• The value of the Little Bluey Portfolio increases past $10,000.
• The Little Bluey Portfolios investment returns passed the 100% mark.
• And, we’ll look at the relationship between luck & skill in generating returns.

Returns as of 1^st of January to 31^st of August, 2020.

This year has presented investors great opportunities to purchase great Australian companies at great prices.

And, we may not see an opportunity like this for some time. The Little Bluey portfolio certainty benefitted from this period.

The current holdings are:

• EML Payments
• Woolworths
• People Infrastructure
• Beach Energy
• Adairs
• Vita Group

By luck, all stocks are currently posting positive returns, which can be a curse at the same time.

In mentioning luck. It is important to note the role luck plays in the short term, as the investor needs to understand the dual roles of luck and skill when it comes to investing.

Luck tends to dictate share prices over short periods, but skill always reveals itself over the long term.

That is why it is best to judge a fund managers performance over a three, five, or ten year period, instead of monthly. And, this applies the Little Bluey portfolio.

Additionally, in the case where a fund manager is earning superior returns within the three years, they need to articulate how their investment strategy is generating these returns, which should include the role of luck.

Michael Mauboussin was the Chief Investment Strategist at Legg Mason Capital Management, when he wrote his book titled “The Success Equation: Untangling Skill and Luck in Business, Sports, and Investing.”

Inside, Mauboussin uses this diagram, within the book, to explain luck-skill continuum.

Source: Michael Mauboussin

The left-side involves pure luck, where you find most types of gambling. The odds are placed firmly in favour of the house, so even if you have some strategy when playing roulette, based on the probabilities, massive wins are driven by luck.  

On the right-side involves pure skill, where you’ll find a game of chess. Chess requires many years to master where you’ll become a chess master. It’s challenging to beat a skilful opponent, chess master, through luck alone.  

Investing falls to the left of the continuum involving more luck than skill.

For activities falling to the left side of the continuum, Mauboussin recommends a good process as the surest path to success in the long term.

And, an investment process, grounded in the investment principles, is what investors need to follow in order to grow their investments over the long term.

The six stocks held in the Little Bluey portfolio were selected on two fundamental investment ideas:

• Each company is producing growing streams of revenues, net earnings, and cash flows that are reasonably expected to increase the value of the company over the next five to ten years.
• Each company was purchased at a price below what each company is expected to produce, by way of cash flows, over the next five to ten years discounted back into present value (discounted Cash Flow Formula).

Both these ideas require skill, which is within our control—involving evaluating and valuing each company independently, and patiently waiting for each company’s share price to fall to a satisfactory level before purchasing.

That 100% rise in portfolio value, falls within the luck side of the continuum.

That brings us to the second important point; purchasing stocks when the share price trades at a reasonable price to the present value of discounted future cash flows.

Okay, what does this mean?

Warren Buffett wrote the following, in The Superinvestors of Graham-and-Doddsville, regarding the relationship between the share price and risk:

If you buy a dollar bill for 60 cents, it’s riskier than if you buy a dollar bill for 40 cents, but the expectation of reward is greater in the latter case. The greater the potential for reward in the value portfolio, the less risk there is.

And one quick example. The Washington Post Company, in 1973, was selling for $80 million in the share market. At the time, that day, you could have sold the assets to any one of ten buyers for not less than $400 million, probably appreciably more. The company owned the Post, Newsweek, plus several television stations in major markets. Those same properties are worth $2 billion now, so the person who would have paid $400 million would not have been crazy.

And, this occurred to Adairs (ADH.ASX) when its share price fell to 49.5 cents per share, on the 23^rd of March, as Adairs book value (shareholders equity) per share, at the time, was 85 cents per share and was generating strong free cash flows, which were growing at approximately 200% year-on-year!

Your risk of losing money falls when the share price of a high-quality company falls. But, the potential reward increases dramatically.

You put luck on your side when you can purchase high-quality companies at very reasonable prices, which is what happened to the Little Bluey portfolio.

In summary: Your job as an investor is to focus on the activities within your control. Understand that by doing so, you are putting luck on your side. Your investments may not pay-off immediately, but be patient, as the market will eventually recognise this mispricing.

We’ll end on a Benjamin Graham quote.

You are neither right nor wrong because the crowd disagrees with you. You are right because your data and reasoning are right.