I am The Greater Fool
I am The Greater Fool
Improving my process one mistake at a time
Around this time last year, I had a big winner. It was the first time I thought for myself and got it right. Hearing the name of the company brings me back to a time and place filled with happiness and nostalgia like listening to an old song. The company was named Atlantic Power, an independent power producer with 13 power plants and long-term contracts to sell energy to local utilities. It was run by an individual who had prior experience rolling up these kinds of situations before and he planned to do the same.
When it came to my analysis, I didn’t have to think too much. I read his shareholder letter and he said at the end of it he estimated the equity value of the company to be around $3 a share. I put the letter down, looked up the ticker, and saw it was $2 a share. My stomach dropped, my heart began to race, and it was hard to swallow.
“Did I just find buried treasure?”
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This immediately became priority 1 and I did the mad dash investors do when they’re onto something. It’s like writing a news-breaking story or trying to crack a case as a detective. The process consumes those who give themselves to it.
After digging I came to the conclusion his math was probably right and I took a position. It wasn’t huge but with the limited funds I had scrapped together in school living on next to nothing, it meant something to me. I worked like hell for the next year and a half to save money and build the Atlantic Power position up to a higher level in terms of dollar figures because “portfolio allocation” doesn’t mean much when you have little. This idea had my highest conviction and I wanted to get as much in as possible. This kind of situation was one I had been dreamed about. Scouring annual reports, finding little clues in the footnotes, and then betting heavily on my conviction. Charlie and Warren would be proud.
On January 12th, 2021, I opened the door to get into the truck with my boss on the ride to work. He pulls out of the park and rides and says, “Did you see what happen to Atlantic Power?”
“No?” I peered over.
“It’s up 40% premarket.”
“WHAT!” My body went numb. I scrambled to look at the app on my iPhone and sure enough.
I only felt this feeling a few times in my life; big championship wins, getting a better grade on a test than expected, or breaking school records. The nights spent up late studying the numbers, checking, and rechecking every few months finally paid off and I made 50% on an investment that moved the needle for me. I would put this win in the same column as the others.
The company was acquired and I sold the shares that morning on the news, pocketed the win, and thus began looking for the next investment and found it 3 days later. This was the beginning of my next mistake.
I heard the pitch and was able to get up to speed over the weekend. There was a big name value investor who owned 20% of the company and it was easy to see the margin of safety was huge. So I went all in.
I plowed all the earnings from the Atlantic Power win and then some blindly following the prescription of Munger that you MUST go big in your best ideas because the opportunity cost is too grave not to. I went HUGE. Riding the high from the big win I felt invincible and made the new bet of about 40% of my net worth. I decided to size it so my earnings from my day job would dilute the weight over time as I saved more. I rationalized it in my head as, “If I am wrong I can just work more to make the money back.”
About 8 months later I went big in a similar fashion to the one described above. I felt like I was hit over the head with a 2x4, Charlie’s words and the visualization of being right like I had previously experienced pushed me to go even bigger than my investment in January. But I went so big I couldn’t sleep at night and the risks associated with the investment, if materialized, would be unforgivable. Plus the stock was down 30% since I bought it. There is nothing like losing money that keeps you humble. After tossing and turning I sold the position down to a much more manageable level.
I have heard a quote before that the time between you buying and selling a stock shows the gravity of your mistake. The sooner after buying, the larger the mistake. After selling the position down only 3 days after taking it bigger I made a huge mistake. It became obvious to me, and I’m sure obvious to dear reader, that there was something in my process that needed fixing. After racking my brain for where I went wrong it was time to go back to the drawing board and restructure my investment process to focus on reducing errors like this.
Howard Marks has the ability to distill the complex nature of the investment world down into simple sentences anyone can understand. After my mistake, I sought refuge in his book, The Most Important Thing, and focused entirely on his risk section. It didn’t take long for me to realize if I kept investing the way I did one day I’d get killed. The process was sloppy and I was reckless. A disappointing admission.
I came out of school with the idea that I would set up my financial affairs in the same way Warren set up Berkshire, keep a conservative balance sheet, let cash pile up, and swing at your best idea’s hard. Warren has also been quoted saying “If I was running small money I would put 40% of my net worth in my best idea” and I took this as gospel but the most logical rebuttal I have heard to this was, “Warren wouldn’t take a 40% position without some sort of control” and I believe that to be true. But here I was with 80% of my net worth in two stocks with no type of control whatsoever, pretending to be the next Buffett. What a joke.
There is another detail that makes me look even more insane. To build the next Berkshire you need stability and at this point in my life, there was none. I was transitioning to a new job, moving out of my parent’s house, and began the process of becoming an adult which comes with a lot of unknown unknowns. After watching a year’s worth of saving and spending data, I have much better base rates for forecasting my future savings. With this new perspective, I took a hard look at my investment portfolio and asked, “What if I’m wrong?”
There was no good answer. If either position took a hit of size I would be prolonging my ability to achieve my goal of spending more time with investments and writing about what I pleased. I had no protection against tails, and to make matters worse, one of the investments was in a satellite broadband company that straps a $1 billion asset to a rocket. There is actually a blow-up risk. I was and, still am, a fool.
A side note, the stake is much less than 40% now. I might be leaving on the table but at least I can walk away with money in my pocket at the end of the game no matter the outcome.
After a re-enlightenment with Professor Marks, I had a newfound respect for Risk and the topic began to really soak in deeper than it had before. I was no longer the kid out of college with little savings trying to shoot the lights out. The portfolio now hovers around a year and a half of living expenses and I want to protect this garden with my life and cultivate it so my little family will be able to reap what I am sowing years from now.
The switch didn’t flip from “must-win” to “don’t lose” overnight. It actually is sad how long it took, considering how much Buffett and Munger content I have consumed. They preach not to let yourself sink deep into any specific ideology and while I follow that, I poured over their writings and materials like a bible and cited many of their remarks for reasoning in my own decision making. See the irony?
I began to really think over the things I had done in the past because “that’s what Warren would do” and started to really question myself and ask “what would I do?”.
My portfolio didn’t pass my new sniff test. It’s hard to say you are trying to be risk-averse while also maintaining 80% of your net worth in two stocks and as time passed my comfort with the risks in one of them began to take up more headspace than I wanted but I stayed massively concentrated because Uncle Charlie says to go big in your best idea and walk away. But, no one tells you this approach has massive path risk. No one, except Dan McMutrie.
I am not going to try and blow smoke but I do admire the guy. He came out of Notre Dame and launched his fund in his early twenties. Now older with the scars and wisdom to tell war stories he has done around 3 podcasts over the last year and I have consumed each of them multiple times. He is a strong force with plenty of logic behind his ideas and this kind of strength was needed to overcome my deep Buffett ideology.
In one of the podcasts, Dan introduces this idea of path risk. Although there is no clear definition, here is what I was able to pull from it. If someone comes up through the Buffett and Munger school of investing they are taught to concentrate on their best ideas. Why? Because the opportunity cost of not going big and being right is large. But they neglect the other side of this idea. What if you go big and are wrong?
Truth be told I didn’t think much about this side of the coin because my brain was too distracted by the money I was going to make if I was right. Even though I felt the odds were in my favor, any gambler knows it’s reckless to bet a large portion of your bankroll on one hand because being able to keep playing the game is more important than any one win.
My level of concentration exposed me to black swans and if there is one thing Taleb has taught me, it is that they come around more often than you think. I want to be able to invest in all environments and if a black swan hit one of my 40%postions, it would be detrimental to my net worth when you take into account what a big loss can do to long term compounding.
I wised up. I took my positions down to a much more manageable level and put a few more names in the portfolio. Yes, this means I might not be optimizing for returns but the overall risk profile is much better. Should a black swan show its ugly face in any one name, the hit will be much more manageable and won’t sink the ship.
My investment goals have shifted over the past few months to a much more defensive stance. The real goal is to stay in the game as long as possible, achieve above-average returns while taking on below-average risk. After spending time with Professor Marks and listening to Dan speak I knew it was time to go back over my portfolio and restructure it in a way to withstand the hard sea that is investing in the markets. I am thankful to come to this conclusion now and not after a bone-shaking loss. If only Buffett advocated for a rule that emphasizes defense first.
Oh, Wait.
Peace and love,
Michael
Please be advised, Wall St Gunslinger is not an investment advisor and does not give personal investment advice. All content is for educational and entertainment purposes only and should not be interpreted as anything other than such. Investing entails a lot of risks and should be managed appropriately. Please do your own research and consult with an investment professional before making any investing decisions. Thank you.