April 3, 2024

Lessons from the Plate to the Portfolio: Finding Your Investment Sweet Spot

There’s a correlation between many life lessons and investment lessons. Whether in life, business, or investing, when we do what we are passionate about and are good at, we can be exponentially more successful.

Ted Williams was one of the greatest hitters in baseball history, with a batting average of over .400. Warren Buffett has shared that his average was so high because he’d only swing when there was a “fat pitch.” During Williams’ career, he outlined that there are approximately seventy-seven strike zones on home plate and figured out which pitches he was best at hitting. Waiting for a pitch in his sweet spot increased the chances of getting a hit. With this knowledge, he wasn’t afraid to not swing at pitches—passing on low-probability opportunities—and swinging when there was a high probability of a hit. Buffett does the same with investing. This practice takes patience; however, everyone can still experience a missed “at-bat.” The advantage of investing is that you don’t have to swing at any pitch; you are not out after three strikes. You also don’t have a split second to swing. Therefore, you shouldn’t have a fear of missing out—you only have to be right about the investments you decide to make.

I have been investing for decades. It is said that good judgment comes from experience, and experience comes from bad judgment. I have made plenty of errors and tried a number of different strategies. During that time, I have reflected on my successes and mistakes to uncover my strengths: what I enjoy, what I understand, and where I have done well.

I am committed to lifelong learning—whether that is educating myself on other companies or investors or trying to take as much as I can from the many mistakes I have made. I have tried several strategies over time which did not work well. I spent an enormous amount of time reviewing over 750 of my public equity picks of over a decade, and we found that most of my mistakes were in two areas; over 90% were in value traps (buying cheap, but they weren’t necessarily great businesses) and growth traps (speculative growth companies). I’ve found it incredibly challenging to figure out which young companies would be winners in the long term.

Many great investors emphasize the importance of making fewer mistakes because winners tend to take care of themselves. Avoiding significant losses is critical since a -50% loss requires a 100% recovery to break even. This extreme insight has reshaped my approach, leading me to set much higher standards. I strive to stay disciplined, keeping emotions in check, and focusing on rational decision-making. Additionally, I am working on establishing qualitative parameters to better manage risk and try to make wiser overall decisions.

There’s a difference between being stubborn and being patient. Peter Drucker, a renowned management consultant, once wisely said, “Most people see what they want to see, not what they are.” It’s about being intellectually honest, admitting faults and not just rationalizing what you did. Approach life with open eyes and a willingness to see beyond our own biases. It’s not only about doing smart things; it’s about trying to avoid doing foolish things. Buffett shared, “The most important thing to do if you find yourself in a hole is to stop digging.” You don’t have to repeatedly do brilliant things to have good results, you just need to avoid doing foolish things and losing money.

After much reflection and review of why we had much success when selecting businesses that have already proven to be outstanding. These are exceptional companies with sustainable competitive advantages, purchased when they were either out of favor because of market conditions or were dealing with short-term perceived problems. Rather than dollar cost averaging (buying continuously periodically), I am more comfortable with value cost averaging (buying more when it is less expensive) and holding them for long periods of time. This approach doesn’t work all the time, but it tends to work overtime. I like to refer to these as compounders, that have quality, value, and growth. When you find something truly great like this, my holding period can be defined as “forever”. I want to buy and hold great companies. I’ve found that selling great businesses often results in regret and there is reinvestment risk.

Investing is part business and part human nature—part science and part art. It’s needing to be the hunter in the woods; prepared to shoot versus chase (stretching). It’s important to have a watch list and have the process to duplicate. Charlie Munger encouraged ‘inversion thinking’ which is looking at each situation by turning it upside down to uncover all the reasons why you should not make an investment.

When I consider an investment, here is the simple checklist of questions I review when assessing:

  • Quality
    • Is it a good business or industry? Is it very special within the industry and why?Is it wide moat? (e.g.: strong brand, cost advantage, intangible assets, switching costs, network effect).Is it defensive, constant and predictable relative to industry peers?
    • How is the quality of management? Are they shareholder-friendly? Are they good capital allocators?
  • Value
    • Are the current valuation multiples higher or lower than its historical averages?
    • Are the current valuations multiples higher or lower than peers?
    • Are the valuation multiples attractive if we look out 2-3 years?
    • What is the Price/earnings-to-growth (PEG) ratio?
  • Growth
    • Does it grow intrinsic value at least -10% annually?
    • Does it have secular industry growth or sustainable earnings growth?
    • Is it organic growth or outstanding at executing inorganic growth?
    • Does it have a long runway for sustainable growth?

Ultimately, there are many factors, both qualitative and quantitative, when completing an investment framework.

Investors improve their performance not through what they buy, but through what they exclude – by avoiding losers. When buying value stocks, the risk is a value trap when you hold a stock for many years and the intrinsic value doesn’t increase…or worse, it decreases. Value stocks are usually not wonderful businesses, which is why they’re cheap. When buying growth stocks, the risk is growth traps, which is when you pay a premium valuation multiple for a stock but then growth slows and the multiple contracts.

The ability to forecast short-term cycles is very hard and circumstances can change. It’s about finding high quality businesses and buying at attractive valuations that have the ability to grow and prosper long-term. Let the magic of compounding work.

I’ve learned the impact of having strong convictions but need to balance humility and confidence. It’s much safer to buy proven companies with strong, consistent and predictable results. The S&P 500 and Dow Jones prove that buying the best businesses in America produces attractive investment returns over extended periods of time. Buffett has demonstrated patience. Investors can do very well buying these wonderful businesses when they become mispriced by the public markets.

Competing in areas where we don’t have an edge—the extensive knowledge and expertise—and expecting a home run, is a way to get beat badly. It’s imperative to learn what we’re good at, where we have had proven success and what we enjoy—finding your “sweet spot”. The focus leads to consistent hits (increased batting average). In investing, trying to avoid mistakes is a good risk management strategy. The first rule of investing is don’t lose money. And according to Buffett, the second rule is to go back to the first rule. Enhancing the process increases the likelihood of achieving better results. Be patient and have a long-term perspective. And like Ted Williams ‘swing’ when in your sweet spot.

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