The Bias of The Overlooked & Misunderstood: An Accountability Post

**EDIT: After posting this I realized this is my 100th post on The Market Plunger blog. Thank you to those that have been with the blog from the very beginning — and thank you to those that have joined between then and now.**

This blog’s purpose is to hold me accountable. Whether in my valuation, research methods, investment criteria, or my psychological fallacies; the blog helps me check myself to see if I’m doing anything wrong (or if I could be doing something better). Complacency is the bane of any investors existence and should be feared like the Plague. However, like anything in life, the opposite of complacency isn’t easy. In fact, a steadfast determination to not be complacent puts one at the center of humility — the continual realization that you’re wrong, you’ve failed, you didn’t measure up. That’s why complacency feels so warm and fuzzy — it keeps us in our cashmere blanket of “You can’t get better from here!” or “You’ve made it!”. It’s my job to fight that urge, to fight the desire to settle. 

So, that’s a long-winded introduction to the following post on a bias I’ve recently overcome over in the last year and change. For those that are regulars to the blog you’ll notice this is one of a handful of posts that isn’t related to a specific deep-dive into a potential investment. I want to start doing more of these — as time allows — because it gives you, the reader, a better understanding of how I combat personal biases in my investment process and overall life journey. This post may not be for you — you may have this bias under complete control — and for that, I congratulate you. If you find yourself saying, “wow, I think I have this problem” — I hope this post brings confidence that fighting this bias will produce in its final form a better, more well-rounded investor.

What Is The Bias? And How Did I Discover It?

The name I gave of this bias (ever so creatively) is: The Bias of The Misunderstood and Overlooked. What does this mean? Simply put, as a value investor who likes to look at off-the-beaten-path securities and situations, I found myself trying to fit a story and a discount into a company that isn’t valuable — solely due to the fact that it’s obscure, peculiar and off-the-radar. In other words, if I spent so much time digging through OTC listings, pink sheets, etc., shouldn’t I be damn-well compensated for it in the form of an  investable opportunity?

Digging a bit deeper, I realized this bias was inherent in my desire to be original. Investing is an extremely arrogant profession in which every time you make a decision (whether to buy or sell), you’re assuming you know more about the security’s situation than the person on the other side of the trade. Along with that arrogance is a desire to find something nobody else has found — and to be right doing it! This desire stems from my natural tendency to be a “rebel”. I don’t like following “rules” in the sense that I’m not big on having parameters set for myself (hence why my investing mandate is wherever value takes me). If I can find an investment that nobody else has discovered, I score one for my ego. I start thinking, “man, I might be better than so-and-so”, and I begin to think that my s**t doesn’t stink — “I can’t miss baby!”. THAT AIN’T GOOD!

Never Underestimate a Hot Shower

How did I discover this bias? In the shower, of course. It’s where I do most of my deep, philosophical thinking. I spend quite a bit of time thinking about the investment ideas I’ve had in the past, my thought process, and how I was right or wrong. In between rinsing off my face wash and applying some Head & Shoulders, I harkened back to an idea I had for a company engaged in the renewable energy business that made encapsulants for solar panels. I thought the company was ridiculously cheap at the time (trading for less than 1x EV/EBITDA, less than half of its book value, and no debt). Sounds like a winner right? Maybe, but it wasn’t the stock itself that was the glaring issue — it was how I formulated my thesis — my desire to write about it. It was all backwards.

Psychological Incentives Matter

It’s not enough to find an idea that might be valuable — it should line up with your psychological methods and practices as well. Why did I want to write about the above idea? Not because it was super cheap, not because it had zero debt, but because it was an OTC stock with no following (read: I could be the first to discover it). Notice that I’m not judging the security itself as a bad idea, but rather the pathway I followed in deciding to write about it.

Unfortunately I let me ego get in the way. I ended up writing the post, sending it to one of my investors that I bounce ideas off of, and rightfully got ripped to shreds. It was the first time in my investing career that I wrote something that I knew was garbage just for the sake of having my name attached to something obscure and “interesting”. His response to that write-up? “This [write-up] actually made me want to short the company, not buy it. In fact if the volume wasn’t so illiquid I would short it tomorrow.” Talk about a kick in the groin!

Just like the management teams I try to invest in — personal interests and incentives need to be aligned. Am I investing to scratch an egotistical itch? Or am I investing because I love finding great businesses at ridiculous prices, regardless if they’ve been looked at before by others. Am I writing this blog to get my name attached to an OTC stock that nobody’s ever heard of for the sake of “coming in first” in finding it? Or am I writing to improve as an investor and to develop a public track record that can help me grow? I needed to start asking these questions.

How Did I Fight It? What Were Some Tools?

The first step I took to fight this bias was to go through all of my investment write-ups before that and see what I did right. This might sound counter-intuitive in the sense that when one discovers a flaw, a common theme is to go and find all the times they’ve made that mistake. However, I wanted to see in real-time when and where I went wrong. If I could boil down the problem to its first principles, I had a better chance at nipping it at the source. By doing this, I came to the conclusion that I was focusing too much on the quantitative while trying to shove a slip-shod story into the valuation similar to the way my sister shoves the last few ounces of clothing into her carry-on bag before a flight. 

The story you tell about your investment must be synchronized with the quantitative figures. It’s not enough to shove numbers into people in a few paragraphs, run a DCF spreadsheet and say, “Look at all these metrics … check out this DCF … buy the stock because the DCF model says the shares should be worth $X and its trading at less than $X.” That’s just not good enough. Moreover, it’s lazy valuation work, and by the transitive property I realized: I was getting lazy. I thought it was enough that my stocks had funny names, weird symbols and traded on exchanges not many people followed.

Tool 1: Surround Yourself With Different Thinkers

To defeat personal biases you need coaches, not cheerleaders. For example, if a child wanted to become a world-class painter, he shouldn’t go to his mother for art critique. In the eyes of the mother there is no such thing as a poor work from their child. The same goes for investing. If you constantly ask for feedback from the “mothers” of your circle, you’re going to hear a lot of what you want to hear — which can be destructive to your growth. I would’ve never realized how much my bias hindered me if it wasn’t for my investing colleague pointing it out in the most honest and blunt manner. Find people who care enough to give you the hard realities of your short-comings.

Tool 2: Get Comfortable Being Uncomfortable

I’m a huge fan of Jocko Willink and his mindset of taking ownership, getting after it, and never making excuses. His podcast is a must-listen, link here: http://jockopodcast.com/. Jocko focuses on teaching people to take ownership of their mistakes — and broadly — take ownership of everything they can in their life. As investors there are things we can control and things we can’t control. We can’t control the broad markets, we can’t control what the Fed will do or how any President might react to monetary policy — none of it. We can, however, control our emotions, our investing process and our dedication to becoming better.

In order to do all of those things — in order to take ownership — we first need to get comfortable being uncomfortable. It’s not easy admitting that a failed investment was because of some shortcoming in your valuation process. It’s hard to take ownership when you sell a stock because of an emotional reaction instead of a calculated underwriting of the valuation after new data is presented. These things are hard to do. But they’re worth it. Aswath Damodaran likes to say that he would rather be transparently wrong than opaquely right. I fully agree.

Tool 3: Start an Investment Journal

I first heard of this idea from Christian Ryther of Curreen Capital (if you haven’t had a chance — read his investors letters, they’re fantastic). This blog is in essence my public investment journal. Yours certainly doesn’t have to be displayed on a piece of Internet real-estate, but here’s how it should be structured (wherever you keep it):

• Write down why you’re buying the stock at the current price.
• Document what you expect the stock to do after you buy it.
• Expand on where you think the fair value of the stock will be in a given time frame (say 3-5 years).
• Dive into specific risks that could undermine the potential value creation.

By doing this for every investment you can then go back, say every 3 – 6 months, and review each investment made and how you thought about it at that time. Once a healthy backlog of stocks are documented, you could check for biases or destructive patterns in your own process. There’s a saying that goes something like, “If you can’t document it you can’t track it” — I probably butchered it — but the point rings true. Even for investors like myself that aren’t systematic, we still need a way to help us find weaknesses in our approach.

Final Thoughts

Investing is an endeavor for the curious, not the egotistical. I had to fight my ego in order to help reveal an area of my investing process that was lacking. Sure it was uncomfortable, sure it took some brutally honest criticism from a close colleague, but it was worth it. 

I will continue to make mistakes as I go through the journey that is value investing. As much as I try to learn from those that I look up to in this business, I realize there will be times my biases and failed heuristics will let me down. However, I hope this post reminds me that when I do fail, when I do come up short, it’s not a time to mope and blame something else — but rather a time to reflect, to learn, and to pursue excellence instead of ego.