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What Buffet and Druckenmiller teach us on a key investing skill

It is not the strongest of the species that survive, nor the most intelligent, but the one most responsive to change – Charles Darwin

Our ancestors roamed around in the wilderness of the jungles and made a living hunting for food; some investors now are roaming in the wilderness of the world’s stock markets and are trying to make a living hunting for mis-priced stocks. But the need to be responsive to change is as relevant today as it was for our cave dwelling ancestors.
“We are living in an ever changing world” is both a cliché as well as an understatement. Regulations are changing, new technologies are emerging, unique business models are evolving and more importantly, disruptive innovations have now become a common feature across all walks of life.
In such a dynamic scenario, one of the key skills required today to survive in the stock market and more importantly to be successful, is of “Flexible thinking”.

In psychology, flexible thinking (flexibilitas in Latin means elasticity) is also referred to as “cognitive flexibility”.  Psychologists consider cognitive flexibility as one of the key thinking skills required to succeed along with other thinking skills like creative thinking, critical thinking and problem solving.
Broadly, flexible thinking refers to the ability to consider with an open mind the various alternatives upon encountering new facts or situations; and then be adaptive to change one’s view from the previously held thoughts or beliefs.

Relevance for Investors

As an investor, you have to brace yourself daily to face a deluge of new information, facts and figures. It could be a new political event, a new regulation, new information on a specific business, a new emerging technology, a newly evolving macro trend, new set of economic data….the list is endless.
Faced with such  situations, an investor should be able to consider with an open mind the new information, consider the information from multiple angles and then be able to change their existing views.
There are many scenarios in investing where an investor should display this key skill of flexibility in thinking.

Tactical Decisions (Short term)

“They must often change, who would be constant in happiness or wisdom” – Confucius

Drukenmiller is considered one of the greatest investors not without any reason. In the book, Inside the house of money, there is a fine description of Druckenmiller “Stan may be the greatest money making machine in history. He has Jim Roger’s analytical ability, George Soros’s trading ability, and the stomach of a riverboat gambler when it comes to placing his bets.”
On the fateful Black Monday of October 19, 1987 when the markets started crashing, Druckenmiller exhibited great flexibility in thinking to reverse his initial trading position and that too with speed, to turn in a profit from a losing position.
Here is an excellent description of Drukenmiller’s flexible thinking from Ben Carlson:

In his book, The New Market WizardsJack Schwager tells the story about how Druckenmiller pulled a 180 the day before the 1987 Black Monday market crash, only to pull another 180 when it looked like he was initially wrong:
Druckenmiller made the incredible error of shifting from short to 130 percent long on the very day before the massive October 19, 1987 crash, yet he finished the month with a net gain. How? When he realized he was dead wrong, he liquidated his entire long position during the first hour of trading on October 19 and actually went short. Had he been less open-minded, defending his original position when confronted with contrary evidence, or had he procrastinated to see if the market would recover, he would have suffered a tremendous loss. Instead, he actually made a small profit. The ability to accept unpleasant truths (i.e., market action or events counter to one’s position) and respond decisively and without hesitation is the mark of a great trader.

A successful investor must display extreme agility and nimbleness when confronted with important new facts. The ability to be flexible in thinking and quickly adapt to the evolving situation is what separates the wheat from the chaff.

Strategic Decisions (Long Term)

 “When the facts change, I change my mind” John Maynard Keynes

In an interview with Telegraph in 2002, Buffet famously called himself an “Aeroholic” and expressed serious reservations about investing in airline stocks.
buffett airlines industry
Here is a transcript of the interview related to Airlines business:

Telegraph: Do you still regard USAir as your worst investment?
Warren Buffett: I made the comment that if a capitalist had been present at Kittyhawk back in the early 1900s, he should have shot Orville Wright. He would have saved his progeny money.
But seriously, the airline business has been extraordinary. It has eaten up capital over the past century like almost no other business because people seem to keep coming back to it and putting fresh money in.
You’ve got huge fixed costs, you’ve got strong labour unions and you’ve got commodity pricing. That is not a great recipe for success.
I have an 800 [freephone] number now that I call if I get the urge to buy an airline stock. I call at two in the morning and I say: “My name is Warren and I’m an aeroholic.” And then they talk me down.

This was in 2002 and 14 years later in 2016, Berkshire Hathaway revealed holdings in not one but FOUR airline stocks: American Airlines; Delta Airlines; Southwest Airlines; United Continental Holdings. Buffett explained that he had strong reasons for jumping into airline stocks and as history has shown multiple times, he may be proven right with this call too.
However, the point here is of the flexibility in thinking shown by one of the greatest investors. When the long term industry dynamics and facts of the airlines industry changed, Buffett too changed his mind.

Difficult decisions

Many long term fundamental investor buy stocks with the idea of holding the stock for a very long time (insert 5 years / 10 years / ever as applicable). Even in such circumstances an investor needs to verify their investment thesis regularly.
If there are signs of deteriorating fundamentals or changes in the original investment reasoning then an investor should display flexibility in thinking to take difficult decisions. Difficult decisions include liquidating a position even if it means incurring a loss on that investment. It is easier to sell a stock at a lower profit than to make the tougher decision of selling it at a loss.
But then that’s what great investors like Buffett do.

Buffett and Tesco

In 2012, Buffett increased his holdings in the U.K food retailer to over 5% by picking up additional shares of Tesco. A year later he started selling a part of his holdings and by 2014, the entire position was liquidated. Buffett explained the Tesco investment in his 2014 Shareholder letter:

 At the end of 2012 we owned 415 million shares of Tesco, then and now the leading food retailer in the U.K. and an important grocer in other countries as well. Our cost for this investment was $2.3 billion, and the market value was a similar amount.
 17 In 2013, I soured somewhat on the company’s then-management and sold 114 million shares, realizing a profit of $43 million. My leisurely pace in making sales would prove expensive. Charlie calls this sort of behavior “thumb-sucking.” (Considering what my delay cost us, he is being kind.)
During 2014, Tesco’s problems worsened by the month. The company’s market share fell, its margins contracted and accounting problems surfaced. In the world of business, bad news often surfaces serially: You see a cockroach in your kitchen; as the days go by, you meet his relatives.
We sold Tesco shares throughout the year and are now out of the position. (The company, we should mention, has hired new management, and we wish them well.) Our after-tax loss from this investment was $444 million, about 1/5 of 1% of Berkshire’s net worth.

Buffett once said “If you are not willing to own a stock for 10 years, do not even think about owning it for 10 minutes.” But as you can see, he has shown great flexibility in thinking to change his mind and to also make the difficult decision of accepting a loss on his Tesco investment when the facts changed.

Final thoughts

Edward de Bono famously quipped “If you never change your mind, why have one?” As an investor we are processing lots of new information continuously. The flexibility in thinking to assess the new materially important facts with an open mind and to change one’s mind when the facts change is a key skill required for surviving in the stock markets. At the very least, it should help investors in increasing their odds for investing success.

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