letter
Thanks, Ian. Glad I’m not competing against him 🙂
Some thoughts on failure, mistakes in business offered out of a concern that many investors fall victim to the belief that “I am a superior investor — brighter, more competent than the average — therefore when I buy a stock and it goes down, or doesn’t go anywhere, the market is wrong and I am right.”
Yes, everyone I know who has achieved great success has made a lot of mistakes persevered through failure. But that doesn’t mean that people who persist through failures automatically or generally achieve success. Most ultimately fail. Yes, Southwest Airlines persisted through adversity to prevail. Most airlines persisted through failure to go bankrupt. At least once. Some a number of times. Steel companies have been persisting through years of adversity. Coal companies. The list of failures and mediocrities who persisted through failures is much longer than the list of successes.
“Bucky Fuller and Marshall McLuhan exemplify to me the importance of being single-minded. The single-minded ones, the monomaniacs, are the only true achievers. The rest, the ones like me, may have more fun; but they fritter themselves away. The Fullers and the McLuhans carry out a “mission”; the rest of us have “interests.” Whenever anything is being accomplished, it is being done, I have learned, by a monomaniac with a mission. Bucky spent forty years in the wilderness, without even the Children of Israel to follow him. Yet he never wavered in his dedication to his vision. McLuhan spent twenty five years chasing his vision until it captured him. He too never wavered. And when their time came, both had impact.
” The monomaniac is unlikely to succeed. Most leave only their bleached bones in the roadless desert. But the rest of us, with multiple interests instead of one single mission, are certain to fail and to have no impact at all.”
– Adventures Of A Bystander by Peter F. Drucker
Persistence and hard work are important, but good judgment more important. Where I live in a nature preserve there are miles of stone fence through the woods around me, including up a steep hill right beside my cabin, called Sprig Mountain. Years ago, apparently, a farm family or families decided to embark on a multi-year, backbreaking effort to clear stones out of the woods to create more pasture. It didn’t work very well. I look at those fences and marvel. Building those fences probably destroyed men physically by the time they were forty. Maybe mentally too. But I admire their persistence.
Good judgment on its own isn’t enough — good judgment needs to be accompanied by hard work and persistence — but in my opinion good judgment — the ability to look at complex situations and identify the one factor or very few factors, on which the success of an endeavor ultimately depends, is the single distinguishing characteristic of highly successful people. And then focus, laser-like focu,s on that one or very few factors. The highly-successful people I’ve known have focus bordering on obsession, but, most importantly, their focus is on very few factors, and the crucial ones.
Good people skills are crucial — the ability to inspire confidence in others. Do I have faith in this person as a human being? That’s why an important consideration in evaluating a company is, “What is the background of the directors? Do they have a record of success?” Weak managements surround themselves with family, toadies and hacks. Kelleher surrounded himself with smart, successful mavericks like Sam Barshop, founder of La Quinta Motor Inns.
Invest in haste, repent at leisure. In investing, the more you know about the crucial factors affecting a company, the more persistence is likely to pay off. If you don’t know much, you are better off getting out quickly when the price turns against you. The question boils down to “Do I know more than the market about this company, its prospects and value?” If yes, it pays to be a long term investor, to buy on weakness. If no, it pays to take your losses without hesitation, and buy on strength. You can make money both ways — as a short term investor or long — but you need to know which you are. I read somewhere that when asked by a reporter what he learned working with George Soros, Jim Rogers said that the most important thing that he learned is that he is an investor and not a trader. You can’t be both, he said. Well, you can be both, you just can’t successfully confuse the techniques of both.
Soros is a great trader, perhaps the best in the world. Buffett is a great investor, perhaps the best in the world. Whose record is stronger? Probably Soros, based on the detailed study I’ve read, although he has less money, he’s given away many billions in support of the causes he believes in, diminishing his capital base and adversely affecting long term absolute returns. Soros is all about admitting defeat when necessary.
In military terms that’s called the tactical withdrawal (ie running like hell for any place the enemy isn’t) — preserving your forces for the day when you have a tactical advantage. As Field Marshall Montgomery wrote in his memoir, “It is impossible to be too strong at the decisive point.” To be strong at the decisive point, you need to have resources at the decisive point. If you fail a lot, and most of us do, that means being able to admit failure.
Some other, related, Montgomery quotes:
As a schoolboy and possibly also as a young man, I realize now that I said little straight and nothing whole, and generally failed to detect the difference between what is important and what is trivial. But as I grew older I began to learn these things. Possibly the factor that has been the greatest use to me in later life has been the ability to be able to simplify a problem and expose the fundamentals on which all action must be based — to concentrate on essentials and to leave the details to my staff. I also learned to regulate my life, not to overdo social activity and never to worry.
Great leaders of the past had in common an inner conviction which, though founded (and very closely) on reason, transcended reason. It was this which enabled them at a certain point-the right one-to take a short cut which took them straight to the objective, more swiftly and surely than equally careful but less inspired commanders…. Moses and Cromwell believed intensely in a divine mission, which never failed them in battle, Napoleon in a human destiny, which in the end did…. To exercise high command successfully one has to have an infinite capacity for taking pains and for careful preparation; and one has also to have an inner conviction which at times transcends reason…
No leader, however great, can long continue unless he wins victories. The battle decides all.
Rod, I absolutely agree with you and thanks for the insightful comment. Merely making many mistakes will not automatically guarantee success. To me, the ability to make mistakes and move on is like an engine in a car; it provides the energy necessary for locomotion. Just don’t expect to drop a 12 cylinder engine 500 horsepower engine on a road and get much to happen. Many other components are necessary to get that engine to work as intended, just like the concept of achieving success. Often it takes a lot of trial and error to get something that works, but without focus or great people helping you, it’s a lost cause. This is where the preparation meets opportunity comes into play.
As the quote from Drucker mentions, super focus is a necessary component to success as well. Being preoccupied with 100 things does not allow a person to put their fullest effort. Many opportunities pass us on a daily basis and most people are ill prepared, through lack of focus, to take advantage of these situations. This is where the fanatic part comes into intelligent fanatics, they are fanatic on their one vision. They will drop everything that does not promote their vision. I’m reminded of a concentrated investor here versus someone who invests in 100’s of stocks. You can only know so much about an investment and the greatest investors tend to be those who concentrate very heavily.
You also mention great judgement (the ability to distill a complex subject to the key variables) as something that is extremely important. I agree, too. The only thing that I would add here is that great judgement or insights for each person varies for each different situation. I’m speaking on a more granular level where people are best suited for certain industries, activities, etc. For example, Herb Kelleher had great insights into airlines as a service business and providing a means of transportation to the masses, but he probably would have been a poor gold mine operator. People need to find out their niche and stick to it.
As for surrounding yourself with great people, that is absolute right too. Successful people surround themselves with the smartest people. Successful people seek out those who have done what they want to do and learn from them. They are open books ready to be molded, but only by the best.
It is difficult to write about investing — it doesn’t lend itself to black and white pronouncements — the profits are made in the nuances, the shades of gray, the degree of emphasis on one consideration versus another — when to hold and when to fold.
I look at Buffett’s portfolio and see all the losers and think, mmmm, that’s interesting. And see lots of positions that don’t fit his published criteria.
It’s an art, not a science.
Excuse me, thanks Sean (not Ian).
As an investor in a microcap company, how one should react when the Intelligent Fanatic of the company makes a mistake? What are the factors which should be looked into to get the conviction back to hold on to the investment?
Harshit, good question. I would observe how the leader handles the mistake. personally my interpretation is that intelligent fanatics are humble with plenty of integrity. If a mistake is made, a great leader takes all the blame. When things are successful, they deflect the praise onto their workers since the workers are the people on the front lines doing all the work.
For your second question, as Rod stated above, investing is an art and you just have to really know the situation, the leader, their system and the other gray areas to maintain conviction.