Doubling Down--think carefully

 DOUBLING DOWN—Think Carefully

“The guy with the lowest average cost wins”, Bill Miller

“Only losers’ average losers”, Paul Tudor Jones

I've pondered the above comments by two of the renowned investors, which on the surface appear contradictory. Although contradictory, they do point to critical issues and risks in investment strategies.

Firstly, what are they implying? The first quote tells a truism: the lower your entry price, the better off you are and the bigger your profits if the share price climbs higher as you realise your valuation. In some ways, this is like dollar cost averaging (DCA) and systematically lowering your entry cost over time into a favourable investment.

The second quote is a bit more esoteric, especially to value investors. The point, I think, that is being made here is that a winning business keeps on winning, the strong get stronger, that share price winners keep winning, it is momentum, but more than that, I feel. The market is telling you something, so please pay attention. No DCA for PTJ!

Is this simply a value versus growth perspective on the world? Maybe to a small extent. I want to bring in another quote that helps me sort through this: “a 90% loss is a stock that is down 80% and then halves”. The maths is, of course, correct. However, and this is important, a $100k investment that is down 80% to $20k shows a loss of $80k; if it then halves, it loses another $10k. That last loss is not great, but it’s not a destructive $80k; the damage has been done before.

Tying all this together, this is what I make of it. Both strategies work, but with one critical proviso. If you are into DCA, you must be certain of what risk you are taking on as you continue your buying. For example, if you had topped up to $100k when the stock was down 80%, and it halves from there, that is a disaster.

To me, it talks about risk. Big disasters can come from DCA into ever-deteriorating fundamentals and misjudging risky propositions. Some of the largest disasters in investing that I have witnessed are when someone, through pride or ego, like the Persian king whipping the sea who refused to obey him, or the manic captain Ahab chasing the whale, some have plunged into the investing abyss. The moral of this story, imo, is that DCA can be dangerous if risk is not properly assessed. If you are doing it, make sure you fully understand why the market is selling down the stock. I am only comfortable in DCA for very high-quality companies where the outcome is much more assured. Any balance sheet risk (avoid), obsolescence risk (avoid), whatever it is, must be precisely defined. Know exactly what you are betting on in every case, but especially in this case.

An example and counter-intuitive imo, is when the market collapsed in the GFC and C19. Share prices were much lower, but importantly, we knew exactly why, that is, you knew precisely what you were betting against. Knowing the cause or fear is critical. In both situations, I doubled down aggressively. What I find much trickier is the stock-specific issues. The question that should be answered correctly is what the market is concerned about. Coming up with the wrong answers here can be very costly, and sometimes the answers are not that apparent.

Like in many areas of investing, there is no silver bullet. It is a case-by-case situation.

Unfortunately, for me, this lesson comes from experience. If you are into DCA, make sure you keep to quality (low risk), don’t be bloody-minded and keep in mind the market could be right! 😊