Five years of managing the FNArena-Vested Equities All-Weather Model Portfolio has triggered a reflection upon experiences and errors made.
Below are my seven ingredients to become a successful investor in Australian equities.
1) Quality Beats Valuation
Too many market participants are too focused on scooping up “cheap” stocks. Sure, we all like a bargain, and a share price that falls to an extremely low price level will (at some point) rally higher, but sustainability and continuity are usually not included.
Cheap stocks, according to the value-investor’s narrative, are most beneficial entry points for long-term returns.
But when societies go through tectonic changes, and economies and business models are being disrupted on a daily basis, “cheap” looking stocks are simply the equivalent of the price discounted block of cheese at the local supermarket.
The expiry date is near. Don’t plan too far ahead. It’s a short-term fix, at best, not a long-term sustainable value creator.
Instead, it pays to identify high quality companies with a multi-year runway for growth, don’t get too spooked when valuations get temporarily a little bit bloated, and stay the course.
The best performing stocks in the Portfolio were trading on a PE multiple well above the market average when purchased, and they are still owned today.
2) Don’t Lose Your Focus Because Of Technical Analysis
I’d be homeless and roaming the streets by now with an empty coffee cup in hand, begging for change if I had to pay a dollar each time one of the stocks in Portfolio got hit by a negative trading signal stemming from technical analysis.
On my observation, technical analysis works best for low quality, highly speculative, small cap stocks. Probably because most of such stocks have nothing else going for them.
Quality, larger cap stocks can fall through the 200 moving average, or be rejected at a certain pivot, but as long as profits and fundamentals remain intact, it’s nothing but short-term market noise.
Pay attention, because so many others do, but don’t lose your focus or conviction because of short-term trading impacting on the share price. Positive fundamentals shall prevail.
Plus, of course, Quality companies surprise positively more than they do not. The latest example, as I am writing today’s story, is provided by Fisher & Paykel Healthcare ((FPH)) shares rising by more than 6% after releasing FY20 financials on a day when screens are almost universally coloured red.
3) Timing Trends Is Really Difficult
Plenty of books and newsletters out there that educate investors about cycles, changing trends and the investment clock, but putting it in practice proves a lot more difficult most of times.
At the beginning of the year the general idea was to jump on board oil and gas stocks, which then fell the hardest.
Only a few weeks ago strategists were re-weighting model portfolios towards more exposure to banks and miners.
Guess which sectors are among the weakest performers in June?
Robust, non-cyclical all-weather performers won’t keep up with those high beta, cyclical exposures when sentiment moves into Risk On mode, but on the other hand, they don’t fall as deeply when market sentiment sours either.
The latter means the Portfolio doesn’t need to make up as much to turn positive after a period of extreme volatility and heavy down-draught.
In simple terms, Quality and robust businesses are more resilient during tough times, and quicker to recover. These core characteristics are mirrored in how their share prices behave during downturns and bear markets.
This, I believe, is one of the key factors supporting the Portfolio’s performance.
A second factor lays with mega-trends; they run for many years, and create long-lasting mega waves along the way.
It’s so much easier for any management team to obtain labels of quality and excellence when their business is carried by such positive mega-trends. But every investor should be aware that the opposite very much holds true as well; irrespective of a "cheap" looking share price.
4) Accept Your Mental Barriers
Suppose you are convinced a share price has overshot to the upside, why would you not sell all your shares?
Because if the long-term growth trajectory of the company remains intact, that share price will end up a lot higher in years to come.
In other words: today’s over-valuation is but a temporary, short-term phenomenon and if the share price doesn’t pull back far enough, you won’t get back on board.
On my observation, quality companies in great shape are most likely to surprise on the upside, and they will take you by surprise shortly after you sold out.
Selling all your shares automatically creates a mental barrier, which makes it much harder to get back on board.
Taking profits in Xero ((XRO)) at $48 in September 2018 would have generated a nice profit, but today the shares are trading at $87. What if I subsequently had failed to quickly buy back in during the pullback?
I could potentially have missed out on the next 80% in additional upside (and the shares have been higher).
Many investors, on my observation, are too easily guided by short-term considerations. Of course, it’s only worth sticking around when companies deliver on their promise and potential, and there will be doubt and disappointments along the way.
One of the ways to deal with constant uncertainties is to adopt a holistic, portfolio-oriented approach. This means you can deal with falling share prices, and small disappointments, because the Portfolio as a whole is performing.
Keep the following motto in mind: for an underperforming company, it’s never too late to sell, while for a consistent, solid performer it’s seldom too late to buy.
5) Risk Management, Not Trading
Irrespective of what transpires inside or outside the share market, you will be selling and buying shares, irregularly or otherwise.
There is, however, a difference between trading the Portfolio or simple risk management.
Over the past 5.5 years I have mostly sold shares to reduce risk when the odds seemed to move in favour of a large drawdown (when Cash is King), or to skim a bit off the top of a temporary overheating market darling.
I sell out completely when I believe the future trajectory of a company has been severely damaged, or when I have to conclude that buying in was a misguided decision.
We all make errors, but the worst one is sticking around because the share price is now lower than when we joined the register.
We must accept things do not always turn out the way we envisage them. Changes are happening every day. Some cannot be anticipated; in other cases, we might have been blinded by whatever.
I tend to sell quickly, without regret, and move on.
Part of my Portfolio management also consists of getting rid of dead wood and disappointments when another bear market hits (we had three since 2015) in order to concentrate on the High-Conviction holdings.
6) Know Your Stocks
Marcus Padley once wrote a story about the one stock portfolio. The idea is to get to know everything about that one company, so you know what moves it, what is important and what is merely noise or market tribulation.
It’s a rather extreme concept, but I see a straightforward similarity as to how I keep track of the companies I own in the Portfolio.
You first select them because you believe in their growth prospect, and once you own them you keep track of them, so you get to know them better as time goes by, learning new things, discovering fresh insights.
The true value of investing with a long-term horizon is that you accumulate knowledge and insights about the investments you own. On the premise, of course, that you continue reading and paying attention to research updates and fresh developments.
As the old saying goes, you can copy somebody else’s stock tip, but you cannot copy their conviction. That conviction to not sell out when Xero shares hit $48 can only come from your own knowledge and personal insights.
7) Regrets, We All Have A Few
The best comparison for investing is a round of golf. It’s never about being perfect. It’s about making sure that the mistakes you make don’t destroy all the positive achievements.
Not being perfect also means we all end up with a few regrets, every now and then, in hindsight. In golf parlance: that’s simply par for the course.
My regret is called Macquarie Group ((MQG)), without any doubt the highest quality financial institution in this country.
When the covid-19 lockdowns arrived, and a new bear market seemed to have been thrown upon us, I sold out of Macquarie shares because I envisaged multiple years of asset write-downs and challenging deal-making conditions.
Of course, things turned around rather quickly since, and as yet another example of the human brain creating barriers, the Macquarie share price simply rallied away from me.
Regrets, we all have a few. That’s simply the nature of this game. But if the overall performance of the Portfolio isn’t too bad, we should not dwell upon them for too long.
The share market being the fragile, unpredictable and mercurial beast it is, there will be opportunities to get back on board, patience permitting.
But before that can happen, we must have Macquarie on our radar in the first place. This too is where my personal narrative differs from the ones that are dominating the general focus and commentary.
I don’t look for “cheap” stocks, and then jump on board. I have a pre-selected list of quality stocks I’d like to own. Then the story begins…
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Great article as usual Rudi. I share your pain re MQG, I did EXACTLY the same thing, I'd tripled my money on them over the years and they were 6% of my entire Portfolio. I sold half of my FPH earlier in March at $22 because everyone said they were too expensive and 4yrs ago I sold out of XRO at $19 for a 25% profit because everyone said they were way overvalued and would never make money. Live and Learn, I need to live forever !
I learnt something from that thank you.
I wonder how could the General Electric's demise be explained in light of your 1) Quality beats Valuation- conviction. GE share price reached $60 in 2020 and here 20 years later down to $7. "GE is a global digital industrial company with products and services ranging from aircraft engines, power generation, and oil and gas production equipment to medical imaging, financing and industrial products." a quality company by digital era metrics and yet failed miserably. Please explain.
I don't think a decision can be judged based on its near-term outcome. If I bought MQG at $90, sell it at $110 for a perfect rational reason, and the share price hits $150 a month later, is that a 'bad' decision? What if the share price plunged to $80 the following day? Do you then call that a 'good' decision? You can only judge your decision based on the process of how you make it, not by looking where the share price is heading.
Lover your reflections and general common sense Rudi. This quote of yours one of the best I will treasure: "Keep the following motto in mind: for an underperforming company, it’s never too late to sell, while for a consistent, solid performer it’s seldom too late to buy."
Good analysis. In regard to your points about prioritising quality, one thing that always bemuses me in most debates about investing approaches is that people seem to think there are only two - value vs growth. In fact quality should be the key criteria as you mention above. Pure value and pure growth are both dumb as neither considers quality.
Amazing stuff mate! keep it up i'm learning heaps from you. Thank you for sharing.
You're right! Investing is like golf. Harder than it looks and lessons are expensive. Still the occasional win is enough to keep us coming back.
Your first point reflects the fact you haven't been investing through different market cycles. Over the last 10 years growth/quality stocks have vastly outperformed value stocks, to the point where the valuation difference between cheap and expensive stocks is at extreme levels. Over the long term value stocks outperform growth stocks as investors price in too much earnings growth. Be careful extrapolating from a recent trend. And be extra careful saying this time it's different.
To A. Ozaydin: I think you already answered your own question. Companies can lose their way. GE was probably one of the best quality performers in the 20th century, but they lost their mojo and never got it back. At least Woolworths in Australia only fell victim to too much hubris at the top level for a short while:)
To Nick bird: if you look far enough throughout history, you'll find that 'value' requires simple & straightforward economics and long, drawn out cycles to outperform. What many investors are (still) painfully missing is technological disruption and economic transformation are the deathknell for value companies because they either lose their reason to exist or must go through a laborious transformation, which seldom coexists with great rewards for shareholders. We are experiencing a repeat of the 1920s on steroids. I suggest you start reading up on that period. Ultimately, the pendulum will swing back towards 'value' again, no doubt about that, but what if that point is still five or ten years away? And yes, this time really, really is different. I actually cannot believe there are still people out there who put a question mark behind that statement. It's been different for over a decade now, and it's not going back to what it was, not anytime soon anyway. Sorry to disappoint you on so many levels :)
To Ricky Yeo: Last year, 2019, marked the formation of CSL millionairs. Everyone who put $2000 in the CSL IPO, and kept their shares up until that point instantaneously became a millionaire in 2019, dividends received over the period not included. There is one big condition: thou shalt not take profits or sell your shares at any point. That's the key point I was trying to make. If you abide by a different strategy, that's fine, but realise you then will never become a CSL millionaire. The portfolio I run has several CSL-alike types of investments. Time for that Warren Buffett quote: what's my favourite holding period? Forever!
To Nick bird (2): My analysis suggests the buy "cheaply" narrative that dominates the share market painfully misses the point about long-term investing. I can easily show you how/why. What is the best performing bank in Australia over 20, 10 and 5 years? CBA. Which one is the worst? NAB. Here comes the apparent contradiction: CBA has steadfastly been the most "expensive" stock while NAB was consistently the "cheapest" of the bunch. Quality does matter, and it has nothing to do with 'value' versus 'growth'. Once you understand this, and by all means do your own research, but you will never ever look at shares in the same way. That's the essence of the first point I was making in my story
I bought more MQG when I saw them @$79 as MQG was my star during the GFC. I bought them then at a ridiculously low price of around $20 & they rebounded so with that faith I bought them again @$79 hoping they wouldn’t let me down & they, as yet, haven’t!