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Basic but important investment considerations

Oct 24 2016 11:28
Simon Brown

Simon Brown, founder and director of JustOneLap.com.

I recently had drinks with a friend who has been in the market since the early 2000s and whose thinking I have enjoyed ever since I first met him. In fact, two of the cornerstones of my investing logic come from him. While I have written about both before, I am going to once again do so because we often need reminding from time to time, myself included. 

Try to discover the ‘unknown unknowns’

The first is a comment he made once that one can price risk, but we cannot price uncertainty. This is not an exact science, but what he was saying is that it is important to know the difference between risk and uncertainty. 

In a sense it ties into the much-laughed-at comment by former US secretary of defense Donald Rumsfeld when he was talking about “unknown unknowns”. In truth he was right:

“There are known knowns; there are things we know we know. We also know there are known unknowns; that is to say we know there are some things we do not know. But there are also unknown unknowns – the ones we don’t know we don’t know.” 

As an investor, there will often be issues that we are aware of where a company is concerned. There will also be areas in which we are not as well versed – but generally we know that we have to brush up on them either by conducting research, looking at competitors or just asking the right questions. 

The problem is the last: unknown unknowns, which may have a positive or negative impact on the company. These are things we are not even aware of until they come out of left field. But how do we know what they are if they’re unknown? That’s the difficult part. 

The way we manage this is by digging. You should always be asking questions and always be on the lookout for something unexpected to occur. Get opinions from others, even those who may not be experts.

I often find that asking somebody who is not an investor at all about one of my ideas often gives me great results as they approach the issue from a completely different perspective. 

I also look at industries that perhaps aren’t that close to each other. For example, these days the vehicle manufacturing industry is also linked to self-driving cars (technology), the sharing economy and battery technology. 

Wait for stocks to double in price

My friend’s other great comment is that a 10-bagger has to be a one-bagger first, and we should wait for the one-bagger (doubling of price) before jumping in. This is especially true when we’re trying to buy a stock that has been falling hard. Buying as a stock falls nearly always ends in tears as the stock falls far further than we imagined it could. But if we wait for a stock to stop falling and double in price and then buy it, we’ll have a much lower risk position.

An example here is the local commodity stocks. Late last year I did a presentation where Kumba was one of the stocks being discussed. At the time it was trading at R100 and everybody was saying it was great value. I suggested waiting for it to double in price before buying. If one had waited, one would have watched Kumba hit the R25 mark and could have bought it at R50. This is a great trade that would have made investors some serious money, whereas trying to call the bottom would almost certainly have seen you buying well above R50 and maybe bailing before the stock started to rally higher.

So, to sum up the two lessons in a nutshell: First, always be digging and creative in looking for those unknown unknowns. Second, don’t jump into collapsing stocks. Wait for them to bounce strongly and buy when they have doubled in price the first time.

This article originally appeared in the 20 October edition of finweek. Buy and download the magazine here.

 

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