MMM

Investment Perspective – February 2015

“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

The markets – do they matter?

What I mean by that is prices rise and fall on the back of market sentiment. When the markets are happy prices tend to rise and when markets are sad prices tend to decline. This is a bit like night and day – dependable.

However, what is less dependable is how investors respond or react.

I have watched those with significant education and intelligence fall victim to the fear and greed cycle. One would think they would “know” better.

I have watched others with much less education and a lower level of intelligence, but with the right mentality, stay the course and succeed with money where others with the same opportunity have failed.

For the inexperienced and those without the right mentality, markets can side track or even trick people into thinking things are different than what they really are.

What I mean by that is sometimes prices rise strongly very quickly (e.g. Xero). Or sometimes they decline very swiftly as though the end for that particular business is all but a foregone conclusion, e.g. Creditcorp (CCP.AX) declining from a high of $12.55 in late 2007 all the way down to 41 cents in 2009.

Whilst none of my clients bought at the top, they certainly bought part the way up that “mountain” and rode it all the way down.

By the way, if you care to google https://au.finance.yahoo.com/echarts?s=CCP.AX you will see the extent of the rise and decline in the trading price.

Long story short, there was good reason for the price to decline however if we look at the underlying business model we can see why my clients and I stayed the course, averaged down the original buy price and kept doing so until such time as the price stabilised. The result has been good returns for investors because the price declined so much and has since recovered.

My clients and I cannot predict the future. What we can do is have an understanding of business and how it works – and how it does not work. Anyway, that helps us to focus where it matters which is on the underlying business fundamentals rather than the rising or falling share price.

Markets have a way of side tracking us and making us focus unwittingly on that fear and greed cycle if we do not focus on the right thing – the underlying fundamentals of the business.

The winning investors’ mentality

Investors who are cautious rather than conservative invest to not lose money and keep their capital “safe” – that’s it.

Investors, who are conservative rather than cautious, have an intense dislike for unacceptable risk, invest also to keep their capital safe and they invest for growth.

They understand the difference between price and value.

They are able to separate out the noise of the market from the fundamentals of the business operation.

If it were that simple and logical though why don’t all accountants and professors of finance practise Value Investing?

The answer is that it is not about one’s level of intelligence or ability to crunch numbers (they are not bad things) however, it seems to come down to one’s money mentality (mindset). That is the bottomline.

It has been well documented that intellectual intelligence (IQ) and emotional intelligence (EQ) are different things.

A number of years ago I developed what I call Mentality Quotient (MQ) which in simple terms is about one’s mentality, mindset (habits, attitudes and experiences) and psychological makeup.

Whilst I am not always able to convert those who are strongly cautious into advanced conservative investors who tolerate pricing volatility easily and invest for growth, I have been able to assist many, many conservative investors who dislike risk but understand the need for a degree of pricing tolerance, keeping our feet firmly on the ground as it were, and investing for growth.

Nothing tricky, nothing clever, just fundamental, sound, reliable with a good degree of certainty.

Method

Method is how we do it. How we do it is in simple terms to look for good businesses that fit certain criteria.

For example we can look for a business offering growth opportunity such as Starbucks and know that its financials will fit a specific criteria.

We can look at another business that represents a value opportunity knowing that its set of financials broadly fit yet another set of criteria based around a good business that represents good buying.

There are other methodologies too. For those who are perhaps more advanced(?) or certainly more tolerant of pricing volatility, we can look at small companies such as FSA that are more risky and not for the inexperienced. They offer a much bumpier ride so to speak than a Value Play generally and of course they can offer much greater upside potentially as well.

The point here is that a specific methodology and discipline around the method are key components of investment success. That is my experience and it is the experience of others who are successful financially.

Markets, mindset and method

These could be called the three M ’s. They matter, because investing is not just about putting money into things and hoping for the best. I grant you that the uninitiated might think investing looks a lot like that, particularly in the short term as prices gyrate significantly.

Longer term though, a simple understanding of how the markets work, discipline around strong method with the right mindset to pull it all together and make it work, is a simple recipe that has worked for my clients and I for many years.

I have mentioned to many of my clients that there are certain rules of the universe that we cannot ignore.

Things like…

“The things that hold you back are the raw material for further progress”.

“There are no mistakes, only medicine.”

“When investing in the stock market in the early years the money we make is determined by the voting machine (market sentiment). The longer we invest the more the returns we make are based on the weighing machine (the underlying fundamentals of the business).” That of course is a famous phrase by Mr Warren Buffett himself.

The point here is that there are some simple guidelines and principles that we can follow that are not complicated but do require a certain mindset for success.

Sometimes just understanding that is an excellent place to start …