Skills, competency and experience is important but not absolute to remove losses

In active investing, there is a tendency for courses to give you a head start to bring you up your competency. Often, the course trainers will tell you, even after paying $3000++ or $600++ for the lessons, it is still not enough.

And that is because the ones that are likely to succeed are the ones who are not just motivated to build wealth, but have established a system/process/habits to practice, execute, prospect stocks on a recurring basis.

I came across a good lesson learn article from someone that I followed on and off that I find rather interesting.

You can read it here: Learning from the Past, Part 5B [Institutional  Stock Version] 

David Merkel talks about a blunder that was due to his prospecting and recommendation that caused his firm to lose money.

The context of this is that, David Merkel had extensive experience in the insurance and reinsurance field, and the business that is in question, is in his competency.  His methods of evaluation is value tilted as well.

In other words, he probably understands such things much better than the value managers who does a lot of work.

His level of risk management is extensive:

I spent hours and hours going through obscure insurance filings.  I analysed every document that I could get my hands on including the rating agency analyses, because they had access to inside data in aggregate that no one else had outside of the company.  The one consistent thing that I learned was that insolvency was unlikely — which would later prove wrong.

The lesson learn for me is that if you are skilled in prospecting, have competency in an area, have done extensive work and have good risk management processes, it doesn’t mean you HAVE to be rewarded for your efforts and skills.

As an indirect business owner, rather than an owner operator, there is always a layer of unknown unknown or “what i think I know but actually I don’t know” risk that is challenging to iron out.

The risk management philosophy is that concentrating ensures the effort you put in terms of prospecting is rewarded, but not to an extend that it causes severe impairment to your ENTIRE WEALTH.

The second lesson learnt is that prospecting take place even after you purchase and on a recurring basis to ensure you provide new valuation to what you purchase. Business improve or become worse, and valuation, which is a discounted sum of future cash flow, changes.

That is why I hate the term “passive” when put with stocks because if you buy 20 value stocks, I doubt you can passively collect dividends cheques without continual assessment that your capital is impaired.

In the case of the author, his valuation competency and continual risk management process ensures that the firm lost LESS than all their money:

The stock price fell and fell all the way down to $3, with rumors of insolvency swirling, when Mass Mutual and Cerberus rode to the rescue on November 27, 2006, buying 69% of the company for a paltry $600 million in convertible preferred stock.  At that point, I finally got it right.  All of my prior research had some value, because when I read through the documents that day and saw the liquidity raised relative to the amount of ownership handed over.  Given the data that they now handed out, I concluded that Scottish Re was worth $1/share, and possibly zero.

But there was a relief rally that day, and we sold into it.  We ended up selling about 4% of the total market cap of Scottish Re that day at a price of $6.25.

Lessons like this remind me that I actually do not know that much as I learn more, compare to the newbie phase, where you think you have the world at your feet. You become more sceptical on things and question things more.

If this looks like a lot of work, perhaps sticking to a portfolio allocation of low cost exchange traded funds or unit trust make more sense.

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