In his recent shareholder letter, the Oracle of Omaha - one of the greatest investors of all time - admitted how hard it is to consistently pick winning stocks. And once again reiterated that he and Charlie Munger “are not stock-pickers; we are business-pickers”.
- Investing involves Mistakes.
Over the years, I have made many mistakes.
Our extensive collection of businesses currently consists of a few enterprises that have truly extraordinary economics, many that enjoy very good economic characteristics, and a large group that are marginal. Along the way, other businesses in which I have invested have died, their products unwanted by the public.
Capitalism has two sides: The system creates an ever-growing pile of losers while concurrently delivering a gusher of improved goods and services. Schumpeter called this phenomenon “creative destruction.”
- A few big winners carry most of the freight in an investing lifetime.
In 58 years of Berkshire management, most of my capital-allocation decisions have been no better than so-so. In some cases, also, bad moves by me have been rescued by very large doses of luck. (Remember our escapes from near-disasters at USAir and Salomon? I certainly do.)
Our satisfactory results have been the product of about a dozen truly good decisions – that would be about one every five years – and a sometimes-forgotten advantage that favors long-term investors such as Berkshire.
The weeds wither away in significance as the flowers bloom. Over time, it takes just a few winners to work wonders.
Prashant Jain shared these insights from over three decades of investing, when he exited as the CIO at HDFC Mutual Fund. He is the only fund manager in India (and one of the few globally), to have continuously managed a scheme for over 28 years.
- You cannot avoid losses if you are an equity investor.
Everyone makes mistakes. Everyone makes losses. Be it an individual investor or a professional asset manager. Because we are all dealing with the future, and the future is uncertain.
A lot of attention is focused on going for the big winners, the multi-baggers. But since equities are a lot about discipline and portfolio construction, we can win big over the long term by simply eliminating mistakes. I successfully avoided a long list of businesses that caused large and permanent loss of capital.
But I also missed some great opportunities. I made more mistakes of omission than of commission. I let go of many opportunities because of improper understanding or whatever. Some prominent missed opportunities were Asian Paints, Bajaj Finance, Eicher, Kotak Mahindra Bank, and Divi’s laboratories.
- Appreciate the underlying uncertainty or risk in the individual investments and size them appropriately.
Every portfolio will have its share of winners and losers. But how much is each cornering? This is why sizing is most important in portfolio construction.
Out of the 465 stocks I invested in, 1 in 4 resulted in a loss. (The data is across the 3 funds that Prashant Jain managed from October 2003 to July 2022).
Nevertheless, the end results were quite strong because the mistakes were quite small. They were well sized. Out of the 113 stocks that lost money, 110 were in the lowest two categories where the losses of each were less than Rs 250 cr. The gains on one large winner were more than the total losses of all loss-making investments.
When going in for portfolio construction, sizing of the bets is extremely important. Do it based on the assessment of the risk-reward associated with each investment. Don’t just focus on security selection to the exclusion of sizing. And if you size appropriately, the portfolio returns over time are extremely good.
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