Valuation in Motion: ‘Doing Nothing’ Investing: A Thought Experiment

thumbnail
Reading Time: 4 minutes


If you have been reading my blog posts since a long, long time, you may appreciate the fact that ‘Masterly Inactivity: A Case for Very Long Term Passive Investments‘ was one of my earliest posts here. Since it had more to do with dissecting why passive investments work, it really didn’t do the title justice. So, let’s get our thinking hats on and understand why patience or in a crude sense ‘doing nothing’, is a powerful virtue necessary for any investor.


Masterly Inactivity

The term ‘Masterly Inactivity’ was coined by Charlotte Mason in her famous book Original Homeschooling, a masterpiece on child development, parenting and education. The idea is that, parents should develop a child by ‘some letting alone and some wise openings’. I believe the idea of ‘masterly inactivity’ applies to investing as well.
Charlie Munger, Warren Buffett’s business partner often loves quoting Carl Gustav Jacob Jacobi, a German mathematician who became famous by solving notorious equations by first imagining the required answer and then working backwards to connect the dots. One of his famous maxims was: “Man muss immer umkehren” or in English, “Invert, always invert“.

So in our quest to find out why being inactive is important to investing success, we shall start with successful investments.

Also Read on FinMedium:  The Flying V-Shaped Recoveries

Invert, Always Invert

I am going to gather data about some “multibaggers” in the Indian Stock Market, that are well known to most investors. My choices are:

  1. Bajaj Finance
  2. Eicher Motors
  3. Symphony

For reference purpose, here’s what each of these stocks have returned in the last 15 years:

It’s clear that in varying degrees, these stocks have been successful to very successful investments when viewed in the lens of history. But beyond these mind-boggling figures lies a very important lesson.

The Thought Experiment

Before proceeding further, we should agree on something. Investors base their ‘Buy’ or ‘Sell’ decisions on many factors. But chief among those of course, is the price of the stock itself. As in, if a stock moves up too much, selling would seem reasonable and vice versa for buying.

But how much is ‘too much’? In statistics, we define this using Standard Deviation. Usually 3 Standard Deviations from the Average is counted as an ‘Outlier’. But we can also consider 2 Standard Deviations from the Average as substantial ‘deviation’.

If you’re confused about what this is all about, I’m going to measure the daily returns of the above mentioned stocks and see how many of these days had substantial deviations (Remember, according to our above agreement, substantial deviations command a response from investors).

Also Read on FinMedium:  Why Indian market's PE Ratio scaling New Highs?

Bajaj Finance

Out of the 3,711 days traded in the last 15 years, Bajaj Finance has had a grand total of 31 days of substantial deviation days. That’s equal to ~99% of ‘neutral’ movement days.

Eicher Motors

Out of the 3,711 days traded, Eicher Motors has had a grand total of 175 days in the ‘substantial deviations’ zone. That’s ~95% of non-substantial movement.

Symphony

Out of the 3,711 days traded, Symphony has had a total of 176 days of substantial movement (Just one day in addition to Eicher Motors – a lucky coincidence). That once again, is ~95% of neutral movement.

Here’s the entire data in tabular format:

See where I’m getting with this? On average, these stocks didn’t make any substantial movement for ~96% of the time on their journey to becoming excellent investments. So, assuming you had 50 years of investing life as a successful investor, you probably wouldn’t have to do anything for 48 of them. I understand that there may be some failed investments too along the way, but I hope you get my point.

A quick note: If you want to look at the same experiment repeated, instead with a constant threshold of +/- 5%, you can refer to the Quora answer I wrote a year or so back.

Also Read on FinMedium:  9 Fintech apps you should know about

If you think 3 is a tiny sample size (Certainly it is, I don’t disagree), feel free to pick any great investment of the past decade or so and repeat the same experiment. I am willing to even wager with you that you will end up with very similar findings.

The Deceiving Act

Mohnish Pabrai, Founder and Managing Partner of the Pabrai Investment Fund once said:

You don’t make money when you buy stocks. You don’t make money when you sell stocks. You make money by waiting.

And he’s absolutely right.

Well, of course I am not going to deny that you need several other things ranging from a business acumen to incremental capital. But underlying the very essence of making money in any investment is the deceiving act of waiting.

I’ve read the following phrase somewhere a long time ago, and it’s stuck with me: Good investors trade because they have something to do. Bad investors trade because they have to do something.

Dear reader, do you want to be a good investor or a bad investor?



Source link

Every Wednesday and Saturday, we send Info-Graphic and FinMedium Weekly Digest newsletters to our 25000+ Subscribers.

Join Them Now!

Please Share :)
Dinesh Sairam
Dinesh: Investor | Risk Consultant | Finance Geek | Writer @Quora | Blogger | Poet | MBA from XIME
Back To Top