The Importance Of Being Right And Honest

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Includes: ERUS, GLW, LCI, SPY
by: Victor Lai, CFA
Summary

We spend a lot of time thinking about, designing and backtesting our investment strategies.

However, honestly evaluating results is an important part of learning from our mistakes and for improving our strategies.

In this article, I share some of what I've learned by evaluating the results of my Seeking Alpha opinions.

Process and results

We've all heard process can be more important than results, but that's not always true. Investment process matters, yes, but an important part of the process is to evaluate results. That explains what's working, helps us learn, and allows us to improve the process to achieve desired results. In this article, I'll share some of what I've learned by reviewing the handful of investments (and their results) I've written about on Seeking Alpha over the years.

Setting the record straight

I haven't written much on Seeking Alpha, but Table 1 below shows the five investments I provided opinions on through SA articles and blog posts since 2011, along with their results. In addition to the holding period returns for each position, I've also included a benchmark for comparison.

Table 1: Price Returns

Source: YahooFinance

The holding periods are different, but overall, the simple average return was +31%. I made money on the picks, and that's a good thing, but the average return for the benchmarks was over twice as high at 67%. And in fact, the best result on the table was to simply buy and hold the SPDR S&P 500 ETF (SPY), that was worth 156% from August 15, 2011, to October 1, 2018.

The ugly truth

Everybody knows stock picking is hard, very hard. And even when we do it well, in the end, it's often just not enough to beat the broad indices. I'm not saying it's impossible to pick stocks that beat the market, I've done it and many others have too. But the real question is can we do it consistently enough over time. The honest answer for most people is simply no.

The ugly truth about stock picking is sometimes we're right, sometimes we're wrong, and over time our results average out -- which is exactly what the market is, to begin with, the average. Add in taxes, transaction costs, bad-timing, opportunity cost, and it's no wonder most stock pickers just can't beat the market.

For example, Table 1 shows a wide range between my best and worst stock picks. The best performing position was Corning (GLW) at +94% and the worst was Lannet (LCI) at -88%. I had sound fundamental reasons for liking both companies and both stocks looked undervalued. But GLW worked out well while LCI was a complete and total failure.

It was my fault because I did not properly evaluate Lannet's acquisition of Kremer's Urban. News of the deal and select information had been released during my evaluation of Lannet, but the final details weren't reported until February 2016. I underestimated how much the transaction (highly leveraged) would flip Lannet's finances upside down.

There's no excuse, I was wrong about LCI, plain and simple. The lesson to learn is individual stocks and companies have many, way too many, specific, idiosyncratic risks. It's impossible to understand or avoid them all and that inevitably results in large and unexpected price swings, both ways (just ask TSLA investors). It doesn't matter if I gain 94% if I also lose 88%.

Roughly right, totally honest

I'm not saying stock picking doesn't work, it just doesn't work for everyone. I've made more money stock picking than I've lost and it's certainly fun and exciting. But honestly, practice and experience have shown it's not the best I can do.

In retrospect, I've been most successful using a macro-oriented approach. That is, investing in markets instead of single stocks. For example, in September 2015, I wrote my long case for the Russian equity market. In 2016, my vehicle of choice, the iShares MSCI Capped Russia ETF (ERUS), delivered a total return of 58% for the year.

I could have made even more had I picked the right Russian stock (speed-boat), but I also could have lost big with a bad pick (leaky-boat). Keeping it market-level reduced the risk of being wrong and allowed me to ride the rising tide. I'll admit my timing was lucky, but the underlying fundamental case for the market was right. You can decide for yourself if I'm just lucky by reading my other macro ideas where I blog.

I'm not patting myself on the back, I'm just being honest about what's worked and what hasn't. Investors are often fooled by sophistication. The more fancy, complex, and precise a forecast is the more respect and confidence it gets. But the irony is markets are highly unpredictable so the more precise a prediction is the more likely it will be wrong.

The truth is to make money in the markets, we don't need to be fancy or precise, but we do need to be right. Macro, market-level investing improves our chances of being right by emphasizing accuracy over precision. John Maynard Keynes said it best with, "It's better to be roughly right than precisely wrong." It took many years, a fair share of bad stock picks, and some swallowing of pride to appreciate that simple truth. And to be totally honest, it's usually the simplest adjustments that are most important.

Disclaimer

The information in this article solely represents the personal opinions of Victor Lai. None of this information represents advice. Investing is inherently risky and involves the potential loss of principal. You should conduct your own due diligence and/or consult with relevant professional advisors before making any investment decisions.

Disclosure: I am/we are long ERUS.

I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.