The confessional: My worst calls ever
One of the hardest things about analysing one’s mistakes, at least in my case, is knowing where to start. For once in my life, I’m spoilt for choice.
Please forgive my self-deprecating tone; we all know that mistakes in investing are unavoidable, necessary even. In the long run, it’s not the money you lose but what you take from the experience that matters.
Over the next thousand words or so I’m going to trawl through the entrails of my investing history at Intelligent Investor and show you what I’ve learned. If I do my job well, you can learn from my experience for a lot less than paying for your own. As a value investor, I’m sure you’ll appreciate the proposition.
Key Points
- My greatest error is not in the stocks I bought but the ones I didn’t
- Performance has been good despite the catastrophes
- The greatest mistake is not the mistake itself but the failure to learn from it
One day I’ll get to write about my biggest wins but we don’t learn much from our successes, except perhaps excessive self-confidence. Here then, laid out in Table 1 are my biggest mistakes since joining Intelligent Investor Share Advisor over seven years ago.
Company | Upgrade | Total loss (%) |
---|---|---|
Westfield Group | Long Term Buy – $21.38 | 9 |
GPT Group | Buy for Yield – $2.96 | 66 |
Envestra | Buy for Yield – $0.76 | 46 |
Billabong International | Long Term Buy – $10.62 | 16 |
Aristocrat Leisure | Long Term Buy - $6.76 | 27 |
History fails to repeat
In Profits propel property sector from 5 Sep 07 (Long Term Buy – $21.38) I stuck with Westfield Group because I thought a property downturn would enable the company to take market share from highly leveraged rivals, as had been the case in the past.
History did not repeat. The GFC meant the company simply stopped doing the things it would usually have done and property groups that should've gone broke, such as Centro Properties, were bailed out. The total loss after adjusting for the split and subsequent Sell recommendation for Westfield Retail Trust is currently 9%.
GPT Group was upgraded on a yield of 9.8% after the share price had almost been sawn in half in General’s grand plan unravels from 4 Mar 08 (Buy for Yield – $2.96). As the company had to raise billions of dollars to repair its balance sheet when its foolishly-contrived overseas funds management business collapsed, I pulled the pin and locked in a loss of 66%.
One month after upgrading GPT I upgraded Envestra in A profit in the pipeline? on 10 Apr 08 (Buy for Yield – $0.76). In December of that year I then recommended selling after suffering a loss of 46%. In its place I recommended the many hybrid securities that were trading at deep discounts to face value.
These were a better bet as they wouldn’t be diluted in a capital raising and weren’t beholden to debt refinancing. Although Envestra has three-bagged since, I still feel this was the right decision but still, initially losing half your money isn’t to be sneezed at.
In between these two calls I managed to squeeze in what eventually became a real disaster, upgrading Billabong on 10 Oct 08 (Long Term Buy – $10.62). The company’s strategy to expand into retail seemed sensible but the execution was appalling. I handed this poisoned chalice over to colleague James Greenhalgh on 15 Dec 10 (Long Term Buy – $8.10). The total loss was 16%, but ultimately the losses were far greater.
And lastly, I was too early in upgrading Aristocrat Leisure in Aristocrat spins the wheels from 13 Jun 08 (Long Term Buy – $6.76) after its share price had fallen 62% as slot jockeys around the world started betting less. The GFC exposed the company’s poor game line up and wasted research and development. Previously, it had been hidden by massive profits during the boom. The company’s share price remains 36% below that initial recommendation.
Omission sin
The average loss from these five stocks was 33%. Fortunately, the recommendations that have worked out more than made up for them. We’ll get to the lessons from these failures later but there’s one mistake worse than these five combined.
Undervaluing REA Group, owner of the realestate.com.au website, is my biggest investing mistake, one of omission rather than commission.
Since initiating coverage in REA Group onto the watchlist on 5 May 09 (Hold – $4.44), the share price has increased sevenfold if you add in dividends. An equal amount invested in REA Group and the five mistakes of commission detailed above would have left you well in front. Where did I go wrong?
First, an investor I respected was down on the company. Yes, we’d just experienced the biggest panic in over 20 years but I was biased by his view before even opening REA’s annual report. Psychologists call this authority bias and I was suffering from it. It hindered my independent thinking and prevented me from backing my own view.
Second, I thought that the number of real estate agents in Australia would fall as property prices fell, reducing REA’s potential customer base. This is still a risk but it hasn’t eventuated.
Third, I spent too much time looking at reported earnings, which were artificially low, rather than free cashflow (see Why cashflow yield beats PER). Depreciation was high due to the large, upfront expense of building the website. It wasn’t going to be an on-going drain on the company’s cashflows but I failed to appreciate that.
Fourth, I painfully underestimated the company’s pricing power reflected in the massive increase in average revenue per agent (see Chart 1). I thought having almost every agent signed up would actually limit growth. Instead, users are paying more to distinguish their properties on the realestate.com website.
Most painfully of all, I failed to re-evaluate the businesses’ value after the share price had tripled. Had I been open-minded and not anchored to lower share prices, the stock would have still produced a 150% capital gain.
These are the lessons from my biggest investing mistake. Having dragged myself through the mud, here’s what I’ve learned from my five errors of commission and one of omission:
- Anchoring drags you down – Too often I anchored on past, lower share prices when valuing a high quality or high growth business. This has been far more hazardous to my wealth than anchoring to my purchase price after a stock has fallen.
You cannot lose more than 100% of an investment but returns can be multiples of your original investment. Don’t underestimate quality and don’t worry that a share price has doubled or even tripled if your research suggests it can do so again.
- Be imaginative – You have to use your imagination to conceive of every risk possible, but also to imagine how well things might turn out if a business is successful. I underestimated REA’s quality and overestimated Westfield’s and GPT’s.
My five sins of commission were made around the time of the global financial crisis. I simply did not consider the risk that credit markets would literally freeze up and any company carrying debt, regardless of the quality of their underlying assets, would suffer. The GFC was an exceptional event but I should have incorporated the potential into my thinking given that I was well aware of the situation in the US before the stockmarket plunged.
Had I been more imaginative in this regard I may have avoided one or two of these five mistakes.
- Think big – It’s easy to get bogged down in things like ‘per share’ ratios but the bigger picture matters more. Spend time thinking about how a company’s market value could significantly increase and also how it might come undone.
CSL is a much larger business than it was 10 years ago but could be far bigger in 10 years time. Analysing a product or service’s life-cycle will help. While technology services or products might have short lives, healthcare products might have very long ones.
The underlying dynamics of an industry and a business produce the analytical ratios on which we rely. We need to understand what drives them. The numbers alone are not enough.
- Valuation is more art than science – Discounted cashflow models have a place but sometimes you need to give a business room. Buying cheap and holding on to a great business while it’s performing despite what might seem a high valuation can multiply your money many times over. If you already own such stocks, sometimes your best course of action is to do nothing.
If you find the next InvoCare, CSL or REA Group, don’t try to be too cute with your valuation. Buying a few wonderful businesses and holding on is far easier than coming up with 10 new ideas every year. And it’s likely to be a faster way to multiply your returns.
- Don’t be too hard on yourself – I’m extremely pleased that since the GFC my team’s performance has been very strong because it shows we’ve learnt from our experience and become better investors, not just in picking winners like News Corp and Macquarie Bank but in avoiding major blow ups.
We wouldn’t have been able to do this without being able to move on. Investing, of its very nature, entails getting things wrong.
But we shouldn’t let our mistakes cripple us. Learn from them of course, but move on. In this way investing is a little keyhole into life itself. The past does not determine the future; we do learn from our mistakes; and we get better at what we do.