We are living in very interesting times. We have to admit, at some points, market movements have left us with our heads scratching. We find solace in Munger’s famous quote: “Anybody who is intelligent who is not confused doesn’t understand the situation very well. If you find it puzzling, your brain is working correctly.”
More than dwelling on the causes of securities’ prices soaring, or daring to make forecasts as to the direction of the general market, experience has taught us to focus on investing, an activity defined by Ben Graham as “an operation which, upon thorough analysis, promises safety of principal and an adequate return.” In a market where safety of principal is overlooked for the sake of returns (note we left adequacy out of the line), we have found the greatest challenge an investor faces is emotional control.
Value investors know boom and bust cycles, read thoroughly about the origins of manias and depressions, understand the pyschological biases that affect us (even have a branch of economics dedicated to it called behavioral finance), and yet, succumb at the imperative fear of missing out (FOMO), jealousy and envy like any other investor. Even the great investors struggle with FOMO, as the Druckenmiller story goes. As you might recall, Druckenmiller knew valuations were very extended in the dot com era, and yet, he couldn’t keep himself from following the rally. His comments after the experience are insightful: “I didn’t learn anything. I already knew that I wasn’t supposed to do that. I was just an emotional basket-case and I couldn’t help myself.”
Buffett called it when he said “You can’t stand to see your neighbor getting rich. You know you’re smarter than he is and he’s doing these things and he’s getting rich.”. Munger also mentioned “Envy is a really stupid sin because it’s the only one you could never possibly have any fun at. There’s a lot of pain and no fun. Why would you want to get on that trolley?”.
So what is an investor to do now? As Druckenmiller would say, we KNOW what to do already. As in life itself, the difficulty lies on execution. Below is our manifiesto, a reminder to ourselves of the principles that should guide our investment decisions going forward.
- As Buffett puts it: Rule #1: Don’t lose money. Rule #2: Don’t forget Rule #1.
- Only price can protect us. Insist on investing with a margin of safety.
- “Manage the downside, the upside will take care of itself.”
- “Many shall be restored that are now fallen and many shall fall that now are in honor.” – Horace Markets always provide second chances. Be patient.
- “The stock market is a device for transferring money from the impatient to the patient.” – Buffett
- “The world is full of foolish gamblers and they will not do as well as patient investors” – Munger
- Invest in things you know. Remember your circle of competence.
- Trust your valuation under conservative estimates, do not stretch it for the market price to make sense.
- If it sounds too good to be true, it most likely is.
- Remember base rates: how many times has a company grown revenues at xx% per year before?
- Use reverse engineering: what are the implied growth rates in the key variables that justify the price? Do these make sense?
- Never forget opportunity costs, make these a central part of your portfolio allocation.
- Never forget the best quality of having cash is optionality.
- Never outsource your thinking. Own your decisions (for good and bad).
In the current environment, it is likely that like us, you’re struggling to find operations that meet the two criteria laid out by Graham for investing: 1) safety of principal and 2) adequate return. We believe becoming the “Abominable No-Man” for a while (or an extended period of time) cannot be that bad, as it is within the normal scope of investing. At some point, valuations should make sense again (in general, we are not saying everything is overvalued now) and potential rate of returns should beat opportunity costs. We close with an invaluable Munger quote: “The wise ones bet heavily when the world offers them that opportunity. They bet big when they have the odds. And the rest of the time, they don’t. It’s just that simple.” (We just note simple is not the same as easy).
Adastra Finance 