Do You Feel Lucky?

manage-your-risk-dice

A fellow investing friend of mind (let’s call him High Flyer) likes to invest in penny stocks (i.e., share value less than a buck). And though he knows I don’t touch highly speculative stocks, he still likes to share his excitement with me. Every time he does so, I remind him that he may as well be laying bets at a Vegas roulette table given the high risk nature of companies with minimal revenue, profit, and business prospects. But High Flyer comes by his name honestly: he’s a gambler and gamblers get their kicks through taking risk that us non-gambler types shy away from.

A few weeks ago, High Flyer is telling me why I should I buy a company called Petrolia Inc. (CVE:PEA). PEA is a Canadian based oil and gas exploration company. In Canada, given the outsized contribution of the energy sector to the national economy, these kinds of companies are a dime a dozen, all eagerly searching for pools of black gold.

That said, the vast majority of them do not go on to find Alaskan sized gushers. Rather, they stay small, burn through money provided by seed investors (i.e., people who fork over the initial dough necessary to get the business running) and eventually shrivel and die.

Though High Flyer was his usual buoyant self when trying to sell me on buying PEA, I listened to his harmless ramblings in stride, eventually telling him I’m not particularly fond of flushing money into a sewer. Not that I expected High Flyer to follow my lead on this one. Because his style is to go it alone.

So, in keeping with his nature, High Flyer bought a fair amount of PEA shares. And yesterday, he calls again to inquire whether I loaded up on PEA, knowing full well I didn’t.

“That’s too bad,” he says with a glint in his eye (sure it was a telephone conversation, but I swear I could hear the glint).

“Why’s that?” I ask, playing the game, knowing he desperately wants to share his good news.

“Because they just announced payment of a one time 25% special dividend. Meaning, I just earned myself a 25% return in two weeks! And this is before the shares have started to take off! See, you should have listened to me, Mr. Bigshot BuddhaMoney!”

images-1


What’s Luck Got To Do With It?

Daniel Kahneman, Princeton psychologist, recipient of the 2002 Nobel Prize in Economic Sciences, known for his work regarding the psychology of judgment and decision-making, and for playing a significant role in creating the field of behavioural economics, wrote a bestselling book titled, ‘Thinking Fast and Slow’. For anyone who manages money (that would include, um, let’s see, well … just about everyone), and for anyone who wants to learn more about the chaotic and fascinating workings of the mind, the book is an informative read.

Okay, inadvertent book plugging aside, here’s a noteworthy comment from Kahneman:

“There is general agreement among researchers that nearly all stock pickers, whether they know it or not – and few of them do – are playing a game of chance. The selection of stocks is more like rolling the dice than like playing poker.”

Kahneman doesn’t believe that ordinary investors (i.e., if you’re not Warren Buffett, you’re ordinary; okay, slight exaggeration, but not by much) are able to beat market returns.

Disagree? Think your hand picked investments can perform better than an S&P 500 index ETF over the next 5, 10, 40 years? Maybe. But not likely.

Marketwatch recently reported that a mere 1 in 20 actively managed large cap (i.e., holdings include companies like Pepsi, Ford, Google, etc.) mutual funds beat returns of the S&P 500 index over the past 15 years. And across all fund categories, more than 80% did worse than an S&P 500 index ETF.

Add to this billionaire extraordinaire all time greatest investor Warren Buffett stating that, after he’s passed on to that hallowed place where genius investors pay no heed to earthly concerns such as money, his 80 or so billion dollars should be invested as follows:

“My advice to the trustee couldn’t be more simple: Put 10% of the cash in short-term government bonds and 90% in a very low-cost S&P 500 index fund. (I suggest Vanguard’s.)

I believe the trust’s long-term results from this policy will be superior to those attained by most investors — whether pension funds, institutions or individuals — who employ high-fee managers.”

In the end, we all roll the dice. For some, however, (i.e., Buffett) the dice are loaded in terms of knowledge and information facilitating more advantageous decision-making. Yes, these people will lose on some investments, but they win more often than not.

As for the ordinary investor, our dice rolls are governed more by the Gods of Chance, and the Gods of Chance really don’t give a hoot as to whether or not you win or lose money, whether or not your bills are paid on time or not.

So before buying your next stock instead of the safe and boring (oh, but safe and boring are the best type of investments!) index fund, ask your self: do you feel lucky? And even if you do, know that the long odds point to you losing.

images-3


“Success = talent + luck; Great Success = a little more talent + a lot of luck.”

This is another quote from Kahneman who says that luck plays a large role in every story of success. Okay, if this is true and accurate, the challenge for investors is distinguishing between one’s own skill and luck.

Unfortunately, when short term success comes our way, too many of us attribute this to skill. And when we lose? Well, naturally, that’s just bad luck.

Actually, win or lose, like Kahneman says, it’s a combination of skill (or lack thereof) and luck. And to think otherwise means you are under the spell of that little something we call greed, accompanied by a healthy side dish of delusion.

For those who truly want to evaluate their investing chops, chart your portfolio over a period of at least ten years. Then compare results to the S&P 500 performance during the same time period. If you outhit the index, only then can you count your self among those whose skill plays a larger part than luck when it comes to investing.

images


High Flyer Grounded

PEA looks like a winner, short term at least. Not only did High Flyer earn several thousand dollars from the company’s special dividend payment, but the company will be reverse-splitting its stock (i.e., shares are merged to form a smaller number of proportionally more valuable shares) so shares that were worth 40 cents will now be worth $4.80.

The share merger in itself doesn’t make the stock more valuable but it does remove the company from penny stock ranks. In turn, this may serve to attract more retail and institutional investors who attach more credibility to non-penny stock shares. Once again, in turn, this may serve to lay a foundation for further share price increases should the company’s business perform well.

Notice my use of the word “may”. Because there are no guarantees. High Flyer is still rolling the dice, even though these dice now appear to be slightly more advantageous.

And if PEA shares zoom, well, good for High Flyer. He could use a win. Because for every winning horse in his stable, he’s had five who’ve been taken out to pasture. That’s what happens when you roll the dice often: you win some, you lose lots.