Mistake #2 – All In!!

As value investors, our main indicator is only on one key aspect – VALUE. That is going on an everyday treasure hunt to source for undervalued gems and to purchase them at 50c for a dollar. I don’t know about you but when I chanced upon a potential ‘treasure’, excitement and adrenaline filled me. I go on an intensive research on the company – finding out everything possible within my capability and if by then, the price still warrants that value (and of course, with a reasonable margin of safety), that particular company is UNDERVALUED. Next step? That’s of course to get into a position in that company. Yet this is also the moment when most beginners investors start to commit a grave mistake.

Imagine you are convicted that Company A is valued at $1 and it is trading currently at 50c. You thought that at 50% margin of safety, nothing can be ever so cheap and so, you bought into the company. Few days passed and the stock dropped to 40c. Few weeks then passed and it dropped further to 30c. Now, you are still convinced the such price decline warrants no drop in business fundamentals but a mere investors selling frenzy and value investment says that when price drops (& assuming you are still convicted in your own research), you do not sell along with the market herd but buy more. HOWEVER, at such a golden opportunity, you realised you are unable to execute such any additional trade simply because you have went all in with your first purchase.

This definitely sucks 

Firstly, you can’t increase your stakes to take advantage of the price fall and secondly your investment needs more room to climb before achieving any profit. And yes, as you may have expected it, I committed such a mistake during the recent sell down. In recent months, I bought a HK-listed stock (which I will cover a research on it soon) and soon enough, its price continued to fall. Panic moment – not because I have made a poor investment decision. I am convinced in its fundamentals but the panic was largely due to not having more capital to grab hold of such an advantage.

Lesson learnt

Out of this mistake, I learned a valuable term – averaging. Averaging is to spread out your investment purchase (in a particular company) across a period of time. Now, I did not mention averaging down but merely averaging because I believe one should leave more ‘bullets’ to ‘fire’ for the future regardless of whether the price may fall or rise. This is so because what I have learned is not that price can fall after my purchase but more so that the future is unknown to me and price can either rise or fall. I see averaging as a hedge against the unknown future. One thing definitely, you do not want to be caught off unprepared or simply have ‘no ammunition’.

Let’s say you set aside 1/3 of your intended capital to invest in Company A. You do want to leave the other 2/3 for the future to invest in it when the future is more certain to you. Yes, if prices fall, you will benefit strongly from your averaging. But yes, I also know that the concern is with price rising? In my opinion, you should still continue to average up (and that’s if you fully believe it is not a fake rally). The average may be higher than your original unit cost but hey, if you are convinced that the company warrants at least a 2-bagger, what’s the concern with that extra 2 to 3 cents?

In a book “The Mind of Wall Street” written by Leon Levy, it speaks of a particular incident when the author and his business partner was on their way driving to meet a prospective major client. Yet halfway along the highway, the car was low on gas. Leon’s friend however decided to go with the risk and not top up the fuel tank because of the additional cost in fuel wastage made from the detour needed. In the end, the fuel tank went empty and they lost their prospective client.

Each of us is after all a single player in the huge financial markets. We are victims of the unknown and can never be certain of everything. Averaging, hence, is a vital hedge against the unknown.

Will be glad to hear your comments on this. 🙂