Late last year, in a post titled “Go where it is darkest”, I argued that the best investment opportunities are likely to be found in the midst of fear and uncertainty. I looked at two companies, Vale and Lukoil, that were caught up in perfect storms, where commodity prices had moved against them, the countries (Brazil and Russia) that they were located in were in turmoil, the local currencies were in retreat and the companies themselves faced corporate governance questions. I concluded that post with the statement that I was investing in Vale and Lukoil, notwithstanding the high risk in each one and the uncertainty that I felt about valuing them, because the risk/return trade off seemed to be tilted in my favor. A few months later, with my investment in Vale down substantially and the investment in Lukoil treading water, I decided to revisit the valuations.
Looking Back: Testing your investment serenity!
Satchel Paige is rumored to have once said “Don’t look back. Something might be gaining on you” and most of us take his advice to heart, especially when it comes to investments that have gone bad. We spend almost all of their time thinking about investments that we can add to their portfolios, we repeatedly check on our “winners”, crediting ourselves for our foresight in picking them, and we studiously avoid looking at the “losers”. Studies of investor behavior find substantial evidence that investors hold on to losers too long and that they are quick to blame outside sources or bad luck for these losers, while attributing winners to their stock picking skills.
I believe that the biggest mistakes in investing are made not in what or when you buy, but in what or why you choose not to buy and what and when you sell (what you have already bought). I know that I need to look at my past investments, not to lament mistakes I have made or to wallow in regret, but because each investment in my portfolio has to meet the same test to remain in my portfolio, as it did when I first bought it. As an intrinsic value investor, that test is a simple one. I should buy when a stock trades at a price below its value and should not if it trades above value. Consequently, when I look at my portfolio this morning, I should apply the same rule to every investment in it, asking whether at today’s price and today’s estimated value, I should buy more of that stock (if it has become even more under valued), hold on to it (it is remains under valued or has become fairly valued) or sell the stock (if it has become over valued).
Simple, right? Yes, if are a serene investor who can be dispassionate about past mistakes and rational in your judgments. I am anything but serene, when it comes to assessing past investments and I know that what I choose to do will often be guided by the worst of my emotions, rather than good sense. I will double up (or down) on my losing investments, not because they have become more under valued, but because of hubris, will hold on to my losers, because denial is so much easier than admitting to a mistake, and sell because of panic and fear. While I cannot will myself to rationality, there are things that I try to do to counter my all-too-human emotions.
- Due Process: Left to my own devices, I know that I will selectively revalue only those investments that I like, and only at the times of my choosing, and ignore revaluations that will deliver bad news. It is for this reason that I force myself to revalue each investment in my portfolio at pre-specified intervals (at least once a year and around significant news stories).
- Spread my bets: I have found that I am far more likely to both panic and be defensive about investments that are a large portion of my portfolio than for investments that are small, one reason I stay diversified across many stocks (each of which passes my investment test) rather than a few.
- Be explicit in my valuation judgments: I have found that is far easier to be delusional when you buy and sell based upon secretive, complex and closed processes. It is one reason that I not only try to keep my valuation assumptions explicit but also share my valuations. I know that someone will call me out on my delusions, if I try to tweak them to deliver the results that I want.
- Admit publicly to being wrong: I have tried to be public about admitting mistakes, when I make them, because I have found that it frees me to clear the slate. I must admit that it does not come easily to me, but each time I do it, I find it a little easier than the last time.
- Have faith but don’t make it doctrine: I have faith (misplaced though it might be) that I can estimate intrinsic value and that the price will eventually converge on the value and that faith is strong enough to withstand both contrary market movements and investor views. At the same time, I know that I have to be willing to modify that faith if the facts consistently contradict it.
I can hope that one day my investment decisions will not be driven by need to defend, deny or flee from past mistakes, but I am still a work in progress in my quest for investment serenity.
Vale and Lukoil: The Original Rationale
[drizzle]I invested in both Vale and Lukoil at the time of my original post (November 19, 2014) and justified my decisions on two fronts:
- The Macro Argument: I argued that since both companies were being weighed down by a combination of commodity price, country, currency and company risk, a lifting of any one of these weights would work in favor of my investment. I did confess that I had no market timing skills on any of these fronts and that I was drawing on statistical likelihood that one or another of these weights would lift.
- The Micro Story: I picked these companies in particular, rather than others in these markets that faced the same risks, because I felt that they were better positioned both in term of surviving continued market troubles and that they were under valued. In November 2014, I felt that Vale was a better bet than Petrobras, partly because it carried less debt and partly because the Brazilian government had not been as active in directing how the firm was run. At that time, Lukoil carried less debt, was less entangled with the Russian government and had better corporate governance (everything is relative) than Gazprom or Rosneft, two other Russian commodity companies.
My valuation of Vale at the time of the post is summarized below:
At $8.53/share, it looked under valued to me, even with significant drops built into its operating income.
With Lukoil, the valuation at the time of the post is