Tuesday, July 26, 2016

Investment screw ups (as in my screw ups) part III



Hey guys, welcome back to the “Investment Screw Ups” series where I talk about the times I violated sound investing principles and went full retard. In this article, I will be talking about my disastrous investment in Mongolia Growth Group.
 
Note on Mongolia Growth Group: While I definitely think I made a mistake investing in the company, I don’t want to give the impression that things are hopeless for Mongolia Growth Group. The company probably has some time to turn things around as it doesn’t have much liabilities.
 
Update on the Greedy Dragon Portfolio: Picked up an additional 250 shares in Barclays after the stock was destroyed when investors freaked out that the UK actually decided to leave the EU.
 
Lesson number 1: Is the company making that paper?

Benjamin Graham warned against investing in companies that have reported an annual loss over the past 10 years. I believe that most investors should follow this rule. I definitely deserved to lose money for not heeding the knowledge dropped by an Original Gangsta of value investing. Yes, an experienced investor may not need to strictly adhere to this rule. However, if an investor chooses to invest in a company that’s currently making losses, he needs to be confident that the company can quickly return to being cash flow positive even without an overly optimistic future scenario. Just to clarify, achieving positive cash flow by messing around with working capital accounts doesn’t count.

 

I obviously wasn’t thinking about this rule when I invested in Mongolia Growth Group as the company had negative operating cash flow before net change in non-cash working capital balances over the past 3 years. I invested in the stock because I thought that the company would continue to experience strong rental income growth, and its rental income will eventually exceed its operating expenses. Looking back, I think I was being too optimistic.
 
Lesson number 2: Do the correlations check out?

When I talk about correlation risk in this article, I ain’t talking about the bullshit finance students learn in university. The fucking course material teaches them that they can look at past stock price movements to predict how the price of 2 stocks would move together in the future. For example, “if stock A goes down, stock B would go up because the 2 stocks have a negative correlation.” I guess that’s what happens when someone tries to compensate for a lack of business knowledge with fancy mathematics.

 

When I talk about correlation risk, I’m talking about risks events that can negatively impact the actual business performance of companies across different industries. In the case of Mongolia Growth Group, its ability to raise the rent on its properties was at risk as Mongolia’s economy was dependant on commodities that were trading at depressed levels back then.
 
Lesson number 3: Don’t chase returns

One of the reasons I invested in Mongolia Growth Group was that I was frustrated as many stocks were either overvalued or close to fair value at the time. The correct thing to do was to just leave my cash holdings alone, play some video games, and wait for the easy opportunities to emerge as they always do (I believe Buffett calls them fat pitches, but I don’t know shit about baseball). Instead, I went around reading about exciting investments on the internet. That’s how I came to know about Mongolia Growth Group. Of course I don’t blame the article that introduced me to the company, as at the end of the day only I can make the decision to buy. I chose to believe in the exciting story of the company, and it was that believe that caused me to make errors in my analysis.


The moral of the story is to be skeptical of growth stories. More often than not, a company in the growth phase could see their growth rates fall significantly in a short period of time and/or see their growth in expenses significantly outpace their growth in revenue. While unrelated to my failed investment in Mongolia Growth Group, investors should also be skeptical of companies trading at low valuations as a lot of the time, there is a good reason why a company appears “cheap.” Always, always conduct your own thorough research before investing in anything.



This concludes part III of the investment screw ups series. I hope I don’t ever have to write a part IV. However, even if I never make a mind-numbingly stupid investment again, I’m sure that I will still continue to make mistakes here and there. And I might share my experiences with you guys on this blog. So, please check back every once in a while. After all, you profit by learning from the mistakes of others. I want to give a shout-out to all my value investing homies that have been following this series. Take care and stay rational.