I write today in the calm before the work rampage that is Q2 results. To the untrained eye, this quarterly ritual seems to involve a group of (alleged) adults abandoning their families, social circles and health goals with extreme prejudice while they have their sense of self-worth dictated to them by numbers on a screen.
While this is cause for a good deal of concern, I’d argue that yet greater concern should be afforded to the fact that many of these adults seem to enjoy the process, myself included. Jokes aside, in the next few weeks, investors will receive and digest new information that will help us monitor our investments, present new opportunities and help us determine whether we’re right or wrong. In all of this, it’s easy to focus too much on the latter and lose sight of the goal: making our investors money.
A card game illustrates this point well. The game is a bit like poker:
We take a 52-card deck.
Ace = 1, faces = 10, other cards are worth their face value.
We deal 3 cards face down in the middle of the table. The goal is to estimate their sum once they’re all turned over.
One of the centre cards is turned over at the start of each round. Each round, the players bet on what the sum of the three cards in the middle of the table will be once all the cards are turned over.
We also deal one card each to the players and give them a bankroll of $1m.
Most people will play this game by trying to estimate the sum of the three cards using maths. The maths is reasonably simple. The sum of our deck of 52 cards is 340 with the average being 6.54. Before any cards are turned over, we expect the sum of three random cards to be ~19.6 (i.e. 3 x 6.54).
We deal a card each to the players and turn over the first centre card, the 10 of clubs.
Player 1 is dealt a king of hearts. This makes the average of the 50 cards player 1 can’t see 6.4. If you’re rational, you’ll bet the sum of the three cards in the centre will be 22.8 (the 10 of clubs you can already see + 2 x 6.4). Player 1 places bets on 22.8 and is right.
Player 2 is dealt an ace. From their point of view the average of the 50 cards they can’t see is 6.58. They think the sum of the three cards in the centre is 23.16 and bet accordingly. Again, they’re right.
This continues for a series of other players, and using further dry maths, your author could alienate his audience before getting to the point. But we’ll skip the other players and get to the part where we deal a certain blonde-haired maverick a 5 of diamonds, which she doesn’t really look at. Instead, she spends her time buying at 22.8 and selling at 23.16 – and makes a killing.
The point is you should worry less about being right and more about playing the right game. Let’s take Tesla as an example. The value of TSLA is probably not $252.64 / share (as it was at the close on 15 July). If you perform some intense fundamental modelling and valuation work, you might think it’s worth $160.17 / share. And you might even be right. But TSLA doesn’t trade on fundamentals so probably won’t trade on that figure for a very long time, if indeed it ever does. Your $160.17 estimate, while right, probably won’t make you any money because the game is not about fundamentals.
Another example is when a manager buys a company at €89 with a price target of €138 / share (55% upside). Over the next 6 months the stock rallies to €120 (a ~35% gain, not bad at all) and enters a holding pattern. At this point, many investors will say “it’s worth €138, I’ll hang on until it gets there.” By holding at €120, you’re betting the company will rally a further 15%. Perhaps it will. But when? What will catalyse this change? Or is this just a bet that the market is wrong and you are right?
By holding at €120 you’re also foregoing investments in other companies that might have much higher upside potential. In focussing on being right, the manager hits the target but misses the point. The goal is not to be right. The goal is to make money.
I’m entering Q2 earnings with this front of mind.
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