Have you beaten Peter Lynch’s 6 out of 10?

Referring back to the Investors Anthology book reminded me about this great investing essay titled The Loser’s Game. the_losers_game.pdf (52.0 KB) Investing is not all about picking winners, but avoiding losers as well.

The essay includes a super correlation between amateur tennis and investing. In amateur tennis you can win matches simply by allowing your over-ambitious opponent to make too many mistakes:

“The strategy for winning in a loser’s game is to lose less. Avoid trying too hard. By keeping the ball in play, give the opponent as many opportunities as possible to make mistakes and blunder his way to defeat. In brief, by losing less become the victor.”

I have tried to ‘lose less’ with shares by going for simpler opportunities, while avoiding over-ambitious investments that involve more speculation, complexity and probably more mistakes.

This approach will never see me top any leaderboards, but — now using a cricket analogy! — hopefully keeps me at the crease while other players retire hurt.

My disaster with Tasty shows the significant effect one great loser can have.

Between 2016 and 2019, my portfolio recorded annual gains of +7.6%, +10.5%, -6.6% and +13.1% = +25.6% total.

Without Tasty, my portfolio would have recorded annual gains of +10.6%, +19.1%, -1.8% and +16.1% = +50.2% total.

I would have doubled my returns had I made one less mistake.

Wishful thinking perhaps, but I don’t think I have made too many investing errors.

Peter Lynch once saidIn this business, if you’re good, you’re right six times out of ten. You’re never going to be right nine times out of ten.

This table keeps track on how many shares I have got right and how many I have got wrong.

I have bought 32 different shares since 2004, of which (as at 30 September) 22 resulted in a profit and 10 resulted in a loss. So a 6.9 out of 10 success rate.

Looking at the 21 shares I have bought and then sold since 2004, 14 show a profit and 7 show a loss — so 6.7 out of 10.

So I am just ahead of Peter Lynch’s 6 out of 10, but not by much.

I just wonder if anybody here thinks first about trying to limit losers rather than pick winners?

Or is owning losers just part of the game — and what really counts is ensuring you own a few big winners to compensate?

And has anybody got close to 9 winners out of 10 — something Peter Lynch implies is impossible?

Maynard

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Hi

Probability theory is the method I am leaning towards to make investment decisions as I get older, looking at the expected value of an investment. i.e. chance of success multiplied by gain if successful less chance of failure multiplied by loss if failure = the expected value of an investment. With sufficient diversification, this leads to an asymmetric distribution return in the investor’s favour. (I hope!)

Not many people have the nerve to do this and play Monesh Pabrai’s game the way he does it, with few investments.

I actually prefer the way your old mucker David Gardner does it, with a large number of investments over a long investing period for each.

Another example of this approach may be the way Baillie Gifford invest. They invest such that the downside may be 100 per cent, however the upside is potentially many thousands of a per cent and this relationship is what is important when evaluating current investments rather than the share price at the time.

I think I am trying to say that for me it would be a mistake to avoid investments which may have hugh potential gains because they possess a large downside (but therefore still have a hugh expected value), if you can have at least 30 of these opportunities invested at the same time for a duration of many years on average.

I don’t achieve 9 out of 10 profitable exits, either, probably 6 or 7 out of 10 like you, however the top 10% of investments cover all of the losses and the remainder garners a positive overall return.

Maybe Tasty had a large effect on your returns because you run such a concentrated portfolio, which allows your returns to fluctuate wildly above and below the average expected return?

I don’t go along with Warren Buffett’s view that diversification is an excuse for ignorance any more, because random things seem to happen so frequently and the black Swan event may affect an investment due to an ‘unknown unknown’.

Didn’t Peter Lynch hold alot of positions at once - I mean in the hundreds at one time, which would smooth results assuming his investment thesis was always of good quality, which it was?

My approach isn’t therefore a value based one and maybe would cause you an allergic reaction if you were to follow it (!) - I guess part of being successful is finding the approach which suits the investor’s individual personality.

Ben

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Hi Ben,

Thanks for the reply.

I think if the returns from your winners outweigh your losses on a consistent basis then the 6 or whatever out of 10 does not matter.

That said, I do think there is something to be said for the accuracy and reliability of any approach.

Taking a Baillie G approach to an extreme, a 10-stock portfolio with two shares up 500% and 8 complete losses gives the same 100% total return as a 10-stock portfolio with every share doubling.

I am not sure which of these two scenarios is more likely, but if these were managed funds I think I would prefer to invest in the latter as its approach would appear more reliable and repeatable (i.e. more winners than losers).

I guess everything boils down to the calculations of upside potential and probabilities.

With a more concentrated portfolio, the same returns as a Baillie G could be achieved by betting more on shares with much greater chance of reasonable upside.

Of course, where the Baillie G strategy can really win is enjoying an AMZN or two and becoming untouchable. Such fortune is unlikely to occur with a more conservative upside approach.

What I think I am saying is that I am not attracted to a strategy that depends on finding – and then holding onto! – a few multi-baggers to succeed!

Maynard

Hi,

It’s safe to say I disagree, but then maybe that is the point of a forum! Here is why, though;

Not true imo - it does matter. The lower the expected gain in investments, the need to be more frequently right.

I would agree this is a pretty extreme scenario and therefore really unlikely (for 8 out of shares to go to £zero)? That is my experience in any case. If an investor wants certainty they should invest in gilts (and suffer the much lower returns).

Baillie Gifford/Scottish Mortgage up 13.4% p.a over the past 25 years and 34.3% p.a. over the past 5 years, after fees, which speaks volumes to me. They also have other investment trusts with outsized returns. I struggle to find ‘quality’ investment trusts which possess the same returns, and these investment trusts seem to rely on never having cut a dividend payment in the past 50 years as their sales pitch, rather than actual returns, which seems like a weak argument to me.

My problem with concentrated portfolios of individual stocks is there is more risk involved in this than the investor appreciates, partly because the investor feels they know the company well but there is always information which is either not made public but known to the directors or the aforementioned ‘unknown unknows’.

The supposition that one has to ‘strike it lucky’ and be so fortunate as to find the next Amazon or Netflix, to ‘win’ is just that - an assumption made which in this case is empirically untrue. There are a large number of companies which multibag and are not of the scale of Netflix/Amazon.

I agree you need to have the right mindset at the beginning to avoid selling too soon, but if you own a large number of investments of lessor value then the temptation to sell winners is much less.

Don’t get me wrong - I do invest in funds such as the Terry Smith funds (which endeavour to go for quality concentrated factor investing in sectors with tailwinds), however there is a proportion of my investible funds in Baillie Gifford and also in individual Baillie Gifford type US stocks - I therefore kind of agree with your approach, as well as proposing that this other approach can work over the long term. I may therefore have some sort of multiple personality disorder, or maybe adopting these 2 types of investing is a form of diversification?

Ben

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Hi Ben,

You could say the lack of ‘quality’ ITs with SMT-type returns is because SMT got lucky. with a few huge winners :slight_smile:

If as you say…

…then surely there would be loads of quality ITs with impressive records driven by owning multibaggers. The fact that they are not suggests finding/holding multibaggers (at least among IT managers) is not that easy.

I think to a certain extent SMT is a freak IT – an amazing performance driven by technological change, superb ‘visionary’ stock-picking and low rates causing a shift to growth investing. The main point is whether the approach is repeatable over time. Will a new Tesla need to be found to maintain the 35%pa record?

I think I need to look deeper into SMT and see if I can discover whether the trust has been dependent on just a few investments. And I will try and do the same with FundSmith, and then report back.

Maynard

13.4% over a quarter of a century is probably smt’s long term return rate ex Tesla etc. (Tesla floated a decade ago). Is it possible to stomach a couple of 60% drops along the way?! Not sure. However, sometimes ‘stop losses’ result in ‘stop profits’, so for me it is necessary to position size to increase my draw-down tolerence.

Ben

Had a look at SMT and excluded AMZN and TSLA:

Essentially the trust the would have still performed very well without those two stocks. I concluded SMT’s approach (2011-2020) has not been obviously dependent on a few huge winners offsetting numerous losers.

Maynard

I often save snippets and interesting tidbits to my computer when I find them. This is an image from an old invesitng journal or book of sorts (sorry, I cannot remember where I picked it up) but it seems relevent to the subject here. so perhaps others will find it useful in the timelesness of the advice. Sell losers early

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I agree with Maynard that a high win rate is preferable, for two reasons: it reduces drag from losing positions (this is why cutting losers is a good idea if you can be ruthless enough to do so - says the man sat on a position in Photo-me and Equals group for at least a couple of years, in my defense they were/are small positions languishing at the bottom of my portfolio :slight_smile: and provides validation of skill in stock selection in the first place. Note, making a gain on an investment is not a win in my book - tying up capital in something for a long time only to make a small gain is not a successfull outcome in my book given the opportunity cost. You need to consider the base rate too I.e. if 70% of stocks went up over 3 years and 7/10 of your investments made money, you’ve not demonstrated a good process.

However, I also strongly agree with Ben that real success requires big winners, “multi-baggers”, which requires selecting excellent businesses, ideally at reasonable valuations (though great businesses are rarely cheap for long). This is what drives a high compounded annual growth rate (CAGR, %pa). Baile Gifford had been praising the work of an academic, Hendrik Bessembinder…

https://www.bailliegifford.com/en/usa/professional-investor/funds/baillie-gifford-international-concentrated-growth-equities-fund/ic-article/2018-q1-the-pursuit-of-extreme-returns-the-pursuit-of-extreme-returns-usm-we-0096?p=

…that highlights the huge impact of extreme outliers in terms of the way they have driven returns of stock markets as a whole. So the skill lies in constantly looking for new opportunies to invest in but having the discipline to buy few of them - the very best, hold the ones with conviction they have really big long term potential and eliminate the bad ones as soon as it’s clear you made a mistake). Holding too many stocks suggests your selection criteria is too low - but for me 20-30 not too many and is more comfortable than 10; there is also something optimal about getting to 4-5% positions in stocks you’ve gained conviction in, since if they halve you’ve only lost 2% which is bad but not terrible, while if they double they are rapidly at 8-9% and can make a big impact of you can run them further over the long term, ie potential for positive asymmetric impact at the portfolio level). Black swans do happen and every investment is an educated guess about the future which is uncertain (I have no crystal ball at any rate and I doubt anyone else does either!), so a certain level of diversification is clearly prudent, but it is vitally important to run winners as long as possible.

Cheers
Steve

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Steve

Thanks, that’s interesting.

My main constraints are time and competence. I have time to invest in c. 5 to 8 stocks and to follow the same again. Based on c. 8 year performance (current approach), I think I may have some advantages in UK stocks in certain sectors with an initial EV in the £30m to £150m range. Outside that, I use passive or active funds.

Cheers

M

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Great discussion all around. I think the scenario depends on your portfolio sizing approach. Were the 10 positions equally sized? What matters is how much you have invested when you are right vs wrong (Kelly criterion). Being right at a higher win% will give you confidence, but we all have to check that confidence at the door to ensure mistakes aren’t made in the future.

Also the time horizon matters a lot for the measurement. You could have 5-10 years where a position does nothing or is down but the business grows over time and then there is an inflection point. All great investments have massive drawdowns along the way, and it is really difficult to tell in a down 3-5 year period to hold on to one’s conviction.

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I have been taking a quick look at the success record of Simon Thompson - the small caps commentator at the Investors Chronicle. His suggested portfolios of 10 stocks for 2019 and 2020 have both outperformed the market - the FTSE all share. Positive returns on 7 of the 10 stocks in each portfolio, which is pretty good, I think. And, obviously, he is under a lot of pressure, picking 10 stocks each year.

However, 1 stock in the 2020 portfolio has been de listed and 1 holding in the 2019 portfolio has been sold at a loss because of questionable behaviour by the BoD.

1 share in each portfolio has had a 30% drawdown. The overall positive result for each portfolio has depended heavily on 1 share - a result of 534% for TMT Investments and 254% on Xaar.

3 shares in the 2019 portfolio have returned less than 10% versus 1 in the 2020.

The returns, although overall positive, are massively skewed and it is not easy to see whether Covid-19 has had a material impact on these apart from in the case of RFX, where the fact that their shops were closed for many months and foreign travel was restricted obviously affected performance. But 14 out of 20 is creditable. On the other hand, some of his one-off tips have been disastrous, such as GYG, which he tipped when it launched in 2017 only to see a halving of its price after a profit warning the following year.

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I used to be a share tipster and I would have always taken 7 out of 10!

I think recommending 10 stocks in one go is easier than producing the one-off tips, as the 10 stocks should even out and any marginal selections/complete duffers could well be offset by a lucky big winner. And the returns will always be assessed on a portfolio-average basis.

In contrast the one-off tips essentially say to readers “this is the very best share I can recommend right now”, which if it then craters does raise questions about your tipping ability.

Always difficult to judge the luck/skill element when looking at portfolio returns where the result is skewed significantly towards one share. Is such a performance repeatable over time? I am never sure.

I mentioned in a post above about “avoiding losers”, and a lot of this stemmed from my tipster days as the losing/problematic tips would always absorb more time and energy at the expense of finding new ideas. The losers would also garner the most attention from readers. A strategy of ‘avoiding likely aggro’ led to my somewhat dull recommendations, which did not out-perform in the short term and ultimately persuaded my then employer to look for alternative tipsters!

Maynard

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Interesting comments, Maynard. I suppose portfolio theory tells us that diversification is a good thing, up to a point, but on the other hand, to beat the market you need to find at least one outstanding performer. The other problem is about timing. At the small cap level, the amount of coverage and research is often very low and it is difficult to get the market behind a change in the story. Sanderson (SDG), it seems to have taken a change in the Chair and CEO in Match/April 2019 and then just over a year before the shares stopped falling and began to rise. The fall began in early 2017. It would be a brave investor to have bought in before the new directors came along and it would have taken considerable courage to stay invested until June last year, when the turnaround began.

It is easier but less exciting just to keep tipping Halma or Spirax.

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