If you were asked to name three famous non-British swimmers from recent Olympic Games, who would you pick? Michael Phelps and Ian “The Thorpedo” Thorpe might spring quickly to the mind of the casual sports follower but then … who? If the next name to pop into your head was Eric the Eel, you have just chosen two of the greatest competitive swimmers of all time – and one of the worst.
How about the world’s greatest ski-jumper? No? Any ski-jumper at all then? Did you go for Eddie “The Eagle” Edwards? So, not to take anything away from his bravery, you have just picked one of the very worst competitive ski-jumpers of all time. There are other examples in this vein but let’s just say only one hit movie has been made about a bobsleigh team – and they were not very good either.
The value investing element to this – and, yes, there is one – is that the human brain is programmed to work and to prioritise and process information in a certain way. But how we learn, recognise and remember things is not necessarily all that helpful in enabling us make judgement calls.
We tend to remember extremes, which on the downside would mean the Erics and the Eddies for sports followers and the worldcoms and the enrons for investors. Closer to home, we have owned companies that have gone bust and that, a lot of people would suggest, is something of a disaster. surely, they say, that means the portfolio has performed terribly?
No. On aggregate performance reflects the contribution of the overall portfolio because, while the corporate blow-ups tend to be the ones that make the headlines, on average many of the companies we hold do better. They recover. Their performance reverts back to the mean.
As we have said before, value investing is a game of averages. It is not glamorous. Seldom do value investors end up buying a Thorpe or a Phelps – sometimes we do but, just as importantly, we are looking to avoid an Eric the Eel or an Eddie the Eagle and only aiming to buy the players that are slightly better.
These are the companies you pick up when they have had the equivalent of a bad season but generally they are good steady performers that have fallen on hard times. These companies may well not be ones you have heard of – they are unlikely to be Thorpe or Phelps and in fact the only reason you might have come across them is because they made the news for the wrong reason. However, the reality is that these are the kind of investments that are mispriced and which you can pick up very cheaply – and you will do better that way.