During a lifetime, you will likely own 10-20 big winners and hundreds of failed impostors. Time and interest are the primary components of the power of compounding. The hard part is we don’t know how much time we have. Identifying the losers in your portfolio is as important as holding winners because losers dilute your returns. Losers are a waste of your time.
“Take your losses quickly and your profits slowly because your objective is not just to be right but to make big money when you are right”
– Bill O’Neil
Many investors do a post-mortem analysis of their investment decisions. A port-mortem is analyzing an investment after you’ve killed it (sold). You may have sold because it was a bad investment or because it was a good investment. The objective of the post-mortem isn’t necessarily to review the individual investment (ie this was a bad investment or good investment) as much as it is to review if making the investment and holding was consistent with your investment strategy and principles. Here is a good video by Steve Jacobs on post-mortem analysis:
Last year my wife and I sat down with an estate attorney to make changes to our Will. Embarrassingly we kept pushing this off for far too long. The attorney asked me, “How will your wife be taken care of if you die?”. I replied jokingly, “I’m not worried about it. She will marry again quickly.” My wife threw a quick glare in my direction 🙂
But in all seriousness, as soon as I got married I created a 911 file. The 911 file is password protected and only my wife can access it. If God decides my time is up, whether it’s later today, next year, or in 40 years, my wife can go to this file to retrieve all the important information on our finances. Brokerage accounts, bank accounts, people I trust that can help, etc. Since I’m heavily invested in a relatively small amount of illiquid public and private company investments I try to keep an updated and detailed account of my thoughts on each investment.
A post-mortem analysis is one thing. Writing down your thoughts on an investment that is to be read and understood upon your demise is a whole other exercise. My hope in providing my thoughts in such a way was to give some sort of guidance. The intention is that many of the acorns I’ve planted that have started to grow will hopefully turn into large oak trees that can support my wife and family long after I’m gone.
The 911 file is organized very simply with my thoughts on each investment outlined in the following structure which I update periodically:
- A paragraph on when and why I made my initial investment.
- A paragraph on how my investment thesis has changed or evolved since making the investment.
- A paragraph on how the management and business have impressed me and disappointed me since making my investment.
- A paragraph defining why the business is special (ie describe the relationship between the business and the customer).
- A list of issues, events, threats, that could hurt the business. What could hurt the relationship between the business and customer? Which ones are glancing blows versus knock out punches to my thesis?
When we sat down with the estate attorney I slid the printed 911 file over to him and said this is all my wife would need. He took 30 seconds, scanned over it, and slid it back and said, “This won’t be necessary. Mr. Cassel all your investments will be sold soon after you die. There is no possible way a portfolio such as yours can be managed by people that don’t have your experience.” As I let that sink in for a moment, I quickly realized he was right. In a fast paced, quickly changing environment of microcap investing which are primarily small emerging public companies, it’s very hard to simply transfer investment knowledge. It was quite stupid of me to think that my positions could survive past me, not to mention the undue stress doing so would put on my wife.
I continue to keep the 911 file updated, even though it won’t be useful to my wife upon my demise. Why? The exercise of writing it helped me invert and balance out my bullishness and biases. It focuses me on when I need to sell. It’s been seven years since I started the 911 file and I can point to three separate occasions where the thought process saved me a lot of money.
It’s OK to fall in love with your microcap positions. I know I love mine. You just have to be prepared to divorce quickly. You can’t let your ego get in the way when the facts change. You need to know your investments better than most so you can spot when something has changed long before other investors. As Keynes said, “When facts change, I change my mind.”
I’m still a full-time investor today not because of my gains, but because of the losses I didn’t take.
Some other articles you might enjoy:
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Another topic related to documenting your thesis as it evolves is price targets. I’m often asked what my price target is on a stock. I never answer that question because I continuously analyze my thesis/expected execution vs. the current stock price. A price target tends to cement your thinking to a static thesis/expected execution, and stock price combination which rarely works out exactly as one thinks. So, I like to have an idea of where the stock price will be given a certain execution but I hate specific targets as I need to be flexible in my decision making.
Obviously Buy and Hold has worked for you. But in the micro cap world do you think more active strategy is called for? Even big companies are getting disrupted in the market. The competitive advantage period is shrinking every decade. These micro caps face even serious challenges on a daily basis.
What in your opinion is easier for most regular investors…Finding regular value investment ideas in this under researched segment . The ideas that will give good pop over 1 to 3 year time frame OR identifying the companies ex-ante that you can hold for years and that will defy the gravity of market competition and thrive for many years? Identifying eventual winners over long term is not easy for the most people.
Would love to get the different thoughts from you guys.
Each investors strategy is and likely should be different from the next person. And it’s good to be different from others. I think too many focus on cloning others when it’s a mistake. It’s not who they really are. There are 30,000 Elvis impersonators, and their combined income is far less than the original. Be original. I think in general microcap investing lends itself more to an active strategy because many microcaps are small emerging companies and things can change quickly. You can’t afford to buy and forget. You need to buy and verify your thesis. You can’t say “I’m going to hold this for 1-2-3-10 years”. No, you are going to hold it as long as management executes. That could be 3 months or that could be 30 years. Hold times are skewed towards the former (3 – 18 months) because there aren’t many microcaps that will prevail over the long-term. You need to have a high hurdle for new ideas but not too high that you never let any investments in. No company, especially a small one, is perfect. They all have a wart or two or fifty, but warts can be removed. It’s why it’s important to stair step into a position and add as management executes and proves themselves. If they don’t execute you sell. Let their execution determine your position size, not some formula you read in a book. It’s not batting average that is important, it’s slugging percentage. You can have a lot of losers and still win big if you hold your winners and are diligent in selling your losers quickly.
For me what I tend to do is over time I move more capital into my best ideas. For example, a large percentage of my portfolio is in three companies which I’ve owned for 3 years, 4 years, and 5 years. The other handful of positions are smaller that I hope will mature into what I think they can become. Some will and some won’t. I hope to average up in all my positions.
Well written it’s a necessary condition for succesful investing enjoyed reading.