Most of us tend to believe that successful investors are financially savvy, and have a deep understanding of balance sheets, profit & loss, and valuations. There are many people who understand these well, and make for very good accountants and analysts but few graduate to becoming successful investors.
A basic knowledge of financial concepts is a necessary but not sufficient condition to be a successful investor. In my opinion, financial savvy explains less than 20 percent of an investor’s success.
What determines the balance 80 percent?
I knew a friend who had put in about 30 percent of his investible wealth in two high-conviction stocks. Like every savvy investor, he too realised that successful investing is not about avoiding risk, but about managing it. Over the next 12 months, these two stocks did extremely well. They beat the index by a good margin. One fine morning, all of a sudden, an unanticipated event resulted in the markets crashing. The float in these two stocks was low and their sector sentiments were negative. As a result, they spiraled down faster than the index. From being 60-percent positive they were now barely breaking even, and there were indications that they would soon be under water. My friend failed to understand and struggled with the thought that maybe the markets knew something he did not. Nothing he read on the Internet pointed to anything concrete. After agonising for a couple days, he sold his entire stock at just above his purchase price. The market, and these two stocks, continued their downward slide, and he secretly delighted at this because he had offloaded just in time.
Gradually, the sentiment reversed as the markets went up. The two stocks went up even faster. There was a buzz in the market about these stocks being great value picks. After having just escaped in the nick of time, he was wary of making a hasty reentry and was happy watching the developments from the sidelines. Things moved fast from here on, and before he knew it, these two stocks went past their pre-crash levels. At these prices these stocks were testing new highs. At a much lower price-to-earnings ratio compared to peers, these stocks would soon catch the fancy of investors and get re-rated. And eventually, a year down the road, they were five times his purchase price. He had lost the opportunity of owning a multi-bagger and the chance of being rich. After dabbling a little longer in stocks, he slowly went back to the safer fixed income instruments. He still lives in his modest apartment and wonders how some of his peers have been lucky with the markets.
There are several lessons couched in story:
- Leadership is rarely about knowing what to do or what causes something; it is, instead, about doing it and having the courage of staying the course when there is doubt all around: The leap that most leaders fail to make is between knowing and doing. Every prophet in history has provided a recipe for happiness, but happiness still evades most of us! Warren Buffett had disclosed the secret of his investing success, which is to “be fearful when others are greedy and be greedy when others are fearful”. For my friend, it needed guts to hang on to the two stocks when the market was plummeting, leave alone buying more of them. When an irrational panic (or exuberance for that matter) sets in, it is difficult for even the most hard-headed individual to avoid joining the frenzy. Running with the herd is such a basic survival instinct that few can break away. This instinct has been the bedrock of survival. Those who didn’t run with the herd were either eaten or starved to death. With such evolutionary muscle behind it, it takes real uncluttered thinking, and dollops of guts, to break away from the herd. In today’s world this ‘herd mentality’ is not particularly advantageous given that the risk of being eaten or starving to death is minimal! If you look around in the corporate world in general, particularly the startup world, you would spot a lot of companies chasing whatever is in fashion and avoiding what’s out of fashion. This 'me-too' strategy gives a company very little chance of doing anything game changing.
- Know who you are: Some investors love value investing, which is about spotting and buying undervalued stocks, while some others specialise in growth stocks. Some understand technology and some others are happy with blue chip stocks. There are others who specialise in spotting sunrise sectors early and placing sector-level bets. Successful investors are those that have a preferred strategy, are good at it, and stick to it. If you know your strengths and stick to doing stuff that requires you to leverage them, you are much more likely to be successful, and happy. Those who seriously dabble in stuff that they neither enjoy nor are good at, because this stuff is considered cool or financially attractive, are going to get up with a feeling of emptiness every morning – and gradually burn out.
- Ruthlessly avoid the noise while picking up the signal: We’ve all seen individuals glued to financial channels, watching every single programme, and following every single discussion. They would animatedly talk about derivatives trading, the latest macroeconomic triggers, company updates, and sector sentiments, all, if you notice, at a very superficial level. A market is a noisy place, and a stock market is no exception. It is very likely that if your investment decisions are based on such rapidly changing and swinging rumors, you can only lose money in the long run, though you might make a few bucks in a few transactions. Absorbing or trying to decipher the noise, and falling into an activity trap are some of the most common energy draining and wasteful pursuits in every walk of life – be it in investing, in your career or your personal life. If any of you have watched a penalty shootout in a soccer match you would know that the goalkeeper takes a premeditated leap to one side even before the striker hits the bill. This is the case even though rational and scientific evaluation has shown that the best strategy is to stay put. But the goalie will have a lot of answering to do if he stands put and a goal is scored. This is so true in companies. The Board has to be seen to be doing something to show they are adding value and influencing events, and everybody else too needs to be seen to be doing something. You tend to be flooded by so many faddy ideas that you can in an instant say are wasteful pursuits, but still need to devote some energy to because someone in the Board thinks that’s the next best thing after sliced bread. Have the guts and stay away, though you might need to invest in some lip service.
- The inexorable need to assign cause and effect: A lot of events around us, far more than we care to realise or appreciate, are really random. Random means a complete lack of a connection, at least a connection that even intelligent humans cannot make out. When markets go up, every analyst has an explanation! Most explanations are specious, superficial and couched in jargon. When markets slide down a few weeks later, the same analysts are offering reasons. Either they are so stupid that they really believe in what they are saying or are slightly smart and assume everyone has forgotten their previous argument. This need for jumping to conclusions is unbelievable in organisations. Every event will have an explanation. Having a hypothesis is perfectly alright if there is a commitment to test it before doing something based on it. There is an explanation on why the basket size has dropped this month, there is an explanation on why employee attrition has been low this month etc. Usually, the explanation, when the metric gets worse, is about some unfavourable condition, and when the metric improves, it is about what someone did. If you can avoid jumping to conclusions, if you can discourage hasty conclusions or ignore them steadfastly, your ability to lead and take the team in the right direction increases manifold.
A century earlier, war provided the perfect background and fodder for management theory and learning. Now, I find the stock market and the investing world a much better place to draw management lessons from.
(Disclaimer: The views and opinions expressed in this article are those of the author and do not necessarily reflect the views of YourStory.)