The Sketchbook of Wisdom: Now at a Special New Year Discount (Till 5th January 2022)
Here is the latest issue of The Journal of Investing Wisdom, where I share insightful stuff on investing I am reading and thinking about. Let’s get started.
The luckiest part of my investing career is that I’ve been old enough to have invested through multiple bad markets and still young enough to take advantage of the lessons learned.
What I have realized by investing through the crisis periods is that one of the best ways to learn how crises unfold is to learn from the past and not be complacent to the possibility of them occurring in some form or other.
I remember attending a company’s analyst meet in around 2006. It was held in a three-star hotel in a crowded part of Mumbai. Before the meeting began, the company’s safety officer briefed us about the emergency exits and nearest hospitals.
Now, what were the chances of an emergency happening? Probably miniscule. But the loss, if it happened, would be significant.
That lesson applies to investing too. When you multiply the probability of loss into the magnitude of loss, it becomes meaningful. That is the reason why airlines do a safety demonstration before every flight, and surgeons go through their checklists before every surgery.
As an investor, that should be your standard operating procedure too. You should be mentally ready to see your investments go down by 50% rapidly and be prepared to act rationally when that happens.
Investing is largely a game of luck, and relying on luck tends to make us fragile. So it pays to listen to Nassim Taleb who argues that “it does not matter how frequently something succeeds if failure is too costly to bear.”
That is a wonderful, even if a bitter, lesson to take especially when you are basking in the glory of your short term success in the stock market. But that’s a lesson worth taking.
A Super Text
[W]e often have the mistaken impression that a strategy is an excellent strategy, or an entrepreneur a person endowed with “vision,” or a trader a talented trader, only to realize that 99.9% of their past performance is attributable to chance, and chance alone. Ask a profitable investor to explain the reasons for his success; he will offer some deep and convincing interpretation of the results. Frequently, these delusions are intentional and deserve to bear the name “charlatanism.
Let me make it clear here : Of course chance favors the prepared! Hard work, showing up on time, wearing a clean (preferably white) shirt, using deodorant, and some such conventional things contribute to success — they are certainly necessary but may be insufficient as they do not cause success. The same applies to the conventional values of persistence, doggedness and perseverance: necessary, very necessary. One needs to go out and buy a lottery ticket in order to win. Does it mean that the work involved in the trip to the store caused the winning? Of course skills count, but they do count less in highly random environments than they do in dentistry.
No, I am not saying that what your grandmother told you about the value of work ethics is wrong! Furthermore, as most successes are caused by very few “windows of opportunity,” failing to grab one can be deadly for one’s career. Take your luck!
RITHOLTZ: So, Howard Marks is fond of discussing second level thinking. And so, what I’m hearing from you is that just looking at earnings or P.E. multiples is first level thinking, and second level thinking is putting this into the broader context of earnings relative to free cash flow, relative to intangibles and growth. Is that like a wild overstatement or …
MAUBOUSSIN: No, not at all. I mean, I think that the answer is — the — the — the way I might say this differently is that free cash flow is the ultimate thing that we care about. All the other stuff you just mentioned in terms of earnings and multiples, those are all proxies that try to get to the same thing, so they’re short of shorthand, right?
And, by the way, I mean, you’ve had — you’ve had the great Danny Kahneman with you, right? What’s good about shorthands, what’s good about heuristics is they save you time, right? So that’s why they’re useful, that’s why we use them.
What’s limiting about heuristics or shorthand is they have biases, right? And so, the key is not to – the key is not to never use them, the key is to understand where they lie. And I think that’s where people get a little bit – can be a little bit lazy around the edges and just sort of say like it’s — those things always traded at 20 times this, and so it should be 20 times this. That’s not really — you — you want to go back to the core — the core ideas.
There is no such thing as a ‘hold’ decision. If you wouldn’t buy the stock again today, assuming you had additional money, you should either sell, or admit that you are confused.
~ Robert V. Green
That’s about it from me for today.
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