The following article appeared in the Australian Financial Review on July 31, 2018.
Big winners in the sharemarket tend to prompt overconfidence. Investors sitting on a heady gain can’t help but feel they have the Midas touch and that, maybe, just maybe, they’ve got this whole investing game figured out.
As an old saying in baseball goes, though, there are two kinds of ballplayers: those who are humble; and those who are about to be humbled. And investors sitting on big wins who fail to appreciate that luck plays a role in all investing outcomes are likely to learn the wrong lessons.
Admitting that some of your success is attributable to luck and not only a sound decision is always difficult – it is a lot more fun to take victory laps than it is to stare in the mirror. But I suspect that even just trying to untangle the contribution of the decision process versus the role of luck is very helpful in improving one’s process and, ironically, reducing the role of luck in future decisions.
I’ve experienced all manner of process and outcome permutations over the years. Good process, bad outcome? Frustrating, but it happens. Bad process, bad outcome? Plenty of those over the years, and be wary of any pro who pretends otherwise.
Beam me up
I’ve even made some decisions that weren’t particularly good but still had good outcomes thanks to strokes of luck. For example, back in April 2013 I recommended shares of satellite TV juggernaut DirecTV to followers of a US investor service I advised at the time. The shares were conventionally cheap, the cash flow was very sticky, the business was squeezing out growth despite talk of cord cutting, and the business was buying back shares at what struck me as attractive prices.
As it happens, this was right before the company’s growth hit the wall and cord cutting began to pick up steam. About 13 months after the initial recommendation, though, I was able to advise banking a 51 per cent profit thanks to a generous and unobvious bid from AT&T, which itself has underperformed the S&P 500 by just under 56 percentage points since the day before the acquisition was announced.
It might be unfair to say the buy decision was entirely a bad one. After all, the business held enough positive qualities to lure AT&T into buying it out. Still, with the fullness of time, it seems very clear that luck was the driving force behind that good outcome. I wasn’t banking on an acquisition and, had one not arrived, an independent DirecTV could have been in serious peril today.
Buy now, pay later?
And, of course, there’s everyone favourite: good decision, good outcome. A decent candidate for that is Afterpay Touch, which I highlighted in a column for this newspaper last year and is a holding in one of the funds I manage. Shares in the company, where Nicholas Molnar is CEO, have done quite well since that article – they’ve increased from $3.85 to a recent price of $14.81 – but was that payoff a result of good process or good luck?
With the benefit of some – but not total – hindsight, it is fair to say that I got some of the big things right with the Afterpay Touch thesis. Namely, that growth among Afterpay users and merchants would stay strong as network effects took hold. The number of merchants and active users on the platform increased in 2018 by about 175 per cent and 238 per cent, respectively, and the company now estimates that it processes more than 10 per cent of all physical online retail in Australia.
Even for a business that did not look conventionally cheap at the time, such growth tends to work out well for share prices.
A couple of the call options that I then identified have also become material. In-store made up about 12 per cent of underlying sales in the fourth quarter and the US launch is off to a strong start, with $11 million in underlying sales flowing through in the first full calendar month of operations.
But there has also been luck involved with this early winner. The company has executed remarkably well, capital markets are buoyant and Australia has continued to sidestep a recession. None of those factors are within my control and the lack of them would have taken wind from the shares’ sails. Also, while I was right to recognise the potential, I didn’t anticipate the speed of the US launch or the degree of its early success.
It’s also worth remembering that, while this has played out nicely thus far and I remain long-term bullish, the shares remain high risk and the business is still young. For that matter, there are any number of risks – some of little impact, some much greater – that are unknown.
My call on Afterpay Touch looks to have been a mix of good process with a splash of good luck thus far. Even so, as a long-term investor who is slow to rush to judgement, I know there’s still a lot of ballgame to play.
In all investing outcomes, good or bad, luck plays a part. The more an investor sticks to a defined process, though, the better the odds of playing an increasing role relative to luck.
Joe Magyer is the chief investment officer of Lakehouse Capital. The Lakehouse Small Companies Fund owns shares of Afterpay Touch. This article contains general investment advice only (under AFSL 400691).