Priorities
First Principles Reasoning Series
Fellow Partners,
What a past couple of weeks it has been in capital markets. The GameStop / Robinhood / WallStreetBets et al. saga is far from over. Despite a popular narrative, there was institutional money on both sides of the trade, and market structure and regulatory requirements were substantive components of the drama.
This will have important implications when the dust settles, and we may cover it in more detail at a later date. Those looking to read more (and chuckle a bit) will enjoy Matt Levine’s recent coverage.
Turmoil demands clear principles and clear thinking, which makes this continuing series on First Principles Reasoning particularly timely. Here is the second entry in the series. Previous entries can be found in our archive.
Alignment
I recently got into a debate over the merits of a popular consumer product. The details are unimportant. What I realized halfway through the debate was that major points and minor points were being treated on equal footing. That is a recipe for poor thinking, and reminded me of a framework I use often:
But living a just and holy life requires one to be capable of an objective and impartial evaluation of things: to love things, that is to say, in the right order, so that you do not love what is not to be loved, or fail to love what is to be loved, or have a greater love for what should be loved less, or an equal love for things that should be loved less or more, or a lesser or greater love for things that should be loved equally.
Augustine of Hippo
I can’t recall seeing Augustine show up in an investment memo before, but good thinking is good thinking, and this one is a gem. Begin applying it and one will quickly realize how poorly we allocate our resources — especially our time. (A common example: spending time on returns/refunds for inexpensive items while simultaneously lamenting not having enough time to spend with family.)
Time is our scarcest resource. Our ability to do anything well requires adequate time to spend doing it. We must make it count.
Sizing
This framework is universally applicable. In investing, the size of our effort should approximate the size of the prize. When researching a company, have we allocated more time to research companies with greater long-term potential? When managing our portfolio, are positions larger when they have more favorable attributes, or smaller when they have greater opportunity of loss (on a probability-adjusted basis)?
We should comport ourselves thinking through, as a friend says, “is the juice worth the squeeze?” and, to add to the sentiment, “squeeze harder when there may be more juice.”
Sizing positions in our portfolio is one of the most powerful application areas for this philosophy and in the world of investing it is one of the most under-discussed topics. We enjoy gains when we’re right and suffer losses when we’re wrong — but the primary way we manage risk and reward is position sizing. Swinging big at fat pitches, being cautious with difficult (but potentially rewarding) pitches and choosing not to swing at many, many pitches.
Perspective
On this point it may surprise some to know the following:
Charlie Munger, at 97 years old, has said he’s made almost all of his money from 3-4 investments.
Ben Graham, the father of value investing, admitted late in his life that he made more money on his GEICO investment than all his other investments combined.
Berkshire Hathaway has made over $90 billion on its investment in Apple.
Those tempted towards a philosophy of “buy a bit of everything” (e.g. indexing) would do well to think through how that may play out, as this philosophy makes it impossible to swing big at fat pitches. Equally, those tempted to try to pick only a handful of businesses and swing big would do well to think through the implications if they are unable to end up with a few big winners.
Challenge
This brings us back to aligning size of effort with size of prize:
It's not whether you're right or wrong that's important, but how much money you make when you're right and how much you lose when you're wrong.
George Soros
The only way to do this is to ruthlessly align our use of time — our priorities — to be spent on that which has the greatest probability of the greatest profitability.
This is hard. But it is wise. I’m smiling just thinking about the challenge.
Closing items
We will delve deeper into the details of position sizing including diversification and concentration later in this series.
Until next week —
All the best,
John
Founder and Managing Partner