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This is written with serious investors in mind, though sometimes they're just drafts in progress. I'm a former reporter, private investigator and institutional equity analyst who digs deep to find niche undervalued and undiscovered securities. I manage money for individuals, institutions and family offices via my business Long Cast Advisers. This blog is part decision-diary, part investment observations and part general musings about Philadelphia sports. It should not be viewed as a solicitation for business or a recommendation to buy or sell securities.

Friday, September 11, 2015

Rubbing My Nose in My Own Mistakes

As I transitioned in 2014 from sell side research (ie analyzing companies, industries, valuations, etc on behalf of hedge fund and mutual clients) to investing professionally with mine and other people's money, I made a handful of mistakes.

That will happen.

The important thing is burying my noses in them so I understand where my process failed and they don't happen again.

Here are some observations from rubbing my nose in my own mistakes with brief mentions of $OLED, $FHCO and $STLY. (Adding $CCJ, which I totally forgot to mention). All of this happened in the fall of 2014.

1) Overcoming the sense that "I need to be doing something." 

ALL mistakes I've made this past-year ultimately flowed from this one.

On the sell side analysts are not allowed to own the companies they cover and know best. So the stocks I bought for myself had to be super interesting and well researched for me to squeeze the extra work into a 60 hour / week day job.

There was enforced patience. I only bought things that were the most interesting and highest conviction and then I simply waited. A lot of great returns were generated this way.

Fast forward to professional investing and there was this initial compulsion to be "doing something". It's an unusual experience to sit around and read, talk to people, follow leads, learn new markets and industries, read some more, and then ... do nothing

But the source of my success in the past was - slightly tongue in cheek - doing as little as possible, finding, researching and waiting only for the most interesting ideas. Hewing to this model will help avoid this simple mistake in the future.

2) Buying before completing my research.

My equity research relies heavily on the work I did as a reporter and private investigator many years ago bridged with more traditional financial analysis. So in addition to the basic equity research of ...

reading into the company
the competitors
the industry
building a historical model and thinking about drivers of the business
making assumptions on growth rates
flexing the valuation

... there's also a lot of researching the CEO and CFO to get a sense of what makes them tick, what motivates their roles, what are their strengths and weaknesses, capital allocation capabilities, and any other tidbits I can find.

And then there's also thinking about two additional points
i) what needs to go right for the stock to work
ii) and especially what are the risks to owning it

there are no short cuts to any of these areas. Three mistakes I've made in the past year were made from buying a stock before completing my research.

3) Going against my gut. 

I have a pretty good sense of what interests me and what doesn't. Not everything that interests me is a good investment and not everything that's a good investment interests me, but I only want to spend my time on businesses I understand that appear undervalued and / or mis-priced.

When I go outside my circle of competence, it's an uncomfortable feeling.

These three case studies converged all around the same time and combine all three mistakes. 

Case study: OLED. I wrote about it here >> http://thepatientinvestors.blogspot.com/2014/06/oled-my-gut-says-overlooked-value-but.html << Everything about it looked interesting but I didn't understand the business and I didn't have the stomach for the volatility. So I avoided it ... but then emotion got the better of me and bought it on the way up and sold it on the way down. Then the stock took off. Absolute amateur hour. I rub my nose in it everyday.

Case study: STLY. My first impression was this is a shitty business with god-awful management. And nothing has changed. But a value investor friend owns it and I allowed myself to be talked into it even though it's a shitty business with god-awful management. I've come to learn that value recognition is possible from an engaged activist investor who is likely to take over the company at some point in the not too distant future, so I continue to own it. But I bought it feeling the need to be doing something, going against my gut and without finishing all my research.

Case study: FHCO. It's the kind of interesting and weird business I like. I bought it after it cratered to ~$4 / share when they cancelled their dividend. I'd seen that Brian Bares owned it, and I've read his book and like his style. I didn't mind that the product is essentially irrelevant in the US, b/c most of the business is in Africa and S. America. I could deal with the fact that their monopoly was broken b/c they average EBITDA of ~$0.15 / unit and they are still profitable at $0.10 / unit. Plus if there's a competitor it only affirms the market.

But it did not take too many conversations to lose trust, faith and confidence in [prior] management. I won't go into all the details of their ineptitude but had I talked with them more substantively ahead of time I would have seen it quickly. So I sold it at a loss. Interestingly, prior management is now gone and I've revisited the stock at ~$1.40 / share. It is a cash flow machine.

Case study: CCJ. Again, this was around the time I'd just decided to start my own firm and felt the need to be doing something. It's just absolute insanity. I was thinking about uranium, china's desire to build 120 nuclear power plants, the collapse of mining markets in general, my expectation that the decline in mining markets / oil sands production might improve labor rates at the Cigar Lake mine and in general just had uranium and CCJ on my mind when I saw a Barron's article that mentioned a fund buying the stock and I bought some before I'd even cracked a filing.

Then only after buying it, I read about it, learned about the Canadian tax revenue issue, the incredible capital intensity of the refining operations, the trading operations, etc. etc. etc. I'm reminded of a lesson I learned a long time ago; "think before you speak". Do some research before you buy a stock!


It's painful to recollect all this stupidity / absence of judgement / willful avoidance of the simple processes I'd used with prior successes. But the lesson was to reflect on what's worked in the past - I've fortunately had a lot of experience with successful investments - and to not change what's worked simply by virtue of transitioning from a hobby to a profession.

So it's been a short but steep learning curve.

Looking ahead, all patient investors should realize that investing is deeply personal and one of the most differentiated enterprises out there. No one does what you do. Your intellectual capital is your edge. There is no comfort in crowds. In the absence of "consensus" you have to find your own evidence. Understanding this has been a big step in the learning process for me, and I hope to always be learning. That's one of the big draws of this business.

Finally, of course I will make mistakes in the future. Anyone whose not afraid to own them, acknowledge them, honestly assess what went wrong and learn from them should do well. Rubbing ones nose in them isn't such a bad idea either, at least to make sure you don't do them again.

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