“Everything should be made as simple as possible, but not simpler” Albert Einstein
Einstein once listed his five levels of cognitive prowess: Smart, Intelligent, Brilliant, Genius, and Simple. Simplicity on the face of it looks extremely replicable and easy. But it’s the case that the simplest-looking processes are often the hardest. Such is my investing process.
I never took any financial course apart from books and countless hours of thinking endured. It might have been a blessing in disguise as it allowed me to explore my own path and at my own pace. It saved me the horrors of unlearning that I would have had to endure as most of what is taught in financial courses is not useful for replication in the real world. And not studying for exams helped keep the entire discipline extremely fun for me.
Regardless, the first few years coincided with a brutal bear market which was not nice to investors in small and mid-caps. You learn the most in tough situations and most of what I learned over time was a result of the hammerings of that period.
Despite not being successful initially, my enthusiasm for the markets remained. More than the proceeds, I loved the process. The joy of finding a great investment still makes me happy. And I enjoyed the challenge to become a better investor. Also, the process made me explore many different disciplines such as psychology, philosophy, accounting, probability, etc. which have helped me immensely in my investing journey as well as my life in general.
Learning from the gurus of the field of fundamental investing like Benjamin Graham, Warren Buffett, Charlie Munger, Howard Marks, Mohnish Pabrai, Guy Spier, Peter Lynch among others has helped me navigate the markets and simplify my investing process.
It took me some years to pin down an investing strategy that was complimentary to my inherent nature as a human being. I am still a work in progress and will probably be for the rest of my life, but things are way clearer to me now than they were when I started.
If I have to break down my Investment Philosophy into a few pointers, here’s how I’ll go about it.
- Fundamentals
At the end of the day, all stocks signify an underlying business that operates in the real world. My job as an investor is to avoid focusing on the drama that goes with the ticker tape most of the time and instead focus on the underlying business.
And when I buy the stock, I buy a part of that business. That business over the longer term should have a great business model while being run by a competent and ethical promoter. For that, I must have a great understanding of the mechanics of the business, its fundamentals and its medium-term future.
- Valuation
It doesn’t matter if I buy an extremely wonderful business with a great management at helm and an enviable market position. If I pay a high enough price for it, it’s a bad deal most of the time. It doesn’t get simpler than this. Great companies do not always correlate with great investments. It is of paramount importance to buy good companies at a cheap or at least a ‘fair enough’ price.
My focus on cheap valuations checks a few boxes.
- Firstly, it ensures a good Margin of safety on my investments. If I go wrong on my thesis, I don’t lose much.
- Secondly, it keeps the asymmetricity of my investments intact. If I get it right, I want to be really right.
Cheap valuations ensure that I can aim for higher asymmetricity (or a skewed risk-reward ratio in my favor) for my investments while keeping any potential permanent losses on my capital to a minimum. Sometimes it makes sense to pay a higher price for better companies but those occasions are rare and my focus is not to make that the norm.
- Probability
The world we live in is extremely probabilistic as it is full of Black swan events and unforeseen outcomes. Nothing is absolutely certain and at best we can only make sound predictions. My job as an investor is not to avoid these unavoidable events but to assess the potential ways to better deal with any adverse outcomes. Over the longer run, it is way more important to survive and not lose your rationality in times of extreme euphoria or despair.
Thus, it’s important to assess the rough probabilities and likelihood of the scenarios that might play out in my investing positions. Such a process is extremely useful in keeping my losses to a minimum and potential gains to a maximum.
- Temperament
Since I invest in a business for the longer run, it is important to have a sound temperament. Majority of what makes ‘sound investing’ is temperamental. One needs to have enough patience to stick with their bets over the longer term. On top of that, one needs to have a good control of one’s emotions and be aware of their mental biases/incentives at play while retaining their independent thinking. Having such a temperament is the cornerstone of my investing philosophy as a long-term value investor.
That’s about it. Of course, there are many more caveats to my investing processes which are hard to explain briefly in a simple write-up. Such as my selling strategy, views on diversification, preferred industries to invest, etc. But I hope I was able to give you an idea about my “apparently” simple investing process.