Curiosity@Intelsense

 

Multidisciplinary learning is one of the best ways to improve our investment acumen. Here is a summary of some of the best learnings of the week.

It has been a while since I have been critical of “value investing”. I have friends who keep harping on value, value all the time and yet the main thing that they are looking at is PE. So, most “value investors” are closet cheap PE investors. Anand Sridharan has written about this extremely well in his article “Business owner, not value investor”.   The term has become an oversimplified label for formulaic buying and selling of cheap crap with little regard for the nature of the underlying business. While this isn’t illegal, it is a misnomer. This activity is better represented by replacing “value” with “cheapness” in all media references. Cheapness investing, cheapness factor, cheapness index, cheapness style-box and cheapness screens. What is called value investing is often neither value nor investing. This confusion is especially severe since the greatest proponent of the term – Warren Buffett – hasn’t practiced cheapness investing in five decades. “Value investing” ends up leading a double life, one referring to Buffett and his disciples and another to the mechanical application of cheapness filters.   The focus is entirely on business, not stock price. Before owning, we spend all our time understanding the nature of the business, the context it operates in, what makes it sustainably good and what risks can spoil the party. Many businesses will drop off our list, either because they’re clearly not worth owning or it’s simply too hard to reliably establish these traits. Likewise, after owning, our focus is entirely on whether the business continues to be worth owning.   Another subject which intrigues me is decision-making. It is an extremely difficult subject simply because you make a decision usually based on incomplete facts and assumptions about the future. The future may or may not turn out as you expected. The decision may or may not turn out to have been a good one but it will only be known in hindsight. One way of looking at decision-making is the one made famous by Jeff Bezos - that of reversible and irreversible decisions.   Once you learn to see decisions through the lens of reversible and irreversible, everything changes. It also changes how you make decisions.   Make reversible decisions as soon as possible and make irreversible decisions as late as possible.   When decisions are reversible, make them fast. Your biggest risk is dragging your feet and not making a decision. The cost to acquire additional information isn’t worth the effort.   When decisions are irreversible, slow them down. The biggest risk is making the wrong decision. The cost to get the information we need to reduce uncertainty is worth the time and effort.

Thought of the Week:

“There will come a time when you believe everything is finished. That will be the beginning.” ​— Louis L'Amour   Every bear market hides the side of a bull market in it. And vice versa.

Audio/Video of the Week:

Complete story of Israel & Palestine conflict | Jews vs Arabs | Jerusalem | Dr. Vikas Divyakirti

This is in hindi. But by far the best and most comprehensive summary of the Israel-Palestine conflict. Dr Divyakirti is a fantastic teacher and explains things in a calm, composed manner starting from the biblical roots and traces down a couple of thousand years to the current events. This is a wonderful watch if you wish to understand the genesis of the longest-standing conflicts of human history.

Lessons from Charlie Munger's Folly

 

It’s good to learn from your mistakes. It’s better to learn from other people’s mistakes. ~ Warren Buffett   This quote has been embedded in my mind since I first read it. So, I try to observe the world and keep reflecting on the mistakes that I and that others around me make. There is a lot to learn. Today, I will discuss one such mistake. And one made by, perhaps, the person I admire most – Charlie Munger. So, when our guru makes a mistake, you should sit up and take notice.

The Alibaba Saga

Here is what happened. Charlie Munger took a bet on the Chinese giant Alibaba. This was just before the Chinese government decided that Jack Ma had grown too big for their comfort and pared his wings. Munger bought his initial stake at around $246 per share. So far so good. Alibaba was a giant in China. It was one of the largest B2B and C2C ecommerce sites in the world. Alibaba was on its way to launching the largest IPO on the Shanghai Exchange in Oct 2020. Just before this, Ma addressed an assembly of high-profile figures in China with a controversial speech that criticised the Chinese financial system. And then suddenly, he practically went missing for three months. This more or less started the crash in Alibaba’s stock. From above $300 it has now crashed to close to $70, an overall fall close to 75%.

Alibaba monthly price chart

source: tradingview.com Munger probably convinced this was a passing phase and things will get back to normal after Jack Ma is “taught” a lesson in adhering to the government line, doubled down and kept adding as the stock kept falling. He added substantial quantities in the Jul-Sep quarter around $182 and again in the Oct-Dec quarter around $145. Each time he nearly doubled his position from before. He probably realised his mistake and sold half his position in the Jan-Mar quarter of 2022 at $115. Today the stock price is around $70.

Munger kept averaging down before booking partial losses

Source: gurufocus.com

The Lessons

When I sit and think about this trade, here are the lessons I draw from it. Macro matters - Nothing really changed in the company. The underlying macro factors changed. The company kept doing the same business it was doing in 2019, yet the stock is down 75%. So, those who say that macro does not matter are simply wrong. Psychological Bias Impacts All – Even if you have devoted your life to studying and understanding human biases, no one is immune from them. The steadfast belief, a form of narrative fallacy bias, in the superior “Chinese system” that Munger kept alluding to in many of his talks probably blindsided him. Any autocratic system provides great results but only as long as the system works in your interests. If it works in the opposite interests, then the downside could also be equally large. Authority bias may also have had a role to play. Li Lu recommended Alibaba to Munger. Previously, Li Lu had recommended BYD, a Chinese EV giant, and Munger had invested in it and made significant profits. Li Lu is a Chinese-born American investor and familiarity with Chinese businesses was a major advantage for him. Li Lu is also the only person that Munger has given his own money to manage, so one can understand the trust he has in his views. Thirdly, social proof, also probably played a role. Munger had taken a very large and visible position. He had spoken about the great Chinese system. He had praised the Chinese government for stepping in “preemptively to stop speculation”. The challenge with mental biases is when you have a number of them lined up together, they combine and create a lollapalooza effect which has the potential to completely blindside a person. Lack of risk management system – It does not matter how great an investor you are, you will make mistakes from time to time. There has to be a safety net that you create for yourself when you make a mistake. The one that works well is to use a stop loss. The simple reason is that it puts a floor to the maximum loss to your capital. It lets you get out of your position and then assess more objectively if there is something wrong with your thesis. The worst that can happen is after reviewing your thesis if you think that the stock is still worth buying, you can always buy it back. Otherwise, you are paralysed with a stock with falling prices and keep hoping that something will happen to turn it around. Hope is never a good investment strategy.

Summary

Mistakes will be made. You need to keep your guard high all the time. As Richard Feynman famously said, “You must not fool yourself, and you are the easiest person to fool.” As investors, most of the time we keep fooling ourselves. The best way is to have a focus on building processes that will firstly, prevent you making a mistake, and secondly, even if you do, will protect you from making great damage to your portfolio.

Note: This article was first published on The Economic Times.