Investing in Multitudes: The Search for Market Wisdom
From "losers average losers" to "lowest average cost wins" - finding clarity in the middle of market paradoxes.
Do I contradict myself?
Very well then I contradict myself,
(I am large, I contain multitudes.)
-Walt Whitman, “Song of Myself”
The late pastor and Christian apologist Timothy Keller defined wisdom as “competence with regard to the complex realities of life.”
With experience, the difference between good and bad investing advice becomes clearer. Misguided advice I heard earlier in my career - “You only lose money if you sell” and “Dividends mean safety” - can now be confidently set aside and ignored.
The difference between good and great advice, however, has more gray area. It can be harder to discern as it’s often contradictory. Making matters worse, both sides contain some truth.
Here are just a few examples off the top of my head:
Know what you own…but avoid over-familiarity.
Have conviction…but don’t be arrogant.
Rule number one: don’t lose money…but don’t be too risk averse.
“Losers average losers”…but “lowest average cost wins.”
Time in the market matters more than timing the market…but “price is what you pay, value is what you get.”
Diversification is the only free lunch…but diversification is for the “know nothing” investor.
Buy when there’s “blood in the streets”…but “don’t catch a falling knife.”
Cash is a drag on performance…but cash gives you optionality.
The best investments feel uncomfortable…but “if you can’t sleep at night, you’re doing it wrong.”
Markets are efficient…but Mr. Market is irrational.
(If you’re a professional investor) Be patient…but don’t underperform.
On their own, both sides of each is good advice - or at least I wouldn’t place any of it in the “bad” category. The difference between them, however, can feel infinite.
Let’s take one example of two famous investors.
The Jones-Miller Paradox
Paul Tudor Jones famously kept a sign in his office that read “Losers Average Losers” - the idea that adding to losing positions on the way down was a losing proposition.
Bill Miller, on the other hand, said that his team’s approach can best be summarized as “lowest average cost wins,” meaning they look to buy more of their stocks as the price falls.
So what’s the right approach? Buy more as the stock price falls, or do nothing or even sell to cut your losses?
You could make the case that the difference between the two pieces of advice is merely differences in time horizon. Jones was a trader and Miller a long-term investor, but Jones’ advice is similar to the Peter Lynch idea that you shouldn’t cut your flowers and water your weeds (i.e. sell your winners to fund your losers).
Both arguments have merit and have clear examples supporting their cases. If you were buying Enron as its stock fell ever lower, you only compounded your initial mistake - and impaired your liquidity and potentially your reputation (if you’re a professional manager). And before you think, “Oh, I would never have done that,” plenty of sophisticated investors did just that in hopes of lowering their average cost in the stock.
On the other hand, Miller told in 2002 of how he initially bought Amazon for $80 per share in September 1999 and bought all the way down, lowering his average cost basis to $30 per share and becoming the largest outside investor in Amazon. That strategy has paid off handsomely, to say the least, but there’s also survivorship bias to consider. Quality traps can be painful.
Evolution of a thesis
Personally, I’ve leaned toward Miller’s approach for most of my career. When my stocks “go on sale” I’m usually eager to buy more, especially when I feel like I know the business well.
But I’ve also come around to the idea that, with the market being a forward-looking pricing machine, price momentum can be a leading indicator of fundamental momentum. A sharply falling stock price - particularly in an otherwise good market - could be a sign that I’m missing something important about the business and it’s time to seek disconfirming evidence of my thesis.
And vice versa. I’ve had to train myself to not be afraid to “average up” on winning positions and not get anchored into my original buy price, especially when the fundamentals have outperformed my expectations.
Frankly, that’s still a work in progress.
Competence in complexity
This is where Keller’s definition of wisdom comes into play. Being competent in these “complex realities” means that in certain situations, “losers average losers” may be the correct approach while in others, “lowest average cost wins” is the better one.
Understanding both sides of the advice forces you to at least pause and reflect before making major decisions. If you do deep research on a company and own it for years, for example, you might be better prepared than other investors to capitalize when the market overreacts, but it’s also good to be aware that this can introduce behavioral biases.
Investing is a never-ending challenge and learning opportunity. Just when you think you understand it, it makes you realize that it can never be mastered. That’s why it’s the greatest game in the world.
(After baseball.)
What contradictions do you wrestle with? Let me know in the comments below!
Merry Christmas and Happy Holidays,
Todd
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Todd Wenning is the founder of KNA Capital Management, LLC, an Ohio-registered investment advisor that manages a concentrated equity strategy and provides other investment-related services.
At the time of publication, Todd, his immediate family, and/or KNA Capital Management, LLC or its clients own shares of Amazon.
Please see important disclaimers.
Not necessarily contradictory but, for index value investors, a tension exists between the discipline of continuous capital deployment and the prudence of valuation sensitivity during a bull cycle (i.e., feels discomfortable to continue investing at ~25x P/E in S&P but hard to time the market).
these reasons, and age, is why i slowly shift to systematic portfolio managers using economic factors with explanatory power. i dont begrudge them low-weighting correlative factors (size, momentum, etc..) for trade-desk execution.