This is the Second Part in a small Series of just a couple of Blogs and you probably need to read Part 1 first for this to really make much sense. You can find it here:
This is personally a tough one for me. I am fascinated by Macroeconomics and Politics and as a result there is a huge problem that I most likely give far too much weight to Macro issues when it comes to managing my Portfolio. I envy people who just seem to be able to blindly ignore Macro and as much as I try to do it, I just tend to find something in the Outlook that worries me.
Part of the problem is that for the majority of years, Macro doesn’t matter at all with regards to how Stocks do but in the rare Years that Macro does matter (for example 2009), the Markets get utterly massacred with 50% Falls on Major Indexes not unusual. As someone who does not have a real job and who has no intention or much capability to do a job, I find I need to protect my Capital and not take silly Risks. This makes it hard for me to just ignore Macro.
A solution for me is as I hinted earlier in Part 1 in the Stoploss bit. When I sense trouble ahead in the Macroeconomy, it makes sense for me to use Shorts on the Indexes to Hedge my Portfolio, but then to have disciplined Stoplosses that kick in to close my Short Positions if the Markets indicate that they are not too bothered. This would enable me to put on Hedges when I see trouble coming but it could avoid the dangerous Over-thinking that I am prone to by automatically taking out my Short Positions for a small Loss if they are not needed.
It is essential for your sanity that you can get comfortable to function constantly within a highly uncertain and changeable landscape and to accept that there are always vast swathes of things you don’t, and can’t, know about; and that you will with stunning regularity get caught out by the Market’s latest new twists. If you are someone that likes certainty and exactness and preciseness then the Markets are going to drive you totally bonkers and you need to train your brain to accept this Fuzziness and not to fight it.
I am sure for many people this is extremely difficult to do and I have no doubt at all that time and experience help to ‘cure’ you of any such desires for precision and to help you cope it is really a case of using Risk Management techniques like Stoplosses and TopChops as I have mentioned in Part 1, but also to have a wide and diverse Portfolio and to focus on buying Quality Stocks from Companies that make money and pay Dividends and suchlike. It is far easier and less stressful doing things in this manner.
Techniques such as Hedging or by Selling a chunk of your Portfolio and moving into Cash can help when you see tough times ahead and having realistic expectations about Annual Returns and your Personal Risk Level (tolerance) will help as well.
Another useful way of Mental Framing is to try to train your Brain to think in terms of Percentages and Probabilities rather than exact Numbers and Outcomes. For example, rather than being 100% sure that a Market is going to drop (and making Trading decisions on that basis), it might be better to see it as a Probability and say something like “I think the Market will fall but that is a 70% likelihood” – you then would trade according to this probabilistic judgement and this could for example mean going for 70% of a Full Size Position rather than going all in.
Working on your own psychology to be able to accept the Fuzziness will pay off a lot. For example, I see lots of people who are fixated on finding ‘The Perfect Stock’ which is the one that is just great at everything and has no drawbacks that are readily visible. The problem is then that they buy this Wonder Stock and at some point they will learn something that is a fairly minor negative, and quite often totally irrelevant, but because their Stunningly Good Stock has had the bare-faced cheek to come out with something that doesn’t fit this perfection narrative, they Sell the Stock and then a few weeks later they are bemused when they see it is up 20% from when they sold.
The other problem is that such People just don’t buy many Stocks, because if you have such an idea of perfection in your mind then very few Companies will live up to your exacting and demanding standards. This can make things very boring and if you then compound the problems by selling your Perfect Stocks because of some trivia, then it gets even harder and very frustrating. It is like searching for Supermodels in Clacton-on-Sea. Or those God-like Adonises with six-packs on the Isle of Dogs.
The simple reality is that there is no such thing as a Perfect Stock. On the day I am writing the first draft of this, I have had some exceptional Results from Boohoo BOO which I hold and for me that gets near to a Perfect Stock. However, I can see a glaring problem with ‘Fast Fashion’ in that it is attracting a lot of criticism on Environmental grounds and I see this as a big risk. Now many people would not buy because of this or would sell because they are Over-thinking and getting worried unnecessarily, but I realise that I have to accept this drawback because the countless benefits and good points of BOO hugely outweigh the Green concerns in my view.
I also hold Live Company Group LVCG and I have many concerns with Corporate Governance issues being the main one (I am pleased to say that at the time of getting near publishing this blog, many of the Corporate Governance issues have been addressed although it would be nice if the Company can stop shooting itself in the foot !!). However, it is again a case that I accept the Risks and the good aspects outweigh my worries and I am happy to hold and will probably buy more soon but I will never buy loads because of my evaluation of the risks. If you cannot accept Risk and manage it appropriately, then you will struggle in the Stockmarkets.
Holding Stocks that are sub-optimal and often with flaws, is much easier if you hold a wide Portfolio of different types of Stocks and sizes and sectors and strategies and suchlike. Portfolios that are highly focused and lack spreading of Risk are very challenging to manage and can be stressful.
Focus on what is really important
There is so much Noise around and we really need to figure out what is actually important and likely to move the Markets (and also what really matters with regards to the performance of the Business in terms of Revenues and Earnings going forwards) and what is just really yet more irrelevant trivia. To a large extent this is where experience comes in and there aren’t all that many short-cuts although certain things in particular can move a Share Price, such as:
Those are just a flavour but probably cover the main ones.
When reading and interpreting Accounts, focus on the key bits
I think it is very easy to go down a Bunny Hole (and that is not in the Playboy Mansions sense, chaps) when it comes to analysing a Company’s Accounts and this can easily get you tied up in knots (again, not in a Huge Hefner sense !!) and likely to make silly errors when it comes to Buying and Selling decisions.
When it comes to looking at a set of Accounts, the key bits I apply my brain to are things like the progression of Revenues and Profits and suchlike but one of my biggest considerations is focused on the Cash or Debt situation and in what direction it has moved since the last set of Results. For example, if the Cash has gone down then I want to dig through and identify the reasons for this and it is vital to understand if these are one-off and justifiable factors or if the use of Cash is likely to be repeated and in fact shows a Business that might appear to be doing well but in reality is munching through Cash (or adding to Debt) and using Accounting tricks to cover up the problems.
I find this focus on Cash and Debt and how it moves is extremely useful and an excellent short-cut for identifying if there are problems. If something most definitely doesn’t look right (or perhaps things look too good to be true !!) then you can dig into other things in the Accounts such as the Debtors (Trade Receivables – unpaid Invoices), Inventory (Stock), Capitalisation of Development Costs (common for Software businesses), Deferred Consideration (payments due to Vendors of an acquired business in the future), Revenue Recognition (is the Company matching Revenue it shows at the Topline with the correct timing of when these Revenues actually are achieved?) etc.
Just shrug your shoulders
It is so easy to let the constant Noise of the Markets lead you astray and compel you to make silly Selling or Buying decisions. The classic is when some negative news comes out on an excellent Business and the Shares get whacked hard only to then recover in the next few days. This happened with AstraZeneca AZN perhaps about a year ago where they had some bad news regarding a Drugs Trial and the Shares fell heavily by something like 10% or so (I think it was the Mystic Trial). So no doubt lots of people panicked and dumped their Shares but if you look at the Chart now you will see that AZN is up near its All Time Highs and since the Trial failure it has just gone from strength to strength.
Of course, with hindsight it is very easy to say this but at the time of the Trial Failure we knew that AZN had the following positive attributes:
With these positives in mind, at the time of the bad news all this stuff had to be weighed up and considered. There is no right or wrong answer but perhaps if more time was taken over the Sell decision (rather than just hitting the ‘Sell’ button straightaway that morning) then selling at the worst point could have been avoided or perhaps just selling half or a part of the Position would have been the best approach. I didn’t do anything and just let my AZN Position ride.
I guess I am saying that with lots of News about a Great Stock that you hold and that you really see yourself still holding in 5 years time, the best thing you can do is to ‘shrug your shoulders’ and let it wash over you and not get overly worried. So much seemingly Bad News just comes to nothing and it is often the case of “If in doubt, do nowt” which is such a useful philosophy and I know Steve Markus (@smarkus on the Tweets) sometimes takes this approach.
Spend time on Sell Decisions and think carefully with a bias towards not selling
I wrote a Blog on a similar topic to this recently (if you go to the ‘Related Blogs’ bit at the bottom you should find a link) and it is clear to me that we all spend vast amounts of time on our Buy decisions yet we can easily Sell something on a mere whim and with little actual thought. So often I see people buy a Stock and they will be extolling all its many virtues and why to them this is the best Stock on the Market, and then in perhaps a few weeks or months they will Sell it and proclaim what appears to be a sensible and valid reason (more like an excuse !!) but when I think about the reason it is often something that was the case when they bought it so why does it suddenly become a Sell?
I saw one just the other day. A chap on Twitter sold out of a Stock and said something like “The CFO led a Bankrupt Company 15 years ago” and this was clearly a sensible justification for selling. However, this was easily knowable information at the time of buying and it is hard to think of a bigger Red Flag than something like this and if anything, perhaps the Stock should not have been bought in the first place. It is fair enough if it really is ‘new’ News to the Stock Holder but I suspect in this case that was certainly not what happened. I think the simple nub of the issue is that most People put in far too little thought when it comes to selling and very often they would do better if they just held on to their Quality Stocks or if they must sell then a Topslice might be all that is needed.
That’s it for these Blogs, I hope this helps you consider all the Noise and dangers of Over-thinking things and if it makes you pause just a little longer before hitting that ‘Sell’ Button then it probably has hit the spot !!
This is one of the first blogs I ever wrote !! OK, give me a break, it was early days and I had yet to find my muse !!
And at the other extreme here is one of the most recent Blogs in the Archives !!
These blogs look into ‘Noise’ and there is a special treat at the end for Who fans. Also at the bottom you will find links to the first 2 parts:
This one sort of covers how I ‘evolved’ as an Investor – there are Links at the top to the earlier Parts:
This one covers ‘thinking in percentages’:
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