Most people’s beliefs about investing are really tenuous. There are, of course, folks who are really passionate about investing. They don’t view investing as some esoteric subject, but rather as a field intimately connected to the human behavior they observe in their everyday lives.
For everyone else, however, beliefs about investing come in the form of passive knowledge. The tendency is simply to accumulate an inventory of conventional dictums. Investing beliefs are formed much the way a student prepares for a test. If the subject of Investing were as simple as a third grade spelling bee, this wouldn’t be a problem.
But, investing is really a far much more complex subject. That isn’t to say it is necessarily a difficult subject. For some, it is relatively easy. But, it is never simple. An investor can not analyze relationships with the certitude and precision a physicist can. The investor is concerned with human phenomena, which are necessarily complex phenomena.
The complexity of the subject is what makes it appear so difficult. While you can develop a set of guiding principles, it is impossible to devise rules that will lead you towards the best course of action in each and every case.
Should you try to build an intellectual edifice based on principles such as large returns on equity, strong consumer franchises, low price-to-earnings ratios, low enterprise value-to-EBIT ratios, high free cash flow margins, and rock solid balance sheets – you will fail.
The entire structure will collapse, leaving the architect disillusioned. Why? Simply because the items listed above are desirable attributes – nothing a lot more and nothing less. They are not true principles. Even as rules of thumb, they are badly flawed. Ultimately, purchase decisions are not made about general classes; they are made about special cases.
Every investment decision requires good judgment and sound reasoning. You need to commence with the correct principles. But, principles alone are not adequate. You aren’t becoming asked what the law is, you’re getting told to apply the law to the case before you.
This really is where a lot of people begin to feel overwhelmed. Having learned that investing is not simply a matter of running down a checklist, they do not know where to begin.
The answer would be to start with what you know best. Begin with your most strongly held beliefs. Subject them to honest scrutiny. Then, and only then, apply them for the case at hand.
Do you believe the concept of intrinsic value is really a valid 1? Do you believe it can be a useful model? If so, then begin there. What does the concept of intrinsic value really mean? What conclusions follow from this belief?
In the case of intrinsic value, the most difficult conclusion you’ll have to grapple with is the idea that it is possible to pay too much for a great company. For some, this is a relatively simple conflict to resolve. For whatever reason, they prefer cheap merchandise to quality merchandise.
For others, the conflict between intrinsic value and investing in great businesses is painfully difficult to resolve. But, if you’re ever going to have confidence in your judgments, you’ve to be willing to submit your investment beliefs to honest scrutiny. You’ve to be your personal prosecutor. You have to present the evidence against your thesis.
Should you aren’t willing to complete that, you’ll end up questioning the investment beliefs you do hold every time you underperform the market. Several proven investment techniques have lagged the market over short periods of time. Occasionally, the performance gap has been very wide. Regardless of whether you adopt a primarily qualitative or primarily quantitative approach to investing, this short-term underperformance is unavoidable.
It’s avoidable in the sense that a good investor can get lucky and not suffer a down year for a decade or so. Likewise, it’s actually possible to outperform an index year following year – if you’re lucky. But, it isn’t possible to adopt a strategy that guarantees such outperformance.
The finest it is possible to do is adopt a strategy that offers the right odds. A series of investment operations undertaken in accordance with such a strategy will not guarantee favorable outcomes in every case, but it ought to supply satisfactory results over the long-term.
There’s a lot more than a single way to skin a cat. I do not want to encourage dogmatism. But, I do want to make sure you do not confuse that which is conventional with that which is reasonable. There can be a lot of conventional, moderate sounding advice given to investors that does not hold up to careful scrutiny.
The most obvious example is diversification. Creating a series of bets on separate high-probability events is an superb idea. Diversifying across several different asset classes and hundreds of securities is some thing entirely various. Even if there are hundreds or thousands of excellent expense opportunities, it does not follow that an investor ought to make every reasonable bet. Following all, some will appear to be more reasonable than others. There is no sense in taking on a number of difficult tasks in the hopes of achieving a result that will be produced by taking on a few extremely easy tasks.
You do not have to agree with me on all these issues – most people do not. But, it is important that you question the unstated assumptions upon which an expense operation is based. You may possibly come towards the same conclusion as those who engage in wide diversification. But, you will need to come to that conclusion on your own.
Several investors have not even bothered to consider the underlying premise of diversification. They aren’t really sure why diversification is a desirable strategy. They do not know how it minimizes risk or at what point the benefit from adding an additional position becomes immaterial. Diversification may be a prudent strategy. But, it is possible to only decide that for yourself after you’ve considered the benefits in terms of risk reduction and the detriments in terms of selectivity reduction.
If I were forced to spend my existence betting on horse races, I’m quite certain I would bet on really few races. Whenever I did bet on a race, I’d bet on numerous various horses.
Why? Because I know more about individuals than I do about horses. The likelihood that a few horses in a few races get too much favorable attention appears much greater than the likelihood that I could ever make reasonably specific judgments as to which horse is most likely to win a given race. Of course, I would do greatest if I didn’t bet on any horse races at all.
So, the question is whether stocks are anything like horses. I really don’t believe they are. When it comes to businesses, I’m a lot much more comfortable with the idea of picking the few winners from the several losers – especially when the odds get out of whack. The 1 tactic that would remain the same is inaction. Acting less and thinking more is sound advice wherever cash or commitment is concerned.
A productive investor has to have confidence in his judgments. I do not know how you can gain that confidence with out subjecting your beliefs to honest scrutiny. An unexamined philosophy will never exorcise your deepest doubts – and for as long as these doubts stay, you will be unable to find the confidence you seek.
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