Averaging down is a skill. Done well it can be your greatest asset. Done poorly it can mean disaster.
Investors tend to over-analyze when stocks are going down (fear) and under-analyze when stocks are going up (greed).
Investors tend to over-analyze when stocks are going down (fear) and under-analyze when stocks are going up (greed). I think most would say the latter, under-analyzing, is the greater sin. I believe both are equally harmful. An investor’s goal should be to make as few investment decisions as possible but making few decisions doesn’t mean making slow decisions. Waiting too long to buy or sell can be very unprofitable. In fact I would conclude that indecision is an investors biggest adversary.
“ACCURATE analysis of over 25,000 men and women who had experienced failure, disclosed the fact that LACK OF DECISION was near the head of the list of the 30 major causes of FAILURE. This is no mere statement of a theory–it is a fact. PROCRASTINATION, the opposite of DECISION, is a common enemy which practically every man must conquer…. Analysis of several hundred people who had accumulated fortunes well beyond the million dollar mark, disclosed the fact that every one of them had the habit of REACHING DECISIONS PROMPTLY, and of changing these decisions SLOWLY, if, and when they were changed. People who fail to accumulate money, without exception, have the habit of reaching decisions, IF AT ALL, very slowly, and of changing these decisions quickly and often.”
– Napoleon Hill, Think and Grow Rich (1937)
Successful business leaders/investors (aka intelligent fanatics) have a high mental horsepower, a deep understanding of what is within their circle of competence, and can therefore make very quick decisions. These traits allow them to outmaneuver the competition.
John Malone, one of The Outsiders, was CEO of Tele-Communications (TCI). $1 invested in 1973 at the beginning of the Malone era was worth over $900 by mid-1998. Brian Roberts, CEO of Comcast, said this of Malone, “People say John has a three-dimensional-chess type of mind, and it’s true, and a lot of time you feel like you’re still playing in one dimension.” John Malone received this advice from his father, which helped him in school and in business:
Elon Musk is an intense intelligent fanatic. Vishal Khandelwal (@safalniveshak) wrote this great piece on Elon Musk [HERE]. Steve Davis, Director of Advanced Projects at SpaceX had this to say about Elon Musk, “One of my favorite things about Elon is his ability to make enormous decisions very quickly.” Elon Musk tasked, Kevin Watson, then head of SpaceX flight computing group to deliver a $10,000 computing system to power the rockets, a system that normally costs well over $10 million. Kevin had this to say about Elon:
Alice Schroeder, author of The Snowball: Warren Buffett and the Business of Life, knows Warren Buffett as well as anyone. Alice was asked in this interview:
When did you get an “Aha!” feeling that Warren wasn’t a typical human being?
Alice: That was obvious when I met him as an analyst in the first 5 minutes into the conversation. When he opens his mouth it just comes through. His way of articulating ideas is very original. He is a great synthesizer and especially strong at pattern recognition. He’s also able to follow what I would call decision trees and figure out probabilities in his head at an astonishing pace.
So when you are in a conversation with him, he has worked out many of the directions in which the conversation can go, the likelihood of each, and how he wants to manage his end of it. He’s reading you emotionally too. You recognize that right away in a conversation with him. You realize he’s many moves ahead of you on the chessboard. It is eerie, but also fascinating.
You also can see how unusual he is because he’s a great teacher. If you ask him questions he loves to convey the things he’s learned.
1. Become a Learning Machine: I enjoyed Jana Vembunarayanan’s (@jvembuna) eight steps to becoming a learning machine found [HERE]. As a full time microcap investor and entrepreneur it is important to have high creative and intellectual mental horsepower. Since microcap investing is highly correlated to entrepreneurial investing, I read a lot of books focusing on business leaders and entrepreneurs. When I read, I read slowly, with a note pad (physical notepad or notes on iPhone/IPad) beside me. I’ve always been amazed at the creative sparks that occur when you are reading something that you truly connect with. Similarly, life happens and I go through a lull in reading that can last weeks. During these times I can literally feel my creative and mental horsepower decline, and my decision-making becomes slower. Read what you are interested in. Don’t be afraid to put a book down that you aren’t engaged with to pick up another. You don’t get an award for finishing a book you don’t like. The goal is to keep reading and become a learning machine. I’ve found great investor’s offices aren’t filled with computer screens. They are filled with books.
Similarly, when I was getting started as an investor it would take me a long time to read through a annual reports and analyze the financials. After you’ve read hundreds and/or thousands of company annual reports you can analyze much quicker. Instead of taking a couple hours to make a decision it now takes 10 minutes. Making quick decisions doesn’t mean getting to a “Yes” quicker, it’s more often saying “No” quicker. Guy Thomas said, “Investment skill consists not in knowing everything, but judicious neglect: making wise choices about what to overlook”.
2. Know your Circle of Competence: There are 12,000+ microcap companies that trade on US/Canadian markets. I personally only look to initially invest in microcaps <$30 million market cap. i don’t like small companies that operate in capital-intensive industries mining, life sciences, and oil & gas. generally stay away from pre-revenue story stocks. look for with clean share structures owner operator management teams. these qualitative quantitative filters take 12,000 down to several hundred. you then evaluate looking great businesses or good can become great. are left maybe 50-100. might find one two want buy today. the others know fairly well so wait right price an inflection point. Know them better than most so you can buy them quicker than most if you have to.$30>
“Everybody has got a different circle of competence. The important thing is not how big the circle is, the important thing is the size of the circle; the important thing is staying inside the circle. And if that circle only has 30 companies in it out of 1000s on the big board, as long as you know which 30 they are, you will be OK. And you should know those businesses well enough so you don’t need to read lots of work. ……The nice thing about investing is that you don’t have to learn anything new. You can do it if you want to, but if you learn Wrigley’s chewing gum forty years ago, you still understand Wrigley’s chewing gum. There are not a lot of great insights to get of the sort as you go along. So you do get a database in your head. I had a guy, Frank Rooney, who ran Melville for many years; his father-in-law died and had owned H.H. Brown, a shoe company. And he put it up with Goldman Sachs. But he was playing golf with a friend of mine here in Florida and he mentioned it to this friend, so my friend said “Why don’t you call Warren?” He called me after the match and in five minutes I basically had a deal. But I knew Frank, and I knew the business. I sort of knew the basic economics of the shoe business, so I could buy it.”
— Warren Buffett
3. Invest in Great Businesses: Invest in simple businesses that you can understand. Simple businesses aren’t always great businesses but great businesses are almost always simple businesses. They are rarely onions where you have peel back layers to understand them. Great businesses make for great stocks and the market always pays a premium for them. As a microcap investor I have no inclination to buy an undervalued company that will stay undervalued. I want to find undervalued companies that will get overvalued. Great businesses always become overvalued because they are simple to understand and there is a scarcity value placed on simple great businesses. For the same reason you want to focus on such businesses, others will too. My rule of thumb is I need to be able to explain a company in a minute or less. If it’s complicated and takes more time, “dumb money” will never buy my shares multiples higher. In the case of small microcaps, “dumb money” are the institutions. To be a successful microcap investor, you don’t want to invest where the institutions are, you want to invest where they are going to go.
The key is finding these great businesses when they are small. When you find them when they are small and undiscovered you have the luxury of not only earnings growth but also multiple expansion. This combination creates multi-baggers, sometimes very quickly, and it’s why it’s important to find these great simple businesses early.
4. Organize Your Research: Organizing your research is important for full time investors and part time investors. As Warren Buffett said, “Everything you learn in investing in cumulative.” Alex Rubalcava (@AlexRubalcava) did a great presentation on this subject a few years ago. We have a thread started on our MicroCapClub member’s forum on how different investors organize their research. Mike Schellinger (@MikeDDKing), a full time private microcap investor, has a template he uses to organize his database of over 600+ companies he passively follows. Of those 600+ he actively follows around 10%.
“I only update those that interest me. Often, I’ll update one after years of inactivity. In the microcap space, sometimes a company is interesting for a while, hits a rut, and then takes time to hit its stride again. Even after years of no update, I find the notes useful as the history is helpful and allows me to make quicker decisions.”
— Mike Schellinger
5. Keep an Investing Journal: Investing is a life long education and its teacher is loss. Keep a journal of your losses. When you are fully cognizant of your past mistakes you can make quicker better decisions. However painful losses seem at the time, sometimes we forget our lessons from 3-5-10-20 years ago. Similarly to reviewing notes of a lecture, I like to read through the journal annually to remind myself of the painful lessons of years past. Sanjay Bakshi (@Sanjay__Bakshi) makes a great point in this interview about keeping track of not only mistakes of commission but also mistakes of omission:
“I have my own mental “hall of shame” where I display my mistakes I have made, and the tuition fee I have paid. It’s something I look at often. I share it with my colleagues and students. My hall of shame contains not just mistakes of commission, which I referred to above, but also mistakes of omission. I think it’s terribly important to understand the role of mistakes of omission in one’s career as an investor. Many investors I know don’t do this. Their logic is based on their belief that real losses matter while opportunity losses don’t. In my view, that kind of thinking is deeply flawed. It arises from a P&L account prepared by using accounting conventions which only allow the recording the results of what you did, and not what you could have done, but didn’t. The metaphor of an “Opportunity P&L Account” is a powerful one because it records the true tuition fee paid in return for the education acquired. That’s because it reflects both errors of commission and omission.”
— Sanjay Bakshi
6. Go With Your Gut: Your gut feeling, aka intuition, is the sum of all your senses combined with your past experiences. My gut has earned me/saved me millions of dollars over my investment career especially when it came to selling a position. What I’ve found is if you’re focusing too much on the decision at hand it often shields your gut/intuition. The best way to leverage your gut/intuition is to create “white space” and unfocus for a bit. It’s almost like one of those stereograms where you have to relax your vision and look through the picture to see the image. Go workout, hang out with friends, read a book, or whatever you have to do to clear your mind. Fortunately clearing my mind has always come natural to me, just ask my wife 🙂
When I evaluate my biggest winners, the purchase decision was “obvious” meaning it didn’t take me very long to come to the conclusion to buy an initial position. Often times the fact that it is taking me longer to come to a conclusion is reason enough for my gut to say “No”. Similarly on the sell side, I’ve had many instances where my gut provoked me to sell a position even after holding for years.
In conclusion, the greats are great because they are relentless learning machines that focus on what’s within their circle of competence. Great investors have an ability to wait for their pitch and when that pitch arrives to swing quick and hard. Focusing on great businesses, organizing your research, keeping an investing journal, and going with your gut are all things I do to make quick decisions. Napoleon Hill said it best, “PROCRASTINATION, the opposite of DECISION, is a common enemy which practically every man (and woman) must conquer”.
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Nicolai Tangen is the CEO of Norges Bank Investment Management, Norway's $1.4 trillion sovereign wealth fund.
Dilution is the subtle erosion of ownership. This hidden, persistent addition of new supply of shares leaves shareholders with less and less of the company’s value. Dilution, like inflation, is a silent killer of returns.