February 21, 2023

Top Ten Investment Lessons Learned from the Last Year

I feel compelled to share lessons in business, life and investing. When there have been major events like the past year in the public equity markets, I find it’s a good time to reflect on observations, mistakes or lessons learned. Like in life, I’m always trying to improve as an investor and take these circumstances as a learning experience. In some cases, you may discover some new lessons and in others it’s a reinforcement of an area that we already knew and a good reminder.

Consider macro-economics. As trite as it may sound, don’t fight the Fed. You will often hear that investors are either top-down or bottom-up and I have learned the hard way that both are very important. You cannot ignore macro-economics as an investor because these factors will influence your results. For instance, historically, public markets do not completely bounce back when the Federal Reserve is increasing interest rates to combat inflation. Generally, markets do better when rates are low or being lowered. Not as well when rates are high or being raised. As interest rates increase, it creates many challenges as an investor and I should have been more cognizant as valuations could have been seriously impacted. Macro-economics are important to pay attention to, not to try and capitalize on, but to protect yourself from macro risks.

Valuation matters. Although quality is always the most important part of an investment, valuation is also very essential. The pandemic caused a lot of challenges that many of us were not experienced in dealing with; there was a lot of stimulus money, and businesses were growing by leaps and bounds that were ultimately not sustainable. Ignoring high valuations can lead to adverse consequences. If you own an asset that is significantly over-valued perhaps it’s time review the valuation, sell or trim and redeploy that investment into something more attractive. Warren Buffett’s number one rule in investing is “don’t lose money”. Historically I have done this with banks, of which I have invested in 150 over decades, but somehow, I seem to have ignored it with some other growth companies.

I am occasionally a decent buyer, although I tend to often be early. But I have not been as good at being an opportunistic seller when assets are significantly overpriced. When companies are trading at exorbitant multiples, it becomes difficult for them to grow into their valuations, and there are likely better opportunities elsewhere. There’s nothing wrong with holding onto cash. It is a great hedge and can be a way to take advantage of future opportunities if you’re flexible, open-minded and opportunistic.

Quality always matters. Quality is the most important thing. Most businesses are not that great and don’t have something special or unrivaled, so why own them? 40% of the companies in the NASDAQ aren’t profitable. They need to be profitable or potentially profitable relatively quickly. If they don’t have something durable or something outstanding, it’s better just to pass. I’ve made many mistakes where I couldn’t pass up a good deal and ended up with a value trap or quality trap. Remember the execution risk is significant earlier in the business cycle.

Averaging down and holding losers hoping they will bounce back rather than admitting that it’s a mistake, taking your losses and moving on. I sometimes increase my losses by adding more to a loser. And perhaps I get my average cost per share down, but I increase my total losses. When you’ve made a mistake, acknowledge it, accept it and move on. Just because you hang on and add to a loser won’t make it a winner. I have often added to some of my weakest investments just because they have gone down more, and they appear more attractive. You don’t have to make up your losers with your losers.

Good luck and bad luck don’t last long term. But when there is consistently bad momentum and bad luck maybe it will be a bad investment. Sometimes this becomes a trend.

Focusing too much on offense (potential returns) and not enough on defense (potential risk). Many great investors start off with not trying to lose money before they even try to make money. Making up losses is often much harder than avoiding them to start with. Sometimes I pay too much attention to what my past process was or what my average cost was.

Speculative growth is not durable growth. Durable growth companies are proven. Young companies could be easily disrupted. Earlier in the business cycle, the harder it is to determine profitability. Sometimes the disrupter today can be disrupted tomorrow. It’s important that businesses are profitable. Some businesses have outstanding growth because they overspend on marketing or had short term advantages that helped them grow but are not durable. Knowing the difference between durable and speculative growth is very important. In speculative growth there are too many challenges, too many execution risks and too many things that must go right to make it work. It’s much easier buying companies that are already proven leaders at very attractive valuations. Great businesses often have high retention, good margins, good growth, are profitable and have high returns on capital.

Concentrate on what you understand. Another weakness is my fear of missing out on a great opportunity instead of focusing on what I already know and understand. Knowing as much as you can about a company is important. Don’t underestimate how important details are, but also don’t overanalyze and never end up making a decision.

Many investors spend less time worrying on what they missed and concentrate on what they know well. They also acknowledge that you will miss an awful lot, but just a handful of great winners can make you hugely successful. I also found that often, I thought I was being patient, but I was actually being stubborn. I did not want to admit a mistake or loss. There is a very big difference between being patient and being stubborn.

If too challenging, put it aside. There are some businesses that are easy to predict with steady results year after year. There are also businesses that are on a good trajectory today but are very difficult to predict. Putting the difficult-to-predict companies to the side is the first step in risk management.

Allocation is very important. How many investors are comfortable putting seventy percent into five to seven stocks? It’s risky unless those are all low-risk stocks. You will often see some of the greatest investors over-allocate to their best proven ideas—those most certain not to lose money. They concentrate on what will go right and think defensively. Concentration is an offensive strategy whereas diversification is a defensive strategy. Investing heavily into one’s with the highest “potential” returns ignores risk. Low-risk/high-reward works with concentration.

Profitability matters. Great businesses make a lot of money and will continue to make a lot of money in the distant future. It’s that simple. Betting on an unprofitable company that is hopeful it’ll make a lot of money in the distant future is called speculating, not investing.

As I continue to invest, the more experiences I will have, leading to more opportunities to identify lessons learned. Through sharing, it’s a good way to reflect, improve and grow.

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