Sturgeon’s Law states that 90 per cent of anything is crap! This is somewhat on the line of Pareto Principle, which says 80 per cent of the outcomes come from 20 per cent of the causes. What these laws tell us is that there is an asymmetric distribution in cause and effect in all things around us.
There are roughly 5,000 stocks in the listed universe in India. Going by the above laws, only about 500-1,000 stocks are even worth looking into. For an investor, being able to identify 10-20 good companies is sufficient to build a sound portfolio for the long term.
This means picking stocks is a negative art – one of elimination rather than selection. One thought pattern that helps immensely in elimination is having a healthy dose of scepticism.
Scepticism is an extremely useful mental habit for an investor. It is always easy to think of reasons to buy a company. In a bull market, ‘buy’ reports are available on hundreds of companies from different brokerage houses and tips from various WhatsApp groups are abound.
I know people who have bought most of what they have read about once and built a portfolio of 100-200 stocks. They are unable to differentiate the good from the bad or the good from the great. Unfortunately, what it does is that it mimics a broad-based index and gives average or lower-than-average returns and creates an untrackable and unmanageable portfolio.
The entire investment environment is made up of people who are overly optimistic and are trying to sell a story. Company managements are usually trying to sell their growth stories or turnaround stories to analysts and investors.
Tipsters are trying to sell their new “multi-bagger” stock idea! In this kind of an environment, being sceptical of the story being dished out is most beneficial. For most investors, it is better to look at the numbers and then create a narrative than go by the narrative created by the management or analysts.
To make good investment choices, I tend to look actively for reasons to not buy a company. High debt, low promoter holding, frequent equity dilutions, very high management compensation with respect to net profits, frequent changes in auditors, low returns on capital are some of the easy red flags which help in quickly eliminating a potential company.
One of my key learnings in the market over the years is to look for easy problems to solve. There are no extra points for playing a difficult game. I tend to ignore any complex investment thesis in any stock. If a lot of variables need to play out for a company to do well, then it is better to let it pass and move over to the next company.
For me, simple is best. Being a sceptic, I tend to question any complicated scenarios and “too good to be true” cases.
It is best to remember that the art of being wise is knowing what to ignore.