Volatility – Of Haystacks, Poker Games And $20 Bills On The Sidewalk by Matt Brice, The SOVA Group
Warren Buffett has famously said, “If you’ve been in the game 30 minutes and you don’t know who the patsy is, you’re the patsy.”
A specific anecdote along these lines is this brief story:
ADW Capital’s 2020 letter: Long CDON, the future Amazon of the Nordics
ADW Capital Partners was up 119.2% for 2020, compared to a 13.77% gain for the S&P 500, an 11.17% increase for the Russell 2000, and an 8.62% return for the Russell 2000 Value Index. The fund reports an annualized return of 24.63% since its inception in 2005. Q4 2020 hedge fund letters, conferences and more Read More
Jim Rutt, formerly both the chief executive officer of Network Solutions and chairman of the board at the Santa Fe Institute, recently gave a talk about his experience in business. He mentioned that he played a lot of poker when he was young, became pretty good at it, and made some money.
Rutt assumed that the best way to ensure continued success was to improve his skill, so he worked diligently at honing his game by learning the probabilities for each hand and studying other players for clues about the strength of their position. At that point, an uncle pulled him aside and doled out some advice. “Jim, I wouldn’t spend my time getting better,” he advised, “I’d spend my time finding weak games.”
There is an idea among value investors that the best way to win at investing is find the “weak” poker games.
Let’s start with games that don’t involve weak hands: Google, Facebook, Microsoft, Apple, Berkshire, Exxon and Amazon. Top 7 largest companies by market capitalization in the US markets. Not your weekend night dive poker game, right?
In order to avoid these names, your typical value investor might dig around much, much smaller market cap names, or potentially the OTC markets, look for companies that are “dark”, Spanish airports, Russian media names. These value investors remind me of the story from Dr. Seuss….
Another term for this is trying to find the needle in the haystack. I admire the diligence and efforts of people looking for the needles. However, the thought often occurs to me that not every haystack has a needle. In fact, why would you look for a needle in a haystack?
My point is that value investors often approach investing with a “bottom-up” perspective, focusing first on the companies instead of an overarching macro view. However, this bottom-up approach is sometimes clouded by a search for “weak poker” games. Poker is a unique situation where there has to be a winner. If you are the best player in a weak game, you will probably win. However, if you go looking for companies off the beaten trail, there is no guarantee that you will win any card games just because you are picking up a lot of rocks that haven’t been touched in years (do I win any prizes for mixing three metaphors into one sentence?).
The first thing I learned in Economics 101 is that if there is a $20 bill on the sidewalk, it really is not there. And like most “first things” you learn, I think this idea is wrong.
Let me return to the discussion of the top 7 companies by market capitalization. Below is a graphic of the volatility in these names over the past year. Berkshire moved “only” 20% this past year, Exxon over 30% and the rest all over 40%, with the winner being Amazon at 72%. During the past year, the S&P Index, the benchmark for the vast majority of investors, is up less than 1% (around 2% if you include dividends) and has only moved 17% over this same period. I am not saying value investors should look at the top 7 companies, but I would like to make a few points.
One Year Volatility in Top 7 Companies by Market Capitalization
Successful investing is buying good business at a discount to their intrinsic value. You don’t need to be playing in weak poker games to find this. Don’t confuse playing in a weak poker game (i.e. small cap companies, foreign markets, etc) with ensuring the purchase of good companies at a discount. Focus on being a business analyst instead of a stock market analyst.
- You don’t have to look for weak poker games to generate good investment results.
- Lots of “weak poker” games in the market end up having no winners, just poor companies with poor returns.
- There is no “extra credit’ in investing if you find a needle in a haystack when you passed up a bunch of $20 bills on the sidewalk…