By Vitaliy Katsenelson
Volatility can be both a feature and a bug of investing. Value investors attempt to treat it as a feature. We try to take advantage of the exuberance of the upswing and the pessimism of the downswing. I say “attempt” and “try” because although this approach sounds great in theory, reality proves much more challenging. This gap between theory and practice is created because volatility doesn’t waltz in a vacuum.Upswings are accompanied by optimism and a positive news , or at least the positive spin the crowd puts on the news — this pushes a stock up. Downswings don’t happen in a vacuum, either; they are accompanied and usually driven by negative news, which results in Mr. Market marking down the value of your initial investment. Fear sets in: What if Mr. Market is right? What if this new news and the army of commentators on CNBC are right?
As boxer Mike Tyson once said, “Everyone has a plan until they get punched in the mouth.” Theory gives you the game plan (buy more when the stock is down), but then the market punches you in the mouth. Our ultimate goal is to narrow the gap between theory and practice and take advantage of volatility. We do this through thoughtful arrogance. Let me explain. Investing is an act of arrogance. You are basically saying, “I am right and the person on the other side of the transaction, who is buying a stock from me or selling it to me, is wrong.” Value investing takes that arrogance to an even greater extreme, as you are often buying unloved, if not hated, stocks. Arrogance comes in different forms. Plain-vanilla arrogance is dangerous in investing. For example, SoftBank Group /zigman2/quotes/207137761/composite SFTBY -2.94% /zigman2/quotes/207303954/delayed JP:9984 -5.18% CEO Masayoshi Son built Softbank out of nothing. He is one of the richest people in Japan. He is a visionary, and has enjoyed one of the best multidecade investment track records. (I wrote about Son several years ago when my firm was a shareholder of SoftBank stock.)
Nowadays Son’s Vision Funds are at the tip of the spear of dotcom 2.0 as it shatters, losing his investors tens of billions of dollars this year. Son is solely responsible for it. He recently admitted : “When we were turning out big profits, I became somewhat delirious.”
Success went to Son’s head. He started believing he had a Midas touch. This is why temperament is so important in investing: We are our own biggest enemy.
Read: The SoftBank experiment has failed. Here’s what comes next. There is arrogance — and there is thoughtful arrogance. This requires amnesia of your past successes and failures. It is earned with sweat and diligent research, which leads to conclusions that often disagree but sometimes agree with the prevailing trends in the market. Belief in your process and research allows you to follow through on your conclusions, even if the market scorns them. This is how as investors, my associates and I try to close the gap between theory and practice created by volatility. We continuously build and update our financial models, talk to companies and their competitors and to industry insiders, do a lot of reading, and debate companies with our peers. We have to keep earning the right to be thoughtfully arrogant through our hard work. When time passes, facts change, and new information comes out, we must have the flexibility to change our minds. (I did this with SoftBank when we sold the stock in late 2019.)
When you make thoughtfully arrogant decisions, you are ignoring what the crowd thinks and — just as important — your past successes. You are arrogant (I am paraphrasing Seneca here) because through your research you have discovered the truth (what the company is worth) before time did.
Vitaliy Katsenelson is the CEO and chief investment officer of Investment Management Associates, based in Greenwood Village, Colo. He is the author of “Active Value Investing: Making Money in Range-Bound Markets,” and “The Little Book of Sideways Markets .”
Here are links to more of Katsenelson’s views of the inflation landscape (read, listen) and how to invest in inflationary times (read, listen). For more of Katsenelson’s insights about investing, head to ContrarianEdge.com or listen to his podcast at Investor.FM .
Don’t miss: Hear from Carl Icahn at the Best New Ideas in Money Festival on Sept. 21 and Sept. 22 in New York. The legendary trader will reveal his view on this year’s wild market ride.