I recently wrote the following as a response to one of Sebastian Marshall’s posts about investing, in which he breaks down what he’s learning about the financial game, the reasons people shouldn’t try to pick their own stocks, and how he’s going about picking his own stocks. I thought I’d repost it here just for longevity’s sake. I have a fair amount of first hand experience in this area and a lot of second hand experience, so I offered Sebastian my own words of warning. I didn’t mention it in the comment, but I’m not exactly alone in my thinking: I’ve got both history and Warren Buffett on my side. Bottom line: picking stocks is a game you cannot win.
Hi Sebastian,
Thoughtful post. My only qualm comes from the fact that your argument really boils down to “…but I’m smarter than them.” You probably are. From our conversations, you definitely seem like a really smart dude. And being smart enough to avoid investing in something like Ivanhoe is half the game.
But, I don’t think that’s even close to enough to truly be successful. I think there’s three main problems, and competition is the first. There’s literally hundreds of thousands of people who do nothing but comb through financials, or write code that combs through financials, looking for value based picks. You could be the smartest human being in the world, but it’s pretty tough to beat this massive amount of brute force.
The second problem is opportunity. Warren Buffet still reads financial statements for 8 hours a day. He says it’s his favorite thing to do. And yet, as of Dec 31, 2010, 54% of his portfolio was tied up in Coca Cola, American Express, and Wells Fargo. Just three freaking companies. Why? He has a deep understanding of a huge number of companies. His only real job is to find undervalued companies and buy them up. And yet his entire portfolio included just 25 positions. I’m going to guess the only reason his portfolio isn’t more diversified is because he can’t find better opportunities. If Buffet can’t find them, I’m certainly not going to find them in the couple of hours a week I could devote to it.
But the biggest problem, and the real reason I don’t do this kind of stock picking, is fraud. I’ve had the opportunities to meet with people from all areas in this field. Hedge fund guys, I-Bank guys, accounting guys, CFOs, and securities lawyers. They all recognize that the game is rigged. The degree to which they think it’s a sham varies, but they all agree. They all know everyone is lying, at least to some extent. I think unless you’re going to get all the way up a company’s ass like Buffet does, looking at financials alone is never going to cut it.
Anyways, I’ll admit that looking for those diamonds in the rough is fun. Good luck, and I hope you do find one.
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