Investing is full of mistakes. If we are unable to accept we were wrong in our thesis around a stock and it is now time sell, well we won't last long in investing. Even the best fund managers are only getting 6 out 10 of their picks right the other 4 they need to accept they were wrong, sell and move on.
Fund managers may have been wrong because the fundamental analysis they conducted was incorrect. This could be stock specific i.e over estimating sales growth, EPS growth etc or it could be incorrectly assessing the macro environment be that the threat of new competition, current industry dynamics or economic growth. All these factors feed into an overall investment thesis and different managers and investing philosophies will weight different factors more highly than others.
Additionally, reams and reams of reports, books, and articles on psychological biases have been penned to explain outside of incorrect fundamental analysis why fund managers can be wrong and lose money on a stock. Recency, anchoring, ownership bias the list goes on and on. Now a good fund manager will recognise these biases and try and put practical steps in place to mitigate them as best they can. However battling deep-seated natural behaviour can prove very challenging even with preventive measures.
Reviewing our loss making positions can we be a good way to potently try and improve our investment process. If we can't learn from your mistakes we are doomed to repeat them. Some fund managers even look at their big winners and say, well what did we get right here and how can we endeavour to repeat what we did here with another stock in the future.
Asking fund managers how often do they sit down and review analytically their losers and possibly their winners should be a key question in any due diligence process for anyone involved in manager selection in my view. The fact that a fund manager actively sits down and performs the task demonstrates they are trying to hone their strategy and improve their investment process. A blank look when asked should be a red flag to any potential investors in my view.
One investing mistake that I feel that is widely overlooked is reviewing the stocks that we didn't invest in. Many fund managers at both ends of the spectrum are either kicking themselves that they didn't invest in a stock despite doing work on it. Or they will be breathing a sigh of relief that they dodged a bullet on a stock they did the work and eventually passed over and never bought for their portfolio.
As part of a good investment process, I think it worthwhile keeping a small journal with some bullet points of all stocks you have looked in a week or month and go back and review it on a 3 or 6 month basis after your initial analysis. For the stocks, you missed buying and subsequently shot the lights out try and identify what we missed in our analysis and say what can we learn from this, what can we do better next time, what change can we make in our investment process to avoid missing out on big winners in the future. The flipside, of course, is for the losers we avoided. Here is it about asking what have we got in our process that helped us avoid that stock, what if anything additional could we add to enhance our ability to avoid similar stocks in the future.
If investing is a mixture of science and an art then like all good artists fund managers need to hone their craft or investment process to try to achieve a certain level of mastery.
One such stock I missed the boat on after doing the work by selling to early by way of example was Joyce Corp (ASX: JYC). At the time Joyce was in the process of selling a large building at Moorebank. I thought the sale could rerate the share price as the building was roughly equal to their market cap at the time. The operating business you were then getting for essentially next to nothing. The sale went through, the stock went from circa 55c to $1.13 when I sold, all in the space of 6 months. Nice work I hear you say, but what I missed was that their operating businesses Bedshed, Kitchen Connection and Wallspan were all tied into the current housing boom. Post the sale the company now had a debt-free balance sheet and excess capital to grow the businesses. In essence, they were in a great position to capitalise on the housing boom. The stock recently hit $1.75 and has paid out some very nice fully franked dividends along the way. My mistake was only looking for one catalyst to rerate the share price and not looking for additional catalysts after the first one came to fruition. I was too blinkered by one line of analysis to see that the stock had other attractive attributes. Lesson learned to relook at a stock again after your initial thesis plays out to see if there is a second attractive thesis that could eventuate before wildly selling out and patting myself on the back for a job well done.