Acknowledgement: This is mostly a compilation of material from various books and blog post. I have tried to quote source wherever I could recollect.
I have a firm belief that any investor can easily outperform market over 5-10 years by a wide margin only if he follows two rules 1) Focus on the size of the win. In other words refuse to invest in any situation if the upside is less than 5-10x in next 5-10 years 2) Avoid big mistakes [Where you loose more than 50-80% ]. My entire focus of studying failure patterns is to eliminate BIG MISTAKES.
I have received varied feedback from senior investors about utility of studying FAILURE PATTERNS in eliminating big mistakes.
- Some say act of studying failure patterns is nothing less than INTELLECTUAL MASTURBATION, an act just to satisfy our ego with no utility. Just study annual reports and that should be sufficient.
- Some say they do not think in terms of patterns at all. What counts to them is what is priced in the stock price and how the current financial numbers look like.
- Third group of investors feel that studying failure patterns might help, but this is an act of laziness. One should study the business model in-depth, do lot of scuttlebutt and then try to identify all the key risks and keep a close eye on the key risks.
- Fourth set of investors says, number of variables which can go wrong in the business model are far higher than we can think of. In investing we cannot do control experiments, so one has to study patterns of what has worked in the past and what has not worked in the past. Studying success and failure patterns are very important and one should not get too fussy about survival-ship and hindsight bias. [I fall in the fourth category]
I am in no way suggesting that my view of studying failure patterns is the only way or the correct way. I will continue to look for ways and means to reduce BIG MISTAKES and if I come across another better way, I will switch to that.
In my earlier post on “What Causes Long Term Destruction of Capital – High Valuation or Lack of Sustainable Profits” I have highlighted that
Almost all cases of Permanent Loss of Capital has happened in Bad Business.
In the same post I have tried to group cases of PERMANENT LOSS into FOUR category.
In this blog post I have tried to study various failure patterns which I have come across. In my definition, a non-financial company will get classified as FAILURE if it fails to generate SELF FUNDED Sales, PAT and EPS CAGR of > 15% over next 5-10 years [15% is in Indian context based on last 10-15Y nominal GDP growth rate. Infact the rate 15% is not that important. What’s important is that over long term PAT should grow at higher than or equal to nominal GDP growth rate of the country]. At the current stage I do not have lots of Indian examples. I plan to do this over next year. If you have any failure examples or patterns please do share.
You can download detailed write up from here.