Random Thoughts on Investing

Ever since I got started in Sep 2011, I have been in the market for close to 2 years. I have had many thoughts about investment but have yet to pen them down. This will be random thoughts about investing and the lessons that I have learnt. I can't find a way to categorise them, so there's no structure and it's pretty messy.

Value investment is not about buying something at ridiculously low PE/PB nor buying a company with a sustainable competitive advantage. Neither is it about buying low nor selling high. Who purchases an equity share without believing that he is buying low and selling high? Or rather who buys the share of a company believing that he is buying high and will be selling low? No one, but belief and action often diverge in the market.

Whether it is buying Graham's net-net or buying Buffett's strong moat company, these are merely manifestation of the underlying value investment philosophy. It is easy to be confused that anyone buying the same "value investment kind" of company as Buffett, Seth Klarman and e.t.c. are value investors. One might even buy the exact same companies at the exact same price as the renown value investors are, but that will not make you as successful as they are.

The 2 key principles that define a value investor lies in Mr Market and margin of safety. They are mentioned in the famous chapter 8 and 20 of The Intelligent Investor. Mr Market is the fluctuation in prices of securities and mood of the market. One can profit from the maniac of Mr Market if he is able to control his emotion and avoid being a slave to Mr Market. Understanding the existence of Mr Market entails that price fluctuation and volatility is part and parcel of the market. Price can move in either direction and intensity regardless if you have made the right decision. However, by making the right decision, you know you will come up right in the long run.

Margin of safety is about protecting your downside and reducing the risk. This is often quoted as buying something worth $1 for $0.50. There're many reasons for it:
1) We might make an error in our judgement of its fair value
2) We do not have perfect information to make a good judgement
3) There's no way we can predict the future with 100% accuracy
4) It might be fake/fraud
5) Black Swan ( Anything that you can't think of - that's why it's called black swan)

Margin of safety is demanded in areas other than the price. Diversification is needed because you do not want to let a single mistake or black swan wipe you off the game. However, the problem is that people often diversify for the sake of diversifying, which increases their risk instead of reducing it. Diversification should be done only if one can find a company that can offer similar or even better risk return profile than the portfolio.

Investing is a game of probability or even a gamble. Before the outcome is out, there's no way to know if we will win or lose. In a casino game, the edge is always with the house and statistically we will lose money in the long run. However, the game in the market differs from the casino as the autonomy is with us. We get to decide the probability of the game by choosing which hand we are interested to play. If we consistently choose to play a game where the risk reward ratio is not attractive, we are likely to lose money in the long run. If we choose to play a game only when the odd is highly tilt to our favours, we are likely to profit in the long run.

Over a long period of time, the law of large number will ensure that your investment return will track the kind of odds that you play with. However, in the short run, it is easy to assume that early success equates ability to spot games with asymmetrical risk return profile where others are not capable of. Success in investing does not come from out-performance in the market, though that is the easiest method of evaluation. Instead, an investor should focus on the analysis and decision that he has made.

As it is a game of probability, excellent analysis and decision made does not equate to a rise in share price. Even if the share under-performs, an investor should not blame himself if he knows that he has made the right analysis and decision at that point in time. Instead, he should continue making the same kind of decision if he knows that he did not make any mistake. Do not let a good decision gone wrong becomes a baggage for you in the future. In a game of probability, we can never be right 100% of the time even if we made the right decision 100% of the time. Similarly, if you have profited in a situation where you made an erroneous analysis or decision, be glad that it didn't cost you a penny but remind yourself that you should not repeat the same mistake.

While a fan of Buffett might not be interested in cigar butt or a fan of Graham will not be interested in investing in an excellent business at fair value, they are not contradictory in nature. One is buying at a discount to future value while another is buying at a discount to present value. Benjamin Graham knew that he cannot predict the future with much accuracy and feel that it is much safer to look at the current state of the company than future profitability. Warren Buffett's experience with Berkshire Hathaway as a textile business taught him that finding great companies that are able to consistently deliver return above the cost of capital is likely to present a more attractive option. Both are great and they play the game according to their personality, style and area of competency. It is not the style that matter but the underlying philosophy and principles that drive their decision.

Investing is never easy but there will always be people that try to convince you that by obeying a set of rules and formulas you can easily outperform the market and compound your wealth. Because the famous investor has been using it, copying them will allow you to reach the level of wealth and competence they have. Before you can get your hand onto it, you will have to pay a significant fee to attend the course or even buy some robots.

Investing is not easy as it is often a zero-sum game. A trade constitutes a buyer and a seller who have similar motive in making profit but whose action contradicts one another. Either the buyer or the seller is right, it is rare to have both correct. How do you know that you are on the correct side of the trade? You can try to increase the chance that you are right by asking yourselves what insights do you have about this company that others do not? It is not about possessing insider information, but forming your own independent opinion and analysis about the company. If everybody thinks that Myanmar is going to experience fast growth, obviously this will have been factored into the price of the stock and there will be not be significant upside potential other than speculation.

Investing is when you buy an asset at a discount to its fair value and expect that the fair value can be realised or the fair value can grow. On the other hand, speculation is when you buy an asset in the expectation that a greater fool is going to buy it from you one day. It is often hard to distinguish investing from speculation merely by looking at the stock purchased or the price paid. Famous phrase like "This Time is Different" is often used to justify the act of speculation. Perhaps, only the investor/speculator will know whether he is investing or speculating, that's if he has been able to control his emotion and think rationally.