On Borrowed Conviction

Jason’s Random Words

I'm extremely lucky in that I get paid to research stock ideas. I also have access to some investors who are a lot better than me that I'm able to bounce – often dumb – ideas off of. I didn't start off this way. For the first few years of my stock-picking career, I was like most of you, working a full-time job and finding the occasional hour or two in the evenings to research stock ideas.

Of course, I was lucky to have found a reputable stock-picking newsletter early in my career. Outsourcing ideas, I firmly believe, is something that more individual investors should do. The guest on this week’s podcast episode, Travis Hoium, is an excellent example, with his Asymmetric Investing newsletter that researches companies Travis thinks can deliver 10X or better returns in the next decade. There are newsletters for every sort of investor, whether growth, dividends, real estate, or a mix of ideas. As you know, both Jeff and I do some contracting work for The Motley Fool, which has a lot of different services to help investors find great stock ideas.

There's a problem, though, with outsourcing your research. Too many people just buy the stocks someone else likes and don't do any due diligence of their own. The problem: You can't outsource conviction. Financial educator and investor Brian Feroldi was the first person I heard describe this as "borrowed conviction," a term you hear me and Jeff use a lot.

Let me tell you, it cuts both ways.

• If you buy a stock on borrowed conviction and it goes up, you will sell it too soon to "lock in" gains and miss out on much bigger returns.

• If you buy a stock on borrowed conviction and it goes down, you will sell to avoid the pain of more losses, when you may be missing an opportunity to buy more of a good company that's being mispriced.

If you don't invest the time to know what you own, it's really hard to make a rational, informed decision. It took me years to learn this lesson the expensive way: Selling winners too soon and buying losers I may have avoided with a little bit of research of my own.

We talk about building a toolbox a lot on the podcast. The tools aren't just stocks, bonds, real estate, Jeff, or other assets. Your tools are also knowledge and experience, an understanding of your goals, and how each asset you own can help you reach them. Or to put it another way, the mental and psychological tools that you use to manage yourself as much as your portfolio. If you want to succeed on your journey of wealth building, make sure you're using all the tools at your disposal.

Here's to finding your own conviction,

Jason

Jeff’s Random Words

I want to build off what Jason wrote but with fewer words and more insults.

I completely agree with Jason that outsourcing idea generation to a stock-picking service or newsletter is a great asset for most investors. Neither Jason nor I would be here if not for that. However, here’s where I will disagree with Jason slightly. Because it’s impossible to build conviction immediately, I sometimes will buy a stock based on borrowed conviction, but I do so only under certain conditions.

First, I force myself to learn as much as I can about the company. My goal is to be able to explain what the company does to someone who doesn’t care at all about investing. Second, I make a spreadsheet where I track various metrics. Some are common for all companies (revenue, gross margin, operating income, net income, cash generation) and others are specific to each company. And those company-specific metrics are where I start to build my conviction.

In our podcast this week, one of the companies our guest Travis talked about was Peloton (PTON). I no longer own it, but when I did, I tracked the following metrics:

• Connected Fitness Subscriptions

• Connected Fitness Subscription Workouts

• Average Monthly Workouts per Connected Fitness Subscription

• Average Net Monthly Connected Fitness Churn

How Much Does Jason Like or Dislike this Company (the inverse Jason conviction correlation index is disturbingly consistent)

In simple terms, by watching the commonly reported GAAP metrics, along with these company-specific metrics, I was able to build (and then lose) conviction over time. So when the stock started its fall in 2021, I was able to see that connected fitness subscription growth was slowing and that the number of monthly workouts fell off a cliff as the world started to re-open. This helped me know that my decision to sell was based on business performance and not the stock price. The fact that Jason held on while I sold told me I made the right call (see the above correlation).

I had built conviction, and then lost it, because of how the business was performing. But it was my conviction, at least eventually.

Ironically, in a hat-tip to Travis, I find myself looking at Peloton again. He’s made a compelling argument for why Peloton could make an attractive investment from here. I may borrow his conviction for a bit…

Jeff

Note: We may earn a commission from some of the links we share in our posts. Thanks for the scratch.

Another note: We may own some of the stocks discussed, and nothing we say should be taken as investment advice.