Reflections on Time in the Market

"Experience is what you got when you didn’t get what you wanted."

I’ve read a good deal of annual reflections recently, all of which forced me to confront my historical lack of doing so. Reflecting on last year in a vacuum, however, wouldn’t be much help. My decisions in 2022 were impacted by my decisions in 2021, which in turn were impacted by my decisions leading up to then. A reflection on my overall time in the market seems more suited to my purpose. And my purpose? To learn. John Dewey once said the formula for learning is experience (definition in the subtitle) plus reflection. I certainly gained some experience in the last few years; now it’s time to reflect.

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I made my first investment in September 2017. I bought Amazon because I’d just read Peter Lynch’s One Up on Wall Street, and the book speaks to the value of using your personal observations and experiences in finding a great investment. Amazon was a service I knew well and used often, and I watched as more people I knew bought more, and more varied, goods from Amazon. I thought it was an amazing business.

I didn’t know the valuation. I didn’t know of a fast-growing, highly profitable division called Amazon Web Services. I did know I liked the product and wanted some skin in the game.

By 2019 — thanks to a stroke of luck — I had doubled my money and was hooked. I thought investing was easy. Thankfully, I didn’t think it was easy enough to continue my blind buying. I’d gained enough sense to realize that research was a general prerequisite to a purchase, so instead of letting my personal experience dictate my decisions, I let it inform my research.

A natural starting point was Sonos. I admired the aesthetic appeal and sound quality of the speakers and found the company went public the prior year. I learned the company had a consistent record of growth, a loyal customer base (that consistently purchased more speakers over time), a healthy balance sheet, and a valuation of ~10x free cash flow.

I bought the stock throughout 2019 at ~$10-11 and waited patiently. I experimented with other names during this time but only held most for a month or two, and the gains and losses largely netted out — I quickly learned the trading game wasn’t for me. In Buffett’s words, I realized I wanted to “buy on the assumption that they could close the market the next day and not reopen it for five years." The stock market is a way to buy and sell, but I wanted to own.

This period also produced frustration with what I perceived to be a lack of compelling opportunities. The market wasn’t exactly “cheap” in 2019, and at that point, I was a firm believer in the practice of trying to buy a dollar for fifty cents. With a little cash and nowhere to put it, I once again borrowed some advice from the Oracle — this time on the other side of the spectrum — and began to index a set amount each month (still the smartest decision I’ve made to date).

In 2020, the pandemic sent the world, the market, and my approach to investing into a tailspin. In 2019, I had largely kept to my “circle of competence” (despite some forays into trading) and assessed the valuation first and foremost. In the crash of March 2020, I threw it all out the window and bought anything and everything. I reverted to buying blindly — on a significantly larger scale.

I bought a business that sold engineered parts to water desalination plants (I still don’t fully understand the process of water desalination). I bought a paper packaging business (I still know nothing about the industry). I bought a waste management business (one I regret selling), a semiconductor firm, a renewable energy developer, an industrial REIT, an office REIT, a storage REIT, a tower REIT, an oil and gas major, a construction firm, a consumer robotics company, a digital advertising firm, a media and entertainment conglomerate, a surgical robotics manufacturer, and more than a few others.

I didn’t know much about the companies individually, but collectively, I knew I was buying them at prices ranging from 20-50% below all-time highs. If the market just bounced back, I could make a lot of money.

The market did bounce back, and I made a fair amount of money (one of the purest examples of a poor decision-making process leading to a lucky outcome), but the money didn’t stick around for long.

I came to my senses eventually (realized I didn’t understand what I owned and owned so many companies it was impossible to keep track of them) and sold the vast majority, though I still hold a few purchased in that period. By late 2020, I was rolling the proceeds into other ideas.

In 2021, I was the guy adding fuel to the fire. I bought high-growth, unprofitable tech companies at valuations ranging from expensive to downright obscene. I understood the business models and held a general grasp of the (possible) competitive advantages, but at the end of the day, the valuations were prohibitive (particularly as someone whose interest in investing stemmed from the value discipline of Graham and Buffett).

In one instance, I bought a business at ~20x revenue and watched it rise to over 50x revenue. I even bought some more on the way up because I felt my thesis was vindicated — the market had recognized I was right. The trouble is my thesis was supposed to play out over 10 years, not 10 months.

Over time, I watched it fall to a (still rosy) ~7-8x sales. I sold out and lost ~70% of the total investment (if you could call it that). While the thesis technically wasn’t broken, Buffett reminds us: “For the investor, a too-high purchase price for the stock of an excellent company can undo the effects of a subsequent decade of favorable business developments.”

In another case, I bought a business at ~50x earnings with earnings growing north of 100%. At the time, it looked and felt like a steal. Today, the business trades on negative earnings, and the share price has receded ~75%. The product and the opportunity haven’t changed much, but the conditions under which it operates have changed drastically.

I still own this one (for reasons I’ll explore in a later write-up), but it’s a rude reminder that the surrounding reality can change rapidly, and your idea of the future can be shockingly wrong. Further, it reinforces the value of building a position over time, especially when the thesis is supposed to play out on a time frame closer to a decade than a year. If you’re right, you’ll still make a lot of money. If you’re wrong, you may lose a bit less money.

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Reflection

Since my first investment, I made some money, I lost some money, I had a few winners, and I had a few big losers. I underperformed the S&P 500, but I couldn’t care less. The lessons I’ve learned over the past five years are worth multiples of what I paid. These lessons have driven an evolution in my thought process that would have been delayed years had I not experienced the market of 2022.

• Valuation matters. I wouldn’t pay 20x revenue to own any business on Earth.

• Don’t base your thinking on the movement of the stock price.

• Your thinking can be wrong (both in the short-term and long-term).

• Look at the facts as objectively as possible (acknowledge your biases).

• Understand your argument with the market before you buy.

• Never own a business you couldn’t explain to someone else in simple terms.

• Know the reason you own it (have a thesis). Sell if it’s not true anymore.

• Don’t buy the entire intended position size at once.

• Keep a long-term view (zoom out).

• Understand it’s a game of probabilities. Uncertainty will never disappear.

• “The cure for low oil prices is low oil prices.” Sometimes, you just have to let it play out.

• Know your capacity for taking academic risk (volatility).

• Make decisions based on true risk (permanent loss of capital).

• A stock can always get cheaper.

• Most importantly, enjoy the game.

Investing is difficult, and 2022 was a reminder — if you don’t love the game, don’t play the game. The stock market is the only place where the amateur has an option to beat 90% of professionals with no effort by just buying an index.

I love the game because the pain of losing money (both on paper and in reality) doesn’t change my obsession with the challenge. Everybody makes losing bets. The trick is to have just a few more winners than losers over the long haul. I (perhaps foolishly) think I can still do so, and my strategy has now evolved to align with who I am and my intention of staying in the game for a long time.