Build an Impenetrable Castle

Many gurus have mentioned the importance of learning from mistakes. Because as Howard Marks sums, the keys to investment success lie in observing and learning. And a less costly way is to learn from other people’s mistakes.

Today, some of the mistakes are being offered from yours truly. Enjoy!

I have received many constructive critiques from investment professionals on my Hexcel pitch. Many of them have been very helpful, although their critiques might seem harsh. There are two major things I have identified from different people’s feedback.

Independent Thinking

We all laud the virtue of being independent thinkers. But how many of us can maintain an independent mind when taking in information? Especially in professional fields, like investing?

Looking back at the time when I just started investing, many investment theses were not really mine. They were “borrowed” from Seeking Alpha articles, sell-side equity research reports, gurus on Twitter, or, hell, the company’s IR presentations!

Crafting a thesis is like building a castle. And without independent thinking, our castles are built on other people’s foundations. These foundations cannot be compatible with whatever we build on top of them. And as you can imagine, it won’t take long to destroy these castles. The attackers might be the reality, or largely, comes from within.

You see, when the core of a thesis is not really yours, how much faith do you have? You will doubt yourself when the market acts against you. You will be the first one to exit the investment because you think the thesis is no longer valid–only to find out later that this could be a lucrative investment had you held on to it.

I still find it challenging to build up my original thesis. As a part of the research process, I will inevitably come across other people’s opinions. And the most dangerous thing is that sometimes I believe I have my own thesis, but it’s just a combination of opinions that sound plausible to me.

So, how do we sort this out? Well, I think being objective is tremendously helpful. Having an unbiased view will help you effectively doubt other people’s opinions. It will help you ask the right questions that lead to answers that will generate your original thesis.

But staying objective is hard. Very hard.

We often submit to authorities because we believe that they know more than we do. Sometimes that’s true. But hey, you don’t need to know everything to be successful in investing. You only need to know the right thing. But authority figures stand in our way of being objective.

There are so many polished people in the investing world. Many people on Wall Street have MBAs from Harvard or Wharton and have worked at Goldman Sachs, McKinsey, Blackstone, and all those gilt names. When they offer their opinions in ultra-professional ways, it’s hard for us to doubt them. Because they are so good at using those technical jargons and their writing style is so professional that those well-crafted sentences and well-formatted reports often fool us.

I believe it’s essential to understand that investing is a level playing field. I would even argue that investing is the most impartial activity. It treats everybody the same. It doesn’t care about your educational background, socioeconomic status, gender, skin color, or IQ.

Once you know that this is a fair game, the rest is easier.

Reading more helps, too. The more variant views and thought processes you get to know, the more objective you will become.

Okay, I hope with objectivity, we can build our own foundations. The next step is to build the castle itself.

Intellectual Honesty

I have been intellectually dishonest about my Hexcel theses. I was defensive about my theses. I fell victim to confirmation bias. Once I become bullish about a company, everything appears to be rosy. I don’t care about thorns anymore. I know there are risks, but I failed to address them.

I don’t want to admit that I’m wrong, especially after weeks of research.

It’s called Sunk Cost Fallacy. I don’t want to let go or challenge my theses because I’ve spent too much time on them.

Being intellectually dishonest can be fatal to capital allocators. Sometimes our egos get in our way. Risks are structurally an insignificant portion of an investment pitch. People usually just briefly cite some obvious risks, but few go deeper to address why and how these risks can be mitigated.

It’s like building a castle with the mindset that it will be impenetrable without actually check the potential weak points.

How do we become intellectually honest, then? If we keep doubting ourselves, it will backfire as we will lack the confidence to weather future attacks on our theses. It’s a delicate dance between accepting the wrongs and becoming indecisive.

Charlie Munger already has an answer for us.

I never allow myself to hold an opinion on anything that I don’t know the other side’s argument better than they do.

Play devil’s advocate is a great way to stress-test your theses. If you are bullish, then try to develop an equally compelling bearish view, and vice versa. Poking holes around a thesis is like doing a mock-siege of your castle. Weak points will reveal themselves. Perhaps you will find out that the castle is ill-designed and requires a rebuild. Then rebuild it. It’s better than losing real money later.

I thought I did well on my Hexcel pitch. I put in lots of work to research and format the memo. However, it turns out to be a weak castle that just looks nice. Hexcel is a controversial name these days; I can either make a lot of money or lose a lot (including the opportunity cost).

But I found it very useful to share my ideas with the public. Hedge fund guys might come with harsh comments, but they are exponentially helpful. I learned a lot from their critiques. Hopefully, this memo helps cement your fortresses in some ways.

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