The past five years have tested investors’ resolve, and 2019 has done little to relieve the exasperation and bewilderment of the average investor. We do not know what the next five years will look like and the only thing history tells us for sure is that no investment trend lasts forever. Unfortunately, predicting exactly when things will change is impossible despite many commentators’ ongoing efforts to do so. Given this, how should you approach investing in 2020? A few investment maxims from some of the world’s best investors may help.
“The single greatest edge an investor can have is a long-term orientation.” Seth Klarman, Chief Executive and Portfolio Manager of the Baupost Group
Many investment gurus, experienced advisers and professionals remind us that it takes time for a strategy to work. Yet, when markets are struggling, it’s easy to become very short-term focused. We digest every bit of bad news as if our lives depend on it and we obsess over it, projecting the bad news into the future. It fuels our dinner conversation and compels us to take action.
But it’s worth remembering that some of the most admired investment businesses have been built over 30 years or longer. When you review their histories, there were times of uncertainty and hardship. Despite this, those businesses that stuck to their well-proven processes lasted and flourished, and their clients were well served by their resolve. Any long-term investment strategy will be tested over time. A key component is how you, as an investor, will respond.
“To buy when others are despondently selling and to sell when others are euphorically buying takes the greatest courage, but provides the greatest profit.” John Templeton, founder of the Templeton Growth Fund
For value investors, an ability to stand apart from the crowd is absolutely essential. It’s going to get uncomfortable at times, that is a given – and those who follow this style are feeling this right now. It is worth reminding ourselves that the best investment decisions are often accompanied by a level of discomfort and uncertainty. The negative market environment in 2009 rewarded those who could muster the courage to invest then with a period of strong subsequent returns. Don’t let discomfort drive you to act on impulse and capitulate on your long-term strategy.
“When you look at a stock, ask yourself: Is this an attractive business? Would I buy the whole company if I could?” Pat Dorsey, Founder of Dorsey Asset Management
No amount of in-depth research can help predict developments in the short term, but it is crucial for long-term success. Questions to consider include:
- Is the company likely to be around in five years’ time? Look critically at the strength of its business model.
- Is the company likely to make money at some point in the next five years? We often forget that a good management team responds better to a challenging environment and often creates a more robust company to take advantage of the next upturn.
- Given the answers to the first two questions, is the company likely to be trading at a higher price-earnings ratio at some point in the next five years?
If the answers to all these questions are yes, investors are likely to get a good return from the investment in the long run.
“Confronted with a challenge to distil the secret of sound investment into three words, we venture the motto, MARGIN OF SAFETY.” Benjamin Graham, the ‘father of value investing’
Just because you are looking to invest in a fantastic, ‘failsafe’ company, does not mean that you should do so at any price. Margin of safety is the difference between a company's prevailing market value (its share price) and its intrinsic or fair value. Once the share price moves up to a point where it does not compensate you for the risk that you inevitably take when buying a share, it is time to sell.
At the end of the 1990s, during the 'dot-com bubble', the share prices of even some of the best-quality tech companies fell substantially and took a significant period of time to recover. Although these companies thrived after the collapse of many of their peers, their share prices suffered because they were too expensive to start with. If you are considering a change of tack in your investments, margin of safety should remain top of mind.
“When investing, pessimism is your friend, euphoria the enemy." Warren Buffet, CEO of Berkshire Hathaway
It’s easy to get caught up in market narratives. When news flow is good and sentiment positive, investors tend to buy popular securities at any price, paying lip service to valuation and risk. When news is bad and share prices fall, fear of loss makes investors retreat – from real risks, but also from those that may be unfounded or overstated.
While it is important to avoid getting swept up in prevailing hype or gloom, it is equally important not to ignore the narrative altogether. That said, some of the best investment opportunities can arise from strong negative narratives. In fact, they are often a necessary pre-condition to finding quality companies at attractive valuations.
Before you throw in the towel at a point of deep pessimism, make sure you understand why you are doing so, and why you have greater confidence in your alternative option delivering the long-term returns you require.