Monday, March 16, 2015

Rules of the game

  Here are a few simple rules that I use to kind of keep on track. A few of them were borrowed from Guy Spier's book, The Education of a Value Investor: My Transformative Quest for Wealth, Wisdom, and Enlightenment. Would love to hear your feedback on these and if you agree with them.
  1. Never sell for 2 years after you have bought: This does multiple good things for you. Firstly if you know this you will always think a lot before you become a partner in the business. Secondly it eliminates all biases and gives you enough time to do in depth research before you sell out your interest in the business. This by no way means that you should stop thinking about the business or reading or doing research during the two years. On the contrary it means that you do highly diligent research during those two years in order to affirm or dispute your thesis.
  2. Check prices at most once a week: Checking your portfolio company prices multiple times makes it more likely for you to do something in the heat of the moment – which is precisely what you are trying to avoid. As Buffet one said “You don’t get rich just to look at the ticker tape”
  3. Avoid talking about current positions: When you have bought an interest in a business talking about it does various things. For one it commits you to a position and you may not be able to retract from that position. Secondly it puts emotional pressures on you of being wrong and take rash decisions.
  4. Discuss ideas with few rational and clam sounding boards: You want to discuss your ideas with a sounding board. The most important function of this is to actually present your case in a simple manner to someone who you think is competent of critiquing your ideas. You don’t have to necessarily agree with them but just a healthy discussion is good to clear up your thoughts.
  5. Write a note before taking a position: The note history or what I call the verdict log gives you a clear understanding of why you took certain actions in the past. It also is very useful in learning from your experiences and mistakes.
  6. Learning from Mistakes: You always want to write up a piece for yourself to learn from your mistakes. When you do make a mistake creating a checklist item is also very useful.
  7. Give yourself liquidity from the portfolio only once a year: This is very important because intra year positions can move around and getting out at the wrong time can seriously hamper your returns.
  8. Buy only after complete analysis: Buying into something that looks like the greatest opportunity ever is the fastest way to fall into a value trap. Complete the analysis before you buy along with the conviction matrix and valuation sheet.
  9. Stay within your circle of competence: Your circle of competence is defined by business you understand – as Mohnish Pabrai puts it “You should be able to think like the CEO of that business”. Which implies that you understand the suppliers, employees, customers, value creation mechanism, moat strength, growth avenues, etc. In order for a business to be in your circle of competence you should have studied at least a few companies if not all in the space to understand relative strengths. If there are significant private players that is important as well.
  10. Avoid use of anchors: Anchors are pseudo valuation metrics that do not make business sense. Examples include buy when the stock is down 20% from the highest price in the past – who is to say that the highest price was rational or today’s price is rational or whether there were material changes in the middle. Relative cheapness on P/E or P/B is another anchor which is very tempting. There are only 2 determinants of the buy decision – value and price. If the price is significantly lesser (I think Berkshire says at least 25%) than the value you buy – else you don’t.
  11. Don’t look at the stock price before doing the analysis – This is again very hard to follow especially because most websites will pop the price in your face in big bold 20 point font. TO illustrate this point I would like to make the present the following Buffet quote:  “I don’t want to know the price of the company’s stock prior to my analysis. I want to do the work and estimate a value for the stock and then compare that to the current offering price. If I know the price in advance, it may influence my analysis.”