One of the biggest stock disaster for myself in recent memory was my speculation on AEM Holdings.
The Semi Conductor Stock did some R&D work with Intel and AEM started producing for Intel with Intel being their big customer. In a lot of ways, AEM sounded like UMS holdings in its infancy stage in 2010-2011 when it carried out the capex which eventually brought online its production to its sole customer Applied Materials.
In terms of valuation it was cheap, but I had enough reservations about AEM.
For one thing, the people being AEM are private equity. Looking back, AEM is one of those company that provided so much profit guidance prior to results announcement. These guidance let the public know what were the forecast orders going forward for the year versus the past six months, or the past years.
Call me old school, but I would have think management would focus more on the day to day running of the business then to give out so much positive spin. It gives me an idea they are trying to bring the stock to higher valuation.
The share price is going up, and likely, at some point the private equity people would exit their money from AEM.
When you size up a prospect like this, you put it into the pile that you don’t know enough of the management real intent, or that your sensing that their intent is to not be in this for the long haul.
This inevitably means you have to exit at some point.
The mistake is, as a speculative play, a play on positive earnings result, improving fundamental and still at good valuation price earnings wise, I didn’t ride it well enough.
Had I kept the money in $20,000 likely Would have become $140,000.
Your Level of Conviction Guides your Position Sizing as well as Your Holding Power
In another time period as an investor, given the different level of experience, I might have stupidly bought more, and stayed in there as a core position.
The result might be different.
I might have concluded that buying undervalue business provide immensely profitable.
My sizing of AEM Holdings, and the kind of exit conditions, shows that I do not have high conviction in AEM Holdings as a longer term, high quality business prospect that I believe may be fair to undervalue.
Conviction is an interesting concept.
The dictionary defines that Conviction means a strong persuasion or belief.
To me, it is whether someone have a strong belief in something they talk about, or an opinion on things.
In the investing or wealth building sense, it is how much they believe in a business prospect.
Conviction is important.
Suppose you have strong conviction stock A is a golden goose that keeps laying golden eggs.
If you have a total wealth of $200,000, a risk seeking individual could deploy $150,000 out of his $200,000 wealth into stock A. If your conviction is weaker, you might take a normalize allocation of not more than 10% of your total wealth (in this case $20,000) into stock A.
When stock A falls by 20-30%, you will find your conviction or belief in stock A challenged.
A person with strong conviction holds on to that stock with unwavering certainty. He might add on to his positions, taking advantage of price weakness.
A person with weak conviction on the stock might just sell it at 5% when it makes a loss. They buy in easily to the negative news put out in the media about the poor results stock A suffered in the latest earnings result, or how the recent flooding have hampered production.
Given this, I find that having conviction allows you to concentrate, hold longer. When you hold stocks longer, your wealth stays in the market, you are able to earn the total return (capital gains and dividends)
Given this, how do you gain conviction in an investment, a stock or a way of building wealth?
How to Gain Conviction
You can attend as much courses as you wish, but out of 100 who attended, not everyone would be able to gain the belief that a particular trading method, or value invest method will work.
The level of conviction will vary from individual to individual.
1. Putting in the Work to do the Research Yourself, to Deconstruct a subject Yourself. Most of my larger positions tend to be stocks or financial assets that I have a good understanding about the value, the business, and the risk of the investment.
As I gain an adequate level of understanding, I am able to make a decision whether to invest. If its a good opportunity, how much to deploy. For those with weaker conviction, perhaps a better strategy is to put in a smaller allocation and see how that works out.
Doing the research yourself allows you to be in touch with the numbers, the various trajectory that the company can go. You become clearer, the investing decision becomes clearer.
The same can be said about whether passive index investing or peer to peer lending works.
Over the years I have people asking me these questions as a form of second opinion, or an expert opinion. I always think that even if I tell you it works, you won’t have a high buy in if you know nuts about passive index investing for example. Your conviction is based on my conviction.
You will gain a higher level of conviction by spending a good 2 months deep diving on every aspects about indexes, exchange traded funds, a history of buy and hold, quantitative smart beta strategies, history of market draw downs.
When you have a lot of doubts, and you systematically get each of your doubts addressed, your conviction either disintegrates or builds up.
2. Insider or Informed Information. The executive directors, CEO or parties affiliated with the company would have a higher holding power, or are able to build up large position because they are close to the owner-operator.
They know that despite some poorer recent results, the fundamentals are intact since they are the ones operating this business for the past 20 years. The public retail investors might not understand the business and risks well but these folks do.
And even if they are passive investors, they are able to leverage these connections to depend on the integrity (real or false) of these owner operators or insiders.
3. Ample Trust in Manager/Friend/Trainer’s Process. In recent times, copy trading gets popular. So are mastermind groups on stocks. Retail investors starts leveraging on the buys and sells of the thought leaders in these fields.
The conviction level that you have in these manager/friend/trainer would depend on how well you have seen their past track record, your understanding of their process and the thinking behind these picks.
I tend to think that for many, they do not have a strong idea why someone else buys stock A. They just follow with the trust and hope things will turn out OK.
The more successful ones are those that take an idea from these leaders, do their own background work, marry what they know about the suspected thesis of the leaders for these stocks.
This can be pretty successful, provided you follow the right people. One of the most prominent quantitative way is to follow the stocks purchase by famous great investors.
The SEC Form 13F is a filing with the Securities and Exchange Commission (SEC) also known as the Information Required of Institutional Investment Managers Form. It is a quarterly filing required of institutional investment managers with over $100 million in qualifying assets. Companies required to file SEC Form 13F may include insurance companies, banks, pension funds, investment advisers and broker-dealers.
Those great investors like Berkshire Hathaway, Soros, Seth Klarman’s Baupost have to mandatory declare their purchases every quarterly. While it might not be useful to know the delay information of what funds with high turnover buys, the list of stocks commonly purchase by investors who are value based would give a good list to work on, since their process tends to be one with lower turn over.
4. Experience. The more you invest, the more you can determine where you are in your ability to prospect stocks, do deep work, weed out critical information. Experience may tell you that you better have a particular level of vulnerability that your thesis might not always be correct. You then have to be more anxious. Thinking twice before doubling down might be wise.
Conviction can be a Double Edged Sword
I started by saying a strong conviction allows you to layered in a more concentrated position and hold it longer. You might even add on to it when the price falls.
However, your strong conviction could be false. Some of us gets over confident. Then there are the investors lacking any vulnerability in the level of their prospecting competency.
What might happen in reality is that the quality of the business is not there, and you kept holding or doubling down due to the “high conviction” in the business.
This could just kill your wealth.
Even today, a lot of the times, I don’t trust my prospecting abilities.
Despite the high conviction, I have a failed safe limit of not having a stock being more than 10% of my total wealth. If my prospecting turns out to be grossly wrong, 10% is painful but it doesn’t kill the overall plan. I give enough respect that shit happens. I also understand where I am in the wealth accumulation cycle, and whether I should push my rate of return so hard.
Another failed safe for me is, don’t be afraid to buy things when prices trend higher, and when things becomes clearer. In this way, you get invested when your thesis is clearer, that the current price is still lower than the intrinsic value.
I believe that value investing is tough, requires high competency, and short psychological capital. Most of us, including myself do not have high competency and have our brains wired the right way to invest the value investing way. Thus at this moment I don’t advice people to always buy when prices get lower.
Load up more if you believe you really are experienced enough in prospecting stocks and do it with respect to the level of your overall wealth.
This image was taken from a scene of a Japanese Anime called One Piece.
It shows the main protagonist Monkey. D Luffy displaying Busoshoku Haki. Busoshoku Haki (or Armament Haki) is a high level skill that is able to bash through some very troublesome foes.
Not many people were able to developed it. Those that did was able to use it to varying degrees of success.
I find some similarities in context with whether a person have conviction. Two different investors can do what I advice above and reach a different level of conviction.
Conviction to a certain extend is influenced by experience and guts. Some folks are tune to have high conviction compared to others. A lot of us just don’t have enough of it.
While you might not need to prospect stocks on an individual basis, you need to develop some level of conviction. If you do not have enough of it for the way you build wealth (property, active stock investing, trading, index investing), investing will always remain an inefficient play thing.
How you do it is another matter all together. My overall advice is: Understanding things better. Do enough work.
I keep most of my thoughts on active stock investing in my Active Investing Section. If you are interested in doing active wealth building, you might wish to take a look.
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Monday 5th of March 2018
I always made a point not to look back at "what could have been" after I sell the stock. As a seasoned investor (I'm pretty sure you are), any trades you execute should have underlying reasons. Since it is a speculative play and if you made profit then it is already a good trade made! Convictions based on fundamental should not matter in speculative trades?
That said, I always get annoyed by phrases like, "wah, if I invested then, my returns could have been triple-fold, 5-times fold" because, not many has the foresight and fortitude to hold all the way thru those multi-folds. Along the way, most will have sold to realise the gains.
Tuesday 6th of March 2018
Hi SeekingPrivateReturns, a stock becomes a trade for me if I don't wish to own it for a longer term. A stock becomes a trade if its entirely speculative on recent news. They become speculative trade because of the lack of fundamental conviction that it can be more than that. This is why i believe we still need to look at convictions. If an investor have conviction, this would not be a trade. this would be a core position perhaps. The amount we invested is different, the ability we are able to hold is also longer.
Sunday 4th of March 2018
Agreed. A huge part of successful investing is controlling your own emotions. You may have huge conviction in an out of favour stock, but that doesn't mean that the stock cannot fall another 50% from your buy in price. Personally, I do face difficulties in knowing when to cut my losses or double up in a falling stock, especially when I believe that my underlying investment thesis is still sound. Overthinking may not always be a good thing!
Cheers, and thanks for sharing.
Sunday 4th of March 2018
Thanks for visiting Financial Horse. That problem is always around. It just means that perhaps our brain is impeding us from taking action when the action is a short on psychology. We might need to adjust our strategy to accommodate that