The investment lessons from a decade of picking value shares

What would you say to a younger version of yourself? What wisdom would you impart? Could you boil it down to a set of rules to help hand success to the younger you?

After a decade co-managing value funds, with Kevin Murphy, now seems a timely moment to reflect on what I might say to my 21-year-old self, starting out in investment.  

First a word on “value investing”. There are plenty of technical explanations of this concept, but the spirit of it is simple. It is merely the exploitation of investor emotion.

The value investor waits patiently, observing as irrational investors sell amid turmoil and buy at times of euphoria.

These emotions are often driven by some wider fad, event or trend. For example, the surge in dotcom shares in 2000 or the doomsday scenario painted for banks in the financial crisis of 2008. 

The skill is calculating when emotion has usurped sound investment decision-making.

We screen the market for companies that look cheap compared to the long-term profits they have achieved and then ask ourselves: “Why can’t this business make these profits again?”

We have been deep value investors from the start. But these rules reflect the lessons we’ve learned and how the process has been refined.

Rule 1: Don’t continue to hold stocks that you wouldn’t buy today if you didn’t own them

Constantly review your reasons for first investing and ask yourself if they still stand. Stocks don’t become better investments just because you hold them. But don’t confuse this with rule no.2…

Rule 2: Don’t sell just because the price falls

The best solution to underperformance is often doing nothing. People frequently sell out of underperforming stocks, when the best thing to do would be to wait - or buy more!

Rule 3: Don’t be ashamed to hold cash

Investors believe money left on the sidelines might miss out on dividend income and price gains. But cash is king when opportunities arrive. Cash enables value investors to buy at times of fear. 

Rule 4: Don’t buy the dream 

Don't buy businesses that are pinning all their hopes on the next model, invention or drug.

Rule 5: Don't buy single product companies 

The general advice to investors about putting all eggs in one basket applies equally when evaluating the merits of single stocks.  

Rule 6: Don’t buy stocks you don’t want to own in 12 months 

It is possible to fall victim to a value trap: to be fooled into buying a cheap stock that has genuine structural impediments to generating returns over the long term. Such companies are on a downward elevator of value destruction. Too many investors try to time when this spiral might bounce, and usually get it wrong. The test is to not buy stocks you don’t want to own in 12 months.  

Rule 7: Don’t buy stocks you wouldn’t want to buy more of if they fell 20% for no reason

This is a good test for the true value investor. If your analysis is thorough – and constantly retested –have faith in your decisions, and the stomach to keep buying.

Rule 8: Only back companies with high debts if they are already priced for financial distress

This high risk strategy can yield results for the brave value investor. But it’s a difficult path to tread. 

Rule 9: Don't chase stocks

For value investors, it is of course, all about the value. It is better to not get any of a stock than get too much at the wrong price.

Rule 10: Think long-term and forget about the index

We have a natural inclination to focus on other investors and the performance of stock market indices in the short-term. It can cloud your thinking. 

Rule 11: Don’t let past performance affect future investment decisions

The desire to take more risk when you are ahead of the benchmark index and less when you are behind is powerful, but ultimately self defeating. Ask yourself, would you be doing this same trade if you were 10% behind / ahead of the index? If the answer is no, why are you doing it?

Rule 12: You can’t predict volatility  

Low volatility in the past doesn’t mean the same for the future. It can come out of nowhere. Consider the relative stability of bank shares in the years before the financial crisis. It can also disappear just as quickly, and often unexpectedly. For a patient, long-term investor, volatility is often an opportunity, not a threat.

Rule 13: Don’t buy and sell too much 

Long term investors don’t need to constantly trade. The only certainty with high turnover, is high fees.

Rule  14: Risk vs reward

The danger of losing money should dictate how much you buy, not your view of how much money you might make.

Rule 15: Focus on your weaknesses

Good investing is about identifying what you are bad at, not just what you are good at. People love to focus on their strengths, but trying to limit the impact of your weaknesses is just as important for fund managers. People who think they have no weaknesses are doomed to failure.

Rule 16: Keep it simple

Beware any investment strategy you can’t explain to a 12 year old.

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