“We believe that the price you pay, more than the growth you get, is the biggest driver of future returns”
In every field of expertise, few insights drive large part of success. Strangely, it takes long time and lot of hard work to discover those few as they are buried deep inside hard layers of misconceptions and myths. Investing is no different. In fact, it is much harder to break the cycle of misconceptions here, given the high decibel noise unique to this industry. Some of the familiar misunderstandings that are very common in Investing are:
- Great businesses are great investments
- Waiting for economy to turn-around
- Waiting for all problems to be over to initiate investments
- Disproportional focus on macro
- Urge for constant activity; Idea that money needs to work all the time in a linear fashion
Though each of this can be discussed at great length, let us look at the first three in more details given their huge influence on investor behavior.
Our own past stock picks have much to offer on the first one. One of the fascinating findings from our past track record is that some of our best investment results did not come from the best companies, but from the most mispriced companies. In our experience, investment returns correlate directly to the level of mispricing than to earnings growth. More often than not, best companies are priced to perfection (factoring most of the earnings growth and potential) and hence rarely create alpha returns. As a stated strategy, we look for problems (headwinds) in companies. Unlike other industries, problems excite us here. Because that is when mispricing menace is at it’s worst. Our job is to assess whether the problem is of short-term nature or long-term. Short to medium term problem that leads to huge mispricing is where we find our sweet-spots.
Other common mistake that even seasoned investors commit is to wait for the cloud to clear i.e. wait for all the problems to go away before making investments. That is the least rewarding approach in the investment business. It is important to understand that one gets the best prices when uncertainty is maximum. If the purchase price is where most of the returns reside, then best time to buy is when there is a thick cloud arising out of uncertainties. As the maxim goes, “If you wait for robins, spring will be over”.
Though it sounds simple and straightforward, money managers and investors alike, find the execution challenging for the following reasons:
- Vicious fear cycles can sometimes make the stock prices undershoot significantly thereby testing conviction.
- Typical short-term problems can sometimes prolong for elevated time and thus obscuring returns for longer time.
- Need of high degree of patience and grit both in up cycle (to conserve cash) and in down cycle (reversal can sometimes take elevated time).
- It calls for a very refined emotional skill to sit tight most of times with action needed only in few brief occasions. As someone famous said, “It is awfully hard work doing nothing”.
Those money managers who hone these skills and invest into adversities, will create rewarding long-term returns in their portfolios. As in life, rewards are there for those who embrace problems, not for those who scoot and run at the first sight of trouble.
Happy Value Investing!