Many experienced investors are likely to tell you the role of unexpected pleasant surprises aka serendipity in their investing careers.
The idea that I am trying to explore is how much of equity investing is luck and how much is skill. And, if it is luck, are there game plans which can help us get lucky.
Here’s Peter Lynch “Frankly, I’ve never been able to predict which stocks will go up tenfold, or which will go up five fold. I try to stick with them as long as the story’s intact, hoping to be pleasantly surprised. The success of a company isn’t the surprise, but what the shares bring often is. I remember buying Stop & Shop as a conservative, dividend-paying stock, and then the fundamentals kept improving and I realized I had a fast grower on my hands.“
Hero Honda’s (a 150 bagger from 1994 to 2016) early investors had no clue, (at least initially) that they were capitalizing on a massive shift in consumer preferences. Here’s Mr. Taher Badshah’s interview on Wizards of Dalal Street “I started to flesh out the story in my mind and I used to have these repeated sessions with Raamdeoji late into the evenings and that is how it came about that this is a story, not about the capacity expansion, but this whole element of mobility, mobility was so constrained at that point in time in a country like India and especially in the rural markets. Scooter was only a largely urban city led phenomenon. So, we tried to rationalise that this is a product which can become large. How large, even we did not really have the vision to think that what was a 90:10 scooter-motorcycle market would become a 10:90 scooter-motorcycle market.“
An astute investor like, Mr. Basant Maheshwari for example, thought Pantaloons won’t do well and it subsequently became a 40 bagger for him. He explains this in this short video.
Ayush Mittal, an investor I admire for teaching us the value of turning over a lot of rocks, nailed this idea in one of his presentations, “Many often the stocks where we worked very hard, where we thought we knew enough, gave the worst returns. While many others – not our favorites – gave extra-ordinary returns. Often stocks where we did lot of work haven’t worked out well. Plus they performed best when undiscovered. It’s like a backbencher performing well – he gets rewarded more.”
Sometimes, even founders/promoters don’t know
And here’s a leaf from the legendary investor, Charles Akre “According to Bill Gates’ first book, The Road Ahead, he and Paul Allen tried to sell the company to IBM some years earlier and they were turned down. And so… hindsight my inescapable conclusion is that neither party of the proposed transaction understood what was valuable about Microsoft. In my mind it’s a huge irony at least because in my point of view Microsoft became the most valuable toll road in modern business history. But here again, even the people running the company at an early stage did not understand what it was that made it valuable. And it wasn’t even visible to them. So my point here is simply that the source of a business’ strength may not always be obvious.“
Sam Walton’s biography “I’m always asked if there ever came a point, once we got rolling, when I knew what lay ahead. I don’t think that I did. All I knew was that we were rolling and that we were successful. We enjoyed it, and it looked like something we could continue.”
What’s in it for DIY investors
Given that it is difficult to predict high CAGR stocks, here are some ideas that can help bypass the human limitation of a lack of foresight.
Strategy # 1 – Average up – So what you really need to do is to size positions based on a Bayesian approach. Kill small experiments that you thought would do well but failed, and allocate more and more capital (by gradually averaging up, based on subsequent quarters of good results) to bets that are working in your favor contrary to what you initially thought. Relaxo Footwears was one such bet for me. When I first bought the stock, I thought 40 times earnings is too high a price to pay for this company. Nevertheless, I invested despite what my intuition kept telling me at that time. And the price kept going up, and I kept buying.
The best example of averaging up I have seen till date is Mr. Maheshwari buying Page Industries from 350 to 5600. So he keeps buying the stock until 16x his initial buy price & beyond. No price anchoring. No excuses of the price running up. Just plain execution on his strategy of averaging up on a winner.
A critical part our position sizing process should be to let the validation of our thesis (reflected in business performance subsequent to our initial positions) determine the position size. When we first spot a stock, we shouldn’t pre-decide we’ll allocate 5-10-20-30 or even 40% of our portfolios to a given stock. Every time the management of a company executes on it’s stated plan, by delivering growth and ROE, we should be buying more of the stock. If it doesn’t do as well as we’d expected, we get out of the stock (unless the slowdown is temporary) and add to stocks that are doing well despite what we originally thought.
Strategy # 2 – Basket approach – The second strategy is taking a basket approach. So if you think a sector is going to do well, allocate more of your portfolio to a potential winner, at the start. At the same time, invest small sums into other counter intuitive bets from the sector. Let me give you an example beautifully articulated by Mr. Kenneth Andrade, in an interview from 2013.
So if you were bullish on the 2 Wheeler market in India, in the 90s and 2000s, what you should have done is allocated a lot more to TVS Motors initially and when consumers were starting to accept Hero Honda’s 4 stroke engines, paid attention to disconfirming evidence like a true Bayesian, and moved money from a TVS & Bajaj to a Hero Honda because clearly it was outperforming it’s peers. Hero Honda deserved your capital more than Bajaj or TVS did at that time. The opportunity cost of staying invested in a Bajaj or a TVS was skipping Hero Honda, a subsequent 150 bagger.
Strategy # 3 – Businesses with multiple possible futures aka sidecar investments
I’ll let David Gardner explain this for you.
With this I’ll call it a wrap. Hoping good luck finds you soon 🙂