Contradictions in Investing

When undertaking a recent review of my portfolio I was struck by the great number of logical contradictions in investing. I’ll be publishing this review in the next few weeks but the process of writing it made me consider all the various hurdles and challenges that investors face.

For example;

  1. Patience is a great trait for investors but investors also have to avoid holding a company into decline. Defining that ‘peak’ is no easy task.
  2. Doing nothing is important – but is an investor deliberately choosing not to act or are they frozen by indecision?
  3. Investors have to be decisive and confident – but not so confident that they become arrogant.
  4. Markets go through structural changes over time, but not all short-term changes turn into long-term trends. Investors have to decide when a change is structural and when it is short-term noise.
  5. Sometimes gut instinct is as important as research; I’ve spent hours researching some companies and other times had an instinctive ‘feel’ for successful businesses with far less time required to understand and evaluate them.
  6. In keeping with this, research is important but investors should avoid getting caught in the weeds of minutiae and irrelevant detail.
  7. Good investors need to have a good head for numbers but can’t ignore company culture and market sentiment either. Without profit today many companies are inherently worthless but some will flourish into future giants – just be careful not to mistake a lump of coal for a ‘diamond in the rough’.
  8. Internal culture and management are critical to the success of a business in addition to being almost impossible to accurately determine from outside of it – despite that, investors are inherently claiming to understand these if they are making an investment.
  9. Successful investors are often contrarian in nature (Buy when prices are low, sell when they’re high) but the consensus view of the market can often be right.
  10. Stock prices are sometimes, but not always, an indication of business performance. Investors need to be sceptical and questioning at all times – but also have trust and faith in the future success of their investments.
  11. Diversification can protect an investor and destroy their returns at the same time. Likewise, focussing on the best opportunities can provide rocket fuel for an investor’s returns and set them on the road to destruction in the same breath.
  12. Successes are important to understand and repeat; but focussing on a single strategy, sector, or trade style will likely diminish your returns over time – a long-term investor must adapt as styles and markets change.

Any investor will tell you that trying to balance these inherent contradictions can be a huge challenge but failing to recognise and face them can lead to big losses. For me, it’s a key part of the attraction of investing. By mastering these challenges and trying to overcome them, I learn about both myself and wider human nature.

One of the biggest investing challenges of 2020 has been an increase in volatility, noise, and uncertainty in the markets. It’s easy to believe you’re a great investor when markets are rising but much harder to back yourself when positions fall 30/40/50% in a few weeks. You naturally begin to doubt yourself and question your investment thesis far more than when a position has risen 30/40/50%, even though your risk is actually increasing as the position grows.

The twelve contradictions listed above became increasingly important this year – if I had correctly balanced the two positions then I was OK but what if I hadn’t? For example, one company I held had fallen about 50% from its January peak by Mid-March and I was showing few signs of a reversal. Some investors I knew were telling me I was an idiot for not having cut my loss at 10%; others said I should have cut at 25% or 30%. Without exception, however, there were few positive voices on the company.

Despite this, I held on, believing the fall to be a temporary setback from COVID, and by June the company was up about 50% from its March low and showing no signs of slowing down. I decided to add to my position, averaging down, and today the company is nearly back to its position at the beginning of the year with plenty more room to grow.

With the great benefit of hindsight, that decision sounds like a no-brainer, but a similar position I took on has yet to show a similar outcome – having doubled my investment in January, COVID struck and the position remains down around 45%. Fortunately, it has a strong balance sheet with minimal debt and a ‘normal’ return on equity of over 20% a year. I feel like it has long-term potential and the market seems to agree, with the price having nearly doubled since a March low of 35p to 55p as of the date of writing this article.

Of course, we could all be wrong – maybe the company will be snapped up by a competitor whilst the price is cheap or maybe the changes of COVID will destroy the business model. I can’t be certain of the company’s future but with experience and research, these decisions become easier. Only time will tell and hopefully, with time, my ability to overcome the contradictions in investing will become easier as well.

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