You can handle the emotional side of investing This ... · 12/29/2016 · I’m sure you’ve all...

3 Hour Investor Newsletter incorporating the “Newsletter Portfolio” Week 29- 2016-Dec-27

Who is this newsletter for? You want to manage your own portfolio.

You can afford 3 hours per week

You can handle the emotional side of investing

This newsletter is not for you if

You can’t control your emotions

You don’t have 3 hours per week to manage your Money.

You’re a buy and hold forever investor.


Current Portfolio Valuation. (up 18% per annum)

3 Hour Investor Newsletter incorporating the “Newsletter Portfolio” Week 29- 2016-Dec-27 Comment. We now have 8 stock holdings

Losers >10% -

Losers 5.1%-10% 1

Losers 0%-5% 2

Gainers 0%-5% 1

Gainers 5.1%-10% -

Gainers10.1% - 20% 1

Gainers 20%-30% 2

Gainers 30%-40% -

Gainers >40% 1

3 Hour Investor Newsletter incorporating the “Newsletter Portfolio” Week 29- 2016-Dec-27 This week’s newsletter is a little different. This week we’ll cover off some of the things I’ve learned

whilst “managing” this portfolio.

On the topic of Buffett (or I suppose being purely fundamental in

approaching portfolio management)

I’m sure you’ve all read your fair share of Buffett quotes. It’s fairly easy to find Buffett

quotes online…so here are a few.

“We select such investments on a long-term basis, weighing the same factors as would be

involved in the purchase of 100% of an operating business:

(1) favorable long-term economic characteristics;

(2) competent and honest management;

(3) purchase price attractive when measured against the yardstick of value to a

private owner; and

(4) an industry with which we are familiar and whose long-term business

characteristics we feel competent to judge.”

“Only buy something that you’d be perfectly happy to hold if the market shut down for 10

years.”

“If you aren’t willing to own a stock for ten years, don’t even think about owning it for ten

minutes”

“When we own portions of outstanding businesses with outstanding managements, our

favorite holding period is forever.”

“Over the long term, the stock market news will be good. In the 20th century, the United

States endured two world wars and other traumatic and expensive military conflicts; the

Depression; a dozen or so recessions and financial panics; oil shocks; a fly epidemic; and the

resignation of a disgraced president. Yet the Dow rose from 66 to 11,497.”

Ok I will acknowledge that if you understood everything that Buffett does and did all the things

that he’s done then startlingly effective investment returns would result. And yet how many

people have managed to be Buffett. Exactly not many. Perhaps because of other quotes about

him.

Firstly he’s reported to read 500 pages per day and is constantly researching. This habit isn’t one

off…he’s been doing it for many decades

He has at least one partner in crime and I wonder how many researchers support him. He can

discuss ideas intelligently and with full trust and examine ideas from many different perspectives

Access to information: When Buffett wants to ask a question it’s highly likely that just about

anyone he wants to speak with will take his call, respond to an email and or write a detailed

response and provide access to required information. The resulting information can be

reviewed and cross checked from multiple perspectives.


Investment skills built up over many decades and exposure to the best investment minds over

that period.

Now let’s contrast this to the typical small investor, perhaps allow me to suggest a series of

constraints

Limited time to spend on investing.

o If you have a full time job with a reasonably level of responsibility in a big

corporate, then you’re probably working over 50 hours per week (maybe over

60 including car, bike, plane and train travel time, corporate dinners, lunches

events and so on) and when not working you’re likely dealing with a full to

brimming email inbox and the stress of a tonne of incomplete work. Result. Not

a change will you be able to match Buffett’s ability to invest his and his team’s

time.

o Perhaps you’re retired or by some other chance you also have more time than a

stressed executive. Will you be able to match Buffett’s say 50 hours per week of

reading and research. Whilst you may have some chance you’ll know that you

don’t in all likelihood spend hours per day on systematically researching

portfolio management. If you do spend 50 hours per week…then this newsletter

is not for you sorry.

Limited access to information.

o Where do you get your information from.

o Likely you’ll get some of it from services like Lincoln, newsletters, newspapers,

the internet and so on. This begs the question. How detailed, reliable and

timely is such information? How many times have you seen one announcement

and watched the share price of a company plummet 10%, 20%, 30% or even

more once it’s been released. How many times have you seen the share price

start to plummet before an announcement? You watch as a price that’s been

rising starts to drop steeply and then a day, a week or a month later the

catastrophic news is released?

Limited access to multiple perspectives

Trading halt, institutional and retail book build

related to purchase of quindells

Press release denying accounting practices were

subject to ASIC questions

SGH says it’s aware of quindell’s poor accounting

practices and took account of these during due diligence

SGH loses status of “star growth stock”. Quote from Lincoln

analyst SGH enters FY16 on the cusp of a mighty step up in size and scale. The

company has provided total group fee guidance including the Slater Gordon

Services (SGS) practice guiding in excess of $1,150 million, which is a significant

uplift from the reported revenue of $623.3 million. (SGH promises a good future

but financial strength declined to early warning)

SGH annual accounts issued….and they didn’t look all

bad

All sorts of announcements that things are going to be

ok…even though some thought that UK legal changes

would affect future earnings…SGH denied it.

SGH accounts to 30 June finally record

a loss of over 1billion…..Aaarrggghhh


o As we mentioned above whilst Buffett has a close partner and probably a team

of researchers (plus a network of highly trained and experienced investors,

bankers, lawyers and so on)….well you and I don’t. We may have a couple of

friends who we talk things through with…none of them likely to be superbly well

trained and experienced.

o Whilst Buffett and his team can consider an investment, all of the likely current

and future competitors, substitutes, the current and likely future legal

environment, suppliers current and future powers and conduct an evaluation of

management. They can also then look at an investment from many of those

perspectives. Can you feel confident that you’ve done just that? I know I can’t, I

simply don’t have the firepower and nor does my investor network.

Limited investment skills.

o Whilst Buffett has worked in the investment game for probably over 50 years

and during that time spent perhaps 125,000 hours, studying about, thinking

about, learning about, managing etc in relation to investments most of us have

not. In fact even if we lived for another 50 years we are unlikely to match

Buffett’s experience, let alone putting him and his team together.

o So if we take it for granted that Buffett is approaching 10 out of 10 for

investment skills where would you rank yourselves. I can propose an answer. A

recent survey of about 20 experienced stock doctor users found that they

ranked themselves 3/5 (or lets say 6 out of 10) for investment skills.

o I suspect that investment skills are a bit like golf.

To get from zero (never played golf before) to say 3 out of 10 (I can hit

the ball most times off the tee) might take say 2 hours of lessons.

To get from 4 out of 10 to say 7 out of 10 (handicap of say 18) might

take a 2 or 3 months of practicing with lessons.

To get from 7 out of 10 to say 9 out of 10 (handicap of say 8) might take

2 to 3 years with practice and lessons.

To get from 9.0 to 9.5 out of 10 (handicap of say 3) might take 10 years

of multiple times per week practice plus natural skills.

To get from 9.5 out of 10 to 10 out of ten probably takes a lifetime

dedicated to golf, plus natural skills, plus access to good coaches and

more. (ie at this level you’ll be able to regularly beat par and mix it at

the pro level.)

o So how much do you put in towards learning investment skills. How much time,

how much energy, how much dedication. Do you learn from the best coaches.

Do you hang out with people who are better than you are. Do you have

mentors. How many books have you read and learned from. How highly do you

really rate your skills. I thought so…most of us have little chance of learning all

the required skills.

Conclusion?

For me the big question is, “can I profitably follow a purely fundamental investment methodology?”

Personally I found the answer to be no!. I spent 20 years reading about stocks trying to pick those

with good fundamentals. I used all sorts of information sources including eventually Lincoln

indicators and generally found that whilst I bought companies that seemed to have good

fundamentals, all too often I ended up selling them after they’d declined by 40%, 50%, 60% or

sometimes even more.


The buy and hold forever strategy didn’t seem to work for me. All too often the stock with good

fundamentals eventually developed massive problems or the market changed or the laws changed

or something else changed and the stock suffered. All too often if a stock went down…I’d buy more.

If you need an example then perhaps WOW is a good example of mine. This was a good stock with

great numbers, a large and growing share of the market, good management etc etc. Then what

happened?

Did you follow a buy and hold forever because of good fundamentals. How has it worked out for

you? Honestly how has it worked?. If you were like me it didn’t work. And this then brings the

quote from Einstein on the definition of insanity being “doing the same thing over and over and

expecting a different result. In other words there’s no point in my applying Buffet’s buy and hold

strategy and expecting outsized returns in the future.

On the topic of “Wisdom of Crowds”

The Wisdom of Crowds: Why the Many Are Smarter Than the Few and How Collective Wisdom

Shapes Business, Economies, Societies and Nations, published in 2004, is a book written by James

Surowiecki and here is a quote, but first is a thumbnail summary

Thumbnail summary. If you collect a diverse range of decisions from independently acting

individuals, then the collective decision is likely to be very good and probably better than most

individuals or experts. Here’s the story

“One day in the fall of 1906, the British scientist Francis Galton left his home in the town of

Plymouth and headed for a country fair. Galton was eighty-five years old and beginning to

feel his age, but he was still brimming with the curiosity that had won him renown—and

notoriety—for his work on statistics and the science of heredity. And on that particular day,

what Galton was curious about was livestock.

Galton’s destination was the annual West of England Fat Stock and Poultry Exhibition, a

regional fair where the local farmers and townspeople gathered to appraise the quality of

each other’s cattle, sheep, chickens, horses, and pigs. Wandering through rows of stalls

examining workhorses and prize hogs may seem to have been a strange way for a scientist

(especially an elderly one) to spend an afternoon, but there was a certain logic to it. Galton

was a man obsessed with two things: the measurement of physical and mental qualities,

and breeding. And what, after all, is a livestock show but a big showcase for the effects of

good and bad breeding?

Breeding mattered to Galton because he believed that only a very few people had the

characteristics necessary to keep societies healthy. He had devoted much of his career to

measuring those characteristics, in fact, in order to prove that the vast majority of people

did not have them. At the International Exhibition of 1884 in London, for instance, he set up

an “Anthropometric Laboratory,” where he used devices of his own making to test

exhibition-goers on, among other things, their “Keenness of Sight and of Hearing, Colour

Sense, Judgment of Eye, [and] Reaction Time.” His experiments left him with little faith in

the intelligence of the average person, “the stupidity and wrong-headedness of many men

and women being so great as to be scarcely credible.” Only if power and control stayed in

the hands of the select, well-bred few, Galton believed, could a society remain healthy and

https://en.wikipedia.org/wiki/James_Surowiecki

https://en.wikipedia.org/wiki/James_Surowiecki

3 Hour Investor Newsletter incorporating the “Newsletter Portfolio” Week 29- 2016-Dec-27 strong.

As he walked through the exhibition that day, Galton came across a weight-judging

competition. A fat ox had been selected and placed on display, and members of a gathering

crowd were lining up to place wagers on the weight of the ox. (Or rather, they were placing

wagers on what the weight of the ox would be after it had been “slaughtered and dressed.”)

For sixpence, you could buy a stamped and numbered ticket, where you filled in your

name, your address, and your estimate. The best guesses would receive prizes.

Eight hundred people tried their luck. They were a diverse lot. Many of them were butchers

and farmers, who were presumably expert at judging the weight of livestock, but there

were also quite a few people who had, as it were, no insider knowledge of cattle. “Many

non-experts competed,” Galton wrote later in the scientific journal Nature, “like those clerks

and others who have no expert knowledge of horses, but who bet on races, guided by

newspapers, friends, and their own fancies.” The analogy to a democracy, in which people

of radically different abilities and interests each get one vote, had suggested itself to Galton

immediately. “The average competitor was probably as well fitted for making a just

estimate of the dressed weight of the ox, as an average voter is of judging the merits of

most political issues on which he votes,” he wrote.

Galton was interested in figuring out what the “average voter” was capable of because he

wanted to prove that the average voter was capable of very little. So he turned the

competition into an im-promptu experiment. When the contest was over and the prizes had

been awarded, Galton borrowed the tickets from the organizers and ran a series of

statistical tests on them. Galton arranged the guesses (which totaled 787 in all, after he had

to discard thirteen because they were illegible) in order from highest to lowest and graphed

them to see if they would form a bell curve. Then, among other things, he added all the

contestants’ estimates, and calculated the mean of the group’s guesses. That number

represented, you could say, the collective wisdom of the Plymouth crowd. If the crowd were

a single person, that was how much it would have guessed the ox weighed.

Galton undoubtedly thought that the average guess of the group would be way off the

mark. After all, mix a few very smart people with some mediocre people and a lot of dumb

people, and it seems likely you’d end up with a dumb answer. But Galton was wrong. The

crowd had guessed that the ox, after it had been slaughtered and dressed, would weigh

1,197 pounds. After it had been slaughtered and dressed, the ox weighed 1,198 pounds. In

other words, the crowd’s judgment was essentially perfect. Perhaps breeding did not mean

so much after all. Galton wrote later: “The result seems more creditable to the

trustworthiness of a democratic judgment than might have been expected.” That was, to

say the least, an understatement.”

Ummmm why is he quoting some weird book, what’s this got to do with portfolio management?

The stock market seems to me to be setting prices based on the individual decision making of

hundreds of thousands (or perhaps even millions) of investors. Some of these investors will view a

stock bullishly. Some will view a stock bearishly. The bulls will believe that a stock is under priced,

or fairly priced or even over priced…. and perhaps is likely to go up in future or at least stay the same

but pay an acceptable return. The Bears believe that a stock perhaps is over priced or is trending

down or that they can do better elsewhere. (maybe others just need some cash to pay their tax

debts for example)

3 Hour Investor Newsletter incorporating the “Newsletter Portfolio” Week 29- 2016-Dec-27 Everyone can see the current price. Everyone can see historical prices. Everyone has access to some

pieces of information and use that information to make a judgement about whether the prices are

going up or going down in future.

The market is where all these people come together and set a price. If there are more buyers than

sellers…then the price trends up. If there are more sellers than buyers then the price trends down.

If everyone agrees on the price…then volumes dwindle and prices remain flat.

If there are way more buyers than sellers…then prices can increase possibly even rapidly. If there

are way more sellers than buyers…then prices can decrease…usually much more steeply than they

can increase.

Do markets sometimes get prices wrong? It seems so. Almost every day there are surprising surges

in prices and surprising drops in prices. Sometimes this happens when “seemingly” new information

is released to the market. Sometimes it happens for no apparent reason. Sometimes there are

more and more optimists appearing every day, driving prices higher and higher. This time it’s

different. Growth can continue forever. Everyone seems to be making money. If I don’t join in now

then I’ll miss out. There’s little chance I’ll be losing out. Good news means higher prices. Bad news

is ignored.

So prices drive higher and higher and higher until something changes somewhere, somehow, some

time…then all of a sudden the mood changes and everyone becomes a pessimist. Suddenly it seems

I have to get out now, but where have all the buyers gone. Prices drop sharply. People stop

spending. Bad news means lower prices. Good news is distrusted and down the prices go even

further. The world as we know it is going to end. Let’s put money into gold as inflation is going to

make us poor. And then one day prices seem cheap…perhaps it’s time to buy again.

Conclusion.

So can we trust the markets to properly value a stock. Well I’d say that the markets are made of

millions of decisions made rationally and emotionally and most of the time will reflect the push/pull

between those who are bears and those who are bulls. Yes they will be manipulated by those who

can control what sort of information is released and the timing of that. Yes they’ll sometimes be

emotional rather than rational. And yet the information is probably the best we can get. And we

should pay attention to it. As close as reasonably possible.

On the topic of decision making.

Key questions.

How can I make good decisions (knowing that I’m a human driven by faulty thinking and

emotions)?

What’s the value of stop losses?

What’s the other “hard bit about stop losses”?

What should I do now that I know that?


Making good decisions is hard.

In the past when I analysed a stock with my Buffett hat on I’d carefully think about a stock’s position.

I looked at its financials, profit and loss, cash flows, balance sheet, ratios, dividend payouts and so

on. I’d read about its position in the market, what the management thought future prospects might

be. I’d also check what analysts thought (reading several broker reports and newsletters for

example). Eventually a light would turn green. “aha…I like this stock. I like this story. I’m going to

buy and hold this stock forever. I’m confident in my decision. I know I’m right” and so I’d buy

Then later the stock price began to drop. There was no new news…not material anyway. Nothing to

help me change my mind. I was sure I was right…it was the market that was wrong. So I’d hold. Or

perhaps I’d buy more (the price had dropped so it was a bargain right?). And then the price would

drop further. What now. Pain. No point in taking a loss…the price will turn up. I’m sure I’m right.

Keep going until eventually the news changed. Disaster. No point in taking the loss now might as

well hold on…the price is sure to trend up…don’t want to be stuck with a loss…don’t want to sell at a

low point do I? (is this familiar?)

Conclusion. Message to my brain. “Don’t believe that my decisions are right. Instead believe that I

made the best decision available to me based on

(a) information that I chose to pay attention to,

(b) other information that I chose to ignore,

(c) my emotional state at the time

(d) and my investing skills or lack thereof.

Be willing to change if (a) new information comes to my attention (b) my emotions change or (c) my

investing skills change.

What’s the value of a stop loss?

Ok so the price of my stock has dived. I spent a lot of time deciding to buy (and keep holding) that

stock and now it’s gone down. What should I do now. If I sell it…it might go back up (and I’d feel

pain). If I sell it I’ll be locking in my losses (and I’d feel pain). Perhaps I should hold a little longer?


Conclusion.

Deciding when to sell is hard work. I need to overcome my emotions as my emotions will try to trick

me into holding on longer than is healthy for my bank account. I value losses 2x gains and my brain

does not like to lock in losses. I need another way. I need a system that will override my emotions.

I need to be disciplined. I need to recognise that I won’t like being disciplined…it’s just not human.

And that’s why the newsletter portfolio uses stop losses. I’m not saying that they’re perfect. I am

saying it helps with decision making.

I can also say that after reviewing many tens of stop loss sells over a long period of time I believe

that approx. 80% of stop loss decisions were right at the time. About 1/5th of sells were not good

decisions meaning the stock price rebounded after I sold. However 4/5ths seemed to be “right”

meaning that stock prices either stayed flat or declined after selling.

I think that in portfolio investing if I can get 80% of my decisions right then I’ll make a decent return

and I’ll be happy. (I’ll do my best to not be unhappy about the 20% I get wrong…sometimes the

prices go almost straight up…arrgghhh….I’ll just grit my teeth one those ones knowing that I’m just

being human)

If I’d sold out here…I would

have locked in my losses and

then missed out on the next big

gain!


What’s the other “hard bit about stop losses”?

Let’s look at this graph for DMP

In this case the stop loss at about $68 was about 12% below the peak. If I sold at the stop loss point

I’d be “down” 12% from a recent peak. Darnit…why hadn’t I sold earlier.

This is a pain point in using a stop loss. By the time it’s triggered I’ve already “lost” a large part of my

recent gains. It makes it harder to sell. Really. I don’t want to lock in a loss do I.

Conclusion.

I have to remind myself that about 80% of stop loss decisions are right. I collect all my sell decisions

and the tools I have quickly allow me to see if they were “right” or “wrong”. It gives me confidence

to stick with the system…and take the pain. Its ok I tell myself. It’s just being human

What should I do now that I know that?

1. I know that many of my decisions will be “bad” based on incomplete information,

untrustworthy emotions and lack of skill or persectives. So I won’t be wedded to them. I

won’t be superglued to those decisions. Instead I treat all of them like scientific hypotheses,

once I buy a stock based on that hypothesis the market will help me quickly weed out those

that are incorrect and hold onto those that seem to continue being correct.

2. Stop losses. I know that I’ll regret firing my stop losses about 20 or even 30% of the time

and yet I’ll be happy with 50%, 60% or perhaps 80% of my stop losses. Winner

3. I’ll use a system to help me overcome my emotions. And yet I’ll be flexible …I know my

system isn’t perfect and I’ll have to evolve it over time…hopefully continually testing it and

then improving it over time.

Price

peaked at

about $77

Stop loss

about $68


Bonus Charts:

In this section I’ll sometimes list a chart that catches my eye and provide a brief comment.

If you want a stock reviewed, perhaps email me and I might include it (no promises)

Chart Comment

CAR** Looks a lot like it’ll cross upwards perhaps event this week. Will it then give a solid rebound?

REA. Also looks like it might cross upwards…again perhaps even this week. Will a solid rebound follow?


ANZ Has been rising solidly since about mid year 2016. Several other banks have also got similar patterns. Have you noticed this trend. R U onboard?

Parting comment

It’s generally tricky to observe the markets based on market prices at this time as so many buyers

and sellers are on holidays so volumes are low. If the wisdom of crowds do get prices right then the

size of the crowd has dropped dramatically

I wish you all happy holidays and happy new year. May 2017 be your best investing year ever. May

you learn more in 2017 than any year previously.

Warning. This newsletter is provided for your entertainment only, I’m not a financial adviser, I have not taken account of your objectives, financial situation or needs. You should therefore consider the appropriateness of any descriptions of my Newsletter and its newsletter portfolio in light of your objectives, financial situation and needs, before taking any actions.

All views and information expressed in this newsletter are not the views of Lincoln and or its directors, agents, representatives and employees.

I do invest and trade in shares, I’ll mark the ones that I own with (**)

You can handle the emotional side of investing This ... · 12/29/2016 · I’m sure you’ve all...

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