You’re Smarter Than You Think

Ian Cassel Blog, Educational 15 Comments

Individual investors have an edge over “financial professionals” because you don’t have to prove how smart you are. Successful investing is hard because it’s counter to our human nature. Having to take a public or semi-public stance on the world of investing is a big disadvantage because you are now being judged by the peanut gallery. Just think about Jim Cramer on CNBC. He’s on TV every weeknight, and he has to have an opinion on 1,000 different stocks. I think I’d rather walk through Dante’s Inferno and its eight levels of hell. Cramer has a target on his back, and not many have the stomach for it. I actually loved Cramer’s “Just Show Up” response when asked about his national humiliation on John Stewart’s, The Daily Show.

Individual investors have an edge over fund managers, financial advisors, analysts, guru newsletter services, and anyone else that is forced to have a public persona and/or swing the bat. As an individual investor you don’t have to waste time caring about every stock or what the general market is doing. You don’t have to come up with a pick of the month. You don’t have to be right on all of these companies you don’t understand. All you have to do is focus on making one good decision per year on a few companies you do understand.

Financial professionals have to deal with the emotions of others. Individual investors just have to control their own emotions. This is very important because the way to financial freedom is buying great companies early and holding on with a death grip. As Morgan Housel pointed out in, The Agony of High Returns, and I with, No Pain No Gain, most professional money managers would have been fired for owning the best performing stocks. For example, if a money manager had the foresight to buy Monster Beverage (MNST) in 2003, the stock would have been up 13,000% (130-bagger) by late 2007. Over the next year the stock dropped by 50%. With all those clients in the peanut gallery yelling at you thinking/saying “Are you that naïve? How could you hold something you’re up that much in?” That money manager, even though he/she picked the stock a few years earlier for massive gains, would have been fired and/or forced to sell the position. In doing so the money manager and clientele would have missed out on the next seven years when MNST would go up an additional 50,000% from your cost basis in 2003.

Monster Beverage, Southwest Airlines, and all the other 100-Bagger super stocks have ten, twenty, even thirty of these heart attack inducing mini-cycles. In fact, the more successful the business over the long-term (10-20-40 years) the more you will experience these mini-cycles. Many below average or even average companies experience fewer and/or less volatile mini-cycles. Why? Lack of expectation. The chart below which was tweeted by @jatin_khemani best illustrates why they occur.

Often times expectation, not reality, drive stock prices. The chart above accurately portrays one of these mini-cycles that many growing companies encounter. With growth stocks in particular, shareholder expectations swing like a pendulum from unrealistic to pessimistic and back again. A growth stock transitions to profitability, expectations rise, the stock rises, buying attracts more buying, and analysts initiate coverage creating greater waves of capital inflows. Finally, while retrieving the mail your neighbor tells you that he recently purchased shares in said company. Expectations officially reach the tipping point. Then reality kicks in with the next earnings report. The pendulum swings back in the other direction. Momentum traders and short-term investors exit, analysts go quiet, the stock falls 40-60% from its highs, fundamentals back-fill, new shareholders enter, and the float is turned over. This is one mini-cycle. They can last for 6-12-24-36 months or more. The deciding factor is how quickly the fundamentals backfill. If the business keeps performing, at some point “the crowd” will once again drive expectations too high, and the cycle begins again. The 14 Stages of Investing Psychology often correlate with these mini-cycles and are humorous only because they are so true.

RX.V_chart

We can all find companies with stock charts that look similar to Jatin’s mini-cycle chart. Mike Schellinger profiled BioSyent (RX.V) on MicroCapClub at $0.55 per share in February 2012. The stock was very illiquid, trading 10,000 shares ($5,000 worth of stock) per day. Over the next year, BioSyent’s stock moved over $1.00 per share. The business continued to perform which attracted more and more attention and 18 months later the stock was $12.00 per share, trading 100,000 shares ($1 million worth of stock) per day. I wrote about this a bit more in Don’t Worry About Illiquidity, Worry About Being Right. The irony is you didn’t see much institutional interest or analyst coverage until the stock was $7.00+ per share which was close to the time expectations outpaced reality. Institutions and analysts were on BNN (CNBC equivalent in Canada) touting the stock the whole way until the expectation bubble burst. Investors tend to under-analyze when stocks are going up (greed) and over-analyze when stocks are going down (fear). The stock dropped, the institutions and analysts with public microphones went silent, and the pendulum swung to pessimism. During this time the company kept performing. The fast money exited, new and existing shareholders built positions, the float turns over, and eventually a new platform for stock appreciation is put in place. I used BioSyent in this example, but you can use hundreds of other companies that follow this same pattern.

As an aside, intelligent fanatic CEO’s know when their stock is expensive. When it’s expensive you start seeing some of them use equity to make acquisitions, like Henry Singleton. Other intelligent fanatics like Elon Musk actually come out and say the stock is expensive, like he did in 2013. Sean Iddings and I will be highlighting intelligent fanatic Sol Price in our upcoming Intelligent Fanatic Project. Sol Price was a retailing visionary whom Sam Walton (Founder of Wal-Mart), Jim Sinegal (Co-Founder of Costco), and Bernard Marcus (Co-Founder of Home Depot) credit for many of their successful strategies. When Sol Price’s, Price Club, traded at 60x earnings and analysts had irrational expectations he said, “I think Wall-Street tends to get crazy. They fall in love…pretty soon they run your stock up. I hate to see the stock get hysterical.” These intelligent fanatics are so focused on the long-term that they don’t mind being honest about the short-term.

This is a flippant plug for microcap investing but another big edge individual investors have is microcap investing. Individual investors don’t have to wait for a company to be large, liquid, and known before buying it. Financial professionals are trained to believe volatility and illiquidity increase risk. The biggest advantage of microcap investing is larger, “smarter” money, can’t own these companies until they are larger. You saw this in the example of BioSyent above where analysts and institutions had to wait to buy it. Don’t invest where the institutions are, invest where they are going to go. Microcap investing is A Game You Can Win.

In conclusion, individual investors have an edge over “financial professionals” because you don’t have to prove how smart you are. You don’t have to be active for activity sake. You don’t have to come up with a stock pick of the week, month, even year. You don’t need to have an opinion on things that don’t matter. You don’t have to open yourself up to the peanut gallery. Individual investors can sit at the plate and wait because no one is in the stands yelling “Swing you bum!” [a bit of Buffett]. You can sit on great companies through mini-cycles and wait for your pay day. Experienced individual investors, even those managing small sums, should always have an edge. You have the advantage of only worrying about your own emotions and not caring what the world thinks. Don’t ever think bigger, more “popular” money is smarter money. With a little bit of patience, experience, and discipline, you can and you should beat any of the professional’s performance.

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      Many won’t believe it but I have no idea. I have never tracked it.. probably because I have no reason to keep track of it. I don’t manage other peoples money. All it would do is get me to want to compare myself to others. It would probably be a detriment to my returns as it just reinforces short-term thinking. I’m a full time investor. I’ve turned a little bit into a little bit more and can support myself now. I eat my own cooking. The fact I can support myself, my family, is all I care about.

  1. Excellent piece Ian. As always.

    Equally important is the thoughts you have shared on non-tracking 😊your returns.

    Yes. Mostly people will be surprised. But i could relate to your idea bcos i have never tracked mine.

    I think this idea in itself should be a blog post Ian.

  2. Ian, in the end we do it for the money, I m not saying we need to brag about our return but not follow what we do?
    Everybody knows how much money they invest during the years and how much they got now so putting your head in the sand is not smart in my opinion.
    5 or 10 years return are important and some level of competition allow you to get out of your comfort zone and work harder/smarter.

    1. Hey Ian. I have a question irrelevant to this post, but do you have any good podcast that you recommend. The problem these days is that theres just too much good podcast out there. I subscribe to like 30 business/startup/entrepreneur/psychology/motivation podcast and I feel like I should start cutting down on them.

      Do you listen to Tim Ferris or Pat Flynn?

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        William:

        I do listen to Tim Ferris. It’s easy to feel overloaded. Pin point a few areas where you want to make progress and then focus on taking small steps every day. I guess what I’m trying to say is put what you learn into action. Focus on that.

  3. Hi Ian,
    Just wanted to say I have never come across such a clear and logical way of thinking about investing even after reading tons of material on Buffett and Graham. As a 25 year old newbie individual investor in India, you have given me a very good insight which I can carry forward to my own investing. I have read all your posts from the beginning and just wanted to say that you hold your own compared to the bigwigs 😉

    I am now turning my portfolio into a clean slate to practice a microcap way of investing. Thank you.

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      Thank you Mohit. Very much appreciate the kind words. We all stand on the shoulders of others in some capacity, and I am no different. You try to learn from the greats, from your own triumphs and failures, from mentoring, etc. Combine it all into an investment philosophy. Then break it all down again into its simplest form and communicate in a way that resonates.

  4. Ian I want to say that this article was a great way to portray that individual investors who sometimes feel less confident about their investing just because they don’t manage it for others… I just am a big fan of your articles because they depict what investing is all about simple to understand but not that easy to execute consistently

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  5. If the individual investor is smart then they can easily beat the professionals, especially when they are using their own money. For professionals, some of that money are from clients. And clients want to make a quick buck and influencing these professionals to make rookie mistakes.
    The lesson here is the professionals have more responsibilities than the individuals.

  6. Individual investors have an edge over “financial professionals” because you don’t have to prove how smart you are. Absolutely true, Ian. Many if not most individual investors have an edge over the so-called Gurus too. Only the latter always walk away with all the credit.

    I’d say fame (not necessarily success) in the investing world is a function of how deep one’s pockets are. Let me share a hypothetical example.

    Say, Mark, a lay-investor bought 1,000 shares in $AAPL @ $17.82 (split adjusted) on June 29, 2007, the day the iPhone was launched, and he holds all shares till date, with last Friday’s price being $142.27. While Mark’s gains in % terms comes to a whopping 698%, the absolute amount of unrealized profit he made is $124,450.

    As opposed to this, some Guru or fund bought say 100,000 shares on the same day. Both the Guru and Mark make the exact same gain in percentage terms. But guess who earns the laurels? Obviously the Guru, since he had bought 100,000 shares (he had deeper pockets, and is “well-known”), and made a killing of $12.445mn, which is significantly higher than Mark’s gain of a measly $124,450. Poor Mark will never be able to flaunt his success except perhaps to friends and family (no one else really knows about Mark), while the Guru goes to town, blowing his own trumpet!

    I am sure there are many such unsung heroes among retail investors.

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