I often torture myself by looking at my past mistakes, every now and then. It may not be fun, but it is a very useful exercise
The idea of doing these exercises is not to beat myself up , but to identify patterns of incorrect thinking, and avoid repeating them in the future.
So why analyze mistakes
The human mind has a tendency to ascribe failure to bad luck and success to one’s own brilliance. In addition to this bias, there is also the problem of social disapproval. In school, did you ever get a pat on your back when you came back home with a bad report card?
In spite of all the disadvantages, I think there is substantial value in analyzing and learning from your own and other’s mistakes. The first and more difficult step is to acknowledge to yourself, that you goofed up. A more fool hardy step, is to do it publicly like me and make a fool out of yourself J
A recent example
Let’s look at a recent example. I had posted about facor alloys recently. I wrote about it here, here and here.
The key points of the thesis were
- The company had turned around its fundamentals and was now operating profitability. The balance sheet was sound with plenty of excess cash
- The company would continue to do reasonably well if the industry economics did not collapse (i.e steel demand did not collapse)
- Finally and one of the key reasons driving my purchase, was that the company appeared to very cheap.
As I said in the earlier posts, this was a small position with the intention of exploring the small/midcap space in the commodity sector. I was not able to convince myself to carry a big position (call it gut feel or whatever)
The transaction history
I wrote about the company around March 2010 and started buying around that time. I built a small position over the next few months at an average price of around 6.6 Rs per share. I sold around 30% of the position, when the price rose to around 8 / share and booked some profit (I usually never do that – which shows my conviction levels).
I read the annual report of facor alloys later in the year and posted the following
I was also disappointed after I read the annual report of facor alloys. The company has passed several special resolutions to invest to the tune of 300+ crs in other sister firms, which are expanding into power and other businesses. I get fairly mad with this kind of diversifications. Needless to say, I plan to exit the stock in time irrespective of what happens to the business or the stock.
As you can see, the above was posted in Nov 2010, but I finally exited the position in June 2011. Why did I wait? Good question! The answer is that I was slow to accept my own conclusions and was ‘hoping’ the position would work out. In the end, hope is a dangerous strategy in the stock market
I lost around 12% on the position after including dividend. So what I learn from this expensive tuition?
- Hope is a very bad strategy. If your original thesis turns out to incorrect, then exit the position. In this case, it turned out that the cash was never to going to come back to the investor. The management has their own plans, with which i am not comfortable. In such a situation, one cannot have the conviction to hold on to the stock.
- Accepting mistakes is painful. At the same time, the earlier one does it, the better it is for the overall portfolio (there are opportunity costs involved)
- The market rewards companies which are able to re-invest capital in their own business at high rates of return. If the company cannot do that, then the expectation is that the cash would be returned to the shareholders via dividend or buyback. If the management decides to diversify without appropriate transparency, the market is likely to take a dim view of it (read poor valuations)
- Small and midcap commodity stocks are possibly good trading stocks. You buy at specific time of the commodity cycle and exit before just before the cycle turns. It is not a coincidence that companies like facor alloys are the most touted stocks on the various tip services. These kinds of stocks are a bad idea for me as I cannot play this game at all.
Why do this to yourself?
You may ask – why invest in such stocks in the first place. I personally think, it is not possible to become a good investor without committing a few mistakes along the way. The more important thing is to keep the mistakes small, acknowledge them quickly, close them out and finally learn from them. Easy to say, difficult to do
A side project
I am doing an analysis of stocks which have dropped by more than 50% in the last 5 yrs. The reason for this analysis is to understand the cause of failure and hopefully use the learnings to make better decisions. If you are aware of any such stocks, please leave it in the comments. I would greatly appreciate it.
By the way, in case you are wondering, I don’t always lose money on my stocks picks J. Quite a few do well too, but then what is the fun in boasting when every other guy is anyway doing that.
A happy diwali to all the readers. Hope all of you have a prosperous new year.