Several weeks ago I took the plunge and replaced my aging Droid X smartphone. Spotting a good sale, I was able to get a Samsung Galaxy SIII for $50, a buying opportunity I jumped on. This opened up another opportunity for me; the library of games on my previous phone was old, so instead of re-downloading them, I decided to get all new ones.
I don't know if I was enticed by the college memories it brought back, or if it was the Carmen Electra icon that drew me in, but I ended up getting a Texas hold'em poker app. I'll admit I was pretty bad at first, but after Googling, "how to win texas holdem" and reading the first website in the search results, I was raking in the dough. After only three days I decided to stop playing. The money was fake, it was very addicting, and my left eye was bloodshot. The experience wasn't without its lessons, however (besides the ocular one). I found that some of the strategy from poker could easily be applied to investing.
(For those unfamiliar with Texas hold'em: here. I will be using terminology from the game, including betting, folding, raising, and blinds, as well as A, K, Q, J, T.)
Before writing this article, I did a quick search for comparisons between investing and poker. As I suspected, I was not the first person to draw this parallel. Let me begin by saying that this will not simply be about knowing when to hold'em and when to fold'em, although that's certainly an important skill in both. Rather, I will be exploring the principle of the three P's of poker. These are position, power and patience, and I will demonstrate how they apply to investing.
Poker is a game of betting, and the order in which it takes place is very important. For example, say you're the first person to bet and you're holding A-3s (ace and three suited), a mediocre hand. You might be tempted by the ace to place a bet to match the big blind. This would be a mistake. If a person after you makes a large raise, the best move would be to fold, meaning you just lost your bet on a mediocre hand. So why fold? Even with an ace, this hand doesn't hold up when you look at the odds, and the large raise indicates that someone has a good hand. This is especially so if one or more people match the raise.
Now, say you're dealt the same hand, A-3s, but you're the last to bet and everyone before you has called the big blind instead of raising. This is an indication that most likely no one has a stellar hand and therefore your chances of winning have gone up. You're also given an opportunity to bluff with a raise, that would have been foolish in the first position. Your best move is to call the big blind.
In both cases you're dealt the same hand, but the correct move changes based on the order that you bet. While your outcome is determined by position, the reason for this is knowledge. Being the first to bet means you only have knowledge of your own hand, and being last to bet means you have knowledge of everyone's hand (this is also power, as in knowledge is power).
If you look at betting as if it were the same as investing in a company, position plays the same role. Since you're not restricted to putting your money in any specific order, position is now the timing of your investment. Do you invest when a stock drops, or do you wait for good news, losing out on the opportunity to get in while the price is low? In some cases it's easy. Solid company and the price dropped because the entire market dropped? Buy. Other times it's not so simple.
If you don't have a good grip on what's happening with a company and you invest, it's like placing a bet in an early position with limited knowledge. On the other hand, you can wait for the quarterly results or observe how highly correlated industries are doing. Seeing the actual sales figures and net profit won't give all the information you need, but neither will being last to bet. It will give you a much better sense of whether your observations and intuition were correct however.
A great example of this situation is Intel (INTC). In July 2012, Intel lowered their Q3 guidance based on slowing demand for PCs. Once this happened, everyone seemed to be speculating about the future of Intel and the share price quickly dropped. I was one of these people, claiming that I sold my shares in the belief that PC sales would not recover . Some people disagreed, saying PC sales were stagnant as customers waited for Windows 8. Others claimed that tablets and the smartphone market had doomed these sales forever. While both sides made claims, no one really knew. In hindsight, I now realize that I didn't sell because I thought PC sales would not recover. I sold because my position had changed from a sure thing to a gamble (at least to me), and no matter what the odds, I'd rather put my money into a company that wasn't dealing with the uncertainty.
I use Intel as an example because the Q4 results have now been released, showing a continued trend of low PC sales. This doesn't mean that I was right. It just give a better picture of what's going on, like after the flop in poker. The problem with poker (and investing) is that you might think you have the best hand, but you can never know until all the cards are revealed. To some people, this event was the flop, revealing that they had made the right or wrong decision, and this is the time to take action. For me, it's still a gamble, and I'll bet my money on a different hand. Clearly, whoever has the most knowledge has the power to make the best decisions.
In poker, knowing what cards everyone is holding is a guaranteed way of winning. Going back to the A-3s example, let's say you make it to the flop and three aces are revealed. Your ace plus the three aces from the flop gives you an ace-high four of a kind. In this round, no matter what other cards are flipped, there is no way anyone else can have a better hand than you. You can't lose. With this knowledge, the round instantly changes from gambling into figuring out how to take the most money from your opponents. Perhaps you bet big, hoping that someone thinks you're bluffing and calls. Maybe you call, waiting for the turn card before you make your move. Either case, it's guaranteed money, and you're playing to maximize it.
So what does this have to do with Intel? Everything. The dividend is exceptionally high for a stock of its caliber, but there is a lot of uncertainty. If the latest quarterly results had shown that PC sales were only temporarily lower; if Intel had a big entrance into the smartphone market; if Intel had somehow shown that the profit troubles were behind it, buying the stock would be a guaranteed 4.25% dividend. If this were the case, the dividend would ensure that you're no longer gambling on if or when you'll make money. Instead, you'll be investing to maximize how much money you're making. This knowledge comes at a higher price, as in good news will drive the stock higher and you'll have to pay more to acquire it, also resulting in a lower dividend yield.
On the other hand, having the knowledge that Intel still isn't free of its problems means that you can safely invest elsewhere for the time being. Fold before you bet while you wait for a better hand.
Position is knowing what to wait for, and power is what you get out of that. Patience is the actual act of waiting, and it is the hardest part of both poker and investing. Sometimes it's easier to throw your money in and lose, knowing that you at least had a chance to win, rather than let it sit on the side, doing nothing. The worst feeling comes when you fold a poor hand at the start and quickly find that you would have had the best hand, had you stayed in. I've lost many full houses to folding a bad hand early, and likewise I've missed out on making large profits from holding out on a company that I didn't have enough knowledge about. The only way to get around this feeling is to understand the statistics, that if you had bet on every hand or invested in every company that you had a gut feeling about, you'd end up losing more money than you gained.
You also have to look at opportunity costs. If you had invested in Intel when it went down to $19.50/share, you'd be up almost 9% now (at a current $21.22/share), plus you'd be making an additional 1.15% from the dividend in February. At the same time, investing at $21.22/share today would still net you a respectable 4.25% dividend yield, versus the 4.62% yield if you invested earlier.
Is it worth it taking the risk at $19.50/share for that extra 9% profit? It's tough to say, as it really depends on whether or not you can time the bottom. Unless Intel continues to drop, it was $19.23. For Ford (F) it was $1.01, before reaching a high of $18.97 less than 2 years later. For other companies, such as Research in Motion (RIMM), Nokia (NOK) or Eastman Kodak (EKDKQ), you could have lost an incredible amount of money over the past few years if you didn't have the patience to wait for the good news which never came.
This strategy, in both poker and investing, is very conservative. It reduces risk by focusing on a guaranteed reward. You might argue that it takes a certain amount of gambling and luck to get a big reward, but I disagree. Go to a poker table and match the big blind every time, no matter what you're holding and see how far your money goes. Now, try again but this time only bet if you have one of the best hands (A-Ts and better). You'll be playing a lot fewer hands, but when you do, you'll be winning. Some of them you'll win big. The problem of missing out on great opportunities, like Ford at $1.01/share, is fixed by time. As an alternate to betting big when you have the right cards, you reinvest your dividends. The longer you invest, the more money you make, and this becomes especially rewarding with compounding.
I've heard people say that poker is gambling, and I've heard those same people say the same thing about investing. The problem with this statement is that the same people always end up winning. True, for some people, both poker and investing are gambling. These same people end up losing. Always playing your hand or investing in a company, no matter how bad, will separate a fool from his money. The difference between the winners and the losers is having the patience to put yourself in a position where you can't lose, and then hold onto that position.
Thanks for taking the time to read my article. Please give me your thoughts and feedback below in the comments section. Note that if you try to turn the comments section into a debate about whether Intel is a good or bad investment, I'm going to ignore you. That's not the point of the article at all. Instead, tell about the time you folded before the flop and missed out on a four of a kind.
Disclosure: I am long F.