No investment blog is complete without an analysis of the investing mistakes one has made.
My early mistakes were all schoolboy level mistakes that can be eliminated with a good investment process. The mistakes to worry about are those that one can make even after having a good investment process. The kind of mistakes that manage to creep into your game once you become complacent.
I see too many investors having a mindset of avoiding past mistakes without proactively thinking about what mistakes they might be making in real time. As a matter of definition, any suboptimal investment decision should be viewed as a mistake, not just something that loses you money. With this change in mindset, one can appreciate that mistakes will always be made no matter how experienced one is. The idea is to ensure that a few mistakes do not set you back by too much.
Here are a few mistakes that I made after I had built myself up to a respectable amount of investing competence.
Not doing enough structured work
There are some stories where a back of the hand calculation and an overall analysis can result in good investing outcomes, these are the so-called fat pitches. But they are few and far. The problem is that of consistency and strike rate when the market does not give you the easy balls to score off, which is most of the time.
When you do structured work, you can circle back to why you were fine with buying a business at a particular valuation. You can look back at your work and say – the capacity utilization was hardly 60% while demand expectations were getting better, cash flows are likely to improve and reduce debt over the next 2 years and the ROCE will get past the threshold of 20%.
When you do not do structured work, your mind will only make vague conclusions like buy a better business, buy businesses cheaper, stick to only high quality and the like. Specificity is very important in feedback; else it becomes a mish mash of the same old investment principles that are easy to quote but are tough to implement.
When you do structured work, the consistency of your decision making drastically improves. Today I have well defined templates for all of these
- Sector research
- Business Research
- Management Evaluation
- Corporate Governance
- Valuation
- Quarterly business tracking
- Annual review
This is the painful and back breaking part of portfolio management that not many speak about, most investors believe it is all about finding good businesses and staying put. Which is fine, but it is just one half of the work it takes to have good investing outcomes across market cycles.
The perennial search for multibagger stocks
There was a phase when I believed that unless something could deliver 3x within 3 years, it wasn’t worthy of investing in. The problem with this thought process was that you have a tendency to see possibilities even when the probability is low. When you wear green shades, most things appear to have a shade of green. My approach today is to start with business analysis, do the work and then consider valuation. At worst you have an idea you have researched that you may not want to invest into right now, but the multibagger possibility may emerge during the next big correction.
Running a concentrated portfolio too soon
For the most part till 2017, I had fewer than 10 stocks in my portfolio. Each one of the them worked out well, but that was as much a function of market conditions as it was a function of my skill.
Concentration is what builds wealth fast but it can also decimate your wealth faster.
A concentrated approach is something that investors should evolve into over a period of time, it should not be the starting point in anyone’s journey. I got lucky in the sense 2018 happened after I had seen a good amount of investing success. If it had happened in my second or third of investing, my story could have been different.
Not having enough breadth in the coverage universe
I had no coverage on some sectors till I became a full-time investment manager. I managed to do a lot of work on pharma, speciality chemicals, agrochemicals and fertilizers through the fag end of 2018 and the beginning of 2019. This enabled me to spot the relative attractiveness of a few stories in these industries compared to other sectors. If I hadn’t built healthy exposure to these sectors through 2019, the March 2020 crash would have hit the portfolio much harder.
Investing is mostly about relative attractiveness of opportunities, as are most things in life. Unless you know what a bad investment looks like, you cannot tell a good investment when you see one.
Unless you have dated enough people, you cannot objectively evaluate whether the next prospect is a good fit for you or not. When you do not have enough options, you tend to fall in love with the limited options you have.
Always have a broad enough coverage of stocks across sectors, market capitalizations and business models. This way, you can exercise conscious choice all the time and not end up chasing a few stories irrespective of the valuation.
Quantity matters too, not just quality. Without enough iterations, you cannot build a great product. If you sit and ideate too much rather than testing concepts out in the real world, your end product is unlikely to be of high quality though that is your primary objective.
Not knowing where my real strengths lie
This once again follows from experience. Early on I thought my strengths were my logical abilities and my willingness to put in the hard work it takes. When I attended my first valuepickr Conference in 2017, I realized that every other person in the room was outworking me. I had a better portfolio return than some of them but it was just a matter of time before the cycle turned. And the cycle did turn in 2018, exposing a few fragilities in my way of investing.
Today I have a better idea of what my real strengths are which are my ability to think like an operating manager, inferential reasoning and pattern recognition (not the technical pattern kind). I have also realized that I can never better the market’s ability to estimate earnings over the short term, but I have a clear edge when it comes to the medium term. Pattern recognition takes time to develop, but once it does kick in it beats linear logic most of the time. You can instinctively recognize things that others may take many quarters to understand.
Today I no longer base my investment decisions on what the growth rate or the margin profile can be one year down the line, I base it on what the business can do over the next 4-5 years. Not the next 10 years, which is another segment where I have no demonstrable edge.
I can also visualize better than most other peers what the quality of a business is through multiple qualitative factors like
- balance of power in the equation with customers and suppliers
- what kind of investments are needed to scale the business to the next level
- what is the right mental model to view the business in the first place
I can do this because I have managed P&L for more than a decade now and have done contracting, business development, negotiations, receivables management and MIS reporting. In my current avatar I also have an operating view on how to scale a business and how to market a concept in the digital ecosystem.
Your real strengths are a function of who you are and what you have done with your life over the years. Unless you have this part dialed in, you documenting your investment philosophy is akin to a virgin giving a talk on the Kama Sutra.
Using the wrong mental models
I have sucked at option trading because I was using the mental model of long-term investing. It is a serious achievement that I did not lose money but I did lose precious time over 2-3 years.
Horses for courses.
Choose the right team for the right pitch.
Inability to make the distinction between a good business and a decent business
My biggest mistakes through the 2015-18 period happened because of this. Bull markets can and will blur this distinction, as many new investors in the current bull run will figure out later.
You do not want to pay a fair price for a decent business. In such business you make the bulk of your money by buying cheap. In a bull market, most decent businesses get priced as good businesses and price momentum supports the thesis that the business quality is indeed getting better. Once liquidity flow reverses, the decent business reveals its true nature.
Today I have 3-4 categories that I slot businesses into. Experience teaches you that the world has many shades of grey, unless you can appreciate this you will be pushed into black and white thinking. I now have framework in place that tells me whether something is a core hold or a tactical hold. My estimate of what is a fair price for this business takes this into account. The length of rope given to each of these categories also follows logically.
You can see from the above points that the solution to each one of them involves more work, rarely does one find solutions through ideation alone.
This is why most amateur investors are unlikely to have good investing outcomes across market cycles. It simply takes too much work and is boring work to boot.
Most of the real work happens in the background and is not glamorous.
We want to watch Mike Tyson knock out an opponent, we don’t care about watching him hit the punching bag 500 times a day.
