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Jason Whiting | May 20, 2015

Overcoming memory bias to become a better investor

Hindsight is 20/20, but I believe this is a hindrance to self-improvement as an investor.

It’s easy to say, “I bought stock XYZ and it went up/down, so I was right/wrong.” But does this add to my knowledge? I would argue that it doesn’t, and may, in fact, limit opportunity for growth. Outcomes (whether an investment decision was profitable or not) are much less useful to improvement than process (how you reached an investment decision).

For example, if I sell an energy company at a loss, what does hindsight tell me? Simply that this particular choice was wrong and I should not have invested in said company. But how do I avoid this in the future? Do I sidestep energy companies of any kind?

I can only grow as an investor by studying the process I used to determine the original decision to buy. Was my analysis of the company’s competitive position wrong? Did I make a mistake on valuation? Was the company too levered? Was the management team incompetent or focused on unrealistic goals?

I think many people assume this is easy: Remember how you acted during the original decision and learn from your mistake. The problem, as numerous studies have shown, is that memory is extremely unreliable. How do I overcome memory problems and learn to be a better investor? I keep an investment journal.

My investment journal

On June 24, 2009, I started writing a journal entry for every buy or sell decision made in Trimark North American Endeavour Class. As of the end of March, my journal runs 75 pages and nearly 52,000 words long. (By way of comparison, Romeo and Juliet contains just under 26,000 words; not that I’m comparing myself to Shakespeare as a writer.)

The journal gives me an accurate record of my thought processes at the time I made the decision. After enough time has passed to be able to properly judge an investment (I use three years), I go back and review my journal to try and find patterns of success or failure from which I can learn. It is through this thorough approach that I can say I am a better investor than I was a year ago.

Here are a couple of short excerpts from my journal from 2009. Please be aware that these are rough, and not spell-checked or reviewed for grammar. I use a lot of my own short-hand and acronyms.

October 7, 2009 – Sell Cadence Design Systems Inc. | 3.7% weighting

Cadence hit $7.50, and I seem to remember having a weight below 5% when CDNS was last at this level.
The weight now was 10.7%. A 10% weight made sense at $2.75, but a higher weight now does not.
CDNS probably has $1 in (cash) EPS potential, but the business is not a high growth business anymore, so multiple of 15x or so is probably reasonable.
Given CDNS is at my Buy Price & probably is “only” a double from here it made sense to sell.
Also it was within 10% of SNPS on EV/Sales (recovered sales).
Given the lack of growth at CDNS and lack of a big idea it is mostly a valuation call, therefore 7% seems a bit more reasonable.
It’s not lower because I feel the likelihood of success is higher at CDNS since it is mainly an accounting transition as opposed to a operational turnaround (e.g. HAR) or end market recover story (e.g. CCL).”

September 17, 2009 – Buy Euler Hermes Group | 2.0% weighting

I looked at Euler about 3 years ago and remembered really liking it.
Looking at my notes and updating my knowledge for the time missed reconfirmed this belief.
The market is an oligopoly (top 3 = 86%), Euler is #1 (36%), Euler is low-cost provider, business is short-tail (re-price risk quickly), full-cycle returns are attractive (15-17% ROE) and barriers to entry are large (database).
There are also a number of big ideas here including global trade, selling high margin data offerings & a U.S. penetration story.
Valuation on normalized earnings still seemed fairly attractive (5-7x EPS).

I ranked Euler as the 6th best business I own and valuation was also 6th.
No strong opinion on management yet, hence the 2% weight, but nothing in the past has been scary (e.g. underwriting, leverage, acquisitions, buybacks, profitability).

As always, if you have any questions, I’m happy to answer them as best I can. Thanks for reading.

Sources: Invesco Canada and Bloomberg L.P.

Trimark North American Endeavour Class, Series A provided the following performance returns as at April 30, 2015: 1 year, 1.14%; 3 years, 15.89%; 5 years, 7.24%; since inception, 4.22%.

* The companies discussed are selected for illustrative purposes only and are not intended to convey specific investment advice.

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2 responses to “Overcoming memory bias to become a better investor

  1. Thanks for reading, I appreciate the comment. I think you’re definitely on to something by trying to remove emotion and focus on process. Staying committed to those goals should lead to sustainable improvement for us all.

  2. An interesting case study here, Jason. Your concept is brilliantly simple and practical. I know that I often find myself digging through old or even deleted emails in order to ascertain some semblance of reasoning behind a decision that was made; I believe that this speaks to the importance of process identification and documentation, to which you’ve referenced and demonstrated. We know all too well the role that emotion plays in our decisions – investments or otherwise. This is why removing the emotion and focusing on the facts is integral when conducting retrospective analysis.

    Well done.

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