This is a summary of the equity investment process – investment philosophy – I have developed over more than 25 years of reading and practical investment experience. I thought you may find it helpful as framework on how to think about investing.
Produce attractive positive, real long-term returns irrespective of market returns.
Apply a disciplined, long-term orientated value investing approach based on rigorous fundamental research.
Hedging & derivatives
I believe that markets are mostly efficient and securities fairly valued. Sometimes however securities are miss-priced creating profit opportunities. Such opportunities occur because of irrationality or a short-term focus. Opportunities can appear in any sector or in any type of security thus I am a generalist and do not favour any specific sector or company size. The best investment ideas I have found typically fall into three categories:
- Unknown – No analyst coverage and or small companies
- Unloved – Missed profit forecasts, sector out of favour, restructuring and financial distress
- Special situations – Workouts, liquidations, delistings and spin-offs
I identify possible investments through reading, screening and following asset managers I respect. I however, always do my own analysis before investing.
Circle of competence
I only invest in companies of which we understand both the business and the financial statements. I keep things simple with investment ideas usually explained in a short paragraph.
Is it a good business? Does it have a sustainable competitive advantage? High cash returns on capital? Healthy balance sheet? Strong free cash flow? Has it got pricing power?
Are the trends favourable? What are the competitive dynamics?
Are they trustworthy? Are they good capital operators? Are they good operators?
Is the security really cheap? Why? What is the risk return relationship?
I want to buy at attractive prices the shares of good businesses that I understand and which are run by capable, honest and shareholder friendly management.
I do not believe in investing too much of my money in any one investment idea. Investing is a process with an uncertain outcome (anything is possible) and I have a diversified portfolio with a maximum of 5% in any one investment idea. I follow a strict trailing stop-loss system to let my winners run and cur losers out as quickly as possible and re-invested in new attractive ideas. Securities are bought when they offer an attractive discount to underlying value. Selling takes place when we believe a security is fairly valued or if the proceeds can be invested in a more attractive position.
I define risk as the permanent loss of capital. I do not equate risk with the inevitable short-term movements of the market. I believe that buying a security that is trading substantially below its intrinsic value is the best way to eliminate risk. Only after I have limited our downside risk do I consider the upside potential of a security. I do not believe in leverage.
I made a major update to my investment philosophy – I became a much more quantitative investor – in this article: Quantitative value investing deserves your serious attention
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