How to Make Money – Part 2

Investment Perspective – July 2016

“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

Be Boring and Make Money

Use a simple method that works – apply discipline to it.

I realise the above sounds a bit dull. Remember though, we want to keep our money secure and make it work for us – not just when things are going well and market conditions are playing nice. 

To put this another way, it is not about looking good, impressing our friends or convincing ourselves that somehow we have the makings of an investment guru. Well … you can do those things however they are inconsistent with successful investing and making money do the work.

Price and Value are Not the Same Thing

Do you agree with that? What do you really believe? 

Most people don’t bother investing. Most wish for a better life but alas, are not serious.

For those who are progressive, having considered numerous ways to invest, most investors discover that they can have some good “investment wins” early on and start believing that investing is easy, anyone can do it. 

The longer we invest though, the more difficult it is to generate real returns sustainably. This is especially true if our investment methodology is based around second-guessing and outwitting the market – momentum investing (share brokers), trading, mum and dad investors chasing the “latest idea, everyone is doing it, sure to make easy money”. 

Sure, there are traders who use complicated moving averages, chart formations and logarithms that promise much. Frankly, who really understands any of that? How many stay the distance and master the high level of skill required to make real money this way long term? 

You see, whilst it is no guarantee of investment success, if we can establish a sensible “intrinsic value” for an investment, whether it be big business listed on the sharemarket, a rental property or our own small closely held business, we have a good chance of succeeding as investors. Even though it may not look like it along the way, we will likely achieve more than most as investors.

Big Business Investing and Intrinsic Value

Intrinsic value is based on the underlying performance of the business – not prices moving up and down. 

Why is it then that investors pay so much attention to price fluctuations and the cash up value of their investment portfolio rising and falling from one 12 month period to the next?  

Why do so many investors base their investment success or failure over the last 12 months on whether or not prices are up (supported by popular sentiment) vs prices down (driven by negative market sentiment)? After all, price movement is a symptom, a result, not a fundamental driver / cause.

There can be a real focus on whether an investment “beat” a particular benchmark over the last year or even over the last month! Well, that might matter if we are investing in the price thinking it is value, if we are traders or are playing the standard Modern Portfolio Theory game where price and value are considered one and the same.

Markets and most investors dislike pricing volatility. Funny. Low prices are where the bargains live J

That “Reptile Brain”!!

Whilst it is not “cool” to discuss this kind of thing (particularly with investors!!), the reality is humans are not robots. 

We have emotions and are subject to the “reptile brain”. 

This means then that we will respond, or more likely react to events with our money in a way that does not always match our big picture goals and investment objectives.

You only have to look at how the markets reacted to Brexit to see a mix of uncertainty, consternation and fear that drove prices up and down. 

For example, the New Zealand dollar at the moment is now much stronger against the UK pound because the pound has declined due to worries about what the future holds for the British economy. I might add, some of those concerns are well founded as, more than likely; the impact will be somewhat negative in terms of economic activity and possibly slower growth. 

Quantifying this, as I have mentioned previously, is difficult and we are just not going to know until information continues to emerge and we can get a clearer picture. 

This uncertainty is something the market generally does not like at all. That is when “the reptile brain” kicks in. Investors react by being scared, worrying about what the future may hold and how it might bring damage and hurt.

That is of course unless you are of the “Value Investor variety” that has a different way of investing to almost everyone else.

Brexit Was Unfortunate Because …

Brexit was unfortunate because prices did not decline much. 

I know the popular media made out as though trillions of pounds of investors’ money disappeared in the blink of an eye as a result of the Brexit vote for Britain to leave the European Union. 

If you have had a look at your portfolio then, you will know that actually, the price movement was sharp but did not last long and any “price” decline is now mainly as a result of a weaker pound against the New Zealand dollar (the trading prices of many companies have dropped and quickly rebounded back). 

In fact, the New Zealand dollar is strong against the US dollar, the Australian dollar, as well as the pound.

So, unfortunately the opportunity, the window for us to capture some bargains was limited – I was hoping for more.

The Economic Clouds Look More Structural Than Cyclical

There may be some patterns. Cycles do exist however; because of the significant central bank intervention in many countries around the world, I am not sure that in the current global economic environment that those familiar cycles of yesteryear are quite what they once were. 

For example, the global economy and asset prices in particular are propped up by a significant amount of debt and low interest rates. Central bankers around the world are highly accommodative, particularly when an unexpected event occurs – they step up and “make good”.

We all know that whatever the central bankers do is a patch – not a permanent fix.

So, Shouldn’t We All Be Worried Then?

Personally, I do not waste 1 second on worrying about pricing fluctuations. I also suggest that if you do, that you may like to allocate that time and energy elsewhere…

“If you are going to worry about your investments, I suggest you worry about not investing enough, not investing for growth, not understanding / tolerating pricing volatility, not focusing on your big picture long term goals, not understanding the importance of intrinsic value, not getting help if you need it, not relying on proper method, not being disciplined (boring) …”

By investing in investments that have sound economics, regardless of the global economy or New Zealand’s economy, we can keep our money secure and make money work for us.

To be clear, we invest in the underlying economics of property. That means an income stream from rent, a property situated in a good location, a property that is in a good state of repair and therefore has the ability to attract the right calibre of tenant.

We invest in the economics of big business which is the sustainable competitive advantage, the brand strength and if they have it, their eco-system. 

Price movement whilst an entry or an exit point at best, as you can see has little to do with it. 

We are not investing in the price or the price movement. We are investing in the underlying economics. That is how we know we can be successful investors, long term.

We do not need to predict the future. We do not need to know what the economy is going to do next because we are not investing in the price. Price and value are not the same.

You will know if you have been an investor with WISEplanning for any length of time that you will have had the opportunity to average down on an investment in your big business portfolio. That is normal. It is not a bad thing; fact – it is a good thing. Low prices are where bargains can be found.

What is bad, is expecting the trading price of an investment to track up in a straight line and then being disappointed when it does not!

The solution to that I suggest is to think more about the economics of the investment with less focus and less emphasis on price movement. After all, isn’t price movement, particularly in the short term, all about market sentiment – that reptilian brain – the herd instinct – the fear and the greed …? Surely you do not want to invest in that!

Good businesses use capital well, do not have too much debt and reinvest earnings to grow (rather than pay out dividends). They have sound economics, are also innovative and adaptive.

Let’s just invest in them. Let’s be boring (disciplined) and avoid getting sidetracked when prices fluctuate sharply. That way we protect our capital and make money work for us long term.

“Our approach is very much profiting from lack of change rather than from change. With Wrigley chewing gum, it’s lack of change that appeals to me. I don’t think it is going to be hurt by the internet. That’s the kind of business I like.“

Warren Buffett