Being the Least Wrong
This article was inspired by a talk I gave over Zoom to a group of investors earlier this year. I attempted to summarize our investment philosophy in the fewest words possible. I immediately said: being the least wrong all the time. Here is why.
The very first stock I ever bought, I bought with a clear intention: I wanted to be right and make money. It had a great story, a promising future, and I couldn’t see how anything could go wrong. Yet I lost money on that first investment. It turned out to be the cheapest and the most valuable lesson I could have asked for. It taught me much more than any successful investment that followed and greatly influenced my investing philosophy. I soon realized how many get into investing to be right and make money, and those who stay and remain successful are those who find a way to be the least wrong. They not only make money but also get to keep it! I believe that the real secret of investment success is not to be right sometimes, but to be the least wrong all the time.
Over fifteen years as an investment advisor, I have heard stories of many family fortunes that we at Sicart have the privilege of managing. The common thread is generations of family leaders and advisors who have followed this philosophy. The reason those fortunes still exist, sometimes over a century later, is the successful avoidance of the most significant risk possible – losing it all. This is true for all family fortunes regardless of geographic location or source of wealth. What’s more, it’s been a reliable philosophy for hundreds of years, especially the last couple of centuries, which have led to the most significant wealth creation in history. (You can read many of those stories and their lessons in my book Money, Life, Family.)
However, the important point is that being the most right and being the least wrong are not two sides of the same coin. The goal of the former is to find the highest return on investment regardless of risk; the goal of the latter is to avoid having to start from nothing all over again. Our experience shows that avoiding the biggest mistakes is the key to successful long-term investing.
Stock Selection: Avoiding Zeroes
My first investment wasn’t a total loss; I lost about half of what I had invested. The experience was painful enough to make me pay attention not just to the upside but also to the downside. When it comes to individual stock selection, we have a clear rule – I call it “avoiding zeroes.” We try never to make any investment that has a clear potential to become a total loss — a zero. Studying all the stocks we ever considered or researched, we’ve identified three sources of those potential zeroes: 1) too much debt, 2) secular decline, 3) questionable management. Interestingly, those three sources of trouble often cluster together. I devoted a good part of my first book, Outsmarting the Crowd, to “potential zeroes.”
I also discussed a prime example of such an investment in a Seeking Alpha Article in late 2017. I wrote about Steinhoff International, which is a South African retailer with stores in Europe and the U.S. (including Mattress Firm). It took fifty years to build, but just two days to collapse. Its industry faced headwinds, and the company struggled to grow, borrowing lots of money to buy up other players. At the same time, questionable management opted for cutting corners in the process. The result was a disaster.
Almost as bad as “potential zeroes” are those stocks that bring a significant, irrecoverable loss to your portfolio. This category often includes exciting stocks whose prices take off, leaving fundamentals far behind. Superficially they seem like “can’t miss” opportunities, but in retrospect, their businesses prove to be a lot less attractive than initially presumed. Today, attention might focus on Amazon, Apple, Tesla, or Facebook, or the recent new wave of promising tech IPOs. Still, we might have conveniently forgotten Groupon, Blue Apron, or RenRen, among others. All three stocks are still publicly listed, but the price of each has dropped some 90% since their public offerings (Source: Bloomberg). I remember when Groupon was on magazine covers, and the Blue Apron logo was plastered across the New York Stock Exchange building. I remember a packed venue hosting RenRen’s initial public offering event in Manhattan. These businesses proved to be a lot less attractive than anticipated, and the excitement faded along with the price. Stocks similar to these come and go. Despite their mass appeal, they seldom make it into our portfolios.
Returning to wanting to be right, we can all agree on some truths about today’s market darlings – Facebook, Amazon, Apple, Microsoft, Google. We certainly believe the businesses behind them are impressive and successful. The most important thing is how much we are willing to pay for them. If you buy a company that makes $1 per share, and a few years down the road, it earns $2, the business has doubled. But if you paid $30 for each dollar of company earnings, the market eventually cuts the valuation to $15 for each dollar of earnings — $1 times 30 vs. $2 times 15 amounts to the same $30 stock, despite the doubling profits. If you think this scenario is unlikely, take a look at Xerox. It was once a market darling, even part of the famous 1970s Nifty Fifty, but it’s been an $18 stock for most of the last 20 years. I took Xerox twenty years to go from $18 to $180, where its price peaked during the late 1990s Internet Bubble. Xerox’s stock price fell back to $18 in a little under twelve months when the bubble burst. In other words, it gave back twenty years of gains in a single year. The even more fascinating thing is that Xerox recorded about the same profits in the fiscal year 2000 as it is expected to earn next year — yet its stock price is 90% lower than it was back then (Source: Bloomberg). The business has held steady, but the price has not. The valuation explains it all – how much we had to pay for a dollar of Xerox earnings 20 years ago vs. today. That doesn’t necessarily make it an attractive investment now, but it definitely didn’t make for an attractive investment back in 1999/2000. And that’s a stock of a company that became not just a household name, but a common verb. All this is to say; it matters not only which business you pick, but also how much you pay for it.
Portfolio Management: Nimble Structure
Apart from avoiding zeroes and near-zeroes in our individual stock selection, which is our policy in any market, we also have a portfolio management view that aligns with our ambitious goal of being the least wrong.
As investors, we have to take into account not just whether we bought the right business at the right time, but also the broader context in which we operate. Where are we in the economic cycle (a top, bottom, middle)? Can we expect more inflation or deflation ahead? Is there room to cut interest rates further, or can they only rise from here? Also, we need a good understanding of the fiscal and monetary realities we operate in – do we see bigger fiscal deficits, more spending, is a growing intervention of the central bank likely? Any of these would have an impact on stock prices, market sentiment, and the performance and risks of our investments. Our goal is to build a portfolio that will do well, not in one specific scenario but any scenario.
Our portfolio structure today is based on three building blocks: cash, gold, and a select group of companies, followed by a long wish list of potential investments. Cash serves as dry powder to be invested in the near-term and buffer on the way down when the market sells off. Gold is protection against panic, uncertainty, and inflation. Stocks provide the potential upside, dividends, and appreciation, and may serve as a good hedge against inflation. If deflation proves to be the dominant force in the coming years, pushing prices down, we believe cash and gold should remain steady. At the same time, some quality businesses also can manage their operations through deflation relatively unscathed.
This portfolio structure is not set in stone; it’s actually built for change. Cash levels will drop when we see enticing buying opportunities; we may use gold to supplement our buying power, while our stock exposure is likely to rise at the same time. Could we obtain better performance in the short run? Absolutely. We could quickly replace cash and gold with the fastest-rising stocks. But this short-term success would come at the expense of the biggest risk possible – a significant permanent loss in the long-run.
We think of our options as a wide range from being entirely on the sideline or fully invested, and even invested solely in a handful of market darlings. The beauty of investing is that we don’t have to pick either of the extremes; we can choose a middle path. For some clients, it may mean more cash and gold, for others being more invested. Every client’s tolerance, preferences, and investment horizon can vary. As we believe and often say – peace of mind and the quality of sleep matter more than anything else.
Portfolio Evolution: Buying and Selling
In rising markets, it’s possible to believe that buying without ever selling is the best policy. Though, history shows that the markets experience “sideways” periods when they don’t move in a clear direction for a decade or more. The most recent example is the period between the Internet Bubble peak and 2013 when the S&P 500 didn’t budge significantly. It experienced both rallies and crashes, but for a passive investor, there would have been no price appreciation to be seen for 13 years. Nasdaq, the technology index, took 15 years to reclaim its peak from 2000 (Source: Bloomberg). Over that time, active managers had more flexibility to buy and sell rather than just wait for the market to recover.
Today, with U.S. benchmarks at new highs, we wonder if the upcoming 10-15 years will resemble the previous situations when the market claimed a new peak only to trade sideways for the following spell. If that’s the case, selling policy may be as crucial as buying policy — and waiting on the sidelines with ample cash and gold might prove to be the least wrong one if the markets lapse back into distress.
My colleagues and I never claim to know how to identify market highs or lows, though we may estimate whether we are closer to the top or the bottom of a decades-long cycle. Looking at today’s market levels, valuations, and fundamentals make us believe that we are likely closer to the top. We can’t be more precise than that.
But in our quest to be the least wrong, we stick to our tried and true approach: act slowly, gradually, and pace ourselves in both buying and selling. Just as we don’t need the precisely correct allocation between cash, gold, and stocks, the same is true of our buying and selling. We often say that we “nibble” on stocks when the prices get attractive. Similarly, we will trim our holdings slowly when, in our judgment, prices rise too high to offer sufficient reward, given the risk we’d have to take on.
Here we are, far into the second half of 2020. Unemployment is close to record high levels; corporate profits are down, the economy has contracted, a crucial presidential election awaits us in the coming months, record fiscal stimulus is underway, together with record monetary help. The list of unprecedented conditions goes on and on.
We don’t know when the skies will clear, but we do know that the U.S. economy is big and diverse. We know that it’s backed by strong human capital, and we remain optimistic about the long-term future. For those who want to get into investing and become successful investors, the goal is not to make accurate predictions about the markets. The economy and the business world are too complex to guess what the future holds. But being the least wrong about the investment decisions remains at the heart of our investment philosophy, which we believe to be the true secret of successful, lifelong, generations-long investing.
The information provided in this article represents the opinions of Sicart Associates, LLC (“Sicart”) and is expressed as of the date hereof and is subject to change. Sicart assumes no obligation to update or otherwise revise our opinions or this article. The observations and views expressed herein may be changed by Sicart at any time without notice.
This article is not intended to be a client‐specific suitability analysis or recommendation, an offer to participate in any investment, or a recommendation to buy, hold or sell securities. Do not use this report as the sole basis for investment decisions. Do not select an asset class or investment product based on performance alone. Consider all relevant information, including your existing portfolio, investment objectives, risk tolerance, liquidity needs and investment time horizon. This report is for general informational purposes only and is not intended to predict or guarantee the future performance of any individual security, market sector or the markets generally.