Blog

How to make Asymmetric Bets in Life and in Investing?

January 5, 2023 by Sandeep Anand

I had recently put out a post about the importance of taking asymmetric bets (Low risk-High Returns) in life and I was asked “What are asymmetric bets and how to make those bets to change one`s life?” I mean the question is genuine like how can we have a bet with low risk but high return? Its counter-intuitive to what we are all taught in schools and MBAs that you have to take high risk to reap high rewards in finance and investing. To that extent, can asymmetric bets of low-risk and high-return exist in real world?

Of course there are risks associated with asymmetric opportunities as well. But the risks are downside protected with huge upside returns. Now what are some of those asymmetric opportunities in life? James Clear, the author of “Atomic habits” once collated a list on twitter, few of them like:

Investing in a start up

Writing a book or starting a Podcast

Create a product (software)

Investing in Equities

These are asymmetric opportunities available for everyone out there who can take advantage based on their line of interest or passion. Think about it, what is the downside in pursuing any of the above opportunities as a part time in life and eventually making it full time? Close to none. But think about the upside potential? Its huge and can really change one`s life for good.

How to take smart decisions (bets) to stack odds in your favor?

Life is all about making thousands of small decisions we make every day and there are occasionally few major decisions like career, marriage, kids, where to settle down, investing etc. I recently read a book called “Thinking in bets” written by Annie Duke who was a poker champion and winner of World Series of Poker (WSOP) gold bracelet from 2004. She says in this book “The strength of thinking about every decision as a bet is that you stop to gather more information and think more logically. When you start to think of decisions as bets, you begin to see a range of possible futures and adjust your degree of certainty accordingly. ” To take smart asymmetric bets, she has a formulae:

Expected Value = Possible Reward x Likelihood of reward

You should always make a decision that has a positive expected value. A positive expected value is when the expected value is greater than your personal cost. Personal cost includes the time it takes to carry out your decision and the cost of money and attention you have to commit.

Lets take an example of how to make an asymmetric bet in stock market investing? This is one place where we take investing decisions under heightened conditions of uncertainty about future prospects. We are investing in a company for its future cash flows that is uncertain and difficult to predict for more than a couple of years. So we need to increase expected value of outcome by increasing both factors ie possible returns and likelihood of that return. This happens when we search for stocks in the most hated countries or sectors or companies. As legendary investor Howard Marks puts it ““The safest and most potentially profitable thing is to buy something when no-one likes it. Given time, its popularity, and thus its price, can only go one way; up.”. Basically we are increasing the likelihood of reward by investing at times of maximum pessimism.

Here is a practical example that happened in recent times. There was a popular dogma on all leading global news papers that “China is non-investable”. Here is an asymmetric opportunity that arose in second half of 2022. How can a country that is second largest economy in the world and had proven over last 3 decades that it wants to be and will be a successful economic super power in the world deteriorate into shambles? It clearly became a hated investment destination during second half of 2022.

Look at the leading tech stocks performance over last 3 months once the perception changed. All we needed to do was to load up on such asymmetric opportunities where downside is very limited but upside could be 3 or 4 times up.

We always get such asymmetric opportunities in life. All one has to do is to have an open mind and be aligned to make smart decisions or make bets where odds are stacked more towards their favor. Of course luck has its role too…

Why Benjamin Graham value investing approach is anti-thesis to compounding

December 23, 2022 by Sandeep Anand

‘The Intelligent Investor’ by Benjamin Graham is the most commonly referred book for beginners in Investing field. While there is no doubt this is a great book as often quoted by Warren Buffett, the traditional concept of value investing is actually anti-thesis to creating wealth through the principle of compounding.

What is great about the book? Margin of Safety: The most famous concept introduced by Benjamin Graham was the ‘Margin of Safety principle’. This definitely is the highlight of the book as well as a path breaking idea in the world of equity investing. Margin of Safety in its crude definition states buying something that is worth $1 for 60 or 70 cents. In other words, Margin of safety is a principle of investing in which an investor only purchases securities when their trading price is significantly below their intrinsic value. This gives sufficient cushion for investors against market volatilities. Second great idea from the book is to look at investing in stocks as part ownership of businesses.

Now why traditional value investing approach practiced by Benjamin Graham is anti-thesis to the concept of compounding?

To answer this question, we need to understand what he practiced through value investing approach. The approach states to buy a security whose intrinsic value is $1 but buying it for 60 cents. And sell the security, when the stock retraces back to its intrinsic value thereabouts. Lets see what are the issues with this approach?

Reinvestment risk: The biggest risk every time you sell a security is, to find another idea to reinvest that money. This will be a non-stop process if we practice Graham`s traditional value investing process. We need to keep selling securities and keep buying the next bargain. This causes reinvestment risk because, one its extremely difficult to keep finding bargains and two, we are increasing the probability of errors by taking so many attempts of reinvesting.
Interrupting Compounding Process: The biggest disservice an investor can do to his or her portfolio is to keep interrupting their compounding process. Great Companies continues to grow 50 times or 100 times over long term. So how can investor achieve a 100X returns when we sell after it doubles or triples following traditional value investing methodology. Charlie Munger once said famously,
Frictional Cost: The biggest issue with constantly selling securities and booking profits is Tax. Take a look at the table below how much Tax can affect compounding as a frictional cost. This is a serious dragger on the process of compounding. Over 20-30 years period of compounding, the returns can come down by 5 – 10 times which is huge.

But does that mean you should never sell securities that you invest in? No, its just that we need to find investing ideas with long runway and buy it at a decent bargain. If we did the job right in identifying the right business, then selling becomes relatively an easy decision which is “Few years later when the growth has runout”

Why Investing Is Hard?

December 9, 2022 by Sandeep Anand

There was a great company that Forbes once proclaimed it the fastest-growing company in history. Google had offered $6 Billion to buyout this company in 2010 but they spurned down the offer and decided to continue alone. The company am talking about is Groupon, once a global leader in ‘Daily deals’ touted to have access to 150 Million customers a decade ago. A year later after turning down Google`s buyout offer, Groupon did then second biggest Internet IPO in US (after Google in 2004) listing at a nosebleed valuation of $13 billion in 2011 (twice the valuation Google offered in 2010). It was not even a bull market in 2010-11 and stocks were trading at low valuations in general.

Groupon was growing at an astounding rate. In 2010, it’s revenues grew by 22,000 % to $713 million. And in the first quarter of 2011 (IPO year) alone, it nearly matched all of its revenue from previous year with $644 million in sales, up 13,575 percent from a year ago. The annualized annual run rate was around $3bn in 2011 which appeared to be sustainable for next 5-6 years at that point of time. Gross profits were up about 24,600 % in 2010 to $280 million, from $10.9 million the year before. But they were burning cash every year at the rate of around $500 million and the company management was completely focused on Growth during that time. Any investor who heard about the success of Internet companies like Amazon, Google would have been tempted to pounce on this fastest growing IPO in 2011.

Competitors soon nipped at its heels, results started to falter, company fired their CEO, did a lot of restructuring but never came back to its glory days of growth again. The stock which started at $13 Billion valuation in 2011 has been decimated to a mere $215 Million losing 98% of its value. If an investor had put $10,000 in Groupon stock during IPO will be left with just $165 after holding a decade. Buy and hold for long period would have obiliterated its investors.

Now take the recent example of Meta (Facebook) stock, another legendary hailed company touted to have 3 billion users, strong Moat of network effects, strong social media brands like Instagram, Facebook, Whatsapp. If an investor had bought the stock during May 2012 IPO at a price of $38/share, would have just multiplied the capital by 3 times over last 10 years. That’s a meager 11% compounding on par with S&P 500 index which also multiplied by 3 times over last 10 years. Facebook stock has underperformed Nasdaq index which has multiplied by 4 times over last 10 years.

I can go on with hundred more examples like Alibaba in China, Paytm in India and so on. 10 years down the line, we will be talking about Tesla probably as one such example.

Now let me get to the core topic of today, “Why investing is so hard for common investors? Why are less than just 0.1% of the investors successful in stock markets?” Anyone who is given the great fundamental growth stories of Groupon, Facebook would have been impressed to invest in these companies during IPO. Valuation was expensive but not to the extent to be decimated this levels. What really happened was the business fundamental deterioration to such levels that growth has slowed down like anything.

Where most investors usually falter is entering the stocks at high valuations during bull markets. But there are investors who falter by investing in great businesses a point in time, only to see their returns being wiped away. Investing is really hard but most of the people think that anyone can do this due to the ease with which they can buy or sell stocks on information or news on TV channels.

Investing is no easy way to build wealth. If there were, everyone would already be rich. Let me end this week`s letter with a quote from legendary investor Charlie Munger about Investing and getting rich: “It’s not supposed to be easy. Anyone who finds it easy is stupid.” There are no shortcuts. Period.

Stay Connected with Sandeep Anand

Single gateway to FREE courses and Articles

Single gateway to all courses and portfolios