I haven’t talked about James Montier in a while, and that’s a disservice to anybody taking the time to read what I have to say; before we get to Mr. Montier, let’s get some background information on today’s topic with J.C. Penney’s (JCP) historical stock price at the beginning of each 30-day period over the past 18 months:
Now that’s what you call a roller coaster ride! Considering the relatively small changes in intrinsic value that occur from month to month (or even year to year), one can only conclude that the market price is a lot more volatile than the value of the underlying business; it appears that market participants have an “action first” bias
— sometimes overly optimistic, like in January, and other times overly pessimistic, like today.
Montier discussed this phenomenon in an article called “Beware of Action Man,” where he highlighted a study showing an “action bias” of sorts among goalkeepers:
“The authors examined penalty kicks from top leagues and championships worldwide, and 311 such kicks were found. A panel of three independent judges was used to analyze the direction of the kick and the direction of movement by the goalkeeper. To avoid confusion, all directions (left or right) are relayed from the goalkeeper’s perspective...
Very roughly speaking the kicks are equally distributed with around one third of the kicks aimed at the left, centre and right of the goal mouth. However, the keepers display a distinct action bias: they either dive left or right (94% of the time), hardly ever choosing to remain in the middle of their goal…
[As the data shows], the best strategy is clearly when the goalkeeper stays in the centre of the goal. He saves some 60% of the kicks aimed at the center, far higher than his saving rate when he dives either left or right. However, far from following this optimal strategy, goalkeepers stay in the centre just 6.3% of the time! The action bias displayed by the keepers is clearly a sub-optimal behavioral pattern…
The reason for this action bias seems to be that it is regarded as the norm. A goalkeeper at least feels like he is making an effort when he dives left or right, whereas standing in the centre and watching a goal scored to the left or the right of you would feel much worse. Bar-Eli et al. confirm this by a questionnaire for top goalkeepers, which reveals this exact sentiment.”
In addition to this, let’s look at data from a paper by Terrance Oden of UC Davis entitled “Do Investors Trade Too Much?” In his conclusion to the paper (which looked at 10,000 randomly selected customer accounts from discount brokers), Oden says the following:
“The investors tend to buy securities that have risen or fallen more over the previous six months than the securities they sell.”
Apple (AAPL) stock is the embodiment of this statement in the current environment. The company is constantly discussed in the financial media and among investors, particularly after the recent 20% drop from its all-time high. The way these discussions are framed, it appears that there are only two acceptable options: buy or sell.
So many people appear prone to action (or required to have an opinion on every last company) simply because others do – it’s almost to the point that admitting that the future is unknown, particularly for a company so dependent upon cutting edge technology and brand equity, is unacceptable (“certainly he isn’t too smart if he doesn’t know about Apple?”). Undoubtedly, many money managers buy the stock simply to avoid missing out on the action (“this idiot couldn’t even buy Apple stock after the iPod, iPhone AND iPad had been released?!”), just like our goalkeeper who dives to avoid the feeling of standing idly by, (apparently) doing nothing.
As noted by Oden, retail investors tend to transact in securities that have recently been quite volatile and often fall prey to the vicissitudes of the market (the “stop loss” investors of the world). As noted above on JCP, significant price movements have essentially eliminated the need for fundamental analysis in the eyes of the masses, with weekly moves of 5% or more acting as the guide for many on the underlying success of the company’s strategy (conveniently enough, this also takes significantly less time or the need for any understanding of the business).
For the true investor (someone looking to own a business, with their overall returns tied to the underlying success of the operations in question), I think the solution to this is clear — maintain a focus on companies that you can competently analyze (likely eliminating many of the favorite names among the talking heads on CNBC), as well as a solid mix of humility and arrogance rooted in sound fundamental analysis.
When the market is telling you that you’re right or wrong day after day, it’s easy to get swept up by his opinion and be induced to continuous action to prove that you’re not a lemming. However, the solution to his rapidly changing opinion isn’t greater speed and action — it's patience and analysis. It’s a focus on long-term value creation and selectively buying pieces of businesses for materially less than what they’re worth. Only when you start to focus on these factors will you be able to laugh at the absurd amount of volatility that comes and goes with each passing day in the market.
About the author:
I think Charlie Munger has the right idea: "Patience followed by pretty aggressive conduct."
I run a fairly concentrated portfolio, with 2-5 positions accounting for the majority of my equity portfolio. From the perspective of a businessman, I believe this is sufficient diversification.