Introducing… The Three Wise Monkeys Podcast!

I am very pleased to announce a brand new Australian investing podcast: Three Wise Monkeys!

Hosted by myself, and my good friends Claude Walker from Ethical Equities and Andrew Page from Strawman.com, we’ll be diving in to the most interesting parts of the ASX in a weekly panel discussion.

For our first show, released earlier this week, we discussed the Corporate Travel Management (ASX:CTD) short battle, as well as Kogan’s (ASX:KGN) recent fall from grace.

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While the World Worries

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.

SpaceX last month announced an upcoming Moon tourism mission. Over the past week the company launched another rocket in to space to escort an Argentinian satellite into orbit. Even more epic, the booster returned to the air base eight minutes later, and landed back on its launching pad, undamaged and ready to be reused.

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.

Conclusion

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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3 Lessons from a 31% Annual Return

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.

Outcome

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.

Pro returns by year 2

[Note: from inception in April 2014 to August 2016 I was the Research Analyst for the portfolio, (with Joe Magyer as PM), 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 returns inception1

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.

Process

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). ReturnsByPosition3

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:

ReturnsByPosition3

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.

Conclusion

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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Welcome!

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.

If that interests you, subscribe to receive an email when a new update is released: