Drawing parallels from my previous comparison of natural phenomenon vis-a-vis stock analysis "Bamboo Stocks: How To Successfully Invest in Winners Which Look Boring", I extend the analogy this time to the realm of martial arts and its greatest proponent Bruce Lee.
As argued in "100 Bagger Stocks: Stocks That Return 100-to-1 and How To Find Them", the best market strategy is to buy great businesses with competitive advantages and a margin of safety below intrinsic value, and hold them.
What if we want to practice this value investing concept to the extreme? The below video can be quite revealing (advertisement of Skoda inspired by Bruce Lee).
In this video, the actor who plays Bruce Lee is waiting for the right opportunity to attack his opponent and when the opportunity arises, he hits a knockout punch. Can we apply this to investing? Why not!
Charlie Munger, an American investor said:
"Experience tends to confirm a long-held notion that being prepared, on a few occasions in a lifetime, to act promptly in scale, in doing some simple and logical thing, will often dramatically improve the financial results of that lifetime. A few major opportunities, clearly recognizable as such, will usually come to one who continuously searches and waits, with a curious mind that loves diagnosis involving multiple variables. And then all that i required is a willingness to bet heavily when the odds are extremely favourable, using resources available as a result of prudence and patience in the past."
Again, lessons from cricket are that when one sees a bouncer or a swing ball, one defends or skips it without taking any risky shots. When one gets a full toss or loose balls, one takes advantage of it and hits a six. So is true for investing as well...!!
Some learnings from the above are:
Mohnish Pabrai in his lecture at University of California talks about a similar concept - Few Bets. Big Bets. Infrequent Bets. Click below to watch his insightful video. In this example he mentions how Warren Buffett and Charlie Munger invested in only 5 companies during 20 years!!
If we dissect the above strategy, there are very beautiful value investing concepts that emerge which can ensure investing success.
High Margin of Safety and Much More Favourable Odds
As a value investor, we know that investing is all about enhancing odds in one's favour. There is no way one can eliminate risk, but by buying something way below its intrinsic value, we can ensure a high margin of safety and reduce the odds of a drastic loss.
Anurag Sharma explains this concept in "Book of Value" as below:
"Make no mistake: both gambling and investing are about making decisions now for outcomes in the unknown future. As such, they both require making assessments about the odds; understanding the underlying math is essential in either case. The difference is that where gamblers usually seek low odds with a high payoff , investors are inclined to seek out much more favorable odds for reasonably good returns (say, 9–1 odds for a 15 percent return with much upside potential). Marginally favorable odds (say, 51–49) would induce eager action from gamblers but none from investors."
So, when we wait for the right pitch to swing when the buying price is much below the intrinsic value, we essentially get extremely favorable odds for good returns...essentially almost eliminating chances of loosing money (remember most important principle of Warren Buffett - Never loose money!!).
Also, it gives a high margin of safety. It is beautifully explained in the newsletter "The Superinvestors of Graham and Doddsville" by an example of a truck going over a bridge.
"You don’t try to buy businesses worth $83 million for $80 million. You leave yourself an enormous margin. When you build a bridge, you insist it can carry 30,000 pounds, but you only drive 10,000 pound trucks across it. And that same principle works in investing."
Remember, here we are not timing the market (which is impossible to do). We are simply waiting for the right opportunity (whenever it comes) to ensure sound investment with margin of safety and a high allocation of capital in select opportunities.
Again, as the quality of business is better there may be some compromise in terms of a lower margin of safety, since great businesses in themselves provide a margin of safety to an extent.
How To Practice This Principle?
There could be several ways to execute the above principle but there are few a common things required:
Remember that individual investors have very good advantage of doing this since mutual funds and other institutional investors have a constant pressure to deploy funds and a clear mandate agreed in advance.
This also implies that one need not rely on income from equity as one's primary source of income. At least during initial period of investing.
Do Such Situations Arise in Efficient Markets?
Although broadly markets are said to be efficient, there are swings in the overall market when market participants are in Euphoria and in Depression. It is very well proven that prices fluctuate above and below intrinsic values and sometimes they happen to hover at much extreme levels.
Also, there are always pockets of sectors/companies in a bear phase and bull phase within the broader market.
There are several ways to spot such no-brainer situations. Professor Sanjay Bakshi has written a detailed article to look at companies from different viewpoints to determine they are worth buying - "Vantage Point". In this example he shows how VST Industries was no-brainer at one point of time.
Similarly, he explains how a company like Piramal Enterprises was trading below cash when it sold its business - "The Grand Strategy of Ajay Piramal"
Some of the examples which I have seen recently:
Is it easy to put this into practice? - The fight within.
As I mentioned in the article "100 Bagger Stocks: Stocks That Return 100-to-1 and How To Find Them", Investors crave activity and the stock market is built on it. The media feeds that, making it appear as if important things occur on a daily basis. This results in churning of portfolios in very short periods of time."
The ecosystem doesn't want you to sit tight, they want to charge you fees, brokerage and sell you stuff. The greatest fortunes however come from gritting your teeth and holding on.
Seth Klarman in his book "Margin of Safety" aptly mentions:
"The greatest challenge is maintaining the requisite patience and discipline to buy only when prices are attractive and to sell when they are not, avoiding the short-term performance frenzy that engulfs most market participants."
It is very good if one has interest in other activities such as reading books, music, sports, etc. to avoid any boredom.
There might be cases when one continuously examines several opportunities for long periods of time, but ends up without a good position. That should be perfectly fine but very frustrating. One more quote from "Margin of Safety":
"Sometimes a value investor will review in depth a great many potential investments without finding a single one that is sufficiently attractive. Such persistence is necessary, however, since value is often well hidden. The disciplined pursuit of bargains makes value investing very much a risk-averse approach."
Ability to Endure Pain
Although one buys way below intrinsic value with an extreme margin of safety, there is no guarantee that prices will not go further down. Market could be irrational for a long period of time and swings could be very extreme.
After investing with conviction and a high margin of safety, one needs to have the ability to endure pain when prices go further down and remain there for long periods.
Investors need discipline to avoid the many unattractive pitches that are thrown, patience to wait for the right pitch, judgment to know when it is time to swing, and the conviction and courage to swing it with full force (capital)...!! Just like Bruce Lee...!!
Originally Published in TECHNO FUNDA