Before you venture out into the jungle of investing on your own, you may want to consider the lessons others have learned. I can tell you the lessons that I've learned personally from my investments:
Lesson 1: Management represents your interests as a shareholder.
One of my big lessons is that when you buy shares of a company, you are hiring that company's management team to represent your interests. When it comes to a company like Berkshire Hathaway (NYSE: BRK.A), there is no question the top management does this. You should also learn the lesson that Buffett himself learned (painfully, no doubt) when he bought the failing textile mill called Berkshire Hathaway: There are certain overall factors in an industry or business that even the best management can't change.
Lesson 2: It's OK to feel loyal about the business, but not about the stock.
In investing, one of your biggest enemies is your own emotional mind. Humans are a tribal sort of animal and they want to be loyal just as your dog wants to be a loyal member of your family. As an investor, these loyalties can lead you to trouble because you can, and will ignore negative information about those things you want to be loyal to. You'll hear street-smart investors out there say, "Never fall in love with a stock." You should modify that a bit and say, "Fall in love with the business, not the stock." Now, on to some of the other lessons I've learned.
In 2001, I found what I thought to be possibly the best stock I had ever run across -- Cypriot car shipping company ACLN (NYSE: ASW). I invested heavily in it and when the price dropped, I invested more heavily in it. Using all of my tools of analyzing a business, this one was outstanding and at a cheap price. But the problem was in my assessment of the risk associated with an unusual type of business and an unusual management team. I offered some details in this previous message (you don't have to read it to follow the rest of what I say below). [The Fool's Bill Mann also took up this story in the Fool on the Hill.]
Imagine yourself in the following situation: You've invested 48% of your money in a company. Lots of analysts have been badmouthing the business for a long time. Suddenly, you read an article by one of them that spells out a long list of specific allegations based on extremely detailed information you've never seen that details serious fraud within the company. By the time you finish the article, the stock has dropped by 50% in a mad selling frenzy.
If it were Berkshire Hathaway, you'd probably ignore the allegations and put more weight on the 40+ year career of Warren Buffett and the other great managers. But what if this is a company that is incorporated in Cyprus, has its offices in Belgium, whose CFO resides in California, whose business relies on dealing with people and countries that are probably very corrupt, and who have already fumbled in their presentation of information to investors?
I lost a huge portion of my capital by getting into this situation. Yet the day before this major meltdown, I spelled out five scenarios for the stock based on troubling things I had found the day before. The least likely of those scenarios was "All hell breaks loose within the company" and if that scenario played out, I had figured the value of the business would be around $10. After the meltdown in the stock price the next day, the price ended up within 10% of my estimated value (and it's still within 10% of that value). In looking back on my mistakes, one of them is in lesson 1 above.
Lesson 3: Regardless of how good an investment might be, something catastrophic and unforeseen to you can happen. Diversifying is an important form of insurance against these things.
And of course also...
Lesson 4: Balance the impact and likelihood of risks.
A risk you might think is less than 1-in-100 likelihood might actually be much greater. And while you might be satisfied with a 1-in-100 chance of picking the longest line in the grocery store checkout, you don't want a 1-in-100 chance of a serious car accident at any time you're in the car.
Lesson 5: Be willing to admit you were wrong when the "instruments" tell you you're wrong.
In fact, I believe you should make it a regular habit of admitting your mistakes to keep an objective distance between yourself and what you're doing.
When I read the allegations against the company I mentioned above, I ignored my emotional sense that it was wrong to sell and I put my trust entirely on applying the principles of investing that I believe in. It's much like how an airplane pilot needs to learn not to trust what they feel that the airplane is doing but rather rely on what the objective instruments are telling them. Many pilots have been tricked by the notorious death spiral where keeping the plane at what feels like level flight is really just spiraling right into the ground.
[Editor's Note: In his recent Congressional hearing testimony on the collapse of Enron (NYSE: ENE), Bill Mann made the statement that the biggest thing absent from stock analysis these days is skepticism. You can read the transcript of his testimony here.]
Lesson 6: You can make mistakes and still make money. Of course that won't happen if you're not at least somewhat diversified or if you're using margin.
Despite a massive loss of capital in a profoundly dumb mistake, my returns on money invested during the entire year was still a respectable 19.5% increase. Unfortunately, I was dealing with larger amounts of capital in the latter part of the year when I made the big mistake so in reality it was a significant loss.
But there were people who lost all of their capital due to using margin debt when ACLN took a nosedive. If you lose all of your capital, it's "game over." Even if you lose only a quarter or a third of your capital, you'll feel like the biggest idiot on the planet. You don't want that. You should always be willing to sacrifice some potential gains in return for taking less risk. No matter how sure you are of an investment, you can be wrong... by more than your perceived margin of safety.
This was posted on the Berkshire Hathaway discussion board on Dec. 23, 2001.
RSS Headlines
Fool UK
