Opportunity meets the prepared mind.
Every time there’s a market correction, investors and traders fall into 2 camps: those who believe the market is right, and those who believe that the market is bonkers. We’re somewhere in between. We believe that over the long-term (not a scientifically verified quantity) the market generally homes in (kinda, sorta) on the “intrinsic” value of an asset. In the short term, the market oscillates between unreasonable fear and unreasonable greed, occasionally swinging through the zone of rationality.
“Of course, the best part of [Benjamin Graham's approach] was his concept of "Mr. Market". Instead of thinking the market was efficient, Graham treated it as a manic-depressive who comes by every day. And some days "Mr. Market" says, "I'll sell you some of my interest for way less than you think is worth." And other days, he comes by and says "I'll buy your interest at a price that's way higher than what you think it's worth." And you get the option of deciding whether you want to buy more, sell part of what you already have, or do nothing at all. To Graham, it was a blessing to be in a business with a manic-depressive who gave you this series of options all the time. That was a very significant mental construct. And it's been very useful to Buffett, for instance, over his whole adult lifetime.” – Charlie Munger
The implicit massage in Munger’s observation is: “Take advantage of Mr. Market’s knee-jerk, short-term reactions”. Long-termism is our superpower. This concept of long-termism will show up again in the sections below. It’s a “low-hanging fruit” in the game of investing. There are 2 other Mungerisms that we’ve etched in our brains, that when put together with the worldview that Mr. Market is a manic-depressive, form the basis of our core worldview on investing.
The first such Mungerism is about being READY to take advantage of Mr. Market’s insane behavior:
“Opportunity meeting the prepared mind; that’s the game.”
To us, a “prepared mind” means:
- We have a ready-to-go list of investment opportunities – ready to pounce when Mr. Market offers us an unreasonably good deal. But this implies…
- Having at least a rough idea of what a “reasonable price” is…
Our Watch List is our “prepared mind”. It is a constantly improving tool which we use to make sense of the investment universe on any given day. It sets us up to pounce when Mr. Market operates with fear.
It’s logical to ask whether the fear itself is reasonable. Yes, it often is. But it is also true the fear begets fear, and it spreads like wildfire in an open, transparent, functional feedback loop like the stock market. The ticker doesn’t stop. Fear snowballs into something big because it’s natural for us humans to think, “maybe everyone else knows something I don’t”. Fair enough. But at some point, fear outstrips the facts on the ground. It often overshoots. And that’s where opportunity beckons.
We can never get rid of this doubt of “maybe everyone else is right this time”. The best we can do is to alleviate this fear. The best we can do is to know where the “zone of rationality” is. The problem is that we cannot know what something is worth. We can, however, make a very educated guess about what a reasonable price is, and what is clearly ridiculous. That’s the zone of rationality. That’s as good as it gets. Anybody espousing that they know something’s intrinsic value for sure is a charlatan.
Munger describes the zone of rationality as follows:
“To us investing is the equivalent of going out and betting against the pari-mutuel system. We look for a horse with one chance in two of winning and which pays you three to one. You’re looking for a mispriced gamble. That’s what investing is. And you have to know enough to know whether the gamble is mispriced. That’s value investing.”
Our Watch List (always a work-in-progress) is designed to find mispriced gambles. It doesn’t pretend to “know” what something is intrinsically worth. We’re not pompous charlatans. We operate with humility. Here is a snapshot of our most recent Watch List.
This Watch List has evolved from the one we had a few months ago. This is the best version of our Watch List – something we’re obsessed with because it makes our lives significantly easier. At a minimum, we always a have good sense of where investment opportunities pop up. We’ll spend the next few sections explaining our Watch List – why we do what we do, and where we’ve improved our process.