“Seriously. It is like dating. Do you really want to go after the most attractive person at school? The probability of success is low and even if you do succeed you will be spending a lot of your time looking over your shoulder. The smarter call is probably to look for someone more amazing but less obvious – who sidesteps the limelight and doesn’t know how desirable they really are.” – Dave O. or another person I used to work with.
We were watching a panel discussion at this conference in New York, and I recall telling myself, “I am not super bored. I am learning. I am engaged.”. Then I realized that finance can be pretty boring when it is really dubitable. This respectable conference panel was organized to highlight diverse perspectives, and they did end up saying pretty much all different things. The problem was that they could not all be right so they all sounded wrong. Boring. Nobody risked getting to far into the weeds, except this one portfolio manager.
She actually said very little and looked uncomfortable amid the talkers – almost questioning herself internally – like, “what am I doing here?”. I recognized her right away from past Barrons annual round table articles. She spoke succinctly about how her firm focuses purely on the tangent between growth and value – normally at a point of transition from value to growth. Often where the current business fundamentals support the valuation in their own right, but true growth potential is likely quite underestimated by the market. She reflected, “our positions are generally trending up but not getting any headlines”.
She walked the audience through an example of a recent investment. It was an established energy services company beaten down by the oil price correction, although the balance sheet was spotless. The company provided directional drilling services to North American drilling contractors and had a robust, long time client base. The twist was that had quietly been developing a rig monitoring and operating software system to compete with the 70% market share leader – who had become somewhat lazy and entitled. This incumbent had enjoyed >20% net profit margins for over a decade. Anyway, the new investment was dirt cheap on a cash flow and book value basis already and all the R&D to get the product marketable was spent. Now they are just waiting to see the software scale, and early signs were really good.
Legendary portfolio manager Peter Lynch advocated “watering your flowers and pulling your weeds” – suggesting investors all too often do the opposite. We commonly ‘protect’ gains to settle mental accounts and avoid admitting defeat by realizing losses.
Respect greatness. Let your winners run and limit your losses.
The rub with the gardening/ investing analogy is you need to visit a special kind of garden center when you go flower shopping. This flower shop not only prices different varieties distinctly, but it also prices the individual flowers within a variety differently based on their quality appearance. The shop is also bit lazy and lets weeds grow amongst the flowers. Furthermore, it offers the best deals for seedlings – well before they have matured and when weeds and flowers look pretty similar. The best investors: i) are really good at sussing out flowers from weeds; ii) are not distracted knowing that there will be some inexpensive weeds that will nevertheless grow into fragrant herbs; and iii) spend most of their time looking through the more expensive flower varieties.
Technically Speaking – I also tend to focus disproportionately on top quality ETFs, funds and companies on an uptrend – just not when there is speculative bustle. Openly, though, a decent part of the ‘momentum’ versus ‘value’ weighting mix decision can be emotional and swayed by ‘who you answer to’ (i.e. are investing for yourself or others?). If you only answer to yourself you may be able to better endure the heightened volatility of out of favor positions and perhaps end up with a preferable absolute return profile – particularly when investing in actively managed funds. Umpteen research publications (that I will eventually dig up and reference here) have illustrated mutual fund investors are recurrently better off (on an absolute return basis) picking from the list of worst performers than they are from last year’s stars. However, if you are held accountable to others, top performing companies are often the more defensible, lower volatility investments. The winning horses also tend to provide more predictable return profiles when the growth potential is transparent and seemingly unfulfilled. A good place to start understanding the sustainability of a positive trend is often the value of the asset relative to the size of the potential market(s). As we discussed, future prospects can also be qualified by things like the existence of new growth markets, new product & service offerings, and / or acquisition targets.
Of course, this “bet on the winning team” strategy has its own emotion challenges as, by definition, it requires the investor to have missed the first phase of returns. A winning horse only becomes a winning horse by outpacing the other horses. When dealing with any anxiety towards investing in a up-trending position I sometimes ask myself, “would I sell this if I already owned it?”.
Making It Happen 