How To Be Right Even If You're Wrong
If you've ever golfed you know how frustrating the sport can be.
Even if you have a perfect swing. Select the perfect club. Hit the ball on the face of the club where you want to. And hit the ball with the right amount of speed, if the wind picks up while the ball is in flight. Or hits a small divot when it lands it can make your "perfect" shot look terrible.
The same is true when investing.
If you evaluate a company and decide after researching it for more than 100 hours that it’s undervalued. Has great margins. Produces a ton of cash. And has little to no debt so you buy it...
And then a major competitor has a breakthrough innovation that derails your company's business. Or your company has a small problem that turns out to be big later. These kinds of things can derail your entire investment thesis.
The inverse is also true.
If you evaluate a company and find after putting a ton of time into it that it doesn't fit your required investment thesis so you pass on it. Then it gets bought out at a premium and you feel like you did something wrong.
If you love golf or investing you have to learn to deal with these kinds of situations or you'll drive yourself crazy.
In golf and investing there is no such thing as playing well - or doing things right - every time.
Even when Tiger Woods was at his best during the 2000 PGA Tour season he "only" won 9 of 20 tournaments he entered. Or a 45% success rate during his best career year.
When investing and something goes against your investment thesis it pays to remember this. And also the following quote by investment great Peter Lynch.
But even if the market - or some insane company - proves your investment thesis wrong in the short time. The decision you made can still be the right one.
Why I'm Still Right On KING
In June and July 2015 I did a case study on Candy Crush Saga Maker King Digital Entertainment (KING) at the request of a reader.
At the end of the case study I found even though they had great margins. And produced a ton of cash that they had major risks keeping me from buying into them.
For those who don't the major issues were:
- KING could reprice options.
- It paid company insiders way too much.
- It had the most complicated share structure I've ever seen.
- And it had some related party transactions that were nefarious.
Any one of the above by themselves are bad enough to keep me from investing. But all four combined kept me as far away from the company as possible.
And I remain comfortable with this decision even after Activision announced its buying KING out for $5.9 billion today.
Why? Because the price Activision paid for KING is insane.
Using just one example, Activision paid $2 billion more for KING than what Disney paid - $4 billion - for Star Wars in 2012.
Does anyone on Earth think Candy Crush, Farm Hero Saga, and KING's various other games and community are more valuable than Star Wars?
But this isn't the main reason I remain comfortable with the decision I made in July.
Developing Your Investment Processes
When I began investing I took each investment decision on a case by case basis. I had no strict buy or sell criteria. And every investment decision I made relied on how I felt on that particular day.
This meant most of my decision making process relied on emotion. The last thing you want to rely on as an investor.
Relying on emotional whims early led to lost money. Lost opportunity. And more stress.
The more I learned the more I realized I needed to develop strict buy and sell investment criteria to take emotion out of the equation.
Over time this led to my preliminary analysis checklist. My selling checklist. And my general investment checklist to name a few. And these are why I'm comfortable "losing" out on a 26% gain in a few months.
Just because Activision is willing to waste money. And yes there is a great likelihood the money they spent on KING will get wasted. Doesn't mean my decision in June and July was the wrong one.
Because I stuck to my investment thought processes...
Owning KING involved taking on too many major red flags so I decided to pass. And wouldn't have bought into the company at any price barring an NCAV situation.
Before developing my investment thought processes when seeing the KING buy out it would have frustrated me. Why? Because it was at a 26% premium to what I could have bought them at in June/July.
This would have made me feel like I lost a quick and easy 26% opportunity.
But this makes no sense.
How could I have known KING was going to be bought out in a few months time? And how could I have known Activision would pay such a high price for KING?
I couldn't. So why dwell on what I couldn't have known. I don't now and instead rely on what my research and processes told me at the time.
I may have been "wrong" in the short-term this time. But next time the company could go bankrupt. Could get investigated by the SEC for fraud. Or could lose all its subscribers in a short time. All would be disasters for shareholders.
If done right investing shouldn't be gambling. Buying KING would have been just that. And this is why even though I was wrong I was still right about KING.
Have you developed your own investment processes? Do you require strict criteria to be met for any buy or sell decisions? Would you have regretted not buying KING? Let me know your thoughts on all in the comments below.
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