“Learn from the mistakes of others” is a common recommendation in the investment field. That’s the idea taken up by Michael Batnick in his 2018 book, “Big Mistakes: The Best Investors and Their Worst Investments.”
Batnick is director of research at Ritholtz Wealth Management, a member of its investment committee and head of the firm's internal research work. He is also a steady blogger at “The Irrelevant Investor” (a play on Benjamin Graham’s book title, “The Intelligent Investor”)
In the Preface, he wrote, “From Jesse Livermore to Warren Buffett (Trades, Portfolio) to Jack Bogle, every investor that has experienced success has experienced equal part failure. There are errors of omission, Buffett and Munger not buying Walmart (WMT, Financial), and errors of commission, Stanley Druckenmiller (Trades, Portfolio) buying tech stocks as they reached their peak in early 2000.”
Batnick added he was not trying to say, “Oh, this didn’t work, don’t do that,” but to emphasize that making mistakes is an unavoidable part of the game. He went on to say that investing is extremely difficult and you will make mistakes, adding “You will repeat them. You will discover new ones. And just when you think you’ve got it all figured out, the market will humble you once more.”
The important thing is to take these mistakes in stride and to maintain a positive attitude.
And how are investors to do that? By worrying only about the things that they can control. They don’t worry about the market’s direction nor what the Federal Reserve will do next week. They stay within their circle of competence.
In chapter one, he puts the spotlight on Benjamin Graham, the intellectual father of value investing. In choosing the man known as the "Dean of Wall Street," Batnick was telling readers that even the mightiest have feet of clay when it comes to investing.
Originally, Graham wasn’t even thinking about a career in finance. Described as a polymath, someone who’s brilliant in several fields, Graham was offered “invitations” by three different departments at Columbia after finishing his final semester. But he ended up taking a job at a Wall Street firm. It was 1914, he was 20 years old at the time and started at the very bottom of the ladder, delivering securities and checks. He was promoted after one month and after six weeks, was writing a daily market letter for the firm.
He also taught at the Columbia Business School and the New York Stock Exchange’s school; he educated such future luminaries as Walter Schloss, Irving Kahn and Bill Ruane. Later, he would teach a young Buffett. His research and teaching upended existing notions of how to invest; Batnick quoted Jason Zweig, “before Graham, money managers behaved much like a medieval guild, guided largely by superstition, guesswork, and arcane rituals.”
Graham taught us that stock prices quoted in the newspaper are not the same as the underlying value in a business. To improve his chances of success when stock prices and underlying values were out of synch, he insisted on a margin of safety, which he defined as “the discount at which the stock is selling below its minimum intrinsic value.” For Graham, that meant buying at a price that was at least one-third less than a firm’s net working capital.
In 1923, he set up his own investment partnership, The Graham Corp. Through it, he used arbitration techniques to simultaneously buy undervalued securities and short sell overvalued securities.
In 1925, the firm became the Benjamin Graham Joint Account, where he used what we now think of as the hedge fund renumeration plan: 20% of the first 20% return, and so on. In 1926, that worked for both Graham and his investors as the fund earned 32% while the Dow Jones Industrial Average barely managed to stay in the black. And that looked pale in comparison with the 60% he generated in 1928.
As we know in hindsight, 1929 was not to end well and it took years before the market regained its performance. Graham was also caught by the downturn. Batnick told us Graham covered his shorts and held onto his convertible preferred securities. At the end of 1929, he was down 20%, hit a bit harder than the Dow, which lost 17%.
Believing that the worst was over, he plunged into the market again in 1930, and used margin to leverage his returns. As a result, he suffered his worst-ever year, down 50%. Between the bottom in 1929 and the bottom in 1932, Graham lost 70% of his capital.
Batnick observed, “If such a careful and thoughtful analyst can lose 70% of his money, we should be very careful to understand that while value investing is a wonderful option over the long term, it is not immune to the shore-term vicissitudes of the market.”
He added, “The fact that he remained steadfast in his conviction that security analysis is a worthwhile endeavor is nothing short of remarkable.”
Graham recognized his mistakes and carried on. Later, he wrote (as quoted by Batnick): “In my nearly 50 years of experience in Wall Street I've found that I know less and less about what the stock market is going to do but I know more and more about what investors ought to do; and that's a pretty vital change in attitude.”
Finally, Batnick observed that Graham taught investors that there are no “iron-clad laws” in the investment world, and as from his own experience, that cheap can get cheaper:
“You'll never believe that a stock that falls 50% in a year might not necessarily be a bargain. You have to catch a few of these falling knives before scars develop and you learn that a falling price might not equate to better value. Many of the investors covered in this book began with Ben Graham's teachings, but they, like you, had to discover their own paths.”
Disclosure: I do not own shares in any company listed, and do not expect to buy any in the next 72 hours.
Read more here:
- Christopher Browne: Making the Case for Value Investing
- Â Christopher Browne: Why Timing the Market Means Losing Out
- Â Christopher Browne: Finding Value Away From Home
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