“There are two private companies in the history of this planet that have been to orbit and it’s Space X and it’s Rocket Lab and that’s it.” — Peter Beck, Rocket Lab Founder and CEO
From a remote peninsula on the East Coast of New Zealand, Rocket Lab launched its second commercial rocket into space, carrying spacecraft for NASA. By this time next year Rocket Lab is planning to launch a new rocket to space every week.
Transport to space, space, is about to become as regular and reliable as a flight to Bali. Earth’s next trillion dollar industry has just started, and a company launching out of New Zealand is leading the charge. Not only that, Rocket Lab is doing this with a rocket, the Electron, that is a fraction of the size of Space X’s monstrous Falcon Heavy:
(Source: The Economist)
You’re probably wondering how little Rocket Lab can possibly compete with the gargantuan Space X?
I was curious too. I dug into the economics of the launch vehicles, micro-satellites and the industry itself. I was also fortunate enough to be able to interview Rocket Lab’s Founder and CEO Peter Beck. The answer involves cutting edge technology, deeply customer-centric design, and more than a dash of Kiwi ingenuity.
Rocket Lab’s level of technical innovation has been incredible. But it is their economics that are about to change the world.
Return on an investment always matters, and space is no exception. In 1969 humankind set foot on the Moon for the first time. Three years later, we set foot on the moon for the last time. How is that possible? Forty-six years have passed since and… nothing. Why? Economics.
We could technologically go to the Moon in the Sixties. However that exploration came at a cost: at its peak the U.S. government was spending over 4% of its entire Federal budget on the space program. And with little return to show for it, aside from bragging rights.
Today’s Space 2.0 revolution is about space travel being possible not just technologically but economically.
Rocket Lab is at the forefront. The company has adopted a recursive cycle of continuous improvement that is putting daylight between it and its competitors. Let’s call it Rocket Lab’s Cost-Frequency Flywheel:
#1: Cost minimisation
“I started with one piece of paper and on that piece of paper it had two requirements. Must be affordable. Must launch weekly. And everything has been driven by those two requirements.” — Peter Beck
Every part of the Electron has been designed for regular and reliable space transport. The result is a rocket system that looks strikingly different to other rockets. First of all, it’s small. The Electron stands just 16 metres tall, compared to the 70 metre tall Falcon Heavy. Rocket Lab has very intentionally decided to serve the small space craft market and has zero intention to ever build a bigger rocket.
When Peter Beck created Rocket Lab, he could see the future, and the future was small:
“The big geobirds [large geo-stationary satellites] are declining. And you’ve got Space X and Ariane, ULA all competing for those big geobirds. But if you look at what’s happening in the Lower Earth Orbit market, in the small spacecraft market, it’s 200% growth year on year on year. And it’s something like 2,500 spacecraft that need to launch in the next few years. So the real needlemover in the industry is frequency. That is what is going to fundamentally change the way we use space and ultimately, life on Earth.”
Technology is on a continual path of miniaturisation. If you need a reminder, look at the smartphone on your desk (or that is buzzing away in your hand right now because you’re as tech-addicted as the rest of us) and compare it to the lounge-full of equipment that this cool dude used to need to do the same job:
Peter Beck saw the same trend happening in spacecraft and built his company around it:
“For me it was always very obvious that spacecraft were going to shrink. When you analyse what is in a spacecraft there is a bunch of electronics, batteries, solar panels, and a sensor. And all of those things are on rapid trajectories either down in size or up in performance…Their limiting factor and enabler for that future was the ability to get those spacecraft up in orbit regularly, affordably and frequently.”
Many of the new generation of spacecraft are much smaller than Rocket Lab’s lift capacity of 150kg. These micro-satellites are known as Cubesats. One ‘Cubesat unit’ (1U) is a tiny satellite that can fit within a 10cm cube. A larger cubesat could be 10U or 20U large.
Rocket Lab is taking bookings for cubesats of all sizes, with one rocket ride containing up to 82U. Don’t let their small size fool you, these micro-satellites punch above their weight. For example, NASA is currently planning for a cubesat with an ion-thruster that will self-propel all the way to Mars.
Focusing on small spacecraft mean the rockets themselves can be smaller. Smaller rockets means less complexity, higher reliability, easier mass-manufacture, and ultimately lower cost.
Rocket Lab also sought to align its cost base with humanity’s relentless march of technological progress. As Peter Beck explained:
“We stood back and said well what are the technologies that are either going to reduce in cost or improve in performance. Composites is one of them. 3D printing is another one. And batteries is another one. So there is no coincidence why a lot of the solutions we have chosen align with the trajectories of those either materials or technologies.”
(Source: The Economist)
The Electron contains the world’s first battery-powered rocket engine. Traditionally the main fuel of a rocket (liquid oxygen and kerosene) is mixed together by a gas-powered rocket engine. But those gas powered engines are complex and expensive. Although the industry thought it impossible at the time, Rocket Lab was able to make a battery-powered engine work.
Rocket Lab thereby aligned itself with the rapid decline in battery prices, and equally rapid increase in battery efficiency. Every decline in battery costs, and reduction in battery weight means lower launch costs for Rocket Lab.
(Full thrust. Photo credit: Brady Kenniston)
The company’s Rutherford rocket engine is also the first oxygen/hydrocarbon engine to use 3D printing for all primary components. 3D printing meant Rocket Lab’s engineers were able to create complex but lightweight structures that would have been impossible to achieve using traditional techniques.
(Rocket Lab’s Rutherford Engine)
3D printing reduced the build time from months to days, and significantly lowered costs. As Peter Beck explained:
“The way we have designed the vehicle, it’s designed for manufacture. So while we use very expensive and exotic materials such as carbon fibre, and inconel superalloys and things like that, we don’t use very much of them. And the processes that we use, like the 3D printing of the rocket engines, means that while the material itself is very expensive, because we 3D print them, there is no wastage in the material. It’s additive manufacturing rather than subtractive manufacturing.”
Aside from its size, the other striking feature of the Electron rocket is that it is black. That’s not a nod to the All Blacks (although I might like to pretend). It is because Rocket Lab has pioneered the use of carbon fibre as the primary structural material. For those keeping score at home that is three world firsts in one little rocket.
(Liftoff. Photo credit: Trevor Mahlmann)
Using carbon fibre was immensely technically challenging. Rocket Lab was helped by New Zealand’s world leading carbon fibre industry. The same one that builds America’s Cup yachts. Using carbon fibre means that the Electron rocket is far lighter, stronger, and crucially much easier to mass-produce.
All of these innovations add up to significant cost savings. A single Cubesat slot can be purchased for as little as US$80,000, while an entire mission starts from US$5.7 million. Those prices mean that access to space is now affordable for even the smallest startups.
As a private company Rocket Lab keeps its financials, well, private. However, I estimate that its marginal costs are likely to be a fraction of the sticker price. The company expects to be at cash flow break even shortly, even with just a few launches under its belt. I expect Rocket Lab to gush cash once it hits scale because most of its costs (engineers, launch facilities) are fixed, and its marginal costs continue to decline. Which brings us to the second secret of Rocket Lab’s success: launch frequency.
#2: Launch Frequency
Rocket Lab’s greatest competitive advantage is the frequency and flexibility of its launch schedule. It is incredibly valuable to customers, but also something that its much larger competitors will struggle to achieve.
“The launch regularly bit is the bit that everybody misses. So the reason why we have operations in New Zealand is because of the launch site. Every time you launch a rocket you delay national air travel. When Elon’s Falcon Heavy flew earlier in the year, there were 562 commercial air flights that were delayed or cancelled.”
The East Coast of New Zealand is a beautiful place. But the reason Rocket Lab is based there is not the unspoiled coastal vistas, or the proximity to Hobbiton. It’s the huge flexibility of launch windows. Rocket Lab can launch regularly and with the widest range of orbital inclinations of any launch site in the world. All thanks to the limited aircraft and marine traffic. In fact, while the entire United States only managed to launch 26 rockets in 2017, Rocket Lab has approval from the New Zealand government to launch a new rocket every 72 hours.
(Launch Complex 1: Mahia Peninsula)
That frequency and flexibility of launch allows customers to precisely plan when and where their spacecraft will enter Earth’s orbit. The orbit determines how fast the satellite travels, which part of the Earth the satellite passes over each day, and what time of day the pass-over occurs. It’s not much point building a mesh network of communication satellites if they’re all circling the Earth on random trajectories.
(Fairing separation. Source: Rocket Lab)
This launch control is the primary consideration for Rocket Lab’s customers as Peter explained:
“It’s control of destination and timeline. That’s the number one thing. ‘I’m going to this orbit on this day’ because that’s one thing that [traditional] rideshare can never offer. Because you just don’t know where you are going to go, when you are going to go”
#3: Flywheel effect
Rocket Lab’s low cost and high launch frequency are powerful in isolation. But it is the way that each positively reinforces the other that provides Rocket Lab’s moat. Lower costs mean that more customers can afford to launch more rockets, which provides the cash to fund higher launch frequency.
Increased launch frequency allows Rocket Lab to continuously iterate new innovations, and to achieve greater scale of rocket production. Both of those lead to lower costs. Those lower costs lead to greater demand. Which increases launch frequency. Which lowers costs. And the flywheel spins ever faster.
Peter Beck describes Rocket Lab as not being in a rush to launch one rocket, but rushing to launch one-hundred rockets.
“The easy thing to do would be to just say ok, let’s just build a launch site in the U.S. and live with one [launch] a month, and we’ll work out how to get frequency later. We didn’t do that.”
Rocket Lab took the pain of heavy investment up front, whenever it would result in better performance later on. It meant taking the time to develop multiple world-first technologies; building their own private launch facility and monitoring stations; and going through the regulatory burden of getting U.S. government approval for the export of sensitive rocket technology to a foreign country. As Peter Beck describes it:
“Owning that infrastructure is a key element because we have complete control over our launch windows, we have complete control over, basically everything… I tell everybody that Rocket Lab is a third the rocket, a third regulatory, and third infrastructure. And the infrastructure and regulatory bit aren’t as romantic and sexy like a rocket, but they are actually more the enablers than the rocket itself.”
If that long-term strategy sounds familiar, it is the same relentless approach that has been the cornerstone of Amazon’s success globally. The strategy is summed up by Amazon’s founder Jeff Bezos in the motto: ‘step by step, ferociously’.
Despite its smaller size, Rocket Lab can offer its customers the same price as a rideshare on a much larger rocket. And thanks to the flywheel effect, that cost is continuously falling. Plus, Rocket Lab provides a level of precision that rideshare will never be able to match. Combining low cost and vastly better service is a customer value proposition that is tough to beat – just ask Amazon’s competitors.
The first email
Rocket Lab’s success to date has been awe-inspiring. But speaking with Peter Beck, it’s clear that the company is just getting started:
“It’s a super exciting time in space right now when you think about it. The best way I try to explain it to people is go back to when the Internet was brand new and somebody had just sent their first email. If you went and sat beside that person at that time who sent the first email and explained to them all of the things the Internet was going to create it would largely seem like fantasy. With space, we have just sent that first email.”
Rocket Lab is doing far more than holding its own in this new space race. In fact, when it comes to the hyper-growth small-satellite segment, Rocket Lab has so many competitive advantages that we may actually have the question backwards.We shouldn’t be asking if Rocket Lab will be able to compete with SpaceX.
We should be asking whether SpaceX can compete with Rocket Lab.
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My investing was never the same again after I discovered this. Realising the simple power of fundamental inflection points started me on a journey toward a new (and thus far, fairly successful) investment approach.
But first, let’s get clear on what we mean by a fundamental inflection point. The Investopedia definition will suit us fine:
An inflection point is an event that results in a significant change in the progress of a company, industry, sector, economy or geopolitical situation and can be considered a turning point after which a dramatic change, with either positive or negative results, is expected to result.
To be super clear, we are talking about changes in the fundamental cash flows of the business, not ‘charting’ share price changes.
There are many types of fundamental inflection points. Here are just a few of the types I like to look out for:
Turnarounds (with a major catalyst sparking the revival)
A new fast growing product/segment, ideally whose early growth has been hidden by a larger flat or declining segment
A major demand side break-through such as a new distribution agreement
Growth company tipping in to profitability (with strong operating leverage)
Hyper growth company that has has just ‘crossed the chasm’ (a topic for another update)
All of these have one thing in common, which is a very rapid rapid acceleration in the rate of improvement in fundamental performance.
Today I’ll talk through just the corporate turnaround example, as it is where I first got started as a value investor.
Imagine a company that has been generating steady revenue and profit when it suffers a setback and its performance takes a dive:
There can be a thousand causes. It could have been: a failed product launch; a botched acquisition; or a newly assertive competitor. Revenues slump, and profits plummet.
But whatever the cause, in this example, the declining business finally gets its act together and makes a rapid recovery. Note that this only occurs when there is a specific cause of the slump that can be quickly rectified.
The share price response to both the slump and the recovery is normally exaggerated. Here’s the typical share price moves we’d see in this situation:
This simple chart sums up a lot of ‘classic’ value investing.
Value investors look for businesses that have had some fundamental setbacks (the dip in revenue and profit). But more importantly, they are looking for situations where the market has over-reacted to the bad news (the share price plunge) and the shares are undervalued. They purchase shares during the troughs of the market’s despair and hope to sell later, when the market’s mood has improved.
For many years this was my investing modus operandi: buy something cheap, usually watch it continue to get cheaper, finally (hopefully) a rebound arrives, sell.
It can be painful. Value investors are cursed with being early. That means suffering through significant further price falls before the company’s performance improves. Classic value investing doesn’t really have an answer to this painful process, aside from developing the stomach to hold your nerve (always good advice).
And that is actually the best-case scenario.
“Turnarounds seldom turn” — Warren Buffett
In plenty of cases the turnaround never comes. The traditional value investor is left holding the bag on to a company that looks cheap, but where performance continues to decline. The ‘cheap’ often just keeps getting ‘cheaper’. This slow-motion train wreck is known in the industry as a value trap.
But what if we could cut out most of the pain of suffering through falling prices, and almost all of the value trap blow-ups?
A better approach
Instead of purchasing purely based on an estimated discount to intrinsic value, we can also wait for indications that a fundamental improvement is already well under way. We can wait for the fundamental inflection point:
By waiting until the inflection point has already started we avoid the worst of the losses that long-term holders have suffered. In turn we also miss out on some of the gains, since we are unlikely to be buying at the absolute bottom. But that also means we join in just when the fun is really getting started.
Most value investors arrive for the party two hours early and make awkward chit-chat with the hosts over a bowl of dip. We arrive a half-hour late, a couple of other guests have already arrived and the conversation is flowing. Soon the party will be in full-swing. Later on, when Mr Market has gotten drunk and starts making a scene, we’ll make a polite exit.
Here is a zoomed-in version:
My preferred spot is to wait until *after* there is already some compelling evidence that the company has hit an inflection point (the black line). This has the added benefit that we rely more on observation of the world as it currently is, than solely on forecasts of how it could be in future.
When executed well, this focus on inflection points can radically enhance our expected returns:
Reduce behavioural biases: less pain from holding falling shares means less temptation to sell at the worst possible time.
Shorten the average holding period. This is a key part of generating high annualised returns i.e. it is better to make 50% in six months than to wait two years.
Higher ‘hit-rate’ which allows greater concentration i.e. the number of profitable trades as a percentage of all trades increases.
So why isn’t everybody already doing it?
Why it works (a.k.a. why it’s hard)
Thankfully, there are several challenges to successful inflection point investing.
First: anchoring. “I’ve missed it” are three of the most dangerous words in investing.
By the time the inflection point is already underway, the share price has likely rebounded off its lows. Investors that have been watching the stock often anchor to the lows, instead of reassessing the current value. They avoid buying, thinking that they have missed the gains.
Second: cognitive biases. The changes that happen at inflection points tend to be extremely rapid. We humans are not great at exponential thinking.
Our brains evolved to be very good at linear forecasting. That lion is running towards me. I predict that if this continues I will be his lunch. I better do something. That is very helpful linear forecasting. But it is less helpful in the modern world of finance.
When it comes to forecasting rapid change, our brains are slow to adapt. The market tends to forecast based on a linear extrapolation of recent results:
The market repeatedly under-estimates how quickly the company will improve. Then finally, the market actually overshoots to the upside. The stock then becomes overvalued. Smart investors sell, and the whole glorious cycle of expectations can start again.
Third: the search is hard work. No one rings a bell to tell you an inflection point is underway.
Small-cap and micro-cap companies are often a good place to look for these opportunities. Often nobody else is watching closely. Or more precisely, nobody else that is managing enough funds to move the price.
In these ‘under-followed’ cases it is often possible to identify the inflection point simply by following the company’s latest financial reports. But it is not always that easy. Often by the time the inflection point is readily apparent in the published financials, it is already too late. Smart investors need to be doing the hard work of equity research to identify a fundamental inflection point before it is obvious in the reported results. That means digging through every piece of information about the company, it’s competitors, suppliers, customers etc. Investors also need to ensure they aren’t being fooled with a false positive. Or as Buffett calls it, a ‘turnaround that keeps on turning’. It can be an incredibly rewarding process, but it’s hard work.
Fourth: patience. Or rather, being extremely selective. It is hard enough to find a company that is undervalued. Inflection point investing means holding off, and only investing when you have found undervaluation and a positive fundamental inflection point.
Thankfully none of that is easy, or everybody would be doing it, and the magic would disappear.
Understanding the power of inflection points can significantly enhance a ‘classic’ value investing approach.
We’ve only scratched the surface of inflection point investing. We talked through just one example, the corporate turnaround. But there are dozens of others. In fact, we didn’t get a chance to talk about about my favourite type of inflection point (a hyper-growth company that has has just ‘crossed the chasm’). That will have to be the topic of another update!
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For the past couple of weeks the financial world has been worrying about falling share prices, and interest rates, and sanctions, and things that go bump in the night.
At times like this it helps to take a step back and look at what has been going on in the real world, outside the share market echo chamber. When we take the blinkers off we find a world marching relentlessly upwards.
It is always fun to start with space. It’s hard to raise our gaze higher than humanity’s ambitions to launch ourselves out in to the universe.
That last astounding fact about the rocket-booster being re-usable barely made the news. What better testament to our progress is there than that? This was an incredible technological achievement that only became possible in February. Now, just eight months later, it is barely worth mentioning.
There were some spectacular scenes:
Closer to home, scientists have for the first time used gene-editing to prevent a lethal disease before birth. This technology is just in its very early stages but holds the promise of one day allowing diseases to be removed from children before they are even born. Meanwhile, scientists in China have used CRISPR technology to create mice which have two female parents. A potential win for same-sex parents. But more broadly, successfully editing genes at this level opens the door to major improvements in fighting thousands of diseases.
There was a major breakthrough in the battle with Alzheimer’s: “Scientists believe they have isolated and may even be able to alter the gene responsible for the devastating disease.” It is another example of how humanity may be just at the dawn of a new golden age in health and longevity.
Machines are pitching in to do their part too. A new algorithm can predict which patients are at risk of a heart attack, years before any attack occurs.
While in China, a newly developed AI system saved the lives of coma patients by predicting that they would wake from their coma, despite neurologists giving them a very low chance of ever waking up:
“After reviewing the varying conditions of seven patients in Beijing, the doctors rated the patients on a coma recovery scale. The patients were given very low scores, meaning that it was unlikely they would ever wake up and their families were legally allowed to take them off of life support.
The system which was developed over the course of five years by the Chinese Academy of Sciences and PLA General Hospital, disagreed with the scientists and gave the patients close to full scores with a prediction that they would wake up within 12 months of the scan.
As it turns out, the AI was right – all seven patients woke up from their vegetative states within the year.
The system, which reportedly has an 88% success rate of diagnosis, achieves its efficiency based on its ability to see “invisible” details in hundreds of human brain images. In contrast, the current method of assessing a patient’s chances of recovery are based on subjective reactionary tests and judging certain factors, such as age and the condition of the brain.”
Meanwhile in an impressive technological breakthrough, the world’s longest ever non-stop passenger flight landed safely in New York after 17 hours in the air. The huge 16,700km journey was possible thanks to lightweight composite materials and extremely fuel-efficient engines. Welcome news for those of us that have ever feared falling asleep at the airport during a long-haul stopover.
And finally in a piece of welcome geopolitical news, North and South Korea have finally begun clearing mines from the demilitarized zone.
Those are just a few of the headlines. There are literally millions more stories like them. Stories from people that found some way to make all our lives better. Beneath all the fear and noise there are billions of ordinary people all around the world that cooperate every day to bring forth a better tomorrow.
If you done any work over the past few weeks, paid or not, you too have contributed your part to the incredible international cooperation network that is the modern world. You created something valued by others, and by doing so, you added to humanity’s collective stock of wealth.
Our businesses do this on an even larger scale, by serving customers needs in return for cash. The best businesses then reinvest that capital to expand, developing new innovative products, and serving the needs of even more people, and thereby accelerating our collective upward spiral. When we invest our precious capital into these businesses we are aligning our portfolios with this unstoppable engine of human progress.
Whenever the news cycle gets too negative, take a moment to pause, and look around at the wondrous would we live in. The torch of human progress has never been extinguished. And if we keep our heads about us, it never will.
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One week ago, after four and a half years working on a special portfolio called Pro, and leading an extremely special community of clients, I left The Motley Fool.
We generated some exceptional returns over that time, so to kick things off, let’s explore three of the biggest reasons why.
First, for those just tuning in, here are Pro’s returns on an annual basis since inception in April 2014, through to October 2018. We were just six months in to Year 5 when I stepped down last week.
[Note: from inception in April 2014 to August 2016 I was the Research Analyst for the portfolio, before taking on the Portfolio Manager role myself part way through Year 3. Huge credit over the last 2+ years also goes to our outstanding Research Analyst, Ryan Newman.]
Those returns might not seem so unique to friends in the U.S. where markets have been on a tear for several years, but it is the portfolio’s out-performance vs. our local benchmark (the ASX All Ordinaries Accumulation Index) that we were most proud of:
Pro outperformed the All Ordinaries Accumulation index by 192% over those four and a half years (April 2014 to October 2018).
We generated annualised returns of 31% per year, vs. an 8% return from our benchmark, for an annual out-performance of 23% per year.
There were three core parts of our portfolio management process that set us apart.
#1: Asymmetric bets
We sought out unique investment opportunities which had relatively little downside, combined with very high potential payoffs. In other words we looked for positions that had the potential to either win big, or lose small.
The chart below shows the returns that we generated, on a position by position basis, over the 4.5 years (some positions were only added towards the end of the period, so had less chance to thrive than others).
Over 4.5 years, our worst position only fell by a total of -34%. That is in a portfolio that delivered total returns of 232%, and had eight positions that saw a total return greater than 100%, with five over 200%.
Win big, lose small.
#2: Sell quickly
To deliver on ‘losing small’ requires constant vigilance. And to be willing to sell quickly if a thesis is broken.
So as part of our intrinsic valuation process, we made a downside assessment which sought to answer three questions:
What could go wrong with our investment thesis?
How much would that would impact the company’s intrinsic value?
How could we check if things were going wrong?
The third point is crucial. If we could identify a failed thesis early enough, we could sell before the worst of the downside hit.
For each company we watched certain criteria that would represent a broken thesis if they eventuated. It could be a core operating metric from the company itself, or some intelligence from a supplier, or often from a competitor. We were able to sell very quickly, when those negative outcomes did eventuate, because we had prepared for them ahead of time. It wasn’t flawless, and we got some things wrong, but we avoided the worst falls and kept our losses as minimal as we could.
One of the investment decisions I was most proud to be involved with didn’t make us any money, but it demonstrates this well.
Step back in time with me to early 2014… we had just purchased shares in a local satellite television network which had an enviable monopoly position.
You can probably guess where this is going.
Our thesis at the time was simple: an extremely dominant competitive position, with strong barriers to entry. The company had dealt with disruptive innovation before and had been able to co-opt the new technologies (TiVo devices, DVD-by-mail). Management had a plan to deal with the disruption of Netflix and other online streaming providers while also adding their own internet-based streaming platform.
It was a little over a year in to holding the position, when Netflix launched in the local market. There was a lot of hype, but it was hard to separate the noise from the underlying traction. Was the incumbent going to see off the new challenger once again, as it had done so successfully in the past?
We scoured for new data points that would validate, or invalidate, our thesis. Finally we found one. One of the country’s leading internet service providers made a press release that mentioned that they were seeing huge increases in traffic from video streaming, and most importantly, from the gorilla in the room: Netflix.
We corroborated this new information with other industry sources, and revised our valuation. The shares were now trading below our original purchase price. But despite the fall, the share price was actually above our new valuation once we baked in the new growth rates.
We sold quickly, taking the pain, and realising a total loss of -8%.
As of today the shares have fallen a further -65%. Bullet dodged.
When a thesis is broken, sell quickly.
#3: Buy Low, then Buy Higher
This is a core part of my personal investing strategy, adopted from an excellent private investor, Ian Cassel. “Buy low, sell high” might be the four most famous words in investing, but they cause most investors to sell themselves short.
The market’s long-run average return is not evenly distributed. The big winners dominate the rest of the market, in much the same way that a few actors in Los Angeles star in all the Hollywood blockbusters, while the rest make ends meet waiting tables. A few multi-bagger companies generate the lions share of the market’s overall returns, while the rest do their best to stay in business.
When you find one of these massive multi-baggers early, the trick is to hold on. Or even better, buy more, even at higher prices. As with all investments, what matters is not what the share price has done in the past, but what the business will do in the future.
We often bought more of our biggest winners, even as their share prices increased, because the thesis was improving along with prices. Here is the returns by position chart once again:
To take one example, we purchased shares in ‘Position 3’ on four separate occasions. For our last purchase we paid more than 100% above our initial purchase price.
Most investors do the opposite: they sell a great long term investment simply because it has gone up 30% or 40%, without considering how much the underlying value has increased. Or worse still, they double-down on their biggest losers.
Of course there are times where it makes sense to rebalance. We trimmed ‘Postion 1’ on two occasions to keep the portfolio in balance. And if you are given the chance to buy an outstanding business at an even cheaper price, you should take it.
But most of the time people are really selling because of fear. Fear that their modest gains will disappear. Or fear that if they don’t buy more of a failing position, they will have to face up to their original mistake. Neither are good decision drivers.
Buy low, then buy higher.
There is a lot of great traditional thinking on portfolio management. But to achieve excellent results you need to master all of those basics and then also do a few important things differently. For us there were three crucial differences that set us apart from the rest: win big, lose small; sell quickly when a thesis is broken; and buy low, then buy higher.
And if you are one of those previous special clients reading this, thank you once again for your trust, and continuing to be interested in my thoughts on investing and business.
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This website is the new home of my latest thoughts on investing, technology, and business. I’ll be covering everything from the mindset of investing, to the traits I look for in big winners, as well as digging in to specific examples from interesting companies I have come across.
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