One of the most-read news of this week has been the Valeant (VRX, Financial) statement on Tuesday, with a lower guidance for first quarter 2016, coupled with red ink across the fourth quarter results. To add scrutiny, the news have been followed with more interest as Bill Ackman, who was cherished by Wall Street last year as one of the most promising hedge fund managers, has 20% of its hedge fund capital invested in Valeant. So without saying who is wrong and who is right in this story, what are the lessons that we can learn vicariously, as Charlie Munger (Trades, Portfolio) suggests us to do?
Know yourself: From Shakespeare's Hamlet, the following verse stems:
This above all: to thine own self be true,
And it must follow, as the night the day,
Thou canst not then be false to any man.
Farewell, my blessing season this in thee!
As investors, many of us have learned (perhaps the hard way) not to follow the hot-stock tip and/or follow investors blindly into their bets. It is my opinion that one of the hardest-to-understand industries is perhaps the healthcare industry, and acquiring an edge requires a lot of studying and understanding of the moving pieces involved. Sometimes, the fear of missing out is great, but if we know our circle of competence, we can avoid tragedies such as these if we stay within its borders.
Understand the emotional biases involved: From what I can see, it is likely that the following emotional biases are involved: loss aversion, status quo and regret aversion. Loss aversion is the avoidance of selling to recognize a loss. One of the main conceptions in Wall Street is that we only gain and lose when we sell if we are long or buy if we are short. If, in the mind of an investor, I don't sell my paper in spite of it having only 20% of its value now, I still have a chance to be a part of the recovery. This is unlikely, at least without a great deal of turnaround in the company and obviously, the required time to do so. Another thing that we lose sight from is that if my paper is worth 100 at the beginning, and I lose 50%, I will need to achieve a 100% just to recover my investment. This asymmetry is something that we need to be aware of.
Status quo is the avoidance of action in order to maintain a view or position on things. This is something that generally leads to suboptimal decisions and incurs in great opportunity costs. I am not saying that Ackman is making a mistake by avoiding action, he has stated that the seat on the board that they have will allow them to play a more active role in the outcome.
Regret aversion is when there is no action because of the fear of making the wrong decision. In the Valeant case, an investor might think: What if I sell now and I miss the rebound? At least I could get some of my money out. This, of course, is having too much faith on an outcome that will take some time to develop, with opportunity costs arising.
Be brave if your analysis is right: Now, what if Bill Ackman (Trades, Portfolio) is indeed right? Certainly, he is an intelligent man. With an activist profile he is unlikely to remain quiet in Valeant's decision making. This is something that we all need to consider. Buffett was called a has-been during the dot-com bubble (he didn't lose that much money, I agree). But as investors, we need to review data objectively, re-assess our position and determine if our investment thesis still holds. I give Ackman the benefit of the doubt and the outcome of this story is still in the air.
What do you think?
