I recently made a mistake analyzing YieldCo 8point3 Energy Partners (CAFD). Last Monday, Greentech Media published it. On Tuesday, two of 8point3's analysts told me I was wrong. Thanks to both Michael Morosi at Avondale Partners and Gordon Johnson at Axiom Capital Management for that, and apologies to GTM's readers who may have been misled by it.
Fortunately, anyone who read the (incorrect) but cautiously positive article and bought the stock didn't lose any money in the process. The YieldCo had just raised its dividend, and was surging in response to a number of (analysis-free) articles which cheered the dividend rise without questioning its sustainability.
As I said in the corrected article, the dividend increase (and even the dividend rate before the increase) is unsustainable. But I did not see it, due to what I believe is confirmation bias -- our tendency to seek out information that agrees with our preconceived notions. I started writing the article with the intent of "debunking some crazy comparisons between 8point3 and SunEdison" as I put it to GTM's editors when I proposed the article. When I found numbers to support my thesis, I stopped looking and started writing.
The broader lesson
Any investor who has ever analyzed a stock has also made mistakes. A successful investor recognizes those mistakes before they become more expensive than the good calls are profitable. In this respect, I have an advantage: I'm lucky enough to have intelligent and knowledgeable readers who call me on some of mine.
One solution is to be extremely careful, triple-check your numbers, and use the checks and balances of an investment team to prevent any mistake from slipping through. This is the strategy of most professional money managers. It's also, in my opinion, the main reason why most active money managers underperform, especially after fees.
Once any decision has been triple-checked and vetted until everyone is completely confident, the true opportunities have often been eliminated. To be a successful active manager, you have to invest based on opinions that run contrary to the market consensus. But cautious team decisions will also be consensus opinions. Consensus money management is an expensive way to run a glorified index fund.
Tricks for catching your mistakes
If you are a small-scale investor, you need to have the willingness to make mistakes and strategies for catching them. Excessive caution will lead to analysis paralysis and professional money manager style results. Which is to say, you'll be better off buying an index fund and spending your time more productively than trying to pick stocks.
You could do worse than to start writing about your investments. If you keep at it long enough (I started in 2005), and can write well, you'll eventually get intelligent readers calling you on your mistakes. Then all you have to do is learn how to differentiate between the smart readers and the trolls. These days you can even earn beer money by writing for a site like Seeking Alpha or the chance of a payday at TalkMarkets. Many of us who write about stocks find that the process of writing improves our analysis, even before we get reader feedback.
Many investors also use automatic triggers, such as stop orders, to automatically get out of a position when it moves too far against them. Just like a comment on an article, when the market tells you that you're wrong, it's a good idea to pay attention.
To be successful, an active investor needs to be willing to make mistakes, but also to admit them quickly. Admitting mistakes sounds difficult, and it is even harder than it sounds. Being called out by someone you respect makes it easier. It also gets easier if you have a number of good calls under your belt -- as long as you don't let them go to your head.
It even helps at other times to admit mistakes that never make it into writing. If you are an active investor, make sure you are in the habit of admitting you are wrong to yourself and those close to you, even if you never do it in a public forum.
The only other options are indexing, and letting the mistakes you never admit decimate your portfolio.
At least that's my opinion. If you think I'm wrong, you can let me know. Just don't bet your portfolio on your conviction.
Tom Konrad is the manager of the Green Global Equity Income Portfolio.