Paying for Information (In Reverse)

I’ve written before about my Firebird co-founder Brom Keifetz, who passed away in 2014 while living the life of an online sports bettor and all-night Texas Hold ’Em player in Panama City.1 Brom was a brilliant fount of aphorisms, many derived from gambling, and when we were partners, we often found them perfectly applicable to investing.

One thing Brom used to say was, “You have to get comfortable with the idea of paying for information.” In poker, that means you may have to call a bet or a raise to see the next flop card, and there’s no shame in doing that, then folding if it doesn’t fall your way. In investing, you have to apply the maxim in reverse: there may be information you want about a company before you’re comfortable buying the stock, but if the info turns out as you’d hoped, you’ll be buying at a higher price, and you must accept that.

Gamblers like Brom, cold-blooded calculators of probability (having been a horse race handicapper before B-school, Brom became an A student in the course), would have no trouble paying up once provided with the info they needed.2 Unfortunately for the rest of us who are warm-blooded, it can be psychologically impossible to buy a stock that has already moved a lot — even if the rational part of our brain tells us there’s a good reason for the move. An example: if you were considering Moderna last week and didn’t act on it, would you buy it today at twice the price, even if you felt deep down it might double again in a year? That’s what I thought.

As someone who has always hated overpaying for anything, I’m susceptible to this emotion, one that I know impedes successful investing, so I had to think up a workaround. For years now I’ve been using a simple mind trick I call “taking a psychological stock position.” I’ve posted about it on Substack twice before, but I think it’s the most valuable investing advice I have, so here it is again.

In a recent post about value investing and art collections, I discussed the pain of finding a winning stock and selling it too soon, then watching it climb for years afterward. There’s a related pain that doesn’t hurt as much but is economically worse, i.e., identifying a great bargain, never buying any, and seeing it go up seemingly forever. It doesn’t hurt as much as selling too soon, since you didn’t hold it in your hand and let it slip away; but it’s economically worse because you didn’t make even a little money from your original insight.

In summer 1998, my partner Ian and I were sitting around our office discussing the growth of the Internet and it occurred to me that if computing were to move mostly online where there was a universal language, Java, then Microsoft’s operating system would no longer be as dominant. “It could be good for Apple,” I said, and Ian agreed. We were at that time the rare investment professionals who used Macs, so we were particularly interested in Apple’s outlook.

I checked Apple shares, then trading at the split-adjusted equivalent of $0.20, and did nothing. Later that year, when I became more certain that we were right about Apple’s improved prospects, I checked again and saw that the price had gone up to $0.30, a 50% gain in a few months. This time I didn’t buy any because “I missed it.” I MISSED IT!!3

It’s easy to say, as Jim Cramer often does, that you buy your portfolio every day and what happened in the past doesn’t matter, but it’s hard to be that disciplined. I repeated my Apple mistake with other stocks, both in my personal account and in the funds I co-manage. And it’s not just me. A few months ago, I attended a dinner with successful tech people in Silicon Valley and when the question was asked how many of the 20 or so attendees owned Nvidia, only one raised his hand, while the rest winced as if slapped. I’m guessing that the absence of Nvidia holders in a group that included semiconductor experts wasn’t a vote against the company, but because they had MISSED IT. Since that night, Nvidia has appreciated another 70% [260% now: HS], adding to the pain.4

To avoid more missed opportunities, I had to find a way to overcome my mental barrier against buying a stock that I’d considered and passed on at a lower price. What we’ve done in our funds is: when we have a strong interest in a new name but aren’t sure that we want to build a big stake, we buy a toehold, even as small as a 0.10% weighting in the portfolio. I call it “taking a psychological position.”

If we do this and later become convinced about the stock, and it has declined since our first purchase, we can buy more at a better price: a win. But more important for the emotional side of investing, if the stock has gone up since our first purchase, we can tell ourselves that we’re “adding to the position.” (If I had bought even $500 worth of Apple at $0.20, I wouldn’t have had any trouble buying more — adding to my winner — at $0.30.) If, on the other hand, confidence is not achieved after the initial assessment, we can sell our toehold without a big impact on the portfolio.

This technique can also work for selling: if you’re turning negative on one of your holdings but haven’t decided whether to exit fully, you can sell a little. If you then become sure, you will have already “broken the seal” and can more easily sell the rest. One of the hardest and often the most necessary things to do in investing is to sell a formerly profitable position after it’s already down 20%, and this mind trick makes it a little easier.

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I recently saw a CNBC interview with Stanley Druckenmiller in which he said that he follows a rule learned from his old boss, George Soros: invest then investigate. When an idea is presented that seems attractive, Druckenmiller quickly buys some — if it’s a sectoral idea, he buys a basket of stocks — and does his research later. He said that when he first purchased Nvidia, he couldn’t even spell it.

Unlike me, Druckenmiller doesn’t dip his toe but goes in with big dollars. If he concludes upon deeper review that the idea was a mistake, he sells it all back immediately, even if he takes a significant short-term loss. What I know about myself is that unlike Druckenmiller or Soros, I have trouble admitting my mistakes and dispassionately realizing losses. So my psychological positions have to be small.

If you decide to try this strategy, you should first ask yourself whether you are a trading god like Druckenmiller or Soros, or a mere mortal like me, and size your trades accordingly. Just as a poker player must know his own tells, a serious investor must discover his psychological weaknesses and deny them the opportunity to take control and do damage.5

This communication does not constitute an offer to sell or a solicitation of an offer to purchase any interest in any fund or investment vehicle managed by Firebird Management LLC (the “Adviser”). Any such offer will only be made pursuant to confidential private placement memoranda and related offering documents, which should be reviewed carefully before making any investment decision.

Information regarding specific investments is provided solely for illustrative purposes and reflects selected examples of investments considered or made by the Adviser. Such examples are not a complete list of investments made by the Adviser and are not intended to be representative of the performance of any fund, account, or investment strategy managed by the Adviser. Past investment decisions, including those discussed herein, are not necessarily indicative of future investment decisions or results. Nothing herein should be construed as investment advice, a recommendation, or an offer to buy or sell any security. All investments involve risk, including the possible loss of principal.

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Buffett, Brom, and Betting Wrong on Russia

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Jan 31

I’m reading the authorized biography of Warren Buffett and just learned that he was a horse race handicapper as a teenager. He talked his father Howard, then a Congressman, into pulling all the books about handicapping from the Library of Congress, and he read them all. With these skills, young Warren started going to the track with the