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Trite Buffett quotes that hit me, 22H1 edition: discipline and saying no
One of the things I absolutely hate about Warren Buffett is that he has a ton of quotes that I’ll hear and think “o that’s obvious; how trite”…. and then a few years later I’ll stumble on something and Buffett’s quote will click for me and I’ll think “Gosh darn it; there was so much wisdom in that one damn quote. How does he keep doing this?”
Anyway, I think one of the keys to investing is being a learning machine. I’m trying to be one; I certainly feel like I’ve learned a ton over the past 18 months (and, in a very meta way, I’m always looking to learn ways to “learn better”; let me know if you have any advice there)! As part of that learning process, I find once or twice a year I’ll have a Buffett quote that really clicks for me and I’ll internalize something new. So I’m starting a semi-annual series where I’ll take a Warren Buffett quote that really clicked for me for something I learned in the half-year.
My inaugural quote for the series? It’s Buffett on discipline; he’s got a few of these but I’ll chose this one:
To invest successfully over a lifetime does not require a stratospheric IQ, unusual business insights, or inside information. What's needed is a sound intellectual framework for making decisions and the ability to keep emotions from corroding that framework. You must supply the emotional discipline.
Why did I chose that quote / discipline for my inaugural piece in this series?
Because I’ve always known the value of discipline in my personal life, but the first half of 2022 showed me how critical discipline is in investing.
Consider my personal life: my ice cream consumption is a frequent joke with my wife and me. I have a mammoth sweet tooth; if she buys a pint of an ice cream flavor I like, I am invariably finishing the whole thing with the next meal we have. There are only two ways we’ve found to control my insatiable appetite for ice cream:
For me to be on a no-sugar diet
For her to tell me “This is a not for Andrew ice cream” when she buys it, which means I’m not allowed to have any.
So the only way for me to be disciplined and say no to ice cream (and many other sweets) is for me to just never dip my toe into it. No moderation. No “just a scoop tonight.” It’s complete abstinence or full on gluttony with an entire pint.
What’s that have to do with investing?
With the benefit of hindsight, it’s obvious that a lot of stocks (particularly growthy / tech stocks) were priced for perfection / simply overvalued. Many of these stocks were multi-baggers from their pre-COVID levels, and they were growing rapidly in huge markets. While they were unprofitable, investors looked at their huge TAMs and said “forget about current profits; these things are going to be worth so much once they capture 25% of the TAM.” As the stocks continued to go up and to the right, the last of the bears had dirt thrown on their grave and investors rushed to buy the stocks at any valuation.
Plenty of investors got burnt buying these stocks at the tail end of their run…. but plenty of really sharp investors bought these stocks early, rode them up to spectacular gains, and basically never took any money off the table and round tripped the things (and more) as they crashed this year.
Obviously that whole story is a bit of a simplification, but if you follow the markets closely you know the types of stocks / companies I’m talking about.
Anyway, I’m not trying to call out any particular investor here. I certainly wasn’t immune from that line of thinking. I had several large positions that went straight up and hit (or went through) my price targets, and I didn’t sell them in part because of tax sensitivity but in even larger part because the stocks kept going up and I thought I had a free “management creates value out of thin air” call option given how well the company had executed (and that was probably a little circular to the stocks going straight up). Hypothetically, let’s say I bought those stocks at $50 and thought they were worth $100. I remember staring at them for a few weeks as their prices bounced between $95-105 and saying “I can’t sell; there’d be a tax hit and management will compound enough that I’ll still get a nice risk adjusted return.” Invariably, those stocks are all trading in the $50-70 range currently.
And, with hindsight, I was frequently looking at my favorite (real life) companies with huge TAMs and trying to talk myself into buying them and riding the growth/compounding forever. The main culprit here is Peloton; I wrote about that company non-stop last year. In part, it was because I was Peloton’ing non-stop, but it was also because I saw a market leading company attacking a huge TAM and thought it could be an opportunity to buy into the next NFLX / AMZN / TSLA early in its life span. Embarrassingly, I wrote an article saying “short Peloton at your own risk” when the stock was in the $100s, and I forgave them for raising capital and blowing their credibility in November. I was debating a position in Peloton in the $80s, and here it is in the single digits and I’m not interested. Yes, the environment has changed, but if being interested in a stock in the $80s and not being at all interested in it at all as it approached $8 a few months later isn’t the sign of a poor process / faulty thinking, then what is?
What’s all that have to do with my ice cream addiction and Warren Buffett’s quote on discipline?
Investing is hard. There are lots of smart people pitching lots of smart ideas out there (many of them come on my podcast!).
Increasingly, I think (a piece of) the art of investing is about having the discipline to say no. Say no to opportunities that are just ok. Say no to ideas that aren’t firmly in your wheelhouse. Say no to taking a small flier on ideas that you’re not fully researched on.
It sounds simple. But it’s really hard to do when you’re spending all of your time researching stocks and talking to other smart investors. It’s easy to let your discipline slip just a little, and before you know it you’re binging on an entire pint of Cherry Garcia…. I mean buying a basket of unprofitable growth companies because everyone else is riding them to 50%+ returns and they seem cheap-ish versus their TAM and their huge growth.
Life can catch up to you fast. Having “just one pint of ice cream” can quickly turn into having one after dinner every night for two weeks in a row and putting on five pounds. Speculations in the stock market can go down 90% really quickly, and it doesn’t matter how small a position you have; a position down 90% is going to leave its mark on your returns!
For me, having the discipline to say no means saying no to companies that don’t spit off lots of free cash flow (or have a path to do so in the very near term). Yes, I know that precludes a lot of really sexy unprofitable growth businesses, but I’ve learned that having cash flow support is really critical for me to build conviction in a company. If a company doesn’t have that cash flow support, it’s probably not for me. I’m not going to have conviction in it, and I’m not going to be able to trade it well. I won’t know when to sell it if it goes up, and if it goes down I won’t be sure if that’s an opportunity or if it’s a sign my whole thesis was wrong.
That doesn’t mean I can’t learn from companies that don’t have cash flow. It doesn’t mean I can’t study them, or research them, or think about how they fit into the rest of my world view or impact the companies I’m invested in.
But I need to have the discipline not to buy them.
There’s one other area that fits loosely into discipline that’s worth mentioning. I’ve always been a massive bitcoin and crypto skeptic. But when those “assets” were going straight up and to the right, I spent a lot of time looking at and thinking about them. Every crypto project I looked at I thought was a super inefficient recreation of problems that were already solved or, more often, a flat out Ponzi scheme. But I kept researching and nodding my head yes when people told me crypto would change the world because crypto prices were skyrocketing and these people were making fortunes. I’d look at a project, think “that seems dumb / uneconomical” or “that seems like a Ponzi scheme”…. but I’d keep researching it because so many people were making so much money on it. In hindsight, that research was wasted time, and those projects were indeed mostly Ponzis or just really dumb. I feel the same way about some of the furthest out growth / meme stocks that skyrocketed in early 2022 and have subsequently cracked; it always seemed pretty clear that a bunch of fintechs that were skyrocketing had awful economics and were just a (sometimes awful) tech wrapper around a staid business (insurance, banking, etc; something like LMND comes to mind). When they were going straight up, I was willing to be credulous with people who were saying those companies were changing the world even though it seemed like a lot of them hadn’t done much research beyond saying “tech is changing the world.” Going forward, I’m going to try to have the discipline to say no to obviously stupid stuff, and I’m going to try to do a better job of calling a Ponzi a Ponzi when I see one. I don’t want to be the person on CNBC screaming doom and gloom or how stupid something is, but the next time I see something as silly as stable coins or cryptos offer 20% yields to stake them, I’m going to be better at immediately saying “Nope, that’s a dumb idea and probably a Ponzi” and walking away / closing my email.
So what did I learn in the first half of 2022? The need for discipline. Say no to speculations. Say no to companies that aren’t in your wheelhouse. Wait for the pitches and prices to find you.
I’m looking forward to seeing you at the end of the year for what I learned in the back half of 2022 (assuming I have the discipline to stick to this series and, more importantly, remember to continue the series!).