A lot of trading books and courses will tell you in the first paragraph “Treat it as a business” and whilst that’s boring, it’s right. And one of my tennis partners has another trading cliché, “Do not trust yourself”, which is really the same thing. The more investment, and the more success you have developing a boring repetitive process that works, the more you’ll realise that it is not about “you” and whether you are any good, it’s about your process and whether that’s any good. You have to keep the personality out of it. You have to develop a rather boring process. Otherwise, you’re just another Australian gambler, “Come in Spinner!”.
So what is the process? Here’s an outline of mine.
Before you invest a dollar
- Collect your capital
- Assess your goal
- Calculate the returns necessary to hit your goal and the time period
At 55 for instance, I might set a 10-year timeframe. I might target “X”, the amount of money I think I’ll need by then to do what I want to do. Then break that 10 year period down into goals for this year, then next. You are basically working out whether your expectations are realistic and how hard you have to go to hit your target. You’ll soon work out if you are ahead or behind the 8 ball. At this point, you might want to see a financial planner to do it properly. No, not one whose modus operandi is to love you up for an hour before dumping you into a big fund manager's platform in managed funds so he can earn his trails for life off your super, but one that will tell you about tax, superannuation structure, and will give you strategic advice for a fee. Through this process, you will soon work out a suitable risk tolerance and what style of investor you are going to be.
Now you have your goals get ready to invest
Investment is made complex by a lot of bullshit theory. But when it comes to an individual investor, understand that all the financial theory (diversification, optimal portfolio theory, relative performance) simply does not work unless someone somewhere has invested the money in something that’s going up in price. That’s it. Your job is to invest in something going up in price. For you, as an individual with one goal, which is to make money, all the rest is bunkum.
So you need to develop a process that identifies investments more likely to go up than down (improving your odds is the best you can do – there are too many unknowns to allow certainty) and a process that then manages the risk (cutting losses) and allows the investment to have its head (letting profits run). How do you do that?
If equities are your chosen investment universe, your first mission is to develop a watch list of ‘quality’ companies. What you are trying to do through this process is narrow the probabilities. Improve the chances of buying a stock that goes up not down in price. This is as much a process of weeding out rubbish, volatile, unpredictable, fundamentally foundationless stocks, as it is about picking great stocks. Try and keep the list manageable (no good having 100 companies). You don’t have to capture every stock going up, just some, you will miss many, it doesn’t matter.
Using whatever means possible to collect ideas, from the media, newsletters, fund managers, anywhere. Even hot tips from a taxi driver. It doesn’t matter. You are going to do your own analysis not slavishly trust the word of others so just look for ideas. You are going to make yourself responsible for the stock pick and take responsibility for every outcome, so don’t worry about the detail, just find stock codes to take to the next step.
The next step is to put a stock idea through a set process of assessment to see if it comes out the other side. On this front there is:
1. Facts which you need to know but which are already in the price and add no value. Facts involve you finding out about:
- The business (what do they do)
- The balance sheet
- The historic earnings numbers, the earnings forecasts, dividend history, dividend policy, the PE, yield
- The drivers; the negatives, the positives.
All the stuff everyone knows and is in the price. You need to know the facts first.
2. Judgements, which is what other analysts think. There is a lot of research about and a lot of online offerings that purport to assess stocks. Broker research is the obvious resource. Find out what brokers are saying. Whether forecasts are going up or down, whether everyone is a seller or buyer. I list broker recommendations, target prices and main reasons. What other people think can be broken down into elements beyond just broker recommendations. Some research highlights “Moat”, others rate management (do they have skin in the games, is their interest aligned with shareholders). Find out what the market currently thinks.
3. Value - I am highly suspicious of something so simple as an intrinsic value calculation. It spits out this wonderfully simple number and is a complex enough calculation to suggest it must be right. But it isn't. There are huge assumptions in intrinsic value calculations and many are fatally flawed, but you still want to know what they say...on their assumptions. Basically, you have to have an idea of the value of the company and compare it to the share price, it may be wrong but it’s the anchor point and no matter your assessment of the quality of the business the share price will be one side of the valuation or the other. So collect all the valuations you can. Some are factual and in the company accounts (NTA). Do your own if you have the ability and resources. See what the broker research says about value (as often expressed in a target price). Just get some idea of what the market thinks it's worth. It’s a piece of information, find it. You need it.
4. Industry - Now you are trying to predict the future. What industry is the company in. What are the big drivers, what are the positive and the negative drivers, what could go wrong and right? List them. Now, and this is the first bit of fortune telling you are going to do and is the key to long-term investment success, try and predict what those industry trends are now and chances are they are going to continue. It’s a bit like assessing the trend of the share price without a chart, or maybe there is a chart relating to the industry drivers and how are they trending. You are trying to find companies that are swimming with the tide not against it. Again, you are simply trying to narrow the odds in favour of the share price going up not down. There is a lot of investment success to be had predicting industry trends and then picking stocks rather than just picking stocks.
5. Summarise – Now you should have a piece of paper (I have a page a stock on One Note on an iPad pro and I do it all handwritten with a stylus and colours - I'm visual and it takes too long to do it in type) that has lots of diagrams and numbers and lists of drivers and a range of valuations and broker recommendations and stuff on it. Now get the big marker pen and across the whole page write something that sums it all up. would be one possibility. “Quality stock” another. “Put on the watchlist” maybe, or “Good stock but wrong industry for now”. As I say, I like colour.
Basically, this initial process is about weaning out the crap and the risky and the swimming against the tide businesses and putting the rest on a watchlist as stocks you are prepared to buy. Stocks that have made it through to your watchlist. Lots of people called them “Quality Stocks” but that’s too descriptive. Perhaps just a “Watchlist stock” would be label enough. Stocks that you have assessed as having a higher than average probability of going up rather than down.
Now, this is where fundamental analysis ends and I pity all the fundamental analysts and their victims that think this is what investment is all about. Building a watchlist of stocks is probably 20% of the game, no more than 50% and certainly not 100% as most of the set and forget I can’t be bothered paying attention clients and advisers think. True success lies in the next, somewhat less fundamental steps. They include:
- Timing the buying
- Managing your risk during the trade/investment
Then there is one more step.
- Attribution - analysing your results and tweaking your process.
But enough for one day.
This is an excerpt from the Marcus Today Monthly Insights eBook: An Investing Process
Some great advice! Think I have been following most of this - more to do with dumb luck rather than a formalised process though. More food for thought, thanks.
Getting super excited to read your less fundamental steps Marcus!!!
Thanks Marcus. Some great tips and some worthy reminders.
Thanks Marcus. Some great tips and some worthy reminders.
There are so many holes in this it's bordering on irresponsible. You haven't even mentioned asset allocation, which has been found to account for almost 90% of the long-term risk/return outcome of a portfolio, whereas timing and investment selection is the 10% balance, yet your advice is advocating a self-directed investor spend 100% of their time on the latter. There are also countless academic papers that find the majority of stockbroking analyst reports are useless, the problem is an inexperienced investor is going to struggle to know which ones. As for using tipsheet gurus, a US study of the more than 6,500 calls made by 68 US gurus between 2005-2012 found a success rate of 47% - you get better odds tossing a coin. And Philip Tetlock found an inverse correlation between the profile of newspaper commentators and the accuracy of their calls. Nor have you pointed out that over the past 21 years the Australian stock market's returns have ranged from +30% to -22%, without some assets to offset that kind of volatility your self-directed investor is likely to be in for a gut wrenching ride.