It is important to remember that you never know what you don’t know. Give yourself a margin of safety and realize that you just may not be as smart as you think you are even if you have a long successful record. In other words you have to maintain some diversification in your portfolio. I like to take concentrated positions, but I also like to hold large amounts of cash because I know that there are better opportunities ahead.
I think I’ve got two three good ideas for the next couple of years:
1) Cheap large caps like Microsoft
2) All kinds of companies in the GOM that have been unfairly punished
3) And investing for high oil prices onshore in undervalued fast growers
But because of lessons learned the hard way both on my own and by watching others I know that even though I have confidence in these ideas, there will be key aspects that I will have missed.
In 2007/2008 I watched as Mark Sellers who ran a hedge fund at the time put virtually all of his investors money into Contango Oil and Gas. His premise was that with the proved reserves the company had his downside was virtually zero, and that the upside was significant. He hit a homerun. But what if Contango had somehow created a BP type spill ? They drill exploration wells so it is possible. A BP type spill was not something that anyone had really considered, but there is always going to be something that you won’t have considered.
But don’t worry. You and I aren’t alone. Here is a well respected investor who made some big errors prior to the credit collapse.
Richard Pzena – Freddic Mac is the cheapest stock I’ve ever seen !
Those were the words of Richard Pzena at the 3rd annual Value Investing Congress in New York during November 2007. At that time the stock was selling for $30. We all know what happened next. Through the gurufocus.com website I found the following recap of his presentation where he was recommending Freddie Mac which turned out to be a loss of 100% of any cash invested at the time he recommended it:
* Pzena's talk was entitled 'Evaluating Financials in a State of Panic'
* The only time good businesses sell for cheap prices is during times of distress
* Financial stocks are cheap on a P/B basis against historical multiples
* Freddie Mac (FRE) is the cheapest stock Pzena has 'ever seen':
* Losses are absorbable and GAAP is not useful in evaluating FRE
* Pzena believes the mortgage payment resets that result in higher monthly payments will be handled by borrowers because they will be reluctant to forfeit the equity in their homes
* Fears in the market don’t necessarily impact FRE’s business but are impacting its stock
* FRE Loan to Value = 60% and are mostly in fixed high credit
* Believes FRE will follow similar action to P&C insurance companies
1. Hurricane/natural disaster occurs, P&C insurance companies experience losses, P&C companies raise prices/premiums, P&C stock goes up
2. Housing crisis has occurred, FRE and other industry players will raise fees, tighten credit standards, experience lower losses resulting in strong capital returns and thus improving stock price.
Oh, and I should also mention that none other than Joel Greenblatt has called Pzena the smartest money manager. One lesson I would take from Pzena is that leverage kills quickly. Financial entities don't need to have much a swing in asset value to completely wipe out their small equity bases.
Thanks to gurufocus for the information. If you want to sift through my thinking and help me spot errors before I cost myself money here is a link to what I’m currently looking at: