Edgy Businesses

I only invest in very high quality businesses. Part of this is about the business economics, which can be captured in financial metrics: I like businesses that are highly profitable relative to their costs and how much they need to invest in capital. Another more qualitative part of my assessment is whether a business has an edge. Continue reading

Fat tails

I’ve often read that over the long term the most important factor driving equity returns is valuation. While share prices experience momentum over the short to medium term, eventually investors become more conscious that valuations are becoming ‘detached from reality’ and prices revert to mean.  Along this line of reasoning, momentum following is a dangerous game that can lead to bubbles and then crashes, such as the infamous ‘Dot-com’ crash in 2002-3. While there is truth to this analysis for the stock market as a whole, it misses a key nuance when you look at what is going on underneath. Continue reading

Broadening horizons

There has been one a rather obvious way to improve my investment performance that I haven’t yet exploited. It has been on the back of mind for some time. This is to broaden the universe of stocks I invest in to beyond those that trade on the London Stock Exchange. I think the benefits of this have the potential to be quite dramatic. Continue reading

Using stop losses

I’ve decided to have a more detailed look at my use of stop losses. By using a stop loss I mean selling a share if its price falls to a predefined level. Stop losses fit naturally within a momentum based strategy, as they discipline you to sell shares that lose momentum.

My current use of stop losses is a bit ad hoc and I’ve been wondering whether and how to be more systematic. In particular, I’m concerned that I might be applying them a bit too vigorously. There have been a few occasions recently when I’ve sold a share on price weakness only to buy back again a couple of weeks later when the price has bounced.
Continue reading

Trading news flow

One of the first things I learnt when investing was to ignore news issued by the businesses I invested in. News would be taken account of immediately by the market. Bad news often meant an opportunity to buy a business at a cheaper price as it would already be baked and into the price and, provided the business was good, the bad news was likely to be temporary. This seemed to make sense at the time and appealed to my desire to be smart and ‘contrarian’, but like pretty much everything I learnt from reading beginner value investing articles at the time, it was terrible advice.

I’ve found overwhelmingly from my experience since then that buying shares soon after they issue positive news leads to outperformance (and vice versa). As I have later found, there is a huge wealth of academic research supporting this too. Continue reading

Valuation metrics

Buying assets for less than they are worth is fundamentally at the heart of most sensible investment strategies. However, approaches to identifying value can range widely, from direct attempts to value businesses to approaches that exploit the systematic behavioural errors that other investors make (resulting in ‘factors’).

In my view detailed valuation exercises are generally too arbitrary and difficult and so are a bit of a waste of time compared to basing a strategy on statistical factors (e.g. quality, value, momentum). However, some simple valuation modelling can have incremental value if you understand its limitations and get the rest of your investing framework right. Continue reading

My crystal ball is better than yours: superforecasting

The inspiration for this post is a book I read recently called ‘Superforecasting: the art and science of prediction’ by Philip Tetlock and Dan Gardner. It’s a good read with quite a few interesting insights. The possible applications of these insights to investing really struck a chord with me. Continue reading