The Role of Luck in Investing

In this podcast, Motley Fool analysts Nick Sciple, Jim Gillies, and Emily Flippen got together for a conversation about the role of luck in investing.

They discuss:

  • Being early to trends, and lucky to sell
  • The importance of journaling
  • Time horizons, and what it means for stocks to be “up for sale every day.”

To catch full episodes of all The Motley Fool’s free podcasts, check out our podcast center. To get started investing, check out our quick-start guide to investing in stocks. A full transcript follows the video.

This video was recorded on March 17, 2024.

Emily Flippen: I don’t like the word luck. I think the word I prefer to use is randomness because luck implies a certain positive connotation. You can have randomness to the upside and the downside. There’s always in life and investing, there’s always going to be an element of randomness. Now, how big of a level that randomness has on the outcome? I think probably depends on different businesses, different time periods, whatnot. But what I do is I try to, Jim’s earlier point, separate what is randomness versus what is process. Because you cannot control randomness. You can’t do it.

Mary Long: I’m Mary Long, and that’s Emily Flippen, a Lead Adviser here at The Motley Fool. The St. Patrick’s Day, we’re playing a part of a conversation from our members only live stream, Motley Fool Live. In this segment, Emily is joined by fellow fool analysts, Jim Gillies and Nick Sciple for a conversation about the role of luck in investing. They also discuss how journaling can act as a hedge, intertwining luck with skill, and a built-in inoculation against risk.

Nick Sciple: What is the role of luck in investing? This is hard to separate sometimes in the short term how a company has performed its business performance relative to how the market has driven a company. I think longer term, maybe luck plays lesser role. But Jim ProShopGuy’s question is addressed to you. I’ll let you go first. How do you think about the role of luck in investing, and do you have some stories of being lucky and unlucky to maybe share with the class to help us learn?

Jim Gillies: I think the concept of luck, it is important but I think the more important thing is to recognize perhaps when you have gotten lucky. Because we’re all going to have moments of great luck and frankly, the opposite. I was an early investor in a company that’s long gone called Genesis Microchip. That was basically would make video chips for flat screen displays. This is back in the days when most displays were cathode ray tube monitors

. Yes, I’m not old that I was very early on that. I made good money on precisely half of the shares because I sold them near the top. But then the company got management missteps and better heeled competitors and the rest of it effectively went to zero. But I’ll give you one and again, I did well in this one, but I don’t want that to be the focus because I want you to recognize the role of luck there, which is where I’m going. The largest company in Canadian history market cap. Canadian history is a company called Nortel Networks. For comparison, in the year 2000, Nortel Networks was a $380 billion company.

The largest company by market cap in Canada today is the Royal Bank of Canada, which is at about 170 or 180 billion. A quarter century later after the peak of Nortel Networks, we are still at half the size of the largest market cap ever reached, less than half actually. Nortel Networks ultimately went to zero. Three hundred and eighty billion-dollar market cap at the top goes to zero. I think it topped out in 2000 and it was. It was near zero in 2002 sputtered back to life and then ultimately to zero in 2008 or 2009.

Pity the index investors in Canada first. 130-year money was in Nortel and it went to zero. But I sold Nortel, I own shares of Nortel, I sold shares of Nortel on the day it hit its all time high in July of 2000, and I missed the all time high by 25 cents a share. Well, me selling it was 100% lucky because I was buying a house and I went down my list of stocks that I owned at the time so we can scratch up and down payments. I’m like, OK, that could go. If I buy a house a year later, my Nortel shares are worth 10% of what they were worth at the peak on the day I sold.

That’s a fact. Incredibly lucky there. How did I get my Nortel shares? The answer is I didn’t go out and buy them at the time Nortel was 40% owned by a company called BCE, Bell Canada Enterprises, our version of AT&T, Maple-Flavored AT&T. You can think big bloated phone company, telecommunications company.

Boy, they better pay a dividend because you’re not going to make much on. They owned 40% of Nortel. I’ve noticed about two years before I sold my Nortel, I noticed that if you backed out the value of Nortel from BCE, again, our version of AT&T. If you back out 40% of the value of Nortel from the market cap of BCE at the time, you’re effectively buying BCE for $2 a share. Now I own BCE to this day. It has struggled for years, but it pays a 7.5% dividend and it’s fine But it was like again, buying BCE for $2 a share because you got the Nortel shares as well.

That was not lucky, that was deliberate and so the more experience you have. It’s deliberate because I can recognize the value. Then BCE spun out the Nortel shares to shareholders, which is how I got mine and then of course, sold them. But so luck and skill to my mind are intertwined. What is it a Thomas Edison or Henry Ford, or Mark Twain? Who was he, who said, “The harder I worked, the luckier I became.”.

Nick Sciple: That sounds like Henry Ford, but I don’t have fact check on that.

Jim Gillies: Someone will know better than I. As much as I going to here, Matt Damon’s voice in my head saying this, but fortune favors the brave. Here is luck. I hear fortunate as luck. There’s a certain scared money don’t make no money, which I hate that saying in there but there’s a certain amount of that in there. But a lot of money you make from lucky circumstance, spends the same as money you make investing in Berkshire Hathaway, or anyone else.

I want to throw it back out because everyone including me are tired of listening to me at this point. I think we all have luck in almost every investment we make. But you can’t count on it so I almost exclude, maybe I’ll get lucky but how can I tilt the odds in my favor so I don’t need to get lucky. Does that make any sense?

Nick Sciple: Yeah, I think you have to put yourself in a position to be fortunate. I think in the short term, you’re probably going to have more things attributed to luck than you’re going to see over the long term. It’s more likely to have a lucky year than it is to have a lucky 20 years.

Jim Gillies: Yes.

Nick Sciple: In your portfolio, you’d have the same way. But you’re much more likely to have lucky or unlucky thing happened to an individual stock than it is to have a portfolio of 25 stocks, which I think gets into some of the things that we talked about investing at The Motley Fool. If you have a portfolio that has one stock and you’re fortunate and you could do quite well. However, if you’re unfortunate, you could lose all of it. Jim, talk to you about the Nortel Networks thing.

I’m sure folks felt it on both sides of that. However, with a portfolio of 25 stocks particularly, if you’re trying to fish in the bucket of high quality rule breaking special companies, you’re going to have some of them that don’t pay it out. For every Netflix, you’re going to have a GoPro or what have you. However, part of the approach of investing that David Gardner has talked about is you have this broad portfolio of all these companies with the potential to get you a super lucky to the upside to be your Amazon or Netflix, or your what have you then that’s part of your approach.

I think you can adopt an investing strategy that allows you to benefit from luck and also allows you to, when you get unlucky in the short term when something bad happens with the CEO, he gets involved with a scandal. Jim and I might know something about a company that has that going on from time to time, which would TKO a company. You can weather that storm in your portfolio.

I think the approach that you take and how you invest both in how you assemble your portfolio, the individual companies in your portfolio, the players on your team if have you, and the duration that you think about playing the game gives you more opportunities to benefit from luck into whether bad luck. I think anybody on a long investing career is going to have both of those things and being able to handle that and respond to it well is part of having success over the long term. Emily, thoughts on.

Emily Flippen: Yeah.

Nick Sciple: Luck in your own investing career.

Emily Flippen: I’ll try to be quick because I think you all have done a great job of. I agree with everything you’ve said. The only thing I would add is, I don’t like the word luck. I think the word I prefer to use is randomness because luck implies a certain positive connotation. You can have randomness to the upside and the downside. There’s always in life and investing, there’s always going to be an element of randomness. Now, how big of a level that randomness has on the outcome? I think probably depends on different businesses, different time periods, whatnot.

But what I do is I try to, Jim’s earlier point, separate what is randomness versus what is process because you cannot control randomness. You can’t do it. It’s out of your control. Good luck trying to make sense of it because if you spend your life spinning your wheels over aspects that are just never going to have sway over the choices that you make then you’re just wasting your time. Try to figure out what you can and can’t control. What you can control is the process for which you make decisions. What I do it goes back to just keeping an investing journal.

Write down why you like accompany, write down the risks associated with it, what you’re thinking about the valuation, what do you think is going to happen in the future, what do you think about management? Then craft the narrative about why you may like or dislike this company. What you expect to happen and then take the process and go through.

If this doesn’t happen, what caused it? What could have gone wrong? In 10 years if I’m losing money on this investment, what caused that loss? That’s we list out the risks. Here are the risks that I’m taking by making this investment. Then 10 years from now, if you own Nortel and Nortel’s trading at 70 cents or whatever. I have no idea what happened to Nortel, so you can zero. There it goes bankrupt. It’s gone.

Jim Gillies: It’s gone. Someday we’ll do the Nortel hour because boy, I’ve got stories.

Emily Flippen: I would love to hear it. No doing it that way because I’m interested. But let’s say your company is gone, go back and look at that original investment thesis for making that investment. There’s a good chance that if you’d had a good process and control, that maybe you identified that risk and that’s just life happening. Now if you didn’t identify the risk, maybe the pandemic happened, who could have predicted a pandemic? You probably didn’t list that in your risks and that forced to company out of business for instance.

Then that’s congratulations, that’s randomness, that’s luck to the downside. You can have luck to the upside. But the important point is separating that randomness from your process. Have the best process possible. Don’t penalize yourself for the outcomes, but by the ways of which you got there. Then if that outcome was completely crazy and outside of the whelms of your control, that’s randomness, that’s luck. You made money. Negative luck, I guess if you lost money, but either way you can’t do anything about it.

Jim Gillies: I love that. I think almost luck, and I love that you’ve characterized as randomness because as the Advisor for Motley Fool Options for a decade, helped me hedge away the downside. You realized that, imagine we can make a perfect hedge. A perfect hedge hedges away all volatility, all randomness, all luck if you will. It will converge down to the risk-free rate. At the time, the 10-year bond was trading at with 2/1/2%, hands up who is excited about the risk-free return. When we talk about hedging, we really talking about getting rid of the downside randomness, the downside volatility, the downside bad luck.

But you can’t have the upside, if I told you sure, I can perfectly protect your portfolio, but it’s going to cost you 12% a year. How eager are you to do that? If you are, call me later on a private line, we’ll talk. [laughs]. But what if I tell you yes, I can protect the downside on your stock, that may or may not occur, maybe we’re in a nice bull market and maybe the next uptake for the market or for any particular stock is 20%, but I can absolutely protect your downside using an option strategy. But if it costs you 12% a year in the long-run average for the market as 10, 11, 12% a year, how eager are you to do it? I hope you wouldn’t.

Some people would. There’s one real good way I feel and I’ve had a company where I was convinced the company was playing fast and loose with accounting rules, let’s put it that way. The company was overvalued, playing fast and loose with accounting rules. You all think you know what the company it is, but you don’t, I promise you. It’s not a car maker. When they were reporting certain metrics that started to look unfavorable for them, they just stopped reporting those metrics. Problems solved.

Hey, this is looking bad for us, we’ll just stop reporting that metric. I was convinced it was an excellent shot for valuation reasons. Don’t ever shot on evaluation by the way folks. But for valuation reasons, for governance reasons, for management misleading reasons, there were so many things that lined up perfectly. My process said, and I don’t short that often, but my process said, this is a target rich environment, you should go after this company.

Thankfully, I didn’t because they were acquired at near an all-time high. That’s why it’s not that other company. Clearly, and Emily’s point, have a journal. Have a journal, if you’re fortunate enough to be the face of a foolish investing service, your journal is right out there in front of everyone for all to see. You want to know what I think about the wreck I made Friday, it’s there in 2,700 exquisitely chosen words. Not really.

But the process repeated over and over again should lead to more good outcomes if you’ve got a good process, but sometimes it’s going to lead to a bad outcome. If I had short it based on my analysis, I would’ve taken it in the teeth on that investment. Thankfully, I didn’t. But I very easily could have. Like I said, I don’t short a lot, but I have shorted before or I’ve used option strategies to short as well. But the longer your time horizon is, that’s a built-in inoculation against bad luck. No one complains about good luck, everyone complains about bad luck. If you can really embrace the idea, I’m not someone that says hold forever.

Actually, I think most of the time you shouldn’t hold forever. But I think you should go into an investment with the Buffettism ringing in your head. Our favorite holding period is forever. I think you can have that yin-yang going on where my favorite holding period is forever. I’ve got stocks I’ve owned that are almost legally allowed to rent a car in the United States, I’ll put it that way. But also all of my stocks are for sale every day. If you can have that competing thing in your head, I think to Emily’s point, if you want to minimize bad luck in your process or because no one complains about the good luck. But if I want a minimize bad luck, those are ways that I can inoculate my portfolio against it essentially.

Nick Sciple: There’s no doubt, luck plays a role in investing, however, over the longer-term and across a broader strategy of investing in number of stocks. In theory, your skill should emerge over the long-term. Unlucky year and unlucky company, had to have an unlucky decade. That’s what we’re trying to go for. We’re trying to point you to the stocks that can get you there over the long-term.

Mary Long: If you’re a regular Motley Fool Money listener, you’ve heard from Emily, Jim, and Nick before on the show. But when they’re not talking stocks with us, they’ve got a whole other day job looking for high-quality companies that can beat the market in the long-term. Take Emily Flippen, she’s an analyst on our flagship stock-picking service Stock Advisor. If you’re interested in more commentary from Emily and other Motley Fool analysts plus access to Stock Advisor’s full stock scorecard at our daily subscriber-only live stream, visit www.fool.com/emily. I’ll also drop a link in the show notes for you.

As always, people on the program may have interest in the stocks they talk about. The Motley Fool may have formal recommendations for or against, so don’t buy or sell stocks based solely on what you hear. I’m Mary Long, thanks for listening. From all of us here at Motley Fool Money, we wish you a very happy St. Patrick’s Day, and of course, the best of luck in investing and in life. We’ll see you tomorrow.

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