Last week I posted my thoughts on the importance of learning how to invest. It must have connected with some people based on the emails I received.
One that caught my attention was from a reader who shared with me his experience and was kind enough to allow me to share it with you.
This reader in particular is interesting because he has plenty of analysis experience coming from the a private equity background and has now changed from a top down investor to a more fundamental, bottoms up investor.
See if you can take away anything from what he is sharing.
An Investor has to be Realistic but Pay a Discount for “Pessimism”
A few underlying theses that a lot of investors in emerging markets go with are
- multiples will expand
- the market will re-rate the stock since it is a market leader
- the management is world class
but you can’t go into the show banking on it.
Investing on the back of an expected tailwind from the market is like buying a car hoping for crude oil to fall to $50 a barrel once there is peace in middle east.
When extraordinary management meets an average business, it is always the business that wins, at least most of the times. Many high quality entrepreneurs have tried to turn around things in retail, aviation, commodities. However, the business quality outlasts their efforts.
Look at JC Penney.
Capital Allocation Skills are ALWAYS Different to Execution
These are two very different skill sets often mistaken as the same.
People who are good at execution tend to be “alpha males” – aggressive, focused who get stuff done. Similar to what Charlie Munger describes as a “locker room culture” which is a culture of always trying to win and be right.
On the other hand, great investors are cerebral, relaxed and do not focus on reaching the end-goal all the time. They have a wide view of what goes on around them.
Capital allocators go into a situation to calculate the potential and walks away if the return is not there. Executors go into a situation and the only goal is to turn it around and to come out on top.
In a way, the capital allocators are the more ruthless ones. Emotionless, cold and calculated seeking a profit over ego.
Liquidity Can’t Solve a Business Model Problem
Too many times, businesses that are losing cash get happy about raising cash and continue with their model.
It’s like filling up your car with a leaking gas tank.
You won’t get far.
You need to fix the problem.
My favorite whipping boys of these types of business are the ones in retail, aviation, social media, consumer brands going against a giant without any different proposition.
Understanding Why You Made or Didn’t Make Money is More Important than Making Money
You hear this too often in the venture capitalist world.
“We got this deal cheap at 100 x sales – our competitor fund paid 200 x sales for their investment “.
This is common especially in new and upcoming industries where there are no comparable benchmarks or demonstrated track records of FCF and ROE.
This type of relative comparison and anchoring bias leads to situations where you think the investment is worth a billion dollars whereas the actual market value is a million.
Given the lack of liquidity and any mechanism to discover price, such mispricings stay hidden for 5-6 years before the entire rug gets pulled out from under your feet in one go.
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