Dealing With Failure

"You're neither right nor wrong because people agree with you. You're right because your facts and reasoning are right."

I'm sure many readers have already heard that quote above already, but for those that haven't, well, I think it's a great bit of wisdom to keep in mind when investing. Practically, this means that when you invest in a stock, you are neither right nor wrong because the price rises over the ensuing six months. You are right or wrong because you thesis for the investment was correct.

An illustration. You do a bunch of research on Target (NYSE: TGT) and you decide that you like the long term prospects for the company and its ability to sell "affordable luxury" to a broad base of customers. You also buy some shares of Dynamic Materials (Nasdaq: BOOM) because you think the ticker symbol is really cool.

Six months pass and Target is down because the economy is slowing a bit and taking some of the wind out of its sails. Meanwhile, erratic trading and a recent short squeeze have given you a modest increase on your Dynamic Materials shares. Would you conclude from this that the key to investing success is in choosing cool ticker symbols rather than digging in on fundamental research?

If you said the former, you're probably reading the wrong blog...

But back to my original purpose in this post. Whether or not you're using valid, sound reasoning, you're eventually going to have investments that don't go your way. It's a simple fact that you're going to have to deal with if you want to be a successful investor in the long term.

The key is admitting when an investment has run aground and no longer follows your thesis (emphasis on no longer following your thesis, as above, don't rely on declines in the stock's price to dictate whether you were correct or not) and then dealing with it and moving on. Even significant failures during your investing career can be overcome, so it is important to remember that and not get caught in the mental trap of wishing for a wrong investment to become right.

If you've been investing for any amount of time then you know about that "wishing" scenario: you do your research, invest in a stock, and something happens that proves your thesis completely wrong and the stock declines badly. Then, instead of selling the stock and moving on, you let it sit there in your portfolio as you wish (you're no longer anchored by a thesis) that the stock price will come back to what you bought it for so you can sell at breakeven. Of course, in most cases that never happens. Worse, the stock sits there flat or continuing to fall and transforms from a small nick in your portfolio to a festering sore that not only drains your capital, but takes up valuable mental space and eats away at your confidence.

Yeah, not a good situation.

So how do I know that even major mis-steps can be overcome? Well, if you think about it, arguably one of the best companies/stocks of all time, Berkshire Hathaway (NYSE: BRK-A) (NYSE: BRK-B) was started on the basis of a mistake. What's that? Yup, I went and said it.

When Warren Buffett bought Berkshire Hathaway, the struggling textile mill, he thought that it could be turned around with better management and a tighter ship. For those who know the story, this was far from the case. The textile operations of Berkshire Hathaway were a thorn in the side of the company for years, eating up capital and providing a sub-par, if even positive, returns.

The genius of Buffett was to recognize that the returns that they would get from reinvesting the cash coming out of the textile operations were well below what they could get elsewhere. So he took that cash and used it elsewhere, a move that helped build Berkshire to what it is today. By Buffett's own admission, he kept the textile operations running longer than he should have and reinvested far more in them than he should have, and yet -- bla bla bla, they're really successful now, you get the point.

So do you get it? In investing mistakes are OK, they come with the territory. I know that at least in US schools we're taught that you want to get 100% and earn that A++++++, but it just doesn't happen in investing. The more you fight against that fact, the more difficulty you will have being a successful investor.

And if you're wondering, yes, I'm still reading Buffett's letters to Berkshire shareholders -- that's what sparked this post.

-AvgJoe