I was trying a bit too hard when writing this post. In a sense, that’s to be expected when one is still trying to find their style.
I want to share a beautiful post that resonated strongly with me and that explains much better the ideas that I tried to convey here. The post’s title is Peak Quality?, and you can read it here.
Here’s my favorite quote from that post:
Our view is that the intersection of quality and value is where things get interesting. That could mean owning an extremely high quality company that the consensus investor only believes to be good quality, or owning the mediocre quality company that Mr. Market has left for dead.
Moreover, when it comes to style, there’s another idea that I find compelling. It was most eloquently expressed by Bruce Lee in The Lost Interview. He says:
Styles tend to separate men, because they have their own doctrines, and then doctrines become the gospel truth that you cannot change. Style is a cristallisation. Instead, seek a process of continuing growth.
And the highlight of that interview is even more powerful:
Be formless, shapeless, like water. You put water into a cup, it becomes the cup; you put it into a bottle, it becomes the bottle; you put it into a teapot, it becomes the teapot. Now water can flow, or it can crash. Be water my friend.
Here’s the full interview if you’re interested:
So in a nutshell, while I stand behind everything I wrote below, I find it too limiting and stiff. And the truth it, I allow myself to deviate from it and experiment, as long as it doesn’t put my portfolio at too much risk. After all, a big part of the appeal of this game is the opportunity to experiment and learn.
I really struggle to figure out how or why I would have an edge investing in the market. To some degree, and as far as comparing myself to the market, it doesn’t matter that much. In the sense that I don’t mind underperforming any given index, as long as I’m learning and having fun.
But I feel that the only way I can learn efficiently is by leaning on my strengths, and that’s why I think about what my edge could be.
There’s a lot of hubris and confidence in what I wrote below, but the truth is I’m constantly questioning whether I have any clue at all. So take what you read here with a grain of salt. It’s basically me cheering myself up to keep trying.
My investing approach
My approach to investing stems from the fundamental assumption that everyone out there is objectively more experienced and smarter than me. By everyone out there, I mean everyone that is allocating capital in a serious way. I exclude the gamblers and meme speculators.
On every trade I make, the person on the other side of it is smarter than me.
A good example of who I have in mind when I imagine the person on the other side of the trade is Christopher Seifel. That’s someone who looks to me like he knows what he’s doing.
I’m using him as an example to make the idea stick in my brain.
If that’s who’s on the other side of the trade, and he’s not under undue stress or in a state of complete panic, and we’re trading a stock that he knows well (which will be the case because those are the only stocks he trades), there is no chance in hell I’m coming out on top. That is just the truth.
The way I see the market, it’s full of Christopher Seifels, every one of them with top-notch analysis skills and niche expertise.
You might ask: “Why are you playing this game then?”.
The answer is simple: I shouldn’t play…unless they have some sort of handicap, or they are not playing at their full capacity.
The only way I can trade favorably in the market is if the other party is constrained or unbalanced in a way that I’m not.
By constrained, I mean that they have to trade in sub-optimal conditions. For example, they have to sell a stock that is very illiquid, so they must accept a lower price. Or they have to sell because the stock has become uninvestable in the eyes of most funds.
By unbalanced, I mean that their emotions are taking over and fogging their minds. This can happen when the market goes into panic mode.
In exploring further the consequences of my fundamental assumption, I will consider the two types of businesses I’m interested in buying. The first is the wonderful business at a fair price (Munger), the second is a shitty business at a deeply discounted price (Buffet).
A fair price for a wonderful business
The more people that are interested in a business, the less likely it is that I’ll be able to buy it at a fair price. Therefore, the only way I could possibly pay a fair price is in the microcap world, where there aren’t too many professionals. And even within the microcap world, it should be a low-key, under-the-radar, no-hype type of business, one that no one or very few are excited about. I will pass on any and every stock that has loud and visible cheerleaders.
Moreover, I will not push my luck. Because I don’t trust my ability to do proper valuation, I will not try to justify an optically expensive price. I’ll leave that to the pros. I will always want the businesses I buy to be on the cheaper side. This means I will miss several great investments that never went down in price enough to be considered cheap. That’s OK.
Note that there is no contradiction between the idea that I’m able to buy a wonderful business at a fair price and the assumption that the seller is smarter than me. This is because of the illiquidity of the stock. If there aren’t enough buyers, and if I only look for cheap stocks anyway, then I am bound to stumble on a few situations where the seller needs or wants to sell (for whatever reason) and they have to accept whatever price the market is offering them. If the stock was liquid, they’d be able to sell significantly higher. But because (or thanks) to the lack of volume, they are stuck with cheapos like me.
A deeply discounted price for a shitty business
Here we’re talking about ugly, forgotten, hated, and problematic investment opportunities. If the price is low enough, and I mean ridiculously low, then that is my margin of safety. I don’t need to be super smart. I just need to be somewhat right in order to make a decent return.
Sometimes, the market will throw at us a very visible and well-known wonderful business at a somewhat discounted price, or a good business at a deeply discounted price.
This only happens after a lollapalooza situation, where the business or the market is hit by a series of negative events that end up spooking market participants and pushing them to panic and severely overreact.
I have to admit, these are my favorite types of setup; when there’s extreme fear or disgust. Those feelings are easy enough to spot, and since they tend to spread like wildfire, they make for beautiful entry points. Two recent examples that come to mind are Peloton and Alibaba, although the events that hit Peloton were not close enough in time to one another and the stock didn’t suffer enough for me to consider it cheap.
In a nutshell, I want to smell blood on the street; anguish, anger, desperation, and fear. Those are the feelings I’m attracted to.
This means that the overused adage “Time in the market > Timing the market” is utter horse shit. Timing is SUPER important, at least for picking individual stock entry points.
When it comes to investing, I’m not trying to reinvent the wheel. Everything I’ve said above is just a rehashed version of Buffet’s and others’ wisdom. The same is true for what I believe to be my edge.
My main edge is that I am unconstrained. I’m not using any leverage, and I don’t have anyone I am accountable to other than myself. Even my wife doesn’t have a clue how much our portfolio is worth, for this exact reason. I manage my own little capital, and as long as I don’t get too scared or too greedy, there is really is no reason for me to buy or sell at an inopportune time. I can wait as long as it takes.
Moreover, I have also no constraints in the types of investments I can consider, and I don’t have to justify them to anyone. I can invest in nanocaps and large caps. I can take ESG and DEI into consideration or not. And I can buy stocks that all of Wallstreet hates. I can look everywhere.
So I can have an edge in the search phase of the process. I have no edge (I even assume a negative edge) in the valuation of businesses, and close to neutral in the review and risk diversification aspects, although I think I’m slowly getting better at those.
Looking for a free lunch
Whether I’m buying a wonderful business at a fair price or a shitty business at a deeply discounted price, the investment opportunity needs to be completely obvious. I shouldn’t have to come up with some smart arguments as to why the buying opportunity is interesting. It should stare me in the face. If it’s hard and complicated, it’s not for me.
To be clear: yes, I am looking for a free lunch or a $20 bill on the ground. And yes, I’m willing to wait and do nothing otherwise. As Mohnish Pabrai says, I will be unreasonably demanding.
I will not rely on the quality of my projections. In fact, I’d rather not make any. I want the market to hand me a golden opportunity, without me having to force anything. I am confident that the market does, from time to time, present such opportunities, out of its own volition. I just have to be looking. I will put much more energy into the search part than the valuation part. I will do a review of every opportunity with a simple but thorough checklist and will remain cautious with the risk I’m taking.
By following this approach religiously, in time, I will be very rich.
The other side of the coin
The problem with being stupid is that my level of conviction can rarely be ultra-high. Which means that despite Buffet and Munger’s advice, I don’t see my portfolio being concentrated into 3 companies or less. Diversification is the cost I have to pay for my ignorance. Maybe it’ll change one day, but as of right now, I feel that I could be wrong on any of the bets I’m making.
There’s also another dilemna that is bothering me. I see some wonderful companies selling at a high or even a fair price, but I don’t know that the market is wrong about them. I’m not seeing anything that would indicate that the market is being irrational about them, and so I don’t buy them - but they keep executing brilliantly and outperforming. There are many examples but two examples at both extremes of the valuation range would be $DOO.TO and $CSU.TO. Both are companies I admire, but I didn’t buy them because I never thought I had an edge over the market. I feel like this suggests that there’s something wrong with my current framework, but I don’t know what it is. Time will tell…