On January 13, 1920 New York Times argued that thinking any sort of rocket could ever work in the vaccum of space is essentially foolishness and disregard to high school understanding of physics.
Of-course later they did print a correction but that came 3-days prior to launch of Apollo 11 in 1969.
Sticking to what we believe we know when the facts around us are changing always creeps in a big element of error in decision-making.
We often see generalisations being used while doling out investment advice; for eg.,
- Buy low, sell high;
- Time in the market and not timing the market;
- Don’t catch a falling knife;
And many more
Generalisations do help make decisions simpler, however no one succeeds in making it big whether in life or in investments by sticking to comfort zones and beliefs.
David Dreman in his book Contrarian Investment Strategy talks about how investors find it difficult to follow simple strategies as they tend to over-react and not just that they over-react in a way that you can easily predict;
These over-reactions are often a result of investors beliefs, their understanding of facts as they see it and how they shape their behavior.
Daniel Kahneman puts it beautifully when he says:
What you should learn when you make a mistake because you did not anticipate something is that the world is difficult to anticipate. That’s the correct lesson to learn from surprises; that the world is surprising.
Take the decline in Indian equity markets over the last couple of months.
The crisis that started with one NBFC soon spread all over the NBFC space without any consideration to quality of the various businesses.
30-40% drawdowns and in some cases even more was a result of panic selling without adherence to logic.
David Dreman rightly points that whether it’s a good business or a bad one-
surprises will happen-a negative surprise for a good business and positive one for bad business will occur without warning;
For the investor it’s critical to take a decision being cognizant of the quality of the business and the risk-rewards that it presents. A negative surprise for a good business is hence an opportunity to buy.
Unfortunately even those who understand this find it difficult to let go of their belief systems getting caught in momentum thus losing the opportunity.
Retail Investors need to have clear criteria to make their decisions and none of these criteria can be seen in isolation as they are part of the decision.
Taking a cue from “One up on Wall Street” from the legendary Peter Lynch, I list some of them:
- Buy What You Know-this is just the first step that leads you to;
- Do further stock research; & Think
- Big Companies have small moves while small companies have big moves;
- Any business that can make money for you can do so basis following 3-business expands; earnings improve or stock is undervalued;
If the business is already large enough with limited scope to expand or improve earnings; you have to see whether its priced for growth or is under-valued before making a decision; and last;
- If there is one stock that you can avoid, avoid the “HOTTEST” One; As everyone is running after it-price is almost perfect and the only thing that can happen is a negative surprise;
If you don’t feel comfortable making that leap, you may prefer a stock with these “Lynch approved” characteristics.
- It’s in a dull, predictable, industry that won’t change or draw in rabid competition.
- It is growing earnings at a sustainable level (15-25%).
- It has a niche and delighted customers.
- It is off the radar. You won’t hear many analyst bragging about recommending it, and no one at a cocktail party is going to tell you it’s their hot stock pick.