For just a moment, forget about earnings reports and P/E ratios. Put aside cup-and-handle patterns and debt-to-GDP figures. Beyond all of the day-to-day noise, beyond all of the intricacies of the stock market, what do you really believe as an investor? What principles are at the core of your philosophy? And, while you're at it, could you sum it up in 10 words or less?
That's a question Wall Street Journal columnist Jason Zweig recently asked on WSJ's Total Return blog. At first skeptical that he could distill his own approach down into that short of a mantra, Zweig found that he could, in fact, do just that: “Anything is possible, and the unexpected is inevitable. Proceed accordingly,” he wrote.
Zweig also asked the question of a number of prominent strategists and financial minds. Among the responses:
“Determine value. Then buy low, sell high. ;-)” -- David Herro, manager of Oakmark International Fund
“Own competently managed, competitively advantaged businesses at discounted prices.” -- O. Mason Hawkins, Southeastern Asset Management
“Fallible, emotional people determine price; cold, hard cash determines value.” -- Christopher C. Davis, Davis Advisors and Davis New York Venture Fund
Zweig's piece got me thinking about how some of the gurus who inspired my investing approach (and I myself) might respond. He offers a suggestion for one of them, the late, great Benjamin Graham, who once wrote, “Confronted with a … challenge to distill the secret of sound investment into three words, we venture the motto, MARGIN OF SAFETY.”
I wouldn't want to put words in any of their mouths, so I looked for wise words that some of the gurus I follow have already imparted, and which seem to capture the essence of their approach in no more than ten words. Warren Buffett -- Graham's protégé -- has advised, for example, to “be fearful when others are greedy; greedy when others fearful” (I've edited out a couple extraneous words there). Hedge fund guru and author Joel Greenblatt, meanwhile, has offered this simple yet powerful advice that too many investors forget: “Buying good companies at bargain prices makes sense.” And James O'Shaughnessy, whose research into investment strategy may be the most substantial ever done, has offered, “Disciplined implementation of active strategies is the key to performance.”
Distilling investment advice down into ten words or less is of course somewhat of an incomplete endeavour. You probably shouldn't offer a novice investor ten words and then give him or her $100,000 to invest; things are of course more complicated than that. But when you examine the ten-word advice of some very successful strategists, like the gurus I follow and those that Zweig quoted, some important themes emerge -- themes that average investors all too often lose sight of. Among them:
Focus on facts, and figures Most good stock-pickers have key fundamental and financial characteristics they look for in their buys (and key criteria for selling stocks, too). Greenblatt looks at earnings yield and return on capital; one of Herro's favourite metrics is free cash flow yield; Graham looked at price/earnings and price/book ratios, as well as the current ratio and the ratio of a company's long-term debt to net current assets. There's no one “right” strategy, but the important thing is that the best investors tend to use criteria that identify financially sound companies whose shares are selling on the cheap.
Beware emotion It's easy to get swept up in an exciting story surrounding a stock and buy it, or get swept up in a negative story and sell it. But doing so without actually crunching the numbers often leads to buying high and selling low. The best investors don't let hype itself alter their decisions.
Consider what Peter Buffett once told PBS television about the key to his father's success: “I think it’s because he’s removed emotion from his decision-making. He is not coloured by anything he thinks somebody else is doing, somebody else might want, some feeling he has about something that might not be rational. Ultimately, it’s because he is clear and unemotional, dispassionate about his relationship to those numbers on the page and the information he’s taking in.”
Stay disciplined over the long term No strategy will beat the market every month, or even every year. If that's your goal, you'll probably end up jumping from strategy to strategy and chasing hot stocks, which is a recipe for buying high and selling low. Sometimes, it just takes time for the market to recognize bargain stocks. If you think long-term -- as in a time horizon of at least five years -- you'll be able to better deal with short-term underperformance and reap the full rewards of the bargains that a good strategy identifies.
So, with all of that in mind, what would my own 10-words-or-less investing mantra be? I think it would boil down to something like this:
Follow proven strategies, stay disciplined, trust facts, and beware emotions.
Successful investing takes more than a 10-word “mission statement”. But don't underestimate the importance of such an exercise. The stock market -- and our own emotions -- continually throw tricks and traps our way that eat away at our returns. If you don't have a clear understanding of why, and how, you are investing -- or if you lose sight of that plan -- you can easily get swept up in some very dangerous tides.