Hi James, I was wondering how would you advice someone who is less experienced, when it comes to capital allocation. As Warren Buffet used to say "Diversification is a hedge against ignorance". When I started out investing in stocks for the first time after being an index investor, I realized that nobody tells you how volatile stocks are. I believe that I have what it takes psychologically to run a concentrated portfolio and I have already suffered multiple big one day drops. I am long term focused on the underlying business and not what the share price does, but the market does what it does in an incompletely unpredictable fashion. What I have learned fairly quickly is that I need to be highly disciplined before making any decisions to buy or sell a stock. This is not so much to try to perfectly time my decisions, but more so acknowledging that a stock can go on sale at any time, undervalued stocks can remain so for a long time, and great opportunities are rare. I like your idea of having something that needs to go out before something can get in. Having said that, I think that I should probably consider myself as more ignorant than I think and err on the side of caution. The wider the net I deploy, the more chances I have of making mistakes and learning from them.
Thank you for the question. You are not alone in grappling with this dilemma.
Here's the thing — If you invested in a high quality private company that was growing in strength and profitability, you wouldn't have any mechanism to value that company day to day, but you would be happy with your investment nonetheless. So why should that change simply because the company in which you are invested is a public company?
Nobel Laureate Professor Eugene Fama, famous for the efficient market hypothesis, posits that all information is contained in the price as markets are efficient. I disagree. The primary driver of price is market sentiment, not economic fundamentals. The share price of some companies has been known to go up or down by 40% in a single day, yet no right minded individual believes that any company's intrinsic value changes that much in 24 hours. Either the price wasn't correct prior to the share price adjustment, it isn't right after the move, or more likely both are true.
Market price volatility is noise. It should be ignored. As Buffett says, the market is there to serve you (when you want to buy or sell), not there to inform your investment decisions. Block it out.
- invest for the long term because you are buying a stake in a business, not a lottery ticket. Investing is one of the few vocations where more work doesn't yield better results. Avoid trading too much (see: https://rockandturner.substack.com/p/investing-subconscious-myopia)
Hi Emanuel, I agree with you and I mostly shrug off the short term movement of my portfolio, as that is something I cannot control. But my question is more related to portfolio management itself than individual stock picking. I think being a good portfolio manager requires a whole different set of skills than being a good stock picker and this is rarely discussed. If I invest in a company with the perspective of holding for the next 5-10 years, the feedback mechanism is slow. I will know how good of an investor I am by the time I retire. Compare this with playing chess: you get instant feedback and you can use logic to improve how you play. Investing is complex and unpredictable. You can make the right choices and something out of your control will happen. You can make all of the wrong choices and be lucky. Therefore, we need to think probabilistically with our portfolios and see the big picture. Diversification itself can improve returns by exploiting mean reversion (also called the rebalancing premium). So I think it is a difficult and personal thing to decide how many stocks someone wants in their portfolio. I was thinking on whether you would recommend someone with less experience to do things in a different way, knowing what you know now, or you would say that concentrating is the only way to go. My feeling is that there is a benefit to extending a wider net “as a hedge against ignorance” and as a way to learn.
Investing is hard. Really hard. It takes time, effort and expertise. Most people don’t have all three - and without them, investing becomes more like gambling. That’s a fast track to poor results.
In terms of feedback (your chess analogy), you get that quarterly with results. When you invest you have a thesis on how this company's journey will play out. the quarterly results allow you to test and revise that thesis. If necessary, you can rethink - exit - reallocate capital.
But reading financial results takes time and effort. If you have a full time job doing something else, plus a young family and hobbies, you may not have the capacity to do this. That would be a problem, indicating that perhaps you should allow someone else to manage your money.
Ironically, while you argue for diversification as a risk mitigator, through this lens it increases risk as you have so many more companies to monitor - so much more material to read. It isn't possible to properly manage a huge diverse portfolio without an entire team of people (like the big institutional funds have).
So the question for you is perhaps whether to invest directly, or to put your money with a good money manager.
There is a middle ground - if you invest in a company like Berkshire Hathaway, you have the best money managers looking after your capital without incurring any fees. You also achieve diversification through its vast empire of businesses.
Another one you might like to consider is Brookfield Corporation for the same reason.
I think quarterly reports are not a good measure of performance either (or of your thesis playing out). For some companies like Burford capital, results are so volatile, that management measures results on a 3 year rolling basis. It is also impossible for me to predict that a company is going to make an acquisition or sell a segment of their business (both happened to me). You can also buy the hottest stock in the market that is growing 40% per year, and little do you know that all of that growth is discounted and even more. Regarding having money on a money manager, I have some money on PSH because of the big discount to net asset value, but overall I think we smaller investors have an advantage when it comes to smaller stocks.
Burford Capital isn't a normal business. It is entirely unpredictable and impossible to model. Investing in that is highly speculative. Even the YPF judgement may not result in cash flows - and if it does, no one knows how much or when they will be received.
The best investments are those that are predictable and capable of being measured on an ongoing basis.
Management is everything. The CEO is essentially the trustee of your capital. If he is untrustworthy, focused on personal enrichment, corrupt or incompetent, then it can't end well for an external investor.
The skill is less about finding the right company and more about finding exceptional CEOs. If you had invested in Steve Jobs, Jeff Bezos, Warren Buffett or Jensen Huang, you could have forgotten about the investment for a decade or more and it would have been just fine.
These people are rare - the other 99% of CEOs are mediocre at best. That's the best advice I can offer you.
Thank you for the lovely insights. While I completely agree with your reasonings, what I'm struggling with is whether to average up on my winners or not. Because Mr. Market is irrational in the short term, if the company is doing well should I buy on weakness and if yes then how often? Would love to hear your perspective
Averaging up is psychologically the hardest part of investing for me. I plunge with ease into falling knives, but struggle enormously with bringing up the cost base.
If investing is about risk adjusted returns - and I believe it is when done properly - then sometimes an investment is more attractive at a higher price after the risk has reduced. This may occur for any number of reasons - a stronger moat, the granting of a patent, a successful clinical trial, a strategic alliance, etc.
Food for thought.
I'll be writing about this topic in a separate post to be published in coming weeks.
I will be publishing another article in coming weeks that will answer your question. It involves turtles... that's all I can say at this stage. Hopefully you can wait a week or two?
No. I have a great deal of respect for the team at Turtle Creek, but this is not about them. It's a far more interesting story... (sorry for the cliffhanger!) It should be worth the wait.
Hi James, I was wondering how would you advice someone who is less experienced, when it comes to capital allocation. As Warren Buffet used to say "Diversification is a hedge against ignorance". When I started out investing in stocks for the first time after being an index investor, I realized that nobody tells you how volatile stocks are. I believe that I have what it takes psychologically to run a concentrated portfolio and I have already suffered multiple big one day drops. I am long term focused on the underlying business and not what the share price does, but the market does what it does in an incompletely unpredictable fashion. What I have learned fairly quickly is that I need to be highly disciplined before making any decisions to buy or sell a stock. This is not so much to try to perfectly time my decisions, but more so acknowledging that a stock can go on sale at any time, undervalued stocks can remain so for a long time, and great opportunities are rare. I like your idea of having something that needs to go out before something can get in. Having said that, I think that I should probably consider myself as more ignorant than I think and err on the side of caution. The wider the net I deploy, the more chances I have of making mistakes and learning from them.
Thank you for the question. You are not alone in grappling with this dilemma.
Here's the thing — If you invested in a high quality private company that was growing in strength and profitability, you wouldn't have any mechanism to value that company day to day, but you would be happy with your investment nonetheless. So why should that change simply because the company in which you are invested is a public company?
Nobel Laureate Professor Eugene Fama, famous for the efficient market hypothesis, posits that all information is contained in the price as markets are efficient. I disagree. The primary driver of price is market sentiment, not economic fundamentals. The share price of some companies has been known to go up or down by 40% in a single day, yet no right minded individual believes that any company's intrinsic value changes that much in 24 hours. Either the price wasn't correct prior to the share price adjustment, it isn't right after the move, or more likely both are true.
Market price volatility is noise. It should be ignored. As Buffett says, the market is there to serve you (when you want to buy or sell), not there to inform your investment decisions. Block it out.
My advice to you is:
- be confident in your investments and avoid speculative bets, only invest in solid businesses (see: https://rockandturner.substack.com/p/three-stories-every-investor-should)
- invest for the long term because you are buying a stake in a business, not a lottery ticket. Investing is one of the few vocations where more work doesn't yield better results. Avoid trading too much (see: https://rockandturner.substack.com/p/investing-subconscious-myopia)
- ignore the noise of the market because volatility is not risk (see: https://rockandturner.substack.com/p/thinking-like-pabrai-marks-and-buffett)
I hope this helps.
Hi Emanuel, I agree with you and I mostly shrug off the short term movement of my portfolio, as that is something I cannot control. But my question is more related to portfolio management itself than individual stock picking. I think being a good portfolio manager requires a whole different set of skills than being a good stock picker and this is rarely discussed. If I invest in a company with the perspective of holding for the next 5-10 years, the feedback mechanism is slow. I will know how good of an investor I am by the time I retire. Compare this with playing chess: you get instant feedback and you can use logic to improve how you play. Investing is complex and unpredictable. You can make the right choices and something out of your control will happen. You can make all of the wrong choices and be lucky. Therefore, we need to think probabilistically with our portfolios and see the big picture. Diversification itself can improve returns by exploiting mean reversion (also called the rebalancing premium). So I think it is a difficult and personal thing to decide how many stocks someone wants in their portfolio. I was thinking on whether you would recommend someone with less experience to do things in a different way, knowing what you know now, or you would say that concentrating is the only way to go. My feeling is that there is a benefit to extending a wider net “as a hedge against ignorance” and as a way to learn.
Investing is hard. Really hard. It takes time, effort and expertise. Most people don’t have all three - and without them, investing becomes more like gambling. That’s a fast track to poor results.
In terms of feedback (your chess analogy), you get that quarterly with results. When you invest you have a thesis on how this company's journey will play out. the quarterly results allow you to test and revise that thesis. If necessary, you can rethink - exit - reallocate capital.
But reading financial results takes time and effort. If you have a full time job doing something else, plus a young family and hobbies, you may not have the capacity to do this. That would be a problem, indicating that perhaps you should allow someone else to manage your money.
Ironically, while you argue for diversification as a risk mitigator, through this lens it increases risk as you have so many more companies to monitor - so much more material to read. It isn't possible to properly manage a huge diverse portfolio without an entire team of people (like the big institutional funds have).
So the question for you is perhaps whether to invest directly, or to put your money with a good money manager.
There is a middle ground - if you invest in a company like Berkshire Hathaway, you have the best money managers looking after your capital without incurring any fees. You also achieve diversification through its vast empire of businesses.
Another one you might like to consider is Brookfield Corporation for the same reason.
I hope that helps.
I think quarterly reports are not a good measure of performance either (or of your thesis playing out). For some companies like Burford capital, results are so volatile, that management measures results on a 3 year rolling basis. It is also impossible for me to predict that a company is going to make an acquisition or sell a segment of their business (both happened to me). You can also buy the hottest stock in the market that is growing 40% per year, and little do you know that all of that growth is discounted and even more. Regarding having money on a money manager, I have some money on PSH because of the big discount to net asset value, but overall I think we smaller investors have an advantage when it comes to smaller stocks.
Burford Capital isn't a normal business. It is entirely unpredictable and impossible to model. Investing in that is highly speculative. Even the YPF judgement may not result in cash flows - and if it does, no one knows how much or when they will be received.
The best investments are those that are predictable and capable of being measured on an ongoing basis.
Management is everything. The CEO is essentially the trustee of your capital. If he is untrustworthy, focused on personal enrichment, corrupt or incompetent, then it can't end well for an external investor.
The skill is less about finding the right company and more about finding exceptional CEOs. If you had invested in Steve Jobs, Jeff Bezos, Warren Buffett or Jensen Huang, you could have forgotten about the investment for a decade or more and it would have been just fine.
These people are rare - the other 99% of CEOs are mediocre at best. That's the best advice I can offer you.
Great article. :-)
Thank you for the lovely insights. While I completely agree with your reasonings, what I'm struggling with is whether to average up on my winners or not. Because Mr. Market is irrational in the short term, if the company is doing well should I buy on weakness and if yes then how often? Would love to hear your perspective
Averaging up is psychologically the hardest part of investing for me. I plunge with ease into falling knives, but struggle enormously with bringing up the cost base.
If investing is about risk adjusted returns - and I believe it is when done properly - then sometimes an investment is more attractive at a higher price after the risk has reduced. This may occur for any number of reasons - a stronger moat, the granting of a patent, a successful clinical trial, a strategic alliance, etc.
Food for thought.
I'll be writing about this topic in a separate post to be published in coming weeks.
I will be publishing another article in coming weeks that will answer your question. It involves turtles... that's all I can say at this stage. Hopefully you can wait a week or two?
Turtles as in Turtle Creek Asset Management and their approach to trimming and adding to positions?
No. I have a great deal of respect for the team at Turtle Creek, but this is not about them. It's a far more interesting story... (sorry for the cliffhanger!) It should be worth the wait.
Fair enough, I will wait patiently for it :)
Publication date: Monday 31st March 2025. The title "Three Stories Every Investor Should Know" - https://rockandturner.substack.com/p/three-stories-every-investor-should
That's even better. I can't wait to read it