Don't Get Wiped Out By Our Investment Mistakes!

It has been mentioned far too many times that when you 'play' the share market you need to pay tuition fees. And by making mistakes is how one learns to be better in the share market.

Pay to learn is what they teach you.

But if one pays too much and too often, isn't there a chance one might just quit the game? Who wants to lose all the time? And if one quits, what about all the tuition fees paid?

Or what if one pays so often that it wipes one out financially?

Ah, for me, this is why limiting the cost of one’s mistakes simply paramount to one’s financial health.

And one does that by learning from one's mistakes and better still, we try to learn from other people's mistakes.

Making a wrong judgment is so easy.

Remember always, we are just normal investors, normal investors who would always make mistakes!

So what is a wrong judgment?

Say you invest in a stock and the simple reason is that you expect it to be making more money each year. Now, upon studying the evidence given to us via the current quarterly earnings announcements, we discover that the company is not making more money but instead it is making so much less money each quarter. You expected the company to make more money this year but it did not. Instead, the company's earnings have declined drastically.

Doesn't this mean we are wrong?

Look at it, for whatever reasons, the stock's earnings are not growing but instead its earnings are declining.

Do we want to admit we are wrong or do we take a self-denial approach and give ourselves personal satisfaction by insisting that we are still correct?

And perhaps we would take extreme measures such as finding various (wrong) reasoning to justify to ourselves that it wasn't us that were wrong but it was due to some unforeseen circumstances beyond our control that made our stock selection not correct for the time being.

But hang on a minute here.

Whether it was us that were wrong or not, it matters not, we are still holding on the ticket(s) to a stock whose earnings are declining drastically. And the market it compounds the matter worse by punishing the stock via heavy selling. How? Do we want to be in a situation where we get punished so drastically that it wipes us out of the game? No possible?

Or do we want to live in a delusional world and cheat ourself by insisting that a a paper loss is NOT a loss?

Or how about we invest in a stock because the company is making a massive plant expansion and through our own reasoning, we believe this plant expansion should reward us handsomely. Well, that is a valid reasoning to invest in a stock. But what if the plant expansion runs into massive problems?

Not possible?

Such as, we did not foresee a drastic increase in borrowings to finance the plant. Or for some reason or another, the plant is still not completed. Or when the plant is completed, the economics of the product which the plant produces changes drastically? For example, the product could go out of favor or the product faces new intense competition by other plants or perhaps a new substitute product has been accepted by the market.

Cutting it short, what if this plant expansion is not going to be as rewarding as what we ass-u-me it would be?

Isn't it not possible?

Isn't it possible that we could have a brand new plant but insufficient business to cover the cost of this investment to build the new plant?

How? Once again we are wrong!

We had bet the plant would deliver but it did not happen. Is the best move to accept that our speculation that the new plant would bring more profit is simply wrong? Or do want to take the self-denial approach by hoping that the fortune of the plant would improve in the future? Ah, it is possible but look at what we are doing. Instead of investing, we are now hoping that the market would correct our investment mistake. What if we are not lucky enough? Would the market punish us by wiping us of the game?

Remember if we are really wrong, and no matter how much longer we wait, we are still wrong!

In the share market mistakes costs us money.

So how big a mistake do you want to make? And how costly a mistake do you want to make?

Don't we want to make sure that our mistakes don't wipe us out?

Remember the idea is to find ways of controlling our risk so that, if we are wrong, we don't get killed.

Look at the greatest investor of them all, Warren Buffett. Even he devotes a lot of time on the issue of mistakes.

There was a wonderful compilation of Warren Buffett's sayings done by Bud Labitan called "The Warren Buffett Business Factors" but unfortunately the link I had recorded is broken. In it, there was this one section which was devoted to Warren Buffett's mistakes!

Now think about it... if the great legendary investor acknowledges and admits to his mistakes... what about us, the average mistakes?

Aren't we but normal buggers who are even more likely to make investing mistakes? How?

Anyway here's some comments on some of the stuff written.

Some Mistakes

To quote Robert Benchley, "Having a dog teaches a boy fidelity, perseverance, and to turn around three times before lying down." Such are the shortcomings of experience. Nevertheless, it is a good idea to review past mistakes before committing new ones. So let's take a quick look at the past.

==> Review the past before committing new ones! Do we want to be repeating the same mistakes over and over again?

If a man didn't make mistakes he'd own the world in a month. But if he didn't profit by his mistakes he wouldn't own a blessed thing. - - Edwin Lefevre - Reminiscenes of a Stock Operator.

My first mistake was in buying control of Berkshire. Though I knew its business – textile manufacturing - to be unpromising, I was enticed to buy because the price looked cheap. Stock purchases of that kind had proved reasonably rewarding in my early years, though by the time Berkshire came along in 1965 I was becoming aware that the strategy was not ideal.

==> Hmmm....The folly of buying a stock solely because of the price factor!

If you buy a stock at a sufficiently low price, there will usually be some hiccup in the fortunes of the business that gives you a chance to unload at a decent profit, even though the long-term performance of the business may be terrible. I call this the "cigar butt" approach to investing. A cigar butt found on the street that has only one puff left in it may not offer much of a smoke, but the "bargain purchase" will make that puff all profit.

Unless you are a liquidator, that kind of approach to buying businesses is foolish.

First, the original "bargain" price probably will not turn out to be such a steal after all. In a difficult business, no sooner is one problem solved than another surfaces - never is there just one cockroach in the kitchen.

==> how true? In a bad business, the problems, the bad lucks, they are usually endless! Yes?

Second, any initial advantage you secure will be quickly eroded by the low return that the business earns. For example, if you buy a business for $8 million that can be sold or liquidated for $10 million and promptly take either course, you can realize a high return. The investment will disappoint if the business is sold for $10 million in ten years and in the interim has annually earned and distributed only a few percent on cost. Time is the friend of the wonderful business, the enemy of the mediocre.

==> Ahh also refer to The Lousy Business

I could give you other personal examples of "bargain-purchase" folly but I'm sure you get the picture: It's far better to buy a wonderful company at a fair price than a fair company at a wonderful price. Charlie understood this early; I was a slow learner. Now, when buying companies or common stocks, we look for first-class businesses accompanied by first-class managements.

That leads right into a related lesson:

Good jockeys will do well on good horses, but not on broken-down nags. Both Berkshire's textile business and Hochschild, Kohn had able and honest people running them. The same managers employed in a business with good economic characteristics would have achieved fine records. But they were never going to make any progress while running in quicksand.

==> Ahh.. when the business economics of a business is lousy, it does not matter which 5-star manager is running and managing the business?!

I've said many times that when a management with a reputation for brilliance tackles a business with a reputation for bad economics, it is the reputation of the business that remains intact. After many years of buying and supervising a great variety of businesses, Charlie and I have not learned how to solve difficult business problems.

What we have learned is to avoid them.

To the extent we have been successful, it is because we concentrated on identifying one-foot hurdles that we could step over rather than because we acquired any ability to clear seven-footers.

The finding may seem unfair, but in both business and investments, it is usually far more profitable to simply stick with the easy and obvious than it is to resolve the difficult.

On occasion, tough problems must be tackled as was the case when we started our Sunday paper in Buffalo.

In other instances, a great investment opportunity occurs when a marvelous business encounters a one-time huge, but solvable, problem as was the case many years back at both American Express and GEICO. Overall, however, we've done better by avoiding dragons than by slaying them.

==> The very last line.. Warren reckons it's much better avoiding dragons than by slaying them!!!

And of course, the studying of the mistakes are so important Blogged last month, Mistakes

The Study of Mistakes

My pal Charlie has always emphasized the study of mistakes rather than successes, both in business and other aspects of life. He does so in the spirit of the man who said: “All I want to know is where I’m going to die so I’ll never go there.” You’ll immediately see why we make a good team: Charlie likes to study errors and I have generated ample material for him, particularly in our textile and insurance businesses. Irrespective of titles, Charlie and I work as partners in managing all controlled companies. We enjoy our work as managing partners. And we enjoy having you as our financial partners.

And one of the most quoted Buffett's saying:

To Win, first thing to do is not to lose. - Warren E. Buffett

Is the Study of Mistakes any different for traders? Take these famous quotes:

There is nothing like losing all you have in the world for teaching you what not to do. And when you know what not to do in order not to lose money, you begin to learn what to do in order to win. Did you get that? You begin to learn!

If a man didn't make mistakes he'd own the world in a month. But if he didn't profit by his mistakes he wouldn't own a blessed thing.

If i learned all this so slowly it was because i learned by my mistakes, and some time always elapses between making a mistake and realizing it, and more time between realizing it and exactly determining it.

I was wrong; and the only thing to do when a man is wrong is to be right by ceasing to be wrong.

Losing money is the least of my troubles. A loss never bothers me after i take it. I forget it overnight. But being wrong - not taking the loss - that is what does the damage to the pocketbook and to the soul.

The recognition of our own mistakes should not benefit us any more than the study of our successes. But there is a natural tendency in all men to avoid punishment. When you associate certain mistakes with a liking, you do not hanker for a second dose, and, of course, all stock market mistakes wound you in two tender spots - your pocketbook and your vanity. But i will tell you something curious: A stock speculator sometimes make mistakes and knows that he is making them. And after he makes them; and after thinking over it cold bloodedly a long time after the pain of punishment is over he may learn how he make them, and when, and at what particular point of his trade; but not why. And he simply calls himself names and let it go at that.

Of course, if a man is both wise and lucky, he will not make the mistake twice. But he will make any of the ten thousand brothers or cousins of the original. The Mistake family is so large that there is always one of them around when you want to see what you can do in the fool-play line

-- Edwin Lefevre - Reminiscenes of a Stock Operator.

Or perhaps O'Neil's famous 19! (see Canslim: 19 )

I think this is the biggest thing for one to learn: Many people don’t admit even when they made a mistake(s).

When one does not admit that they have made the mistake in their stock selections, be it in investing or trading, then the mistake will just compound on itself, doesn't it?

The stubborn trader will most likely end up making the same mistake, over and over again, right?

And for the stubborn investor? Not admitting their mistake in their stock selection will turn their investment into a buy and hope.

Imagine one growing an mango tree. Once the mango bear nuthin' but sour mangoes, does it make sense to do nothing and hope the tree would one day bear sweet and juicy mangoes? Doesn't it make more sense to admit one's mistake? Perhaps it was in one's planting, care & maintenance of the tree. But what if fault simply lies in the initial mango seed?

And the classical investment teaching teaches us that investment takes time to bear fruit. But if the initial seed used was to plant our investment was poor, doesn't it make sense for us to admit the mistake? Be the man. Be the woman. Admit our mistake. And move on.

Else.... well simple. Say one is stubborn. Twenty years past. Couple of bull markets came and gone. And our end result? A miserable below average returns for a twenty year investment. How? Wait for another bull market?

So remember, one could easily make a mistake in one's stock selection. Recognising, admitting and then correcting the mistake is the only right thing to do!

Do remember this one famous teaching again!

It takes a man a long time to learn all the lessons of all his mistakes!