Really understanding an industry

Looking back on my past investing, I have invested in stocks that I don’t really understand.

I went long First Solar thinking that its unique technology gave it a low-cost advantage over the everybody else.  This was true until polysilicon prices crashed and the situation reversed.  First Solar is the high cost producer that’s at a severe disadvantage in the solar industry.  The ex-CEO and the short sellers were very adept at anticipating the future and were strong sellers of the stock when First Solar was trading at several times today’s price.

What I know about resource extraction

In my opinion, many of the posters on valueinvestorsclub.com (VIC) don’t really understand resource extraction stocks.  They don’t understand that resource estimates are not an exact science and are often (almost always?) inflated.  ATPG is an example of a stock I shorted despite multiple bullish VIC writeups.

In the future, I am going to work on (A) investing only in companies that are in my circle of competence and (B) on expanding that circle of competence.  As far as the former goes, I am doing poorly.  I am long junior exploration stocks even though I haven’t figured out a way of doing due diligence and verifying the economics of these projects.  As far as the latter goes, my opinion is that it is very difficult to expand your circle of competence.

Let’s take the junior mining industry for example.  To do due diligence on a company, you need the technical knowledge, access to up to date costing information, and (this may not happen) access to the company’s data.  You also need to understand the history of the sketchy junior mining industry and its little ins and outs.  There are little things that aren’t obvious, such as why companies will give away free money by extending warrants (it makes brokers happy so that they pump your stock, and the warrants are a cheap method of raising financing because  the cost of other forms of financing is expensive).  They also don’t tell you about how they spend lots of money on stock promotion, shills, inflated salaries for the part-time insiders and part-time CEOs, etc. etc.  And of course technical reports issued by these companies are often inflated… sometimes ridiculously so (e.g. Barkerville).  It took me a while to figure all this out.  And I am still not at the point where I can be confident when investing (speculating?) in junior explorers.

Predicting the future in a useful way

At the end of the day, investors really want to be able to:

  1. Spot likely winners (and the losers) in an industry.
  2. Know what you can’t predict.  Some things are just too hard.  Warren Buffett makes the analogy to baseball.  As there are no called strikes in investing, you can simply wait for the fat pitch.
  3. If possible, predict the macro trend of a particular industry.
  4. If possible, spot the inflection points and disruptive changes.  Warren Buffett was interested in 2-newspaper cities that were able to turn into single newspaper cities (since the lone newspaper would enjoy monopoly pricing).  On the other hand, Buffett generally invests in industries where disruptive changes are unlikely.  For example, he has bought very few technology stocks and companies (a private punch card business, IBM, and BYD).

Personally, I believe that Warren Buffett understands technology.  He is close friends with Bill Gates and has learned a lot about the computer industry from arguably the industry’s best CEO.  Buffett’s email exchange with Jeff Raikes of Microsoft also sheds light on Buffett’s thinking on tech.  I think that he avoids almost all tech companies because they are too hard to predict.  Perhaps I should too…

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