Some Investors Fail Before They Even Start

Investment Perspective – July 2019

“Neither the investing method nor the fundamentals of the business are right or wrong because the mood of the market is favourable or unfavourable toward the “stock”. That is because when you really think about it, “stocks” (shares) are all about the financials and the trading price, the share price…the cash up value. What matters more is the economics of the business” 

Peter Flannery

In the perfect world, there would be only one reason why any investor could ever fail – simple. 

Unfortunately, we do not live in that world. 

On the other hand, that imperfection is one reason why we have opportunity too.

Modern Portfolio Theory says that markets are fully efficient.  In other words, the idea is that all known information about a business or an investment is instantly known by everyone and therefore fully reflected in the trading price.  The argument therefore goes that the trading price is the value. 

As value investors, however, we have a different view.

We do not believe that markets are that efficient. 

For example, have you ever noticed how when you receive information third, fourth or fifth hand down the line, that the information you receive can sometimes be a very different message to the one that was originally sent? 

Anyway, it strikes me as odd that when the markets are happy, asset prices (the value of them?) is greater than when markets are unhappy – what does popularity have to do with intrinsic value !?  

To my mind (admittedly, I am a biased old value investor!), the intrinsic value of an asset is a function of the relationship between the cashflow it generates and the amount of capital employed along with the underlying economics of that asset. 

The amount of profit an asset can generate is one thing; however, the profitability of the asset or how well it uses its capital is a different measure and more meaningful when thinking about intrinsic value. 

That’s because it includes both the income statement and the balance sheet of the business –  apart from being important when buying, selling and being a measure of popularity, the trading price really has little relevance.

Share market prices are transparent

Share markets perhaps offer the most transparent way to look at how prices can change. 

Because direct shares are listed on a market and open for trade most days of the week, the trading price, unlike unlisted residential property prices, can change in a heartbeat, depending on what news emerges and how the market reacts. 

When it comes to residential property and intrinsic value, the location of a property, how well it matches the tenant’s requirements and the structural state of repair do not suddenly improve because interest rates decline. 

The market’s ability to service yet more debt may increase as interest rates decline.  This in turn may create more demand, which can flow through to prices, making them rise. 

We have seen this over the last 25 years or so.  It is not the only reason that residential property prices in New Zealand and a number of other countries have risen strongly but indeed is one of the major contributors. 

Similarly (getting back to direct shares), the competitive advantage of a listed business (eg Alphabet, Starbucks, Adobe) does not suddenly deteriorate or become broken because the market reacts strongly to what it perceives as negative information, sending trading prices in a sharply downward direction. 

Price and value are different things. 

Unfortunately, many people fail at investing before they even start because they do not understand the concept of intrinsic value.  They likely also may not understand the economics of what they are investing in or the importance of investing in capital assets (investments that have a cashflow). 

By investing in those businesses with strong economics for example, you and I not only reduce risk, but we also improve long term investment returns. 

We can invest with a high degree of certainty, regardless of markets and economic conditions.

I realise that many people have made small fortunes by investing in ways that have little to do with value investing; however, they tend to be the exception to the rule.  Their results are neither standard nor easily replicable.

Some investors will be successful before they even start, no matter what.

In this imperfect world, we have the opportunity to succeed financially – or not. 

Unfortunately, many people choose not to be successful (even though they may not realise it). 

There are many ways that we can be successful financially. 

It does matter though, whether or not the way we choose to go about it relies on a set of financial, market and economic conditions to remain unchanged, for success to be a thing of certainty. 

Perhaps the most popular way for the everyday Kiwi to get ahead is to invest in residential property.  Some investors have fared better than others.  Very few, it seems, have more than five rental properties. 

I am not sure that having one rental property or even two means investment success.  What do you think?

A good many Kiwis are self-employed or running their own business.  With a bit of help, a proper approach to it, some real grit and determination, business success is possible for many people and yet it remains largely elusive for most. 

One reason, for example is because, being a highly proficient and experienced practitioner/tradesperson does not necessarily mean that we know how to run a business successfully. 

Also, as we have seen many times, high levels of education and intelligence are no guarantee of business success. 

In New Zealand, our very own John Key comes to mind because he is highly intelligent and highly educated.  He is also, by everyday Kiwi standards, rich – the exception to the rule. 

As for us mere mortals, whilst we can also benefit from a bit of good luck (let’s face it, we all get our share of it at some point), hard work, determination and consistency are an excellent start for financial success because as we know, it is very difficult to transaction our way to financial independence, even in the long run. 

Equally so, even in this modern, high tech world, it remains very difficult to click a few buttons and get rich quick.  Again, those that do are the exception to the rule, which is they are news. 

Some are naturally intuitive value investors

Those who succeed before they even start, knowingly or unknowingly, have an understanding about value investing (whether they call it that or something else or do not call it anything). 

They know, in simple terms, what an asset might be worth.  They have their own view of how to establish intrinsic value. 

They tend not to follow the herd and rush out with their money, along with everyone else because they suffer from that fear of missing out (FOMO). 

They understand the concept of intrinsic value and so they do not usually pay too much for investments and mostly avoid getting caught out that way. 

They also have their own way of understanding what the return on their investment should be. 

Many, many retired kiwi’s frustrated with term deposits

We know that many retired Kiwis are becoming increasingly compromised as interest rates continue to decline.  They are the retirees that are reluctant to get help with their investments and cling to term deposits because it is ‘safe.’ 

That, of course, is successful parking of money, not successful, long term investing.

That is because term deposits, like cash, are a medium of transfer and not a productive asset.  Productive assets grow, mediums of transfer do not.

You don’t need to be naturally intuitive with math to succeed

So, some investors succeed before they even start because consciously or unwittingly, they invest like value investors (with a fundamental approach – not speculation) and can make money work over the long run, regardless of market and economic conditions.

That is because they have something other than education and intelligence that allows them to be successful.  At WISEplanning, we call it Mentality Quotient (MQ). 

Simply, our behaviour as investors is an important key to success – a very different thing to markets, economies and all manner of clever financial analysis.

My clients, for example, resonate easily with what we now call eBiz Investing (value investing with an emphasis on the economics of the business).  I make it easy for them.

Does all this sound rather boring? 

I am not sure about you … for me though, when it comes to investing, I will take boring over unreliable and risky, pretty much any day of the week.

If it is fun and excitement I am looking for, there are plenty of other ways to go about it …

“Mentality trumps education and intelligence.”

                                                              Peter Flannery