May 01, 2023 (MLN): An Investment Strategy meant to bring fortune. The Article is about making windfall gains by investing in Stocks through tails investing.
Mr. Morgan Housel, the author of the book “The Psychology of Money” quoted “You can be wrong half the time and still make a fortune if luck favors you” as the preamble of one of the chapters. For a long, luck has been considered a prime cause behind one blessing with fortune.
Thanks to advancements in investment mathematics and to legendary investors, such as Warren Buffet, George Soros & Peter Lynch, who by their investment acumen ship demonstrated that it is possible to carve out fortunes from luck through investment strategy based on modern investment premises.
How did they make it happen?
A close examination reveals that investments that brought fortunes to them are few and far between. Investments in Berkshire Hathaway by Warren Buffet and the short selling of Pond Sterling by George Soros in 1939 are classic examples.
It led to believing that few investments may deliver huge returns. It coincides with the concept of the Black Swan Risk, which refers to the happening of a rare event, one in thousands, once happened, left behind a huge financial impact.
It is also in line with the concept of Pareto Law 80/20. According to this, 80% of revenue comes from 20% of the clients. In investment synonym to “20% of the total investment may turn out to be a great investment, if held for a sufficiently long period of time.”
Can this be modeled to make a windfall profit out of a stock investment?
Yes, through Long Tails Investing, but with an understanding of some basic investing presumptions and principles.
Returns on Investment:
We invest in stocks with the aim of target return. But not all our investments produce the desired return. Variation in returns is a normal phenomenon, which in process assumes a bell shape Curve commonly known as Normal Curve. The peak of the curve is the average return, the point around which the maximum numbers of returns cluster, whereas the two identical tails represent the spread of returns around the mean.
Customarily, efforts are put in to keep return distribution on the right-hand side of the X- axis from the point of intersection between the X-Y axis. As long as the distribution falls either in quadrant II or IV and the average return remains closer to the target return suffices to console investors.
Turning Windfall Return a Reality:
Technically speaking, the actualization of windfall return, turning an investment into fortune, means stretching the right tail of return distribution as farthest as possible from the mean. The elongated part of the right tail of the return distribution represents windfall profit. The investment style causes elongation of the right tail regarded as “Long Tails Investing.” – In this investing style investing is diversified based on expected return rather than industry-wise. Stocks are few but promise huge returns if held for a sufficiently long period.
Underline Assumptions:
(i)- Return refers to the capital gains.
(ii)- The market price of a share of a company is expected to appreciate significantly in the long run by weathering all systematic
Invest in stocks whose market values are expected to appreciate significantly, at least 100%, in the long run.
Allocation of Funds:
Commit not more than 10% of the total investment.
Investment Strategy:
Invest in stocks whose market value is expected to appreciate significantly, at least 100%, in the long run.
Stocks Selection:
Ideally, stocks of companies in the growth stage of their life cycle or stocks trading at a deep discount to their terminal value. Selection of stock could further be complemented by choosing companies:
(i)- With Vision & Strategy.
(ii)- Owns & runs by reputable management. (iii)- With maximum financial & non-financial disclosure
(v)- Buy at a considerable discount to its fair value (v)- Companies preferably from industries with high barriers to entry.
If the Life Cycle identification of the company/industry Seems difficult to identify then it may be substituted by Earnings growth.
Dealing with Investment Risk:
While pursuing the “Long Tails Investing Strategy” by exercising certain restraints success ratio can considerably be increased. Such as
(i) Controlling of Greed:
In efforts to stretch Return Distribution to the farthest Right, the greed to maximize return may lead to inducing Black Swan Risk to the entire investment. It needs controlling. A cardinal rule is once an investment starts offering 100% return, realize the profit.
(ii) Overcoming of Fear:
Experiencing extreme dips in price during many market cycles of bulls and bears, ups and downs over the holding period is a common phenomenon in Long Tails Investing. Investors need to stay on the course while navigating market uncertainty
The Long Tails Investing is suited best to:
Long Tails Investing is best suited to those within the age bracket of 20-35 years. It is the formative stage of life, characterized by long service, growth in earnings, higher disposable income, and few liabilities to fulfill.
Together, they outwardly push the boundary of risk capacity for investors to assume for Value accumulation, Optimal Investment Size, growth potential, and the ability to face a bumpy price ride over the life of the investment pre-requisite for a windfall return.
To conclude behavioral standpoint of the investor cannot be overlooked inscribing a success story of Long Tails Investing.
*The writer is a business graduate in Finance and MIS from IBA, Karachi with an MSc in Statistics from the University of Karachi and a fellowship in Life Insurance from LOMA, USA, and a certified trainer by the US-AID Programme. He has been associated with business schools as a visiting faculty teaching courses on investment, finance, and financial risk management.
He is currently engaged in investment research and policy with one of the leading life insurance companies in Pakistan.
Posted on: 2023-05-01T10:00:46+05:00
