Nov 21, 2012

HP And My Impaired Judgement


“Cause ain’t no such thing as halfway crooks”- Mobb Deep

I did something stupid yesterday. Not earth-shatteringly stupid but wrong nonetheless. The mistake was buying a small about of HPQ. This wasn’t a mistake because the trade went against me. Actually so far it’s gone in my favor. Worse, it was a error of process.

Here’s what happened; when I arrived at work on Tuesday the top headline on Bloomberg was about a $8.8 billion impairment charge at HPQ. By the time the market opened the stock was down 12% on the day after already being down 56% year-to-date. Looking back, I had two arguments for the purchase: 1. It had become very cheap on a P/E basis. 2. I conjectured that stock would pop after the negative sentiment surrounding the write-down faded.  In and of themselves neither of these arguments is inherently poor but together they embody a form of sloppy thinking that conflates what to me are two distinct strategies, namely trading and investing. As I see it, investing usually involves a time-horizon arbitrage, where you buy the stock on a valuation basis arrived at  thorough analysis and with an estimate of intrinsic value (hopefully with a margin of safety). Trading is largely about hypothesizing the future behavior of the market or instrument while recognizing there is high probability of being incorrect. The danger combining the two can be illustrated by the following scenario; you buy stock to express a trading hypothesis, and then when/if it goes against you, you rationalize holding it as an investment to avoid admitting you made a mistake.  There are a bunch of cognitive biases that push people towards taking this course that I can’t remember the names of.

The more interesting question is why, knowing all this, I did it anyway. The best explanation I have is that I was greedy. The stock was down 12% I knew the market was absolutely hating it, and didn’t want to miss the boat when it changed his mind.  As I watched and thought about it for a few hours one thing that kept popping into my head was the thought of how I would feel if the stock rallied and I hadn’t invested, it got to be nothing short of a visceral need to get involved and take a position.

Now I am the kind of person who naturally likes going against the grain, if the market is selling it I want to start thinking about buying. To the extent that, given positions of with equal expected returns, I would derive more mental satisfaction from taking the more contrarian of the two. And that is a bias because being contrarian for the sake of being contrarian is just a moronic inversion of going along with the crowd. But that is not say that said bias, which I believe derives both from ego and a healthy sense of doubt is not without some merit.  A healthy skepticism is invaluable to an investor. The art, nay the work is to cultivate a rational skepticism uncontaminated by ego.

Warren Buffet supposedly never bets even a single dollar on a game of golf. Why? Because he can’t afford to break his disciplined approach to making investments. Needless to say if he can’t neither can I.