My findings show that the key to successfully executing great ideas and making lots of money comes down to the actions you take after you have invested in an idea and find yourself losing or winning.
[Part 1 - Iâm losing, what should I do] CHAPTER 1
In this part of the book we meet some of the worldâs greatest investors in losing situations.
These are situations we can all relate to - the investors have lost a lot of money and there is massive uncertainty and negativity surrounding their investments. They are faced with the need to make a crucial decision: to cut their positions or stick with them.
And if they stay invested in a stock, should they invest more money?
Through the Rabbits I will show you the ptifalls you should try to avoid. Through the Assasins and Hunters I will demonstrate exactly what to do if you want a hope of salvaging or indeed turning a loser into a winner.
[Part 1 - The Rabbits - caught in the capital impairment]
The Rabbits ended up being the least successful investors working for me, but you could never say they werenât prestigious. Many of them were celebrated figures in the City and on Wall St. One occupied the top floor of a small skyscraper and had meeting rooms with breath-taking views over the City of London through floor-to-ceiling glass windows; a couple of large security guards greeted you before you even got to the marble-floored reception.
Others had decades of experience and name-recognition- some were real âhousewivesâ favoritesâ. They were always likaeable and whenever I met them positively oozed success. However, like any investment legend, gaining access to them was easier said than done. For me, you could say it took $50 million. That was roughly the sum of each of them ended up managing on behalf of my firm.
As this chapter unfolds you will see why, in the end, I wish I had never met any of them.
(Jumping In)
(Case study: Vyke Communications)
Vyke Communications was a UK- based company that specialised in software that allowed users to make telephone calls and send text messages over the internet using their mobile phones, computers or normal landlines.
Very big things were expected for this company when one investor started looking at it, not least because it basically meant tha tusers could more or less make international phone calls for free. This seemed like a huge deal. Perhaps Vyke was the next Skype. It could revolutionise global communications.
The Investor bought shares in Vyke on 31 Oct 2007 at £ 2.10. As it happened. this would be more or less its peak price.
When the stock started to fall shortly after his initial purchasse he bought more. So far, so good - this is, after all, what you should do if you are sticking with a stock for the right reasons.
Then it kept falling. The investor chose to stay invested -Â but he refused to put more money to work
Roll on 2 and a half years to 2 July 2010. At that point the investor decided to sell his entire position - with the stock down 99% and trading at £ 0.02.
Assuming an annual average return for the stock market of 8% per annum, it would have taken this investor 60 years to make all my money back. he needed to produce a return of 9,900% to break even
(Case study: Vostok Nafta)
Vostok Nafta is an investment company listed on the Swedish stock exchange that invests in assets in the Commonwealth of Independent States(CIS), a loose association of some of the countries that used to make the the USSR. Its goal is to coordinate trade and security.
As you might imagine, many of Vostok Naftaâs investments have been in oil, gas and mining companies - both private and public. In the past this had led many European investors to purchase its shares as a mean of expressing a positive view on commodities; it gave them a leveraged play on that theme.
But more recently Vostok has diversified into consumer-focused companies and has significant investments in Russiaâs first and only credit card lending company (Tinkoff Credit Systems) as well as an online classified ads company (Avito)
The current Vostok really looks nothing like the old Vostok. It shows just how much things have changed in Russia and its neighbouring countries in the past 20 years. It certainly no longer represents a pure leveraged play on commodities.
On 11 April 2008 an investor bought shares in Vostok Nafta at âŹ9.14.
5 months of unexpected underperformance later and he was persuaded to finally sell at âŹ3.95 - realising a loss of 57%.
It is impoirtant to note that the only reason the shares were sold was because I was putting pressure on the investor to either buy more or to sell. The investor did not want to do anything but could not justify why. If I had not intervened, I am pretty sure he would still be holding the stock today.
Assuming the stock reversed course and enjoyed the annual average return for the stock market of 8% per annum, it would take 11 years just to break even,
Phrased differently, having lost 57% of the original capital invested, the reinvested capital would need to produce a return of 133% just to get back to the starting level of capital invested.
(Case Study: Raymarine)
Raymarine is a company that specialises in marine electronics helping yacht-owners kit out their yacht with radars, satellite TVs, fish finders, GPS gadgets and various other communication devices and bits of equipment.
An investor bought shares in the firm on 31 May 2007 at £4.27 per share.
Roll on 23 months and the stock price had collapsed. The investor was still invested. He was still talking about what a great company it was - though he hadnât yet bought more shares.
One of the reasons the investor put forward for doing nothing was that he was unable to buy more. The stock was too illiquid. Of course, that meant the chilling reverse might also prove true: it might be too illiquid to get out.
In investment circles, this is a schoolboy error. You should never get into something that you cannot get out of in public markets.
The investor also felt that enough money had already been invested.
After pressuring him to do something, he eventually agreed - and managed to sell his entire position on 15 April 2009 at £0.17 per share.
That was a loss of 96% on his original investment. Considering an annual average return for the stock market of 8% per annum, it would take 43 years to break even. He would need to produce a return of 2,463% to get back his original investment.Â
(What the Rabbits did Wrong)
The Rabbits often dug tunnels that were so deep, they never saw the light of day again. Why did they make this mistake so many times?
Iâve used a slightly jokey name for this investing tribe, but the fact is their flaws were very human. I went over all their investments, and it broke down into 10 key factors -Â a range of biases and influences to which every investor is more or less prone, but which the Rabbits failed to control or circumvent through better habits.
By giving in to these factors, they too often ended up caught in the headlights - the results of which were never pretty.
1) Unfashionable insects
- one of the most important influences on the Rabbits is what I call NaFF-Bee - or narrative fallacy framing bias.
- It is a condition that was alluded to in 1974 by two brilliant Israeli academics, Amos Tversky and his Nobel-Prize-winning collaborator Daniel Kahneman.
- Tversky and Kahneman suggested that peopleâs decision makings is influenced by a cognitive condition they referred to as a framing bias or anchoring heuristic. In other words, when people make decisions they tend to reach a conclusion based on the way a problem has been presented.
- One of the Rabbitsâ mistakes was allowing their favourite type of investment to dominate how they looked at a stock. The Rabbit that invested in Vyke loved âblue-skyâ stocks, and because he was looking for shares that might be the big next thing, thatâs what he saw when a stock gave him half the chance.
- Naff-Bee also goes one step further than this and suggests that we can make up stories to positively explain losing situations
- Whenever the Rabbits found themselves in a losing position, NaFF-Bee tended to kick in and made them think: âOkay, I have lost money - but my thesis , the story as to why I have invested, is not broken. The share price will turn around and I will still make a lot of money from hereâ.
- They were capable of constantly adjusting their mental story and time frame so that the stock always looked attractive.
- The Rabbits are a great example of how prefessional investors often react to a black-swan event - an event they did not anticipate and which has negatively impacted their investment story. They tend to dismiss it. There were problems at Vyke - serious ones, as it turned out. By 2011, the firm was delisted. Soon after, it went bust. The investor was lucky to get out at all.
2) Iâm in Love
- Primacy error was another issue. This describes the way that first impressions have a lasting and disproportional effect on a person.
- A classic example of primacy error in real life is love at first sight. It is also demonstrated by newly hatched ducklings. The first living thing they see immediately after hatching they take to be their mother. Thus, if the first thing they see after hatching is you, you will soon have a line of loyal ducklings following you whenever you go.
- With the Rabbits, first impressions were often everything.
- The investor who bought into Vostok had taken a view of the firm some time ago and simply failed to update it to match reality. The net result was that they under-reacted when they found themselves losing money.
- Iâm afraid that misanthropic investors cannot rejoice as this point (if that idea is not a contradiction in terms): it is perfectly possible for the opposite of love to be an issue.
- Stuart Sutherland in his book Irrationality talks about the halo effect and the devil effect. If the first time we are introduced to an investing idea we look at a price chart and see that it has consistently declined for the past 10 years, we are likely to classify it as a âbaddyâ (a âdogâ as the investment pros woulc call it). Thereafter this taints our view even when the underlying facts might have changed profoundly for the better. So there can be perfectly good companies shunned for no good reason. Committed value investors will not find this too surprising.
3) Anchor Away
- A closely related cognitive bias to primacy error is anchoring - or dropping our intellectual anchor and letting it sink deep into a view and being unwilling to accept new findings that suggest we are wrong and should haul it up and sail the hell out of there.
- If a Rabbit did eventually change his mind, it was always an achingly slow process
- It took one Rabbit 2 and a 1/2 years to change his mind on Vyke, and another Rabbit almost 2 years to react to Raymarineâs decline. The other never changed his mind on Vostok. Similar stubbornness occurred on many other investments.
- Interestingly, in the investment world, anchoring explains why an earnings surprise typically follows prior surprises. Analysts tend to slowly adjust earnings numbers for a company in their models. No one likes to acknowledge they are wrong, especially if the change requires a complete about-turn.
- As such, change tends to be a slow process of gradual adjustment. âSurpriseâ after âsurpriseâ.
4) Too soon?
- Imagine a scenario where you buy a bar of gold for  £1,000. The next day I offer you  £500 for that bar. Would you sell it to me? I think most people wouldnât.
- Would your response change if I opened the newspaper and show you that the price of gold had crashed overnight and to sell your bad on the open market would only get you  £250?
- You probably still wouldnât, and the same would be true of most people. You are anchoring to the  £1,000 you paid yesterday. Moreover, you have a vested interest (you own the gold bar), so you believe the bar to be worth more than the price being offered. This is known as endowment bias.
- If i asked you to name your price for that bar of gold, what would it be? I suspect it would be at least  £1,000 given that is your anchor value - the price you paid.
- My own experience of managing a team of investors is that large losses that happen over a short duration are almost impossible to accept, especially when they are substantial.
- Itâs easier to hold on to a losing position than realise the loss by selling up. Not least because people believe it to be Sodâs Law that the price will bounce back post-sale. The Rabbits could not bear the idea of crystallising a loss. They were too aware of how much they had paid for those losing shares.
- I want you to now imagine that you have held the hold bar for 10 years. Chances are  you cannot remember the price you paid for it all those years ago, and I suspect you would be more likely to sell it to me for  £500. It would be an easy decision because you would be far less conscious of the anchor value. In addition, I am offering you twice as much as you would receive on the open markets so this would appear to be a good deal.
5) The Pull of the Crowd
- I might be singling the Rabbits out for the money they lost me over the years, but the fact is they were rarely unique in the investments they made. Sadly, that was just another reason why they tended to persist with their mistakes.
- Neuroscientists have shown that when we donât confirm, the amygdala - the part of brain associated with fear - lights up. Doing against the crowd makes an investor nervous. Few investors are willing to be a lone voice for fear of others ridiculing them.
- and many investors got burnt on the same investments as the Rabbits
- Sadly, this same trait of conforming to peer pressure is why most investors only invest at the end of a bull run. No one wants to be seen as the fool who stood by the side while his neighbours and friends were making vast fortunes.
- As a fund manager I can testify that the inner mental pressure to invest in stock that you do not hold and that are going up is immense.
- Furthermore, you have to constantly fight the urge to sell stocks that are hurting you. Feelings of pressure, pain and fear go a long way to explaining investor actions and omissions.
6) Ego
- The Rabbits really didnât like being wrong - they were, in fact, ultimately more interested in being right than making money. Many professional investors I know are, deep down, the same.
- Whenever a Rabbit defended a losing investment it reminded me of Warren Buffetâs famous saying: âforecasts tell you little about the future but a lot about the forecasterâ
- The Rabbits all carried false passports - they actually originated from the fictitious country that Nassim Taleb calls Extremistan. They were never going to accept their views were wrong.
- The fact is, the greatest minds on the planet can be wrong. My findings suggest you should expect to be wrong at least half of the time. The very best investment minds are!
7) Itâs not my fault
- Behavioral  psychologists have a term for when we blame others or external factors for our misfortunes but take full credit when things go well. They call it self-attribution bias. It is one of the key reasons we donât learn from past mistakes but keep repeating them.
- It never ceased to amaze me how many times the same two villains popped up in the stories told by Rabbits harbouring a losing position: Mr Market (âthe market is being stupidâ) and his sidekick Mr Unluckly (âit wasnât my fault, I was unlucky because of XYZ that no one could have foreseenâ)
- The Rabbits were not only good at blaming these two foes. With Raymarine, one of them was even able to blame the illiquidity - a real but entirely optional villain no serious investor should ever encounter - for his inaction.
8) The Wrong Information
- Related to the problems of ego and self-attribution bias, whenever a Rabbit was losing you could always guarantee that he or she would go on a mission to seek out more information to help make the right decision
- Unfortunately, undertaking additional research is not as good an idea as it may first appear. For example, if the additional research is carried out by the very same analyst who recommended the stock - as it often is in the City and on Wall St - naturally his or her focus will be on finding reasons to support the original recommendation. No one wants to admit they were wrong.
- Moreover, the analyst will probably be someone the fund manager likes and respects, which means the manager will not be inclined to challenge his/her view.
- When you consider all the variables and assumptions that analysts have to deal with before they reach a conclusion, it is mind blowing that they could have any degree of confidence at all.
- Because many of the Rabbits had been professionally investing for a couple of decades, controlling a significant amount of assets, they had Rolodexes to die for. When they found the âstoryâ behind an investment being challenged, they liked nothing better than picking up the phone and dialling the CEO on his/her personal number to get to the bottom of things. Despite being reassured by the CEO that the setback was merely a bump in the road and the media was making a mountain out of a mole hill, the Rabbit would do nothing. They either bought more shares not sold their holdings.
- A hugely appealing temptation for more information comes from the need to abrogate responsibility in times of crisis. It is very common when a difficult decision has to be made to see the decision-maker involving more people. The more people involved, the more they can relax because if it goes wrong it was not their fault.Â
- In companies, the unwillingness of board members to make big decisions that may have far-reaching consequences is the reason financial consultants exist. Boards tend to heavily rely on external advisers when making such decisions.
- Various studies focused on betting have shown that while more information increases a personâs confidence, it does not increase their accuracy (success ratio).
9) Too big to fail
- Like many managers, the Rabbits were less inclined to walk away from a large losing investment than a small losing investment.
- The denomination effect described by Himanshu Mishra, Arul Mishra and Dhananjay Nayakunkuppam and Priya Raghubir and Joydeep Srivastava helps explain this phenomenon.
- Their research showed we find it easier to spend money if we have small denomination coins than when we have larger bank notes. The bigger the losing positions, the more nervous and indecisive most of us become.
- This can be more of a problem if you have a smaller portfolio. The investors I worked with readily admitted that in their funds, some of which held up to 100 stocks, it was far easier to sell a losing position because it represented only 1% of the overall fundâs net asset value. Thus, if the stock was down 40%, it had only cost them 0.4%. Whereas with the money they managed for me, that stock was perhaps one of only ten positions, each position being on average 10%. As a consequence, to sell meant realising a 4% loss on the total assets managed.Â
10) I am due a win
- Investors like the Rabbits typically suffer from a dose of gamblerâs fallacy. This is the mistaken belief that the odds for a stock have become more attractive due to recent poor performance.
- Itâs the belief that you will win after a streak of losses playing roulette at the casino -Â âI am due to win.â
- Even when the odds are 50/50, like the toss of a coin, a deluded gambler believes the odds change in his favour the longer he stays in the game while on a losing streak.
- The fact is, the porbability of a fair coin turning up heads is always 50%. Each coin flip is an independent event and all previous flips have no effect on future coin tosses.
(What the Rabbits could have done differently)
The bad news is, everyone can be a Rabbit. The good news is, no one needs to be. There are a few simple things they could have done to overcome their problems
1) Always have a plan
- Investing is all about probabilities. Whether you invest should depend on the odds and your edge you think you have.
- Given the odds and your edge you should know exactly what you are going to do if the stock you are investing in falls or rises by 20%, 50%, and so on.
- When faced with a painful loss-making position, most people do nothing. They turn into a Rabbit and procrastinate, letting all their biases play havoc with their decision-making, hoping time will resolve their issues so they donât have to.
- The best way round this is to draw up a plan of precisely what actions you will take when your investments donât work. The Rabbits didnât have one. You can.
- The necessary actions in a plan are really quite simple. As the next point explains, it all comes down to two choices.
2) Sell or Buy more|
- When you hold a stock that is losing, you feel terrible. You beat yourself up and wish you could turn back the clock. You find yourself unable to sleep.
- Some people turn to religion and pray for divine intervention -Â âDear God, if you make the share price go back to the price I paid so that I can get out and not lose money I will be a good investor in the future. I am not asking to make money or be greedy.â
- I admit I have done this on more than one occasion(in the past). Sadly, it didnât help.
- The only solution to a losing situation is to sell out or significantly increase your stake
- You have to materially adapt if you hope to survive and prosper.
- If a stock price is down after your investment, the market is telling you that you were wrong. If you really do believe you were right to invest in that company, then you were clearly wrong in the timing. The sooner you acknowledge you have made a mistake and take steps to deal with it, the better your odds of achieving a successful outcome.
- Ask yourself this key question I now ask all of my investors:
âIf I had a blank piece of paper and were looking to invest today, would I buy into that stock given what I now know?â
- If your answer to the question above is âNoâ, or âMaybe, but...â then you should sell.
- If you conclude that you would not buy the shares today but find that you cannot push the sell button, be aware that this is because of endowment bias and not a logical investment thesis. Sell.
- Legendary investor Peter Lynch adopted a similar approach:
âEvery few months I checked the story just as if I were hearing it for the first time...(and I would) get out of situations where the fundamentals are worse and the price had increased... and into situations where the fundamentals are better but the price is down... a price stop is any opportunity to load up on bargains from among your worst performers... if you canât convince yourself when Iâm down 25% Iâm a buyer then youâll never make a decent profit in stocks.â
- Doing nothing when you are losing is never an option because if the stock price rises from here you should have put more money to work. If it falls further you should have cut your position.
- The Rabbits werenât terrible investors just because they refused to accept they were wrong. The real giveaway was that they refused to do anything when they found themselves in a losing situation.
- Nowadays, I start to apply pressure on my managers when a stock is down over 20% to ensure action is taken before irreparable damage occurs.
- I have learnt that I cannot trust great investors to do the right thing when they are losing - like top athletes, they require coaching and management.
3) Donât go all in
- A corollary of the previous point is to never put yourself in a position where you find you are still convinced by your original investment idea but are not able to invest more money when the share price falls. That is poor money management. Keep some powder dry.
- This also helps neutralise the denomination type of effect - of feeling an investment is too big to be changed
âIn my own portfolios at Pabrai Funds, I adjust for this [getting the odds wrong] by simply placing bets at 10% of assets for each bet. It is suboptimal, but it takes care of the Bet 6 being superior to the Bet 2 problem. Many times the bottom three to four bets outperform the ones I felt the best about.â - Mohnish Pabrai
âAction may not always bring happiness, but there is no happiness without actionâ - Benjamin Disraeli
Â
4) Donât be hasty to jump in, do be hasty to jump out
- we should all remember the following wise words:
âIt is easier to get into something than to get out of it.â
- Ned Davis in his book Being Right or Making Money, using the Dow Jones Industrial Average from 1929 to 1998, showed that the bulk of investorsâ losses in bear markets come in the final third of the fall.
- This suggests that cutting your losers early is difficult - but makes a lot of sense. Not least because selling out of a stock helps clear your head and enables you to assess a situation more objectively. Itâs like taking a decongestion pill when suffering from a cold.
- And buying slowly over time (known as dollar or pound-cost-averaging), with a reduced position size at the outset, ensures you have plenty of ammunition left to load up when a share finally capitulates (assuming it does)
- What seperates the winners from the losers? The answer is simple - the winners make small mistakes while the losers make big mistakes.â
5) Remember there is a difference between âbeing rightâ and âmaking moneyâ
- Even if you are convinced you are right, remember the saying, â There is nothing like an idea whose time has come.â. In investing, a lot of success can be attributed to being in the right place at the right time - otherwise known as luck.
- A classic example of this is Laker Airways, which was founded in 1966 by Sir Freddie Laker. In 1977 this firm introduced the worldâs first budget airline and operated low-costs flights between London Gatwick Airport and John F. Kennedy Airport in New York.
- Due to a combination of recession, high oil prices, changes in currency and simply being ahead of its time, it went bankrupt in 1982. Contrast this with today when there are many airlines successfully operating low-cost, low-frills flights, the most well known being Ryanair and easyJet in Europe.Â
6) Seek out opposition
- When people lose money they donât want to be told they are wrong. They want reassurance - the same way people sometimes visit a doctor to be told everything is fine.
- What you should really do is to speak to someone with an opposing view.
- Ideally you should also sell out of the stock while you do that so that you have removed the emotional attachment of a vested interest. This mitigates endowment bias and you can always buy the stock back later.
- If you would not put money to work in a particular share today, knowing what you now know, then you have to concede that the investment is dead - and if you havenât already sold, you absolutely should now.
7) Be Humble
- As you can imagine, the Rabbits, like many investors, were incredibly smart. Many of them had MBAs, CFAs and other letter after their name that suggested they had an analytical advantage over the rest of the market. The Rabbits were often very confident. And they could be compelling. They never said âI donât knowâ.
- But this is a very dangerous mindset to have. First, it assumes the market is made up of buyers and sellers that are not equally expert, when in fact many will be. Second, âknowing moreâ often leads to a person not seeing the wood for the trees.
- And crowds are often surprisingly wise - the market can be right even when everyone who makes it up is individually wrong
- in 1987 Jack Treynor presented 56 of his students with a jar of jelly beans and asked them a simple question. How many jelly beans were in this jar? There were 850, but not one student got it right - hardly surprising.
- What is more important is that despite the guesses varying massively from one student to the next, the average number taken from all those wrong numbers was only 2.5% off the actual number of 850. Only one student guessed a number closer tot the actual number than the average.
- Remember this the next time you pound the table shouting âI am right and the market is wrong.â My findings show that on average, only 40% of great ideas make money. If that doesnât scare you then consider this: another study found that fund managers who were 100% confident in picking winning stocks over the next 12 months were right even less - only 12% of the time.
- You should expect your ideas to be wrong and invest with that in mind.
8) Keep quiet and carry on
- Be careful who you talk to about your investments and how you talk about them. Some people have an almost religious zeal for shares they have bought, and like nothing better than sharing their views in public to as many people as possible.
- Unfortunately, this makes it impossible to walk away from an idea without looking like an idiot. Itâs an unnecessary hindrance. The Rabbits might have been less likely to get stuck had they not boasted of anticipated returns.
9) Donât underestimate the downside - adapt to it
- Many of the Rabbits who worked for me loved stocks that could shoot for the moon. They were stocks that had massive potential upside if the story played out. It was no wonder they were keen to jump in.
- Unfortunately, unlike financial options, which have a limited loss (the premium paid), these stocks do have a downside - and it can be large. The prospect of huge profits tends to make the possibility of losses dwindle, but that possibility is always very much alive.
- The solution is simple: treat them as if they are options. Invest an amount you are willing to lose in the same way that you would pay a one-off lump sump (called a premium) to purchase a stock option. This represents the maximum amount of money you can lose if the option contract closes out of the money.
- If the stock does go âbangâ as opposed to âpopâ, then the amount you have lost is not fatal.
10) Be open to different kinds of story
- Many studies have shown that stock with the worst stories tend to produce the highest returns
- Stated differently, value investing - investing in cheap stocks that no one likes because they have terrible stories that led to their stock price falling - produce the highest returns over time.Â
- While I am not advocating the avoidance of what I call âmagnet stockâ (or âglamour stocksâ), remember that there are lots of different stories out there.
11) Get sick of sick notes
- Over the years I heard many wonderful explanations as to why the Rabbits got things wrong, especially if we have to report to a boss and explain our actions.
- Instead of coming up with increasingly fanciful explanations or why an investment hasnât yet come right, I would urge you to use this tendency to your advantage and do the opposite: familiarise yourself with all the well-worn excuses in advance so that you waste no time trying to fool yourself or anyone else into persisting with a mistake.
- Here are some of the excuses I have heard ovet the years:
a) The âIf onlyâ defence.
b) The âI would have been right but forâ defence
c) The âIt just hasnât happened yetâ defence
d) The âWho could have foreseen at the time I invested that XYZ would happen..â defence
- Peter lynch in his book One up on Wall st lists the 12 silliest (and most dangerous) things people say about stock prices. Some of these are well worth including here too:
e) If itâs gone down this much already, it canât go much lower
f) you can always tell when a stock hits rock bottom
g) eventually they always come back
h) when it rebounds slightly, Iâll sell
- having this list of excuses to hand is very beneficial. Check it when you are losing. are you making any of these excuses to justify not selling?
12) Be suspicious of status
- it is dangerous to assume that just because an investment professional is highly educated and has years of experience, he/she will be good at making money and getting the big calls right
[Itâs all about Capital Impairment]
- One of the reasons that the Rabbits held on to losing investments was fear of the unknown: if they sold out, the shares might rally, and they would miss out. It was better to stick with a current loss than worry about that double-whammy.
- This is known as ambiguity aversion, and describes why people prefer to stick with intolerable situations merely because a hypothetical alternative might be worse. Better the devil you know.
- When it comes to losing investments, the facts basically never justify this, and the Rabbits should have used this to fortify themselves against inaction. Hereâs an example of a Rabbit investment showing how wrong this thinking is:
(Case study: Titan Europe)
[Titan Europe is an engineering company that designs and manufactures wheels and undercarriage components for off-road vehicles used in the agriculture, construction and mining industries.
It boasts manufacturing and distribution centres in countries as far afield as the USA, Brazil, China and Japan. Its shares went up a staggering 307% after one of my investors sold them on 5 December 2008. This fact alone would be enough to make any investor feel angry, but that is not the point.Â
In this case, the investor had lost 95% during the previous two years when he held them and the fact is, even if he had chosen to stay invested, he would still have made a loss on the overall investment of 82%.
The only chance to redeem the situation would have been to sell all his other investments and put all the money into the stock when it was down 95%, thus lowering his book price enough to allow him to get his losses back. The problem with that as a strategy is that it is the equivalent of going to the casino and betting everything on black. It either works or it does not. The outcome is binary.]
- To make money you need to have money. In other words, to maximise profits you have to minimise losses. You must preserve your capital. When you are losing you have to materially adapt and mitigate the situation, as you will see when we come to the Assassins and the Hunters. Permanent impairment of capital destroys wealth.Â
- When you have lost this much money it takes extraordinarily large returns to make up the lost capital, let alone turn a profit and make money. Here is one final notable example of this in a Rabbit investment:
(Case study: Cape)
[I have saved the best cast study to last. Make sure you are sitting down and donât have a hot drink in your hand before reading on.
One of my investors bought shares in Cape on 28 Sep 2007 for £2.79 per share. Cape is considered a global leader in the provision of essential services for the energy and natural resources sectors, ranging from industrial cleaning to painting and coating. It has operations throughout Europe, Africa and Asia.
Unfortunately, for this investor, a black swan hit in 2008 in the form of the global financial crisis. This led to cyclical companies with debt on their balance sheets being sold off. Cape, being a company with a small market capitalisation, suffered as investors headed for the doors, and lack of liquidity compounded the problem.
He eventually sold on 10 march 2009 with the share price standing at just £0.18 per share, representing a loss of 94%.
That loss is not the most startling aspect to this story. Nor is the fact that, once it was clear the world would survive the crisis, Capeâs share price rebounded and went up an eye watering 1,129%.
The most shocking aspect of this story is that even if he had stayed invested and enjoyed the rebound in the share price, he would still have lost 32%!]
- Unfortunately, large stock market returns are rare, even if you can hold your nerve and not sell out of one too soon. If you stick with a big loser and do nothing you are virtually guaranteed to be permanently destroying your wealth by creating a hole that is simply too deep to dig your way out of.
- I believe that even the best investors often overlook the fact that a stockâs price would need a practically supernatural rise of 900% to break even if they have foolishly ridden it down 90% and done nothing. Losing 50% means you need a return of 100% to break even.
- Clearly, most of my team knew the danger of suffering big losses and took action before irreparable damage was caused. This is shown by how few large losses we experienced. Overall, we avoided permanently impairing our capital. The remaining chapters show how.
(The lessons of Poker)
- Stories are the biggest factor in determining what decisions we make. For the Rabbits, the stories in their heads led them to invest many millions in companies that ultimately lost them and me vast amounts of money. Their actions post-investment were clouded by the story that led them to invest on day one.
- The moral here is to try to avoid being blinded by your story. Above all, have a plan of action as to what you will do if you find yourself in a losing position, even if you still think you are right.
- The key difference between the Rabbits and successful investors in this book is that when the Rabbits were losing they did nothing. As we will see with the Assassins and Hunters, they acted decisively to bail themselves out of the holes the found themselves in.
âIt is not the strongest of the species that survive, nor the most intelligent, but the one most responsive to changeâ - Charles Darwin
- If only the Rabbits had played poker. Any poker players knows that it is not how many hands you win that matters, itâs how much you win when you win, and how much you lose when you lose.
- Each hand in poker represents a story and the goal for a poker player is to try to make money with whatever story they have been given - good or bad. If the story is poor then you donât stick with it and throw money at the problem; the odds are stacked against you. You fold your hand, cut your losses and live to fight another day.
- Likewise, if you are dealt a good hand but then see the flop and realise the hand is now nowhere near as strong as you though, you fold.
(END OF CHAP 1)
