Ouch (taking a leaf from how Jeff Bezo began his 2000 Amazon annual shareholder letter). It has been painful. Mistakes were made with valuable lessons learnt. It uncovers fresh insight and points to opportunities for growth.
When the financial markets are bullish, there are “no mistakes” and only profits. We can become complacent and not learn much. With the down cycle, it is a good opportunity to learn during a down cycle than being tuned out to wait for the rally. The cycle repeats: we did not learn much during the bull cycle and get tuned out of the bear cycle that we did not learn. It is an irony of life. We enjoy the good times and lament the bad times. We do not take the needed responsibility to own the game to be successful.
A big lesson learnt: Being greedy and hubristic
There are two indicators of greed that I should pay more attention to:
- Too high valuation. Many stocks were flashing very high Price-to-Sales and Price-to-Earnings. Some tech companies are unprofitable and do not generate free cash flow. Expectations are running too high that are hard for reality to catch up; the market assuming the good times will remain for a long time.
- A huge market rally during 2020 and 2021. Many stocks achieved multi-baggers in just a few months. As the market gains by a large percentage in a short period, pullbacks will occur.
The indicators showed that the gains were getting ahead of the expected growth with the valuations became too rich. The investors were happy. Those who have not been investing became more interested in investing (FOMO). There were lots of greed. Good times do not last forever. Covid recovery, together with supply chain issues, led to inflation. Alas, the Russia-Ukraine war pushed inflation higher; leading to aggressive interest rate hikes.
Signs of greed:
- More is good.
- Dreaming for more.
What should I have done more?
- Take more profits
- Cut poor quality and speculative stocks and cryptos early
Changes made
A year of the down cycle gives me a good opportunity with lots of reflections, learnings and pivots to my investing strategies.
1. Growth with valuation
My focus has been growth investing. At a minimum, increasing interest rates affect the discount rates. When the macro environment worsens, the value drivers, such as revenue growth, margins, reinvestment and failure risk (as shown in the Exhibit below) become crucial.
It is back to basic. A business must make money. Its ability to generate cash is a crucial criterion for investors.
Some other notable observations:
- Profitability and free cash flow are critical. Else, failure risks increase in a rising interest rate and bearish market.
- High Price-to-Sales are rarely sustainable; expectations are very high.
- Companies with generous stock-based compensation are at risk. The share counts have increased significantly as their share price is down. Instead of cash, The companies are funding their operations by issuing more shares as their currency.
- Several important metrics measure the resiliency and quality of the companies: growing revenue and earnings, margins, cash flow, and high ROIC.
- There are many types of growth companies and various growth investing approaches. Moderate sustainable profitable growth over a long period (demostrating a strong durable moat) is better than very growth that can be challenging to sustain and manage(time will tell whether the moat is defensible and durable).
- ROIC > WACC, meaning that growth increases intrinsic value.
- Look for low-risk, high-uncertainty businesses (Mohnish Pabrai)
With rising interest rates, the investing environment can be different as pointed out by Howard Marks in his memo, Sea Change.
Corporate finance and valuation will be an area I want to delve deeper into in 2023.
2. Conviction
Conviction is often, subconsciously, meant to be confident that the stock will go up. When the stock prices go down, we begin to doubt our conviction. We may become nervous that we may end up selling them off.
The bear market is where our conviction got tested. It is a good reminder of what conviction means. Our conviction has to work on the upside as well as the downside.
3. Go deeper
I take deeper dives into studying and evaluating companies. It helps to find the gems and to build conviction as my edge.
How can companies thrive in such a challenging situation? I began to look at great companies (such as Amazon, Netflix, and Microsoft) by studying their strategies and relating them to their financial performance. They keep improving their service offerings, have consistent revenue growth, can maintain their margins, have a good cash position and can generate good free cash flow. I also compare their performance to their competitors. They are winning over their competitors. The book, The Outsiders: Eight Unconventional CEOs and Their Radically Rational Blueprint for Success Hardcover, highlighted several companies (many are industrial companies; before the tech era) that have been growing for decades.
What makes Amazon, a mega-compounder?
2022 is an excellent opportunity to study companies that are able to inch ahead of the competition in a challenging situation. Many can raise and burn cash during good times to compete and grow. However, many pull their brakes hard when times are tough, especially those that are unprofitable and low on their cash. Everyone becomes cautious. The challenging period is when the best is able to rise above the rest. The proof is in the pudding. We need to examine their operating metrics and financial performance to validate our investing thesis and conviction.
Bad companies are destroyed by crisis, Good companies survive them, Great companies are improved by them”
Andy Grove
A company improved with a crisis: Pinduoduo (December 2022)
Challenging Nike and Adidas in China: ANTA, Li Ning (June 2022)
There are many resilient companies that are able to keep growing. We have to look deeper to find them than be focused on the macro picture.
4. Go wider beyond SaaS
I used to have a very high allocation towards SaaS. It is a sector I know better. I started to learn and explore beyond SaaS; such as the energy, defence/homeland security and healthcare/pharma sectors and niches. Though the market is rough, there are sectors and companies less affected.
A small cap gem: TransMedics (November 2022)
A potential compounder: Axon Enterprise (November 2022)
5. Accepting dIfferent views with humility
It is good to avoid echo chambers and confirmation bias with different views. With a superficial level of understanding, we can be easily confused by the different views from social media, mainstream media, friends and analysts. Understanding the topics deeper helps to distinguish the quality of the differing opinions. We need to acknowledge the possible gaps and mistakes in our understanding to accept different views.
“Be a free thinker and don’t accept everything you hear as truth. Be critical and evaluate what you believe in.”
Aristotle (384 – 322 BC)
6. On guard against greed
Greed is not something that can be deleted or switched off. It can surface and disguise as being confident. One way to guard is to stay strict and rigid to the investing criteria.
7. Keep learning
To reiterate, never waste the crisis to improve ourselves. Keep learning; don’t just sit and wait.
Updating my learnings with my blog
I learned a lot this year. I have been updating my investing strategies with this blog. Writing helps me to retain, clarify and structure what I learnt. Here are some posts that I have been updating on investing:
Multi-baggers with growth companies
Market crashes are opportunities not to be wasted!
The great investing myth (1): Buy low, sell high
Other changes (not investing-related)
Other changes were made; this is how life pivots as these changes add up.
- Quit coffee: I was having frequent diarrhoea. I always attributed it to my weak stomach and the food I eat. I need coffee as I believe it keeps me to keep awake. I have been drinking coffee as far back as my university days (I think). It has been 2 cups a day. My wife had been asking me to stop drinking coffee temporarily to see the plausible effects. Interestingly, I have much less diarrhoea and adjusting well without coffee.
- Drink water: I used to drink water only in the office. It is coffee, isotonic drinks and others that filled me. With no coffee and high inflation, it is a good reason to switch to drinking water.
- Vegetables: I do not eat many vegetables. Along with quitting coffee and drinking water, my wife encourages more healthy eating and has been cooking a dish of vegetables every dinner.
- HIIT: This was a recommendation by a friend. It is said to be a better exercise compared to jogging which has been affecting my knees. As it often rained in November and December, I have been exercising with HIIT. It has been part of my exercise regime now (apart from jogging and cycling).
- Podcasts: I have been listening to music during commuting and exercise. Someone on Twitter suggested podcasts as an alternative way to consume information. Since then, podcasts have become my valuable source of information.
- Quit listening to music in the background: This is from Dandapani that we tend to overestimate our ability to multitask. Music has been a large part of my life since my secondary school days. It was a difficult habit to change and get used to a more quiet environment.
- Digital wellbeing. This is also from Dandapani to focus and concentrate and reduce our distraction. It is a simple start to practise willpower. I use Digital Wellbeing from Andriod; there are many such apps available. It helps! I am conscious of using my mobile and the apps like checking stock prices, social media and games.
- Volunteering: Volunteering has not been a part of me. I did some visits to The Singapore Cheshire Home during my college days. I tried volunteering while overseas and did once in Shanghai. I chanced upon a YouTube post by MSF on ComLink and it looks doable to start with. Since then, I have been involved several times. I should be doing much more volunteering.
