The role of luck in investing

“Success is never accidental”

“You make your own luck”

“Luck is what happens when preparation meets opportunity.”

You often hear stock market players making millions of Ringgit, 500%, 700%, or even 1000% return from Bursa in a year; even in months. They would cite those phrases above convincingly and relentlessly. How often have you heard somebody confessing that he has loss a fortune in the stock market, and not blaming it on bad luck?

In reality, luck plays a much greater role in short-term investment results than many investors may think, though skill may play a role as implied by those phrases above.

For an investor to both be right and make money in the market:

1. His analysis of the company’s performance and his view of its future must be correct.
2. The things he thinks will happen, such as the convergence of price and value have to actually happen, and
3. Those things have to happen on schedule or ahead of schedule.

Let us examine the return of my portfolio set up on 1^st August 2013 and see how much is the performance or non-performance is attributed to luck or otherwise. The portfolio can be viewed from the link below, with the courtesy of a regular contributor, Mr Tan KW:

http://klse.i3investor.com/servlets/pfs/21089.jsp

There is some difference in the returns due to the timing of recording, weighting used, and exclusion of the dividends as in the link and my data. For example the average return in my record is 44.6% compared to 36.8% as on 22 January 2014, and there are a couple of losers (small though) in mine as compared to none in the link. For discussion purpose, I will use what is provided in the above link. All the stock selections come with detailed analysis as provided in the link below:

http://klse.i3investor.com/blogs/stock_pick_challenge_2013_2h/blidx.jsp

The return of my portfolio

The KLCI rose in the half year period from 1773 on 1^st August 2013 to 1815 at the close on 21 January 2014, for a return of 2.4%. On the other hand, the portfolio returned 36.8% as shown in the link. In other words, the excess return, α is 34.4%. None of the stock in the portfolio of 11 stocks made a loss as all had positive returns and two of them are below the return of the market; they are Kumpulan Fima (+1.3%) and Pintaras (+1.1%).

Seven out of the eleven stocks in the portfolio made double digit return with Datasonic at a whopping +226% return in less than half a year. Many others also shows exceptional return such as Homeritz (+63%), Fibon (+59%), and Willow (+54%), etc.

The return of Datasonic of +226% is an outlier, no doubt, and how can I say it is not mainly due to luck? But even if I exclude this from the portfolio, the return of the portfolio will still be well above +25%, in less than half a year, still a very lucky number.

So the answers to the above questions of:

1. If my analysis of the company’s performance and his view of its future correct?

Answer: I won’t say so as half a year is really a short time. Moreover somebody has to objectively verify if my analysis is actually correct or not.

2. The things I think will happen, such as the convergence of price and value have to actually happen, and

In general the convergence of price and perceived value does actually happen, hasn’t it?

3. Those things have to happen on schedule or ahead of schedule.

They do seem to happen ahead of schedule, haven’t they?

With that, I can’t help myself to conclude that luck plays a more prominent part in my investment portfolio in this short period of time. In general, I believe successful in investing requires a significant degree of luck, whether in the short-term or the long-term, but not forgetting that one must also have a certain degree of skill too.

KC Chong (22 January 2014)