Monday, November 24, 2008

Ten Habits of Successful Value Investors (Adapted)

This post is a timely reminder on value investing principles amid the worst credit crunch in 8 decades ! Apparently, the news just can't get any worse (or can it ?), and no prizes for guessing that someone will pop up every day to say "hey the worst ain't over yet". It is during such times that sticking to an investment philosophy helps to keep one focused and in tune with his financial objectives. Below are 10 habits of value investors (highlighted and summarized, along with my own personal commentaries) adapted from the book "Value Investing for Dummies" by Peter J. Sander and Janet Haley (1st Ed.). Note that the second edition came out just after I bought the first one, so just my luck ! If someone has their hands on the 2nd (updated) edition, perhaps you can help point out if there are any changes to this section.

1) Do the Due Diligence

There is no substitute for hard work and nitty-gritty research, and every aspiring value investor has to get down on his knees and do the field work himself. Avoid relying too much on analysts or others who purport to have a view on a company or industry - best to do the legwork yourself to give yourself the required assurance.

2) Think Independently and Trust Yourself

Basically, avoid following the herd. The stampede can leave one bruised and somewhat crushed and it is never a good idea to behave in a lemming-like way. Make conclusions based on facts and objective data and do not be afraid to appear to deviate from common understanding. Sometimes views may be different purely because of a difference in time horizon (e.g. analysts are looking at a company with a 5-week view; but value investors use a 5-year view). Trusting yourself is a very important quality and having faith in one's ability is paramount in being successful in investing (and trust me naysayers jump at any chance to prove you wrong and shoot you down - people seem to enjoy the misfortune of others, especially so if they feel they are not alone in their misery).

3) Ignore the Market

This point cannot be over-emphasized. When you purchase shares, you are purchasing part-ownership of a company which sells products and services. The stock market is simply a venue for the transaction to be executed. We should thus ignore the noise and din the market is generating unless it is to our advantage to transact to own more of a piece of business.

4) Always Think Long-Term

This goes along with Point 3, ignore the market and focus on the long-term prospects of the businesses you own. Over time, compounding and the effects of dividends will serve your long-term financial goals well, provided you chose the right company of course !

5) Remember that You're Buying a Business

Think of buying shares in the company as if you would like to purchase the entire company. Know more about the company than others and be able to explain the company to a 4-year old (not that a 4-year old will ask, but you never know !). Keep a close watch on the company and keep track of the business, NOT the share price.

6) Always buy "on Sale"

Purchase shares of companies which are going on sale ! This means cheap valuations relative to the long-term growth prospects of the company. By buying cheap, we create greater margin of safety and provide more upside as compared to buying expensively.

7) Keep Emotion out of it

Rationality is important in evaluating potential investments, and emotions should be left at the door. One should purchase a company for its economic characteristics ("fundamentals") and not to be part of one big family (assuming you love the products it sells). Also, do not hesitate to admit mistakes as it can help one to learn and avoid them in future. Value investors have a rational system to determine when to sell in case facts or change or their original reason for owning the investment changes drastically. As humans, we can't be right 100% of the time, but it's how we cope with mistakes that make us a better person over time.

8) Invest to Meet Goals, not to earn Bragging Rights

Investing should be aimed at generating a decent return on your capital, and is a form of rational capital allocation to maximize returns over time. Some people tend to treat investing as a way to boast or brag about their achievements, and how their investment had reaped 20-50% in a bear market while others have "tanked". This is bad form and bad practice because the purpose of investing is not to show-off, but to ensure one can meet one's own long-term financial goals.

9) Swing Only at Good Pitches

This comes from Warren Buffett's baseball analogy. He is saying that as investors, we do NOT have to take every investment that comes along, only the very attractive ones. Thus, we can stand at the pitch all day and refuse to swing at all the balls that come our way, until we see a very good one coming ! This is akin to ignoring Mr. Market who throws all kinds of companies at all kinds of crazy prices - value investors need to sort through the heap to find the gems.

10) Keep your Antennae Up

This last point essentially means an investor always has to keep a lookout for good companies, and always needs to be aware of when attractive valuations may arise. This may not just include local companies, but it can be extended to include shares of companies trading in other countries as well, provided the investor understands the tax laws and operational aspects of the company in that country.

So that's a quick 10-point summary of some value investing habits one should adopt. It's a process of continuous learning and there are probably more habits to absorb than the 10 above, in order to make a good investor. I have not even included the behavioural finance aspects yet ! So let's all keep learning, stay humble and continue to share knowledge !


ntuchartist said...

Hi, mind doing a link exchange with me?

PanzerGrenadier said...

Hi Musicwhiz

Number 7 Keeping Emotion out of investing is one of the most difficult things we can practice as human beings.

To be human is to live life filtered by the lens of human emotion. Why is the market random and irrational? Human beings are the ones behind the swings from euphoria of bull-runs to the despair of bear-markets. And we can be TOTALLY irrational :)

Be well and prosper!

SGDividends said...

Hi PanzerGrenadier,

We think to defeat human emotions, one have to use a calculator and calculate a value to anchor our mind on.

Most people anchor on last year's prices which when you think of it, they are following the herd already.

Anyway point number 2. You know those Analyst reports? They have never told us what the investment horizon is when they state the target price. If one do not state the target price, then one is always right. cos it the price hits it 35 years later. It is ...see...35 year ago, we said it will reahc this price.

musicwhiz said...

Hi ntuchartist,

Sorry, the nature of your blog is not in line with value investing, and I usually only link to blogs which have significant FA or value investing content.


musicwhiz said...

Hi Panzer,

Thanks for visiting. Yes I agree emotion is a very difficult thing to control, especially when it involves money !


musicwhiz said...

Hi SGDividends,

Yes I had highlighted anchoring under one of my posts before (can't remember which). Apparently it's quite pervasive and even I have a hard time shaking it off !

As for analyst reports, most of them use a one-year price target (i.e. 52-weeks).


Anonymous said...

I tend to look at the last 52 mths before deciding to go into the market after considering all the factors. I must say that I have missed a lot of boats in picking stocks at very low price.

musicwhiz said...

Hi Anonymous @ Dec 1,

Any particular reason for usnig 52 months ? Or do you mean 52 weeks instead ?

Don't worry about missing boats, there will always be opportunities to buy shares in good companies at reasonable valuations. We do not need to catch the ultimate bottom because I believe it is an exercise in futility.


Ricky said...

Hi MW,

That's so true. Patience is a characteristic of a good investor, not to be confused with indecisiveness. Hope can pick up some bargains during Christmas period :)

musicwhiz said...

Hi Ricky,

Thanks, yes I hope to pick up some bargains this year too doing Christmas shopping !