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Beyond Numbers: The Art of Investing Amidst Company Performance Fluctuations
I regret to inform you that I missed last week's newsletter due to unexpected personal commitments. While my goal is to post every Sunday, there might be occasional gaps. I appreciate your understanding and patience during these times. Thank you for your continued support, and I'm excited to bring you more content this Sunday.
If you're a regular reader of my newsletter, you've likely noticed that I conduct thorough research on companies before making investment decisions. My strategy involves long-term investments, often spanning a decade or more. If you're new here, I recommend exploring my fragility series, which delves into the intricacies of my investment methodology. In this post, I'll delve into a particular aspect of investing that concerns all of us.
After conducting extensive research on a company and checking all the boxes, we make the decision to invest. However, amid this process, a specific question arises, one among many: "How frequently should we monitor the company's performance?"
This post aims to address precisely that.
Companies are more Animal than Robot
When analyzing a company and projecting its future performance, it's easy to fall into the trap of assuming they'll operate like machines—consistent and linear growth in sales and profits. Yet, companies are more akin to animals, and their behavior is slightly unpredictable. Volatility characterizes a company's sales and profits. Growth percentages aren't steady; they fluctuate annually.
A robot can be programmed to wake up and sleep at precise times each day. Animals, on the other hand, display variations in their waking and sleeping routines. While we can approximately estimate that an animal will wake up and sleep at least once daily, pinpointing the exact timings remains difficult.
Hence, while we can estimate a company's performance over a 5 to 10-year span, predicting its quarterly or annual performance with precision is a challenge.
To illustrate this point, I have plotted the profits of top 10 listed companies for the past 10 years in below chart.
If you closely observe the chart, profits did not grow in a straight line for any of the top 10 companies. While profits of all 10 companies were higher than that of 10 years ago, the path is not a straight line. There is an unpredictable element in companies performance.
With such volatility in performance, does it justify tracking companies performance every quarter? Or does it even make sense to track performance even yearly?
Considering the instability in a company's performance, one can only imagine the impact on its share price. Valuing such a company becomes a complex task for the market. Consequently, the market tends to overreact to a company's performance.
If a company slightly underperforms market expectations, its share price takes a hit. Conversely, if a company outperforms, the share price is likely to surge.
Look at the volatility in share prices of top 10 companies for last 5 years plotted below.
How investment journey in one company looks like
Let me take you through a journey of one investment in my portfolio. I deliberately did not reveal the name of the investment so that the point I wanted to make does not get diluted.
In July 2015, I invested in a company that had witnessed a 50% drop in share price over the previous year. The decline was attributed to a reduction in profits. My rationale for investing rested on the belief that this profit reduction was temporary and would rebound. Unexpectedly, over the next year, the share price plummeted another 50%! Conventional wisdom would have dictated a cut-loss move, especially since sell ratings dominated research reports.
However, fueled by my independent research and a strong conviction in the company's business model, I held onto my investment. It took four years for the company's profits to recover, just as I had anticipated. Consequently, the market's overreaction manifested, leading to a tenfold surge in share price. Recognizing an overvaluation, I partially exited my position. With the market showing signs of cooling down, I re-entered, steadily accumulating shares over the past year.
My research, conviction, and investment were all established in July 2015. Had I scrutinized the company's performance quarterly or annually, anxiety might have driven an early sell-off, resulting in losses. Instead, I remained impervious to the company's performance and share price fluctuations, ultimately reaping substantial gains in the sixth year.
I learned this lesson, in my previous investments wherein I sold early before reaping benefits as I had given importance to others conviction rather than my own conviction.
It's crucial to acknowledge that companies don't adhere to robotic predictability; they behave more like animals, displaying a degree of unpredictability.
Equally important is cultivating personal conviction and adhering to it. Borrowed or weak conviction can lead to early divestment, ultimately making us sell early before reaping benefits.
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