How certain is certain ? How can we be sure when we look at an investment ? Do we really get the risks and are we able to really quantify them ?
In a very real sense the answer to all those questions is somewhere less than crystal clear. If it were possible to be that accurate, there would be a small band of people owning it all… and there is not.
We can look at all the reports, we can look at the published RNS’s, we can dig about the internet or even get on our bikes and go look (possible with a lot of retail and manufacturing places). We can get a real sense of accuracy. But we cannot know it all not least because we cannot know what the prospective customers of companies will do.
There are of course several different types of investment strategy:
1. Value Investing – essentially looking for solid fundamentals (that warm glowing feeling again) but with a price we believe is not reflected properly or that what we perceive as significant growth prospect is not proceed in.
2. Income Investors – the dividend hunters of this world. Looking for solid, reliable and above all growing incomes. Inevitably this tends to older, more established and widely diversified holdings that can manage the different cycles and smooth a shareholder return out … the so called ‘dividend aristocrats’.
3. Contrarian – the likes of Woodford in the UK who is currently out of favour. Having spent a career working for someone making oodles of cash set out on his own and has lost a quarter of his investors billions (on paper). Funny thing is, some of his investments are now looking like turning the cycle. Its all prospective growth 5 years+ down the line really.
4. Growth Investors – those seeking out a holding about to spurt. It is never about income but only about growth prospects. I see postings by individuals and it always strikes me they are just traders really and not investors…. takes all sorts though.
And so on … there are many other names people use and variations on a theme.
In all ways we may choose, and I am rather coming round to a variety for different lumps, durations and purposes, we are in a very real sense placing a bet.
I am not a gambler. Occasional few quid on a sweepstake on the Grand National, a few of us chucking a few quid in a pot and taking it in turns to predict the 6-nations. I have a couple of friends in my village that put a tenner in their online betting accounts once a month and bet a quid or two on the football. All this, is a bit of fun for us to laugh at, maybe get a surprise and have to buy the beers. In no sense are we really ‘gamblers’ and in no sense are we really ‘investors’ looking for a return.
For most PI’s buying holdings we in a real way must all view ourselves as ‘investors’ (or perhaps in some cases ‘traders’). But given we invariably have incomplete information, what we do not on the whole recognise is that we are placing a bet, albeit a calculated one. We accept a risk.
Human psychology around betting behaviour is very well used and abused. I recently went to a lecturer from a software geek in the gaming industry. It was astonishing the levels they went to in code to determine what extracted the most money from punters buying ‘widgets’ and ‘addons’. The level of sophistication was incredible.
Kahneman & Tversky in their paper on Prospect Theory (Prospect Theory: An Analysis of Decision Under Risk, Econometrica Vol 47 Mar 1979) clearly postulated that decision making when there is risk is essentially a choice between definable prospects (of success or failure) and gambling. They describe with some simple mathematics a means to calculate (or at least define) a way to compare and evaluate the risk or prospect. In lots of ways it comes down to cognitive behaviour. For example, say you invest £1000 in a holding and it rises to £1200. We all naturally feel very good and start patting ourselves on the back for our wisdom. But suppose it rose to £1300 and then fell back to £1200. We do not feel on the whole the same as we perceive that we made a loss of £100. Prospect theory is all about our perception of outcome and how that makes us feel. This cognitive quirk leads to so many PI’s selling holdings that fall even after they have risen strongly. As Warren Buffett said ‘the stock market is a device for transferring money from the impatient to the patient’.
I look back at some of my earlier investments and certainly fell foul of that…. but I have learned that information and understanding are king. I have a current investment where my holding (average of 6.2p per share) went to 49.9 in December and fell back with a couple of bounces to 24p before moving up very strongly over the last couple of days to 32p on stonking news (and that is only the start). I have not sold a single share and see a price well in excess of 200 as realistic within 3 years for reasons I shall not go into, but no end of PI’s have been bailing right the way down forgetting why they invested and where the potential takes it. This despite a very large body of accurate and well researched material available. The fear of loosing more just overwhelms (despite the fact it is paper loss only) and the NAV is way higher than the current MCAP so the real risk right now is small.
Fundamentally, the real ‘prospect’ underpinned by real facts is drowned out by the fear of making a paper loss as the price moves up and then down. The long term is drowned out by the near term imperative to realise a gain that is larger than one tomorrow (as the price falls back)….. totally ignoring the long term.
This cognitive bias dominates because deep down, our brain tells us we are making a bet and not because we are investing….. Investing is about a way longer viewpoint, with real goals and a good understanding of the journey to get there.
How many of you honestly make a purchase or sale with your gut ?
In a strange way, the journey I started on Personal Investment Policy is a great help. I am forced to confront and start to define a set of criteria of how I select a holding, how I appraise its risk ongoing and at what point to I sell out or slice. We should on the whole be making purchase and sale decisions based on facts and a set of selection criteria’s where we can quantify the decisions and articulate them (write them down maybe !!). If we do this we cease being punters taking a bet (however informed we feel we may be), but rather make a balanced investment choice with a risk that we can quantify and balance in a portfolio.
So the question is … do you invest or do you bet ?