Pragna Securities: 2021

One of the most frequent questions I get asked from new members at Junto is how we can just sit inactively almost entirely throughout the year with all that is happening in the market and the world.

And when I’m asked at dinner parties (as a courtesy) how I invest, the questioner usually looks with skepticism when I say I probably make 1-3 important investing decisions per year, either buying or selling.

That’s not a way to invest. Didn’t you say you did this full-time?

But it is exactly the way to invest.

To people outside the world of finance—the ones who have outsourced that part of their life to advisers—there is no difference between investing and trading. To them, there are no borders between investing philosophies. They look at the world of finance through fast-paced media and think that that is how real investing is supposed to look. The unfortunate reality is that lots of professional participants within the world of finance think so too.

You would think that this phenomenon is restricted to the world of finance. But it’s not. The do-something syndrome is all-pervading in many disciplines where it shouldn’t be. Also called the action bias, it forces people working on the right stuff to continuously shift into doing the wrong stuff, blinding them from achieving their true objective.

As jobs get increasingly creative, getting results requires constant refinement doing the right thing over and over in order for improvement to surface—deliberate practice leading to the occasional action when the time is right.

But often, humans are prone to act without a sensible plan because motion is mistaken for progress and results. Two false securities feed such behavior:

Movement will protect you from being accused if you fail. Well, at least he did something. At least he didn’t just sit there. We convince ourselves and others that we can’t be blamed if things go south as long as we’re in motion, even though just sitting there might be the best idea.

Movement will protect you from explaining yourself. As social humans seek the validation of others, outright inaction remains a cardinal sin. You get no honors or statue with your name on it if you make exactly the right decision by waiting—for the good of your team, your company, or even society.

Because it’s all about appearance. In a soccer penalty, the probability of where the ball is kicked is equally distributed between the left, the right, and the center of the goal. The keeper has a good chance of saving the ball by just standing still. But he jumps anyway because it feels less embarrassing than freezing on the spot if the ball flies right past him. The very optic of doing nothing would have greater consequences to his reputation, even if he still didn’t save the ball.

We’ve got great flexibility and a certain discipline in terms of not doing some foolish thing just to be active—discipline in avoiding just doing any damn thing just because you can’t stand inactivity.
Charlie Munger

Doing nothing when it’s the right thing to do is not easy.

My Experience From Business

Alongside my work at Junto, I own a jewelry company called Abelstedt with my life partner. Abelstedt was founded 6 years ago as a side project which quickly grew into a comfortable livelihood in a couple of years.

Initially, the business was entirely an online DTC jewelry brand. We worked from home, outsourced production and logistics, and took care of the designing, strategy, content creation, branding, and promotion ourselves. We were slowly grinding every day from the comfort of the couch or by the pool on vacation.

We didn’t work extremely hard. We had fun with it, working whenever we wanted from wherever we wanted. Our promotional activities started to pay off and the revenues and earnings from a high margin business became bigger every month. Our business required no capital reinvestment other than inventories and our earnings turned immediately to free cash flows. We had no debt. Living frugally as we always had, our company savings started piling up. We could see where things we heading.

But we got ahead of ourselves.

A young business like ours shouldn’t earn free cash flows like these and save up liquidity, we thought. We have to reinvest our capital.

As a couple working from home, we felt a sense of imposter syndrome working in the jewelry industry when we had no direct business relationships with anyone in the industry. We didn’t do as incumbent jewelry brands and we were affiliated with no one you were “supposed to know”. Our only stakeholders in our business were ourselves, our few suppliers, and our customers which we sold directly to over the internet.

The imposter syndrome made us feel a sense of falseness. That a business like ours shouldn’t succeed so easily. And even if we did, it wouldn’t be sustainable. And so we had to do something different to make it sustainable.

We started looking to the success of other brands in the industry in an attempt to emulate their strategy.

What we found was that these other companies were hiring bunches of salespeople, agents, and distributors to get their offerings inside the doors of the thousands of little jewelry retailers that operated physical stores. They were hiring bunches of representatives that would nurture these relationships. And they would put up fancy offices into which they could invite various business relations. Many of the brands and representatives seemed to know each other, meeting up at industry conferences, and it all seemed like a club where it’s important to know the right people.

We can’t compete with that, we thought. We must get in on it!

And so, we rented an office space at a prime location in downtown Copenhagen and spent tens of thousands of dollars making it as aesthetically pleasing as the storefront of our website. The office was twice the size of our apartment, justified by our thoughts of wanting to throw evening events and expand our workforce (from just the two of us). Frankly, and foolishly, we were also a bit thrilled about showing the success of our thriving business to the world.

We hired a full-time sales agent in Denmark as well as an independent agent in Sweden, and we started to attend jewelry conferences with expensive exhibits in order to attract trade relations and purchasing agents of physical stores.

Things started working. To our delight, some industry incumbents knew of our company already and could see that we have a good grip on DTC e-commerce. It made our break into the physical distribution channel a whole lot easier.

So we thought.

Our time and energy tilted ever increasingly towards our physical distribution channel and nurturing our trade relationships with lower margin customers. This stuff required loads of time. But the amount of money we were making was not tilting that way. While our margins, of course, went down, what was once a great cash flow generating business became a liquidity-juggling exercise. Where we once collected payments from customers prior to shipping orders with advantageous credit terms from suppliers, our new type of customer required ever longer credit terms on their end, worsening our cash conversion cycle.

We felt forced to make large investments in stunning store inventory as the retailers had a hard time keeping up with our display requirements. Employees and traveling weren’t cheap, and our fancy office certainly wasn’t cheap. But what the hell. We were on our way to becoming a real jewelry brand. And we were busy as hell.

Yes, our size, sales volumes, and revenues were going up, but there was a second-order consequence. While our online business was partly neglected and put on automation, it became increasingly difficult to sell our offering the way we used to online. Channel conflicts appeared as retailers with their own online presence started competing with our ad space, diverting the consumer from our website. And it seemed like the more success our online business had, the worse our relationships with the physical retailers became. While we initially sold them on the promise of our exceptional ability to persuade the online consumer, it soon came back to bite us. We became known as the jewelry company that prioritizes its online channel over its retailers.

We soon learned that many of these retailers were in financial trouble. It’s not like it was any big surprise. A lot of them looked like they hadn’t renovated their stores in decades—which they hadn’t. We knew that liquidity was the problem and that many of them were kept alive just to cover payroll to payroll. E-commerce had slowly eaten into what was once a thriving business that rode the wave of Pandora’s remarkable journey and it became worse year over year. Ever since Pandora decided to close down retailer relationships to make the way for wholly-owned stores, franchises, and e-commerce, it had left a slump in the jewelry retail landscape with only the best turning a modest return on capital.

It didn’t take long before we felt it on our luck of collecting payments. Some retailers went belly-up with us stuck in line as creditor and some simply refused to pay (in time). The administrative work became bigger and bigger.

In the end, we had turned a healthy, highly profitable business into a confused business in which we worked harder than ever before. The revenues kept increasing, but our ability to turn a profit—let alone free cash flow—diminished as we kept patching leaking holes.

About two years into this new journey, we decided to use the cancer surgery formula on our business. We cut loose our agents and distributors, we cut the number of retailers to select few, we closed down the office, and we sold off pretty much all assets other than inventory at scrap value.

We put all our effort into rebuilding our once-thriving online business—the area in which we really had a sustainable competitive advantage—and we started making more money than ever by continuously slicing away everything under the revenue line while the top line grew gradually. All the growing free cash flows earned from the jewelry business are now taken out and invested in the Junto investment portfolio and we keep growing the business with almost no capital reinvestment.

All of this happened due to our urge to just do something to our business which we thought seemed too simple to be true. But simple was the holy grail. Had we understood the opportunity cost we paid from moving from the sweet spot we were in, we would have sat on our ass. I dare not think about the money lost from not focusing on the best part of the business for a couple of years. We sliced off a few years of potential compounding.

Who Are You Working For Anyway?

In all honesty, I think we got on the wrong path with the jewelry business the way we did not just because we wanted to create a “real” jewelry company. The other half of the reason was that we wanted to show our success and ambition to the world. We couldn’t do that behind closed doors from the comfort of the couch.

But there’s a line from The Meditations of Marcus Aurelius I think about a lot. It goes like this:

Ambition means tying your well-being to what other people say or do…Sanity means tying it to your actions.

Ambition is not a bad thing. But it’s wrong to let the contentment of your success be dependent on other people’s perceptions. For our jewelry business, the renewed strategy is: to get rich as fast as possible, as easily as possible, as freely as possible, no matter how the way there may look.

This lesson is not just applicable to entrepreneurs. Even if you’re in a job, you’re the only one who gets to decide what success is.

It’s a mindset that requires a commitment to the work done, as opposed to the rewards. Whenever you work on a project, your work will eventually leave your hands and enter the realms of the world to be judged by either your peers, your boss, critics, customers, or strangers. And you can’t control other people’s validation, recognition, or jealousy. But if you let these things be your motivation in doing your best work—if ego holds sway—you will never fulfill your own standard with pride. You will move around endlessly trying to satisfy this ego, thinking there’s always a better way that leaves other people content.

Another gem from The Meditations of Marcus Aurelius is the following.

Don’t let yourself forget how many doctors have died, furrowing their brows over how many deathbeds. How many astrologers, after pompous forecasts about others’ ends. How many philosophers, after endless disquisitions on death and immortality. How many warriors, after inflicting thousands of casualties themselves.

No matter how brilliant, none of what we do lasts. But what does matter in avoiding misery is living and working by your own standards. It’s when you operate using only an inner scorecard that you will gain independence of mind.

And it’s the independence of mind that allows you to sit on your ass when you’ve got something good while allowing you to not be swayed by stagnant or destructive herding behavior. Recognition and rewards must be the extra. And as the next section argues, there’s good reason to think that the deserved rewards will come on their own.

Benefits to the Sit-on-Your-Ass Philosophy

At the beginning of this note, I argued that exactly the way to invest is to make very few important decisions per year. In some years, these important decisions may scramble together (when the market is filled with opportunities), and in others, they may never arrive.

Of course, if one is an active trader or one simply craves the excitement from participating in the market, this philosophy sounds tedious. But tedious is what gives you the greatest chance of success in the long run.

The reasons are simple.

Less Reinvestment Risk

Having a constant supply of new ideas is diabolically hard. I spend a lot of time getting to any single idea in the Junto investment portfolio. All these ideas go through loads of filters in my head with the overarching one being opportunity cost. If you switch out ideas all the time for the sake of action, you won’t even know what your opportunity cost is.

Alongside opportunity cost, the other most important model is your circle of competence. Selling something you know well to buy something new that seems better is a dangerous game to play. You should even be willing to offer a few percentage points off your opportunity cost if the thing that’s deep within your circle of competence offers lower prospective returns than the thing that’s just outside of it.

This same principle is equally applicable to your other life endeavors. Anything you decide to spend your scarce time on carries an opportunity cost. So it makes sense to spend it on the things that bring the lowest to no opportunity cost. Your purpose and the activities that bring scores to your inner scorecard drive what you should spend time on. And you will often find that just a few things—focusing on the most important variables—will have very low to no opportunity costs. For my purpose, reading (only the best stuff) and writing (only the most important things) are my highest value activities. Frequently buying and selling securities is one of my lowest value activities.

Fewer Transaction Costs

Sit-on-your-ass investing. You’re paying less to brokers, you’re listening to less nonsense, and if it works, the tax system gives you an extra one, two, or three percentage points per annum.
Charlie Munger

Whenever you change direction or take new action, you pay a transaction cost—even if it isn’t necessarily monetary.

When we decided to change direction in the jewelry business, we paid many transaction costs. We incurred searching costs in finding the right people, we spend time every day traveling from home (our previous office) to the downtown office, we spent time on unproductive interactions for the sake of networking. But the most important is that we lost a lot of time making a mental shift in how to conduct our business. We sacrificed sharpening our competitive advantage which was our unique ability to sell online and it kept us from going all-in on the thing we were best at.

Transaction costs are very real and they can be detrimental to the following benefit of the sit-on-your-ass-philosophy.

Beautiful Compounding

The essence of compounding is time and a bunch of tiny gains lining up to massive results.

To many, compounding is a thing of the fairy tales (and something Einstein talked about as the eighth wonder of the world). And so they never attempt to experience in their own lives.

And it is impossible to experience if you do not let compounding do its thing uninterrupted on your best ideas. Many falsely tell themselves that the result of compounding is just a lucky break such as in the case of the school teacher that left a $6 million dollar legacy.

In investing, to achieve a 100-bagger, your investment would have to double six and a half times. Earning your money a hundred times over is an incredible thing to fathom and it’s not easy because sitting on your ass it not easy. But it is only sit-on-your-ass investors that put themselves in a position to perhaps experience such a beautiful phenomenon.

If you do what everyone else is doing, you shouldn’t be surprised to get the same results everyone else is getting.
Peter Kaufman

Many things in life follow a compounding trajectory if little improvements are present every day. Things such as relationships, knowledge, and fitness. But notice that the compounding halts as soon as you change these things around too much rather than sitting on what works for you.

Cultivating Patience

All of humanity’s problems stem from man’s inability to sit quietly in a room alone.
Blaise Pascal

When you practice the sit-on-your-ass philosophy, you, of course, do not expect gratification to arrive on the spot. You will naturally force your mind to practice delayed gratification, bringing tremendous benefits to other areas of your life.

It’s an exercise in self-control. When you’re cultivating patience, you will over time develop skills in separating the important from the minutiae (such as short-term volatility) and you will be mindful in making sure not to spend time on the trivial.

Patience is a virtue.

When Acting

To live the sit-on-your-ass philosophy, the following principles are important when eventually engaging in action.

Dabble Only in Quality Stuff

You become what you give your attention to.
Epictetus

There’s a story about one of the fathers of pragmatism, the American psychologist and philosopher William James, who were once invited to speak by the American Psychological Association at their annual conference. Many thousands attended this conference every year and there was a big buzz going around months up to the event that William James would be the big speaker.

The topic of his presentation was promoted as “Everything we’ve learned in the last 100 years of Psychological Research.”

When the big day arrived and people gathered from around the country, the presenter spoke for half an hour introducing William James.

And when William James finally arrived at the big stage, he said:

They’ve asked me to talk about the last hundred years of psychological research; it can be summed up in this statement …
People by and large become what they think of themselves.

He then left the stage and the conference.

At the time, this idea was profound. The mind is a powerful thing. Because the brain possesses plasticity, allowing it to adapt to experiences and thoughts, it is up to you how those changes come about. If you’re a knowledge worker and you feed your brain with irrational information, your actions will be irrational no matter the amount of information you gathered.

Act With Fierce Decisiveness

Just as having a constant flow of good ideas is diabolically hard, the best opportunities will logically not line up often. So when the proper circumstances present themselves within your circle of competence, act with decisiveness and conviction.

The game is to let opportunity meet the prepared mind.

Stay In the Game

Sitting on your ass is not the equivalent of freezing when things do not go as they should. Along with acting with fierce decisiveness, you should make calculated decisions that allow keeping playing your game.

No matter how much conviction you have on the path you’re on or the idea you’re having, you have to position size your effort (or money) so that even if you suffer the maximum loss expected, you can take the loss and move on.

When Urging To Plan Ahead, Stay Flexible

Eschew the master plan, remain cognitively flexible, and steer the boat toward your purpose every day. In William Thorndike’s The Outsiders, Henry Singleton was quoted as follows.

I know a lot of people have very strong and definite plans that they’ve worked out on all kinds of things, but we’re subject to a tremendous number of outside influences and the vast majority of them cannot be predicted. So my idea is to stay flexible.

***

When you’ve got something good, it’s working, and you’ve spent a lot of energy getting there, it’s probably best to sit on your ass and enjoy the ride.

Cordially,
Oliver Sung