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The Joys of Compounding by Gautam Baid

Value Investor

In 2016,the author bought a stock solely based on the rationale of a peer who he admired and looked up to for his investing skills. A few weeks later, the stock fell sharply, posting weak quarterly earnings, and he exited his position at a 14 percent loss because he lacked the personal conviction to hold. To rub salt into the wounds, the stock then doubled in less than ten months.


The author uses an analogy of a seven-hundred-year-old temple in Japan by Thomas Russo to explain a concept. The temple is made of wood, and none of the wood is seven hundred years old, as the pieces have been replaced numerous times over the years. But people still talk about the temple as if it is seven hundred years old. 


In the stock markets, people see the effect of change in similar ways. Consider the S&P 500, one of the most frequently cited market indexes. On average, over the past fifty years, more than twenty companies are swapped out each year. Yet investors cite and treat the S&P 500 as if it were a monolithic, unchanging object. The constituents of the S&P 500 of 2020 are entirely different from the S&P 500 of 2000, even though the language infers otherwise when investors say things like, “The S&P 500 is trading at a premium/discount to its ten-year average.”


If the story has gone wrong, simply book your losses and move on to a better opportunity. Continuity of compounding is the key to success in this long-term game. After buying a stock, forget what you paid, or this knowledge will forever affect your judgment.


Another faulty anchor is a stock's one-time price—that is, the point at which an investor considered buying it but did not act on it. Following this point, the stock has increased significantly. Missing out on an early opportunity leads to remorse. However, that regret is frequently unwarranted because there are numerous opportunities to purchase stock in a truly outstanding company. A hundred-bagger is, by definition, a ten-bagger multiplied two times. Even if someone bought it after it reached 10x, it rose another 10x.


This demonstrates the importance of actively following a company's story even after it has exited it. Consider investments to be ongoing sagas that must be reevaluated on a regular basis to account for new plot twists and turns. Unless a company declares bankruptcy, the story never ends.


This also applies to selling. Selling a big winner from our portfolio is never easy because we develop an emotional attachment to it over time. After all, it is responsible for the creation of our wealth. A stock, on the other hand, is unaware that we own it. We cling to these stocks because we are fixated on meaningless anchors such as our lower original price, just as we cling to outdated beliefs. However, today's investor does not benefit from yesterday's growth.


When investing, always keep the stock separate from the individual's personality at the helm of the company. Concentrate on the underlying business's merits and economics. Examine the facts and make an objective assessment of the situation.

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