False Defeats and False Victories
Aren’t stocks a lot like heroes in novels we read? Six years ago, when I was putting the finishing touches on my first book: “Outsmarting the Crowd,” my UK-based editor, with a great affinity for novels, told me how much we can learn from works of fiction. Our conversation renewed my interest in novels, stories, and specifically how they are structured. Whether it’s a recent Hollywood production or a 5,000-year-old myth, the hero celebrates false victories and faces false defeats, very much like any investment we research. Let me explain.
I imagine not everyone has ever read an accounting or finance manual, I don’t blame you, but I’d guess that everyone has read a novel in their life. To me, annual company filings with balance sheets and management discussions read just like a novel. An imperfect hero embarks on a journey of growth and transformation, and I’m sure to see both ups and downs on the way. If I’m not careful enough, I could be misled by false defeats and false victories.
Each hero worth our attention will experience some mishaps on the way; in novels, it could be a heartbreak, a lost battle, a natural disaster, in investing a few weaker quarters, a product recall, an economic recession, and more. What keeps us reading or following the hero is the hope that the fortune will turn in their favor. Equally, we may be fooled by a false victory. It may seem that our hero is getting ahead, winning the battle, finding a safe way out of trouble, only to be sent back into the worst turmoil.
It’s the unlikely and the imperfect hero with an almost impossible victory that makes the best story and, I believe, the best investment.
I have never read a novel where a perfect hero lived a perfect life, and only good things happened to them. I also have never seen a perfect stock, with a perfect rise, and success, with no mishaps on the way.
When I got my first New York investment job, one of the things I did was pull up the end-of-the-day trade sheets. It was a long list of trades done by all portfolio managers during the day. They might have seemed dry and uninteresting to many, but they were the treasure trove to me. I was a junior analyst eager to learn, and there is no better way than to learn than from those who have been investing for decades.
I was curious about what they were buying, but I was especially intrigued by the stocks they were selling. Some of those holdings did very well, and I was curious when they were purchased and why. My fellow portfolio managers often accommodated my youthful curiosity, and I was almost always the only one asking them to share the story behind those sell decisions.
I’d also study the price and valuation of those stocks over the years. I found it very intriguing that even the best holdings traded in a wide range. There were times when one could buy them 50% off. These were the imperfect heroes facing their false defeats and celebrating false victories.
The two best examples I can think of that are a false defeat on one hand and a false victory are Apple in the 1990s and WeWork in 2019.
Apple and WeWork are both extremes. Apple went from a near demise to being the highest-priced company in the US, and WeWork went from a seemingly invincible success story to an almost bankrupt company all in a matter of months. Most companies we study fall somewhere in between those two ends of a wide range.
When Steve Jobs returned to Apple in the 1990s, the company was in real trouble, quickly running out of cash. The innovation lagged, and the competition dominated the market. Apple’s survival wasn’t obvious, and recovery didn’t seem likely, but the company started to collect victories from an iPod to iPhone, iPad, and more over the next few years. It surprised us many times over. Its near-death experience of the 1990s proved to be a false defeat. The following quarter of a century has been a path of massive transformation. I’m not aware of a more unlikely turnaround in business history.
When WeWork failed to convince investors to participate in its highly hyped-up IPO, this almost $50 billion company experienced a harsh reality check. Its unprofitable business ran out of support among investors, and it turned out to be not a tech company, but a money losing real estate company. The market refused to fund its growth at all cost and with no regard for profits. WeWork’s false victory turned out to be a very real defeat.
Apple looked like a terrible investment the last few years before Steve Jobs returned. WeWork seemed to be a great investment all the way until the market called the bluff on its meteoric rise. Those two examples also show how hard it is to measure our heroes on their journey, and falsely celebrate investment successes, and unnecessarily wallow over investment failures. The story of either of the companies isn’t over yet. WeWork just managed to go public recently; Apple continues to launch new versions of its products.
Anyone that tries to gauge our investment hero’s journey based on a monthly performance misses the point. We need to keep a long-term picture in mind and see where the growth and the transformation of the business are taking us. Are the odds in our favor that our holdings will be bigger and better a few years down the road or not? That’s the question we try to answer. Whether they will get there after half a dozen or two dozen of false defeats becomes irrelevant in the grand scheme of things.
Studying heroes of novels we read and businesses we research, we find patterns that repeat through cycles and ages. The works of fiction provide a very enjoyable entertainment, businesses, on the other hand, they may offer money-making opportunities for disciplined and patient investors.
Investing could be described as collecting heroes for our portfolios. We accept that they are imperfect; we know well that they will experience victories and defeats on their journey. We do our best to take advantage of the false defeats and not get fooled by false victories. Maybe my editor was right, and we can learn a lot about investing reading works of fiction and looking for unlikely heroes when and where few dare or care to look?
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