Wall Street is enamored with survivorship bias. Let me rephrase that, Wall Street is foaming at the mouth and drooling madly over the survivor strategies and successful investors. The investment system is practically built on survivorship bias. Investors that do well are heralded as genius and spoken about in holy terms. But what about the guy who invented Dogs of the Dow? He's probably sharpening his pencil on a new strategy, one that works. Or what about that Dow 100,000 guy? He's a professor now, slogging away until his next prediction hits it big.
The gurus of today were nobodies of yesterday. Of the tens of thousands or even millions of investors trying to make a buck the current gurus were the ones who were successful. There are hordes of very smart investors who after making mistakes have ensured that will never become well known, they've been lost to the sands of time.
What further perpetuates this complex is that the financial media loves to highlight investors who are at their peak performance. There is this common understanding that one or two lucky bets doesn't indicate skill whereas long term results indicate skill. A flash in the pan manager isn't skilled, but someone who's pan has been flashing for a few years must be skilled. A few years of outperformance will result in calls to appear on CNBC or Bloomberg. This neatly coincides with the length of time before the winds shift in the market and the strategies that worked in the past market fail to work in the current market. It's quite a conundrum. When someone becomes popular and they are willing to share their secret sauce it's just before the sauce stops working.
Of course this situation is well known. There is a response to it, which is "buy the index." Most fund managers underperform the index eventually, and even investing heroes make mistakes, sometimes catastrophic mistakes. We're told if we buy indexes we can avoid all of this mess. Success in the market is fleeting, and that's fascinating to me. It's fascinating because success in the real world isn't the same. Yes, there are flash in the pan successful people in the real world, but I'm not talking about them. It's uncommon to find a serial entrepreneur who's built a number of successful businesses and then suddenly every business they start fails. Or a real estate investor who builds a real estate empire and once large find themselves hemorrhaging money because every new investment is poor.
No, in the real world experience compounds. This is why a senior executive who has managed through numerous business cycles commands a higher salary compared to a fresh executive who has never seen a business cycle. The entrepreneur with a string of successful companies becomes a mentor to new entrepreneurs, they have real experience that they can pass on to help others.
The disconnect between the real world and the market is stark. Why is there a difference between the two? My belief is the difference is due to the layer of abstraction that exists in the market verses the business world. Investing is a derivative function. You are not dealing with customers, suppliers, and employees. You're pushing little bits of paper around from the arm chair while discussing high and lofty things like the baltic sea index, or inflation expectations or a dovish Fed. I have yet to meet a non-investor who's mentioned the dovish Fed. But I've met many that will gripe about how hard it is to get customers to pay on time, an issue that directly impacts the bottom line.
Investors focusing on guru strategies are looking at a derivative of a derivative. The business is at the bottom of the pile with a stock derivative on top. The guru strategy usually identifies something related to the underlying business that can be leveraged to outsized profits. But the investor investing in the strategy is focused on the strategy, not what's happening at the underlying business. The strategy is a derivative based on stocks and stock movements, a derivative of the underlying business.
The best gurus adapt. Arguably the best investor of the world, Warren Buffett has changed his stripes multiple times. From cigar butts and low book value stocks to compounders, to buying regulated utilities and negotiating sweetheart deals for outsized yields. At each step he's recognized when his strategy is topping out and moved onto something more profitable. The problem for investors trying to mimic gurus is that no one knows when the strategy will stop working, or if it's already stopped. Buffett knows when it's time to move on, but unfortunately for his followers he's not going on CNBC announcing "I just wanted to let everyone know that I won't be buying utility-like companies anymore, it's time for something else." He silently moves onto the next thing, eventually people take notice and then start to write about the next thing. But there is always a contingent focusing on the last thing. Far after Buffett has moved on there are still investors discussing how great utility type companies are and that Buffett has invested in them so they must be good.
The world changes quickly. Businesses that survive need to change with it. At the core a successful businesses is always changing. They're adapting to the needs of their clients, employees and stakeholders. But surprisingly investors are looking for The One True Formula, that investment strategy that always works, and will work forever. The strategy that they can plug in and grind out profits until they're rich and drinking fancy drinks on the beach with little umbrellas in their glass. They're constantly searching for The One True Formula. This formula is a fallacy. No formula exists, nothing always works, nothing will ever work forever.
Maybe this comes as a shock. Lynch's strategies will underperform for years or decades. Graham's net-nets aren't always a buy. Low book value stocks should be avoided sometimes. There is a time to buy the compounder, and a time to avoid it. Most if not all investing strategies in the hallowed investing cannon will fail from time to time.
This made me think of the section of the Bible that became a famous Byrds song (listen to the song here while you read), the section of the Bible discusses how there's a time for everything. I took an enormous step of artistic liberty and decided to re-write this in the context of investing:
There is a time for everything,
and a season for every activity under the heavens:
a time to invest and a time to spend,
a time for growth stocks and a time for bankruptcies,
a time to research and a time to act,
a time for low multiple companies and a time for Internet rockstars,
a time for compounders and a time for cyclicals,
a time for pink sheet names and to trawl the NYSE,
a time to diversify and a time to concentrate,
a time to embrace cash and a time to be fully invested
a time to search and a time to give up,
a time to avoid speculations and never a time to look at them again,
a time to listen to gurus and a time to shut them out,
a time to be silent and a time to turn on CNBC,
a time to love your positions and a time to hate them,
a time for failure and a time for success.
Is there value in listening to an investing gurus? Or reading a classic investment book? Or looking at successful investing strategies? I believe there's a lot of value, but not in the way most expect.
The first is I ignore investors who claim to have The One True Formula. They don't, and if they think they do it'll eventually fail. Flexibility is to be admired. Flexible investors will say "I usually look for x, but sometimes it's y that matters more."
One of the reasons I really like Benjamin Graham's Security Analysis is because it lays out a framework on how to think about businesses. Even in his famous chapter on net-nets there more about how to think about value rather than him pushing an investment strategy. It'd be crazy to blindly stick to Graham's strategies 60-70 years on, but it isn't crazy to apply how he thought to the modern market. If a company is selling for less than their liquidation value then it's reasonable to consider that the company is probably undervalued. The question becomes what is liquidation value? That's something that you the investor need to consider and determine yourself. I've seen blog posts where people argue whether inventory or receivables or real estate should be included in a liquidation value, I would answer both yes and no. Sometimes they should, and other times they shouldn't, it just depends. But "it depends" isn't a satisfactory answer for most, they want to be told what to do, not the way to think about a problem.
But ultimately what gets investors in trouble is when they outsource their thinking. You can't outsource your thinking when you're running an actual business. We need to think like a business person, not figure out if a company fits the formula or if it doesn't fit the formula. When we outsource our thinking and start to rely on formulas we've made a mistake, a big mistake.
The best investors are those who've figured out that nothing works all the time and are constantly thinking about the next thing. What is an investor to do? We need to look at guru's and investing books as guideposts, not as maps. The popular investment books should be telling us how to think, not what to do. Each step of the way should be informed by what exists now, not blindly following a strategy that worked well in the past. Sometimes what works now is the same thing that worked in the past, but it usually isn't. And if it is it's sufficiently long enough that everyone forgot it worked at some point previously. At the end of the day we need to be flexible and independent, not beholden to any one idea or strategy, but willing to adapt as market and business conditions merit.