Don’t Try to Predict The Future

We all make mistakes when investing; it is unavoidable, but if we want to survive in this game, we must learn from those mistakes to avoid repeating them. Even better is learning from each other’s experiences to avoid similar pitfalls altogether. With that in mind, I’d like to share a recent investment failure of mine.

The Pandemic and The Need for Decontamination

In March 2021, during the height of the pandemic, I invested in a company called Tomi Environmental Solutions (TOMZ). TOMZ is a disinfection and decontamination company that utilises ionised hydrogen peroxide (iHP) mist to disinfect and decontaminate large and small spaces within minutes, boasting a 99.999% effectiveness rate.

TOMZ, though always a small business, experienced significant growth during the pandemic due to the increased demand for its technology. Its revenue skyrocketed from $5 million pre-pandemic to over $23 million by the end of 2020, shifting the company from reporting annual operating losses to making $10 million in operating profit in 2020.

Because of the change in economic fundamentals, TOMZ’s share price leapt from $0.84 per share to a high of $14.68 per share in July 2020. As the stock market’s pandemic euphoria wore off, I finally bought shares at $4. At 9.0x 2020 operating income, I believed it to be an exciting opportunity.

The business checked all the boxes, including:

1. Competitive Advantage: TOMZ possessed a technology that proved significantly more effective than other decontamination solutions, giving the company a competitive edge over its peers.

2. Strong Management Team with Skin in the Game: The CEO had been at the helm since 2007, and he and his family owned over 20% of the business, aligning their interests with ours.

3. Reasonable Valuation: With a valuation of 9.0x 2020 operating income, I believed I was acquiring the business at an attractive valuation, avoiding overpayment.

Where I Went Wrong

I made a significant mistake with TOMZ, which in hindsight may seem obvious, but it wasn’t apparent then. I erred in assuming that revenue was sustainable.

When I bought shares in TOMZ, it was clear that the pandemic wouldn’t last forever. Still, I did anticipate that certain sanitisation practices adopted during the pandemic, especially in travel and the transportation of goods, would persist.

Furthermore, TOMZ had reinvested its pandemic earnings into developing new technologies, such as its Sterapack, and successfully researched further use for its iHP technology, so not only did I believe revenue was sustainable, but if decontamination was a new norm, TOMZ’s revenue should continue to grow.

However, the world swiftly reverted to old habits, and decontamination and disinfecting were no longer at the forefront of public consciousness.

Today, TOMZ’s revenue has plummeted to one-third of its 2020 levels, and the business is back to making losses, resulting in its share price falling to less than $1.00 a share. Fortunately, I didn’t wait until then to exit the investment, but I did incur a painful 50% loss.

Learning

Despite appearing to make all the right moves, investing is challenging; the economic reality cares little for your research and analysis or emotional state. However, the experience taught me a valuable lesson—while I still believe in the importance of proactive decontamination practices in preventing the spread of the next outbreak, I had no business trying to predict future trends or societal shifts.

As an investor, it’s not my place to anticipate the future. This doesn’t mean I shouldn’t forecast a company’s future earnings or cash flow, but rather, I should refrain from trying to predict the next trend or fad—it’s simply too difficult.

This lesson is exemplified even today in the electric car industry. The initial belief was that the rise of the electric car would be the end of the combustion engine, leading to the rise of many electric car manufacturers, with Tesla leading the charge.

Fast forward to today, and while there is an obvious argument for the need for electric cars, combustion engines remain relevant. At the same time, the cost of producing and the increase in competition have made the economics of electric car manufacturing very difficult.

Many companies in the industry, such as Rivian and Polestar, are now struggling, and even the mighty Tesla is battling increased competition and lower demand, highlighting the unpredictability of paradigm shifts.

The same is true for renewable energy. While the need for alternative energy sources is obvious, the business case for wind and solar is not as clear, especially as regulation changes to make them less viable alternatives.

Conclusion

As investors, we will make mistakes, and part of our arsenal for dealing with those mistakes is ensuring we have a safety net in case we are wrong, such as not overpaying or betting our house on a “sure thing”. But learning from each others’ mistakes is another tool, and today’s lesson is not to try to predict the next “big thing”. It is simply too hard!

2023 Berkshire Hathaway Shareholder Letter

There is no better way to kick off the newsletter’s inaugural “Lessons Learned” segment than by learning from the legend himself, Warren Buffett.

Every year, Buffett writes a letter to the shareholders of Berkshire Hathaway and he recently published his 2023 shareholder letter. As always, we can gain so much investing wisdom from his writing.

Here are my top takeaways from this year’s letter:

1. Invest in High-Quality Businesses

One way to find high-quality businesses is by looking at a company’s Return on Capital (ROC), which examines the earnings produced per dollar invested into the business in the form of fixed assets or net working capital. The higher the ROC, the higher the likelihood it is a good quality business. I was taught this metric for identifying high-quality companies, and I continue to use it in my investing today.

2. Look for Honest Managers

This is easier said than done and something Buffett admits to in the letter; however, it is important to invest in managers that you believe hold their customers’ and shareholders’ well-being above their own. Reading Buffett’s letters, it is clear he is such a calibre person and someone I model my behaviour on, and hopefully, can identify in the managers of the companies I invest in.

Smaller is Better

For some time now, Buffett has admitted that the size of Berkshire Hathaway has been a major obstacle for the business as they have so much capital (money) they need to deploy that it is hard to find companies or investments big enough that still meet his criteria.

Size is a significant advantage that we, as individual investors, have because our investing universe is far broader than Berkshire’s. While we can invest in the high-quality businesses Buffett is buying, we can also buy much smaller, lesser-known companies that Buffett would love to own but can’t because Berkshire has grown too big.

Patience Is Everything

After you have done the hard work and research and decided to pull the trigger, don’t be afraid to sit back and do nothing with that investment for a long time.

Buffett makes this point very clearly in the letter when he states,

If you haven’t read Buffett’s annual letters, do yourself a favour and take the time to read them. There is perhaps no better place to learn about long-term investing. His letters can be downloaded from the company website for free.

Here is your chance to ask those questions on your mind or share your insights with the Lockstep community.

Would you like to be featured in next week's newsletter?

• Simply reply to this email.