My investing mistakes and lessons that I’ve learned

This is a list of the most important things that I’ve discovered.  Sometimes I have learned these things the hard way.

Unethical management

It’s hard to make money if management steals from you or is overpaid.  You might also be buying into a company with inflated books.

It sounds so obvious that unethical management should be avoided.  But this wasn’t obvious to me at first as most investment books don’t mention it at all.  And boy did I learn things the hard way.

Don’t trust, just verify

There isn’t much of a connection between what management says and their integrity.  Some CEOs are very eloquent and say all of the right things.  Ignore it.  You really need to look at their actions and their past history.  The insiders who enrich themselves at shareholders’ expense are likely to do it again.

Mining lessons

  • You gain an edge from reading university textbooks on mineral exploration and mine engineering.
  • Almost all technical reports are inflated.  Gullible and naive me took a long time to figure this out.  I thought that these technical reports were supposed to create transparency for investors.  However, it is clear to me now that they don’t and that Canadian regulators rarely protect investors.  For example, companies are allowed to release press releases about technical reports before the report is filed on SEDAR.  Barkerville Gold has demonstrated the flaws with the current system.  Historically, Canadian regulators have often been a story of “too little too late”.  They continue to be ineffective in protecting investors.
  • You gain an edge from reading quarterly MD&As.
  • Almost all mining stocks should be avoided.  Perhaps this is an extreme opinion.  But I am fairly confident that many mining companies will do a poor job of generating shareholder returns (see my post on mining mania).
  • Very few institutional investors know what they’re doing when it comes to mining.

Don’t copy successful investors

In the past, I used to think that famous/successful investors really knew what they were doing.  I read the book Stock Market Superstars (by Bob Thompson), which interviews many notable Canadian money managers.  But as I started learning more about mining, I began to look into their stock picks and realized that they owned a lot of junior mining garbage such as Yukon-Nevada/Veris Gold, Barkerville, etc.  Nowadays, I think that most star managers are more lucky than skilled.  Sometimes stock markets exhibit bubble-like behaviour and cause those chasing the bubble to temporarily have very good track records.  It’s hard to figure out who is lucky and who is skilled.

Don’t copy other investors (do your own homework!)

Sometimes other investors don’t know what they’re doing.  See my previous post on shorting Value Investor’s Club.  On VIC, it seems that:

  1. Every company has a moat.
  2. The new CEO is going to do a better job than the old CEO.
  3. The stock is about to go up because management is about to get promotional.  They will talk to investors more, a road show is coming, the stock will be listed on a more prestigious exchange, etc. etc.
  4. If #3 doesn’t apply, management is praised for being non-promotional.
  5. There is going to be a turnaround that improves profits.
  6. Everything about the company is considered to be a good thing.  If there was recently a secondary offering, the stock will go up once the overhang clears out.  If the stock is about to have a secondary offering, the stock will go up because the extra capital is a good thing.
  7. Most importantly, the authors rarely understand the industry.  That is why they use dopey metrics such as peer EBITDA multiples, market cap per unit of resource in the ground, etc.  If they truly understood a particular industry, they would know the relevant valuation metrics.

Some assets are way too hard to value

Warren Buffett learned things the hard way when he bought GenRe and lost a lot of money on its derivatives book (Doug Dachille has an excellent lecture that explains everything).  A derivatives book cannot be valued accurately unless you get to look at the individual contracts.  Sometimes, both sides of a derivatives trade will report a profit (!).

I haven’t fully learned my lesson but mining assets are generally extremely difficult to value accurately, especially without access to engineering data and a team of specialized engineers.  These stocks should be avoided.

Some industries are too difficult to predict

Bill Gates has many failed predictions in his book The Road Ahead.  If somebody much smarter than me can’t figure it out (anybody who reads Donald Knuth books is hardcore), then what chance do I have?  I think that many tech stocks should fall into the “too hard” pile, even if you understand the technology.

Secondary offerings and IPOs

These rarely make sense for investors as the transaction costs are much higher than bank loans, leasing, and other forms of financing.  Underwriting fees, lawyers, and accountants eat up a lot of money.  It’s hard for investors to make money when the company spends so much money on raising capital.

The brilliance of Warren Buffett and “wonderful businesses at fair prices”

It took me a long time to realize that Buffett is a lot better than other value investors out there.  I wish I had paid more attention to him when I first started learning about investing instead of focusing on Joel Greenblatt, special situations, and commodity stocks.

Benjamin Graham came up with the idea of buying cheap and applying a margin of safety.  Buffett’s biggest innovation on top of Graham was to buy wonderful businesses at fair prices.  I think that most value investors still haven’t caught on.  On VIC, sometimes you will see writeups for quality businesses like Mastercard, Carmart (CRMT), MTY Food Group, and Altisource.  In many of those cases, the author of the writeup was only looking for a short-term profit.  In hindsight, those companies were worth holding onto.  (An exception would be Contango Oil & Gas.)

Theories that can’t be proven

People often have top-down theories about how businesses and stocks ought to work (myself included).  Most of these theories are wrong.  I need to be more careful about getting suckered into theories that seem to make sense but are very difficult to prove.  For a long time, I believed in the theory that we are in the middle of a commodities supercycle.  Maybe the theory is true… I really don’t know.  But the problem is that the theory is hard to prove or disprove.

  1. There hasn’t been many supercycles.  The supercycle theory might simply be a product of data mining.  If you perform too much analysis on random data, you will find patterns and correlations that aren’t there.
  2. The theory is vague.  How long is a supercycle supposed to last?
  3. The underlying theories don’t have too much empirical support.  In general, macroeconomic theories don’t have a lot of support for them.

Of course, most investing frameworks are difficult to prove.  Nonetheless, I think that the “wonderful businesses at a fair price” model has more empirical support than the commodities supercycle theory.

  1. There has been a lot of wonderful businesses throughout history, so there is a large number of data points that support the model.  It is unlikely that the correlation between wonderful companies and good stock performance is an artifact of data mining.
  2. You can quantify the theory.  Wonderful businesses are those that have high unleveraged pre-tax returns on capital.  (Though I’d admit that moats are hard to quantify.)
  3. The underlying theories do have some empirical support.  The mathematics of compounding favours companies with high returns on capital and earnings growth.  I think that there is empirical support for variances in skill, behavioral psychology, momentum effects in return on capital, buying stocks at low valuations, etc.

The second problem with the supercycle theory is that it seems to have weak predictive power when it comes to stocks.  The theory could’ve gotten me into a lot of trouble as it would predict that the TSX Venture will make money for shareholders.  I think that the TSX Venture will lose money on average, even if the commodities supercycle plays out.

Business is hard

Making money in the real world is very difficult.  To generate above-average returns consistently and reliably is very, very difficult.  Unfortunately, human beings like myself tend to be overoptimistic and don’t have enough skepticism when it comes to above-average returns.

Many of the companies posting above-average returns won’t repeat them.  Those in commodity industries are usually lucky.  New supply will usually flood the market and cause the business cycle to swing the other way.  Other overachievers are simply committing fraud or using aggressive accounting.  In other cases, businesses seem to be making money because they have taken on many tail risks that haven’t blown up yet (e.g. leveraged REITs betting on financial instruments; they blow up every several years).  It takes work to spot the truly wonderful businesses.

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15 thoughts on “My investing mistakes and lessons that I’ve learned

  1. I too was in the same boat as your maybe 7-8 years ago with CDN mining/oil&gas stocks and also learned the hard way… Until I discovered the likes of Warren Buffett and Peter Lynch which changed my entire perspective on investing and how to approach it

    Returns have been fantastic since and I have been able to sleep real ever since practing the motto of buying wonderful companies at fair prices and have recently summarized my approach which was echoed by Charles Munger “compounders, cannibals and spin-offs”

    Great post and keep learning

  2. Great post.

    Seeing as how these are your opinions of commodity stocks, why do these seem to be the types of companies you write about and/or own most? Or now that you have these opinions, will that change?

    • Good question!

      A year or two ago, I made an effort to really understand mining. So I went to the public library and started reading (e.g. university textbooks). Because of that, I’ve looked at a lot of mining stocks.

      The second reason is because I try to avoid currency conversion in my TFSA and RRSP accounts. So I only buy Canadian stocks in those accounts. This forces me into Canadian stocks. And of course, mining accounts for a huge chunk of the Canadian stock markets.

      The third reason is because the TSXV has been getting hammered, so I thought that I would focus there and look for bargains. In the future I don’t want to own as many mining stocks.

  3. Pingback: Learning from investing mistakes | Alpha Vulture

  4. Lesson 1 in my opinion – Is the stock cheap today? Too many people talk about how a stock is cheap based on a (potential) turnaround. Turnarounds take longer than planned, more capital than planned, if the turnaround even works. I have been arguing that for Yukon/Veris for some time. I hope I saved someone money there, (in hindsight) too bad I didn’t short the shares.

    • Personally I don’t think that there is such thing as a mining turnaround. There is little room for the mine engineers to improve operations and to create value. There’s only so much that the engineers can do.

      It was pretty obvious to me that Veris/Yukon was going to be a disaster. You always try to mine the most economic ore first, so a mine’s economics will get worse over time. That’s the reason why the mine shut down in the first place.

      • You are right about mining turnarounds, even less work (from my perspective, I don’t have any hard statistics on this) versus other industries. Veris/Yukon was just a current example I had in my mind and one you mentioned in the article.

        My original comment was really for all industries. Is the stock cheap today? If not, really think hard about buying into it because things don’t work out as planned. Investors get excited for a turnaround that A,B, and C will all be positive catalysts and focus on those. Investors then ignore X,Y, and Z which are all negative catalysts.

  5. Really great thoughts. Glad I somehow stumbled across this. Also, great write-up on shorting VIC. I was just reading a post last week about Dolan Media and couldn’t understand why it was receiving such praise from VIC.

  6. What do you have against Joel Greenblatt and special situations? Just interested to hear your thoughts as I’ve been studying him much more later. Great blog by the way.

    • Betting on these special situations takes a huge amount of time and is mostly a “luckfest” (my term). You’re making a lot of trades in companies that you don’t understand. Sometimes spinoffs double or triple, and sometimes they go to zero. I don’t like that style. And I don’t think that special situations like spinoffs give you a large edge over the market. Most spinoffs don’t make economic sense. It’s a lot of professional fees wasted to shuffle paper around. It does not generate value. I think I’d rather see companies stay complicated and buy back their shares. Maybe this is because I believe that CEOs should try to generate long-term value for society and shareholders. They shouldn’t engage in paper shuffling nonsense (even if it causes the stock price to jump in the short term).

      Greenblatt is good, but Buffett is a lot better. For example, Greenblatt’s books don’t talk about integrity.

      • This is a really late reply (loving your blog, reading everything from start), my apologies.

        But I basically disagree about Greenblatt (who’s a product of Graham, Maurece Schiller & a little bit of Buffett) being worse. Greenblatt and guys like Klarman merely admit upfront that they are not as good as Buffett in delineating what makes a great vs merely good business, but they, like Buffett are excellent at sizing up odds. And so they search for situations where — as Nassim Taleb calls it — the price (risk) being paid for the chance of windfall is less than the bottom of the range of conservative probabilities that such windfall prevails.

        Indeed, as Graham himself put it in all editions of intelligent investor, “the future is a hazard which the investor must guard against.” The fact that one gets lucky in my view is exactly the point or a product of the point: I want to pay as little risk as possible for the romantic chance of getting a little lucky. This doesn’t mean I’m counting on luck (that would be speculation); it merely means, for instance, I prefer not to pay a price for Tractor Supply Company which relies on high chance that the company’s store-opening runway is large enough (including displacing Wal-Mart) to maintain it’s growth and hence justify my price paid. And as Buffett himself noted in the past, he’s done it long enough to know that Special Situations has averaged over 20% compound returns going back all the way to Graham.

        This is one of the reasons I continue to see more similarity between Taleb and Buffett/Munger
        than between many value investors and the later. Of course, this is a heretical statement for the purist. I do agree about the lacking Buffett’s integrity part. Although, reading between the lines of Buffett’s career, he’s been pretty ruthless himself (indeed, you probably have to more ruthless in controlling businesses than taking a true passive stake).

        Thanks again for a fantastic blog.

  7. Just found this blog – great site! Thanks for sharing your experiences.

    W/regard to “wonderful businesses”, would you say that high unleveraged pre-tax returns on capital are a necessary, but not a sufficient indication of a moat? What quantitative aspects (looking at the financial statements) would add to your conviction that there is a moat?

    • The returns can’t be due to cyclicality.
      The returns can’t be distorted due to leverage.

      And the part that took me a while to understand is that the company must have some type of unique competitive advantage or moat that keeps competition out. Competition is bad for unusual returns. If you are Fannie/Freddie, you have a low cost of capital. If you are a broadcaster, there’s only so much spectrum (in the future that moat may become irrelevant). etc. etc. Those things don’t necessarily show up in the financial statements.

      Most companies don’t have moats. Some are able to generate high returns due to an excellent manager. Once that manager leaves, returns drop.

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