Basic Investment Philosophy III
Lets look at my three competitive advantages and what they really mean:
1) I know I’m not a better analyst
Knowing I do not have a competitive advantage in analysing companies means I can focus on those potential investments that meet my investment criteria – the one I know that works, low price to book value – and skip a lot of work. In other words, I begin by acknowledging that IN MOST CASES my analysis of a company’s value will have no particular added value – might as well use the analysis provided by some Wall Street analyst, and we know how much that’s worth. I know there are companies out there that will become the next Walmart, but I also know that I will not be the one to discover them and become filthy rich. Yes, this is a bitter pill to swallow, but better that than lose a wad of money.
My first advantage is psychological.
2. I’m investing to build wealth
I’m not a trader; when I’ve tried to trade in the past the results have been horrible. So I know that if I want to build wealth I am going to have to invest rather than trade, which to me means holding a security for at least 2 to 4 years, and hopefully longer. To successfully invest I have to buy shares at below what I think they are intrinsically worth and wait for the market to share my view. And, boy, the wait can be long and hard. The key here is the discipline to wait. My crutch to help me through the wait is the price/book ratio, my dogma; just as Odysseus had his men bind him to the mast when passing the islands of the Sirens, so do I go forth to battle with my price to book ratio. Furthermore, because the sirens are many, I write down my investment thesis for each position in detail as well as target sales price, so I don’t get confused later on.
My second advantage is part structural and part psychological.
3. I have no investment restrictions
My greatest advantage is perhaps this, the lack of any investment restriction, when others have many. I don’t have to sell when the market cap of a company gets too small, or a company gets replaced in a major index, or when the stock price of a company falls too much and looks bad on my report card. In fact, my major advantage is that I can buy when others HAVE TO SELL. And when they have to sell for non-economic reasons that’s when I can really buy advantageously. This is especially true when those selling are large funds and their selling has a negative impact on the market price.
So where are these opportunities? As Joel Greenblatt says, they’re right under your nose. He lays some of these out in his wonderful little book whose title you can’t but hate, “You can be a stock market genius”. I think it is perhaps the most valuable book for any do-it-yourself investor. His explanations are simple, his examples are pertinent and instructive, his reasoning clear.. what more could you want?
So where does he suggest looking? Spin-off stocks and shares of companies doing major restructuring are his major focus. I add to his list companies whose shares simply languish at or below book value. However, my criteria, unlike the Greenblatt approach, requires a portfolio approach and a willingness to bet on the odds rather than focus on a single investment opportunity.
As part of each investment thesis, then, its important to know who is selling and for what reason. If I can’t come up with a reasonable story I just don’t buy.
My third advantage is simply structural. I’m small fry! But knowing this and making money on it, why that’s psychology too!