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posted on 27 January 2018

Become Wealthy By Controlling Your Emotions

by Robert Rapier, Investing Daily

Investing Daily Article of the Week

Logic versus Emotion

My wife and I have a recurring argument around logic and emotions. On several occasions, she has noted that if I am engaged in a discussion, and one side becomes emotional, I continue to respond with logic. My wife says that I am “logical to a fault" (which she finds frustrating at times when she is the recipient of my logic).

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As she tells me, some issues are just emotional. Still, I try to apply logic even in those situations. This sometimes leads to a breakdown in communications.

I persist with reason because that’s what makes sense to me. If two sides both resort to emotional arguments, it is difficult to progress toward a resolution. To me, there must be a rational basis.

Now, I am sure some readers are shaking their heads and thinking “You just don’t get it, Robert." In response, I would try to reason with you of course. But there is an investment analogy here.

Evaluating Companies Rationally

When I evaluate companies, I do so rationally and logically. Among other things, I look at the balance sheet and the company’s outlook. I look for negative news to make sure I haven’t missed something important.

Sometimes, I can pick a company that I am certain has all the elements for success. I make a Buy recommendation and then watch in horror as emotions drive the stock in the wrong direction.

Was my analysis wrong? I guess that’s what the market is telling me, but I often see something different at play. I see logic fighting emotion, and emotion winning.

Let me give you two examples.

My Solar Pick That Initially Darkened

In May 2016, I recommended a company called SolarEdge Technologies (NASDAQ: SEDG). SolarEdge is a supplier of solar inverters, a high-tech component that turns collected solar energy into a usable electric current and is a key determinant of a system’s efficiency.

The company had consistently and impressively grown revenues, profitability, and cash flow generation year after year. Its outlook was bright.

But sentiment in the solar sector was negative throughout 2015 and 2016. Emotions were working against me, even as the company continued to report one good quarter after another. By the end of 2016, my recommendation was down 40%.

My logical brain refused to give in to emotions. This was an emotional disconnect that couldn’t last. I stubbornly held on to my shares and advised long-suffering investors to do the same.

In 2017 the underlying fundamentals and the logic for owning the stock never changed, but the sector sentiment shifted. Emotions swung back in my direction. SolarEdge turned in a 203% return in 2017. It had been a roller coaster, but logic finally won out over emotion.

Head in the Sand

Last year, I repeated this process with another pick called Smart Sand (NASDAQ: SND). The company produces Northern White Sand used as a proppant for hydraulic fracturing (i.e., it helps hold the fractures open).

Fracking sand producers are notoriously volatile and leveraged to oil prices. But unlike its competitors, Smart Sand had a strong balance sheet and was consistently beating expectations. I recommended shares in April 2017.

As with SolarEdge, I bought shares myself. And like SolarEdge, shares fell. By August, the share price was down 50% from my recommendation. Still convinced that the fundamental analysis was correct, I bought more shares (as I cursed what I viewed as an emotionally-driven sell-off). I advised investors to hang in there.

Finally, in August, oil prices began to recover. Smart Sand - which continued to report one good quarter after another - finally took off. From its August lows, the share price ran up 60% by the end of the year. Sentiment had finally shifted back in my favor. I am still not out of the hole with Smart Sand, but the trend is headed that way.

Of course, I wish I had initially bought both companies after the steep decline each company experienced. But that gets into the emotional part of the analysis that often still eludes me. In both cases the logic was right, but I was in too early.

Good Advice from Warren Buffett

Logic and fundamentals should eventually prevail, but you may be subjected to an emotional roller coaster in the interim.

Sometimes you should throw in the towel, but if you are convinced that the fundamentals still support you, be patient. As Warren Buffett once said:

“It’s an easy game if you can control your emotions."

But with your spouse, I have learned that sometimes you should fight your logical instinct, smile, give them a hug, and just say “I understand."

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