Monday, July 11, 2016

The importance of having your own unique investment process

After observing market behavior for 20 years, I have come to the conclusion that many investors do not have a clue about how to make money in stocks.

There is a lot of noise out there, and a lot of opinions. Many times, you have two equally smart and successful individuals who end up reaching polar opposite conclusions, using the exact same type of information.

You are constantly bombarded by equally opposing and sometimes confusing and misleading bits and pieces of information on TV, Newspapers, Blogs, Forums, Twitter… It can get very confusing, and it is very difficult to make an educated investment decision when you get in this situation. It is equally as challenging to maintain a position that you have already established, if you are bombarded with confusing information all the time.

I have found that many individual investors get confused by all of this noise. It is difficult to go against a rich and successful investor, when you are a small time investor. It is also difficult to go against a publication that is considered to be an authority in the field. Yet, these could be just as fallible and blind sighted as the ordinary investor. This is why I believe it is important to develop my own investment methodology, and then follow it religiously.

This methodology should be tailored to who you are, and what you try to accomplish with your investing. The most important thing however is to establish an investment methodology that you believe in, and which you will stick to through thick or thin. If you bail out at the first sign of trouble, this is a sign that you did not believe in your method of investing in the first place. If you constantly switch strategies, and are looking for the perfect one, you will spend your life chasing hot tips, and clueless experts, all the while failing to take full advantage of the power of compounding to reach your goals. Do not be that investor. On the other hand, do not be the stubborn investor who never tries to improve on their process over time in order to improve odds of success.

As most of you are aware, my investment strategy has evolved over the years. I used to allocate all of my money to dividend stocks in taxable accounts, up until 2012/2013. Subsequently, I started getting smarter about the tax-efficiency of my investments. This is why I max-out my 401 (k) accounts first, and allocate anything that is left over in my taxable dividend accounts. I also try to pick any low hanging fruit, which can provide guaranteed investment returns. An example includes my Employer Stock Participation Plan, which allows me to purchase stock at a discount, and immediately sell it. But this article is about having the investment strategy to hit your goals and objectives.

The first step as an investor is to identify your goals and objectives.

The second step is to decide how to get there. Having a clearly defined strategy will help you get to your goals and objectives. If you do not follow your strategy, but instead look for short-cuts, it is very likely that you will never reach your goals. This is because you will jump from chasing one strategy to another, never really sticking to anything, and never really allowing enough time for a strategy to work for you.

I have found it helpful to follow a strategy, because I have an edge. I have figured out that I can afford to sit patiently on an investment for 5 – 10 – 15 years, as it grows earnings, dividends and intrinsic value. Most other investors would have bought and sold the stock at the first type of profit, and moved on to something else. Little do they know that time in the market is more important than timing the market.

I have found it helpful to follow my own strategy, because my analysis gives me the strength to hold on to my position when the going gets tough. I make money because of my own analysis or I lose money because of my own analysis. But I only have myself to blame ( or pat on the back).

I have found it helpful to follow my strategy, because I get to observe issues over time, so I can improve my investing results. The beauty of doing your own investing is that you get to make mistakes that you can learn from. If you blindly jump from one strategy to the next, from one investment guru to the next, you will never learn much about investing and how to invest your hard-earned money.

I have found that having my own strategy is helpful in removing guesswork and self-doubt. I know what I need to do under most situations. This is all backed by experience, observing company and investor behavior, and reading academic and practitioner accounts of various strategies, investor behavior etc.

I have found that having my own strategy protects me from people whose goal is to deceive me, or take my money away from me

I have found that doing my own work, and following my own strategy provides me with a clear picture of when to buy, what to buy, and when to exit. I do not follow tips from questionable sources, who may provide me only partial information about their investment decisions. Ironically, there is a high number of widely followed "dividend investors" I know of, who do not eat their own cooking.

I do not like tips, because I have found them to be very expensive. I have found that investors who follow others for tips, tend to chase a strategy or a stock after it has done very well. By the time these investors pile in, the stock or strategy has run its course and starts to experience some weakness. Those investors lose patience, and they sell. After they sell, the investment or strategy rebounds and keeps pushing new highs. Our investor is off to the next hot thing, having learned nothing in the process.

If you follow someone into a security, you are giving up control over the selection process. You may know when they purchased the security, but you do not know when they will sell it. You have no visibility as to why they bought the stock. This is dangerous, because you may be the last person to be notified when the stock is to be sold. You are also not learning anything, because chances are that the other person has not shared all of the relevant points with you. When you do investment decisions without any input on your own, you are like a blind person driving on the highway. The problem is that noone has your best interests at heart, than yourself. Actually, many people have an incentive to deceive you and sell you on to a product or service that will enrich them at your expense.

When you focus on others, you may be able to get lucky from time to time. But this is not a good foundation for your retirement investing. After all, you may be following a super investor such as Warren Buffett, and still lose money. This is because Buffett does not make money on every stock he purchases. The man is happy if half of the stock selections he makes end up turning a profit. In addition, you do not have a complete and timely visibility on his portfolio selections. To add insult to injury, you also have to guess whether the investment was made by him or one of his investment lieutenants. I have personally followed Buffett into investments, and have had mixed results.

Back in 2013, I was buying Accenture (ACN) and read about IBM from Buffett. I decided to add to IBM, because if it was good enough for Warren, it should have been good enough for me. Many others were very vocal about adding to IBM stock as it dipped to $190/share. Subsequently, many of these people were no longer owners of IBM stock at its lows around $130/share. Today, I read a lot of articles that either discuss the end of IBM, or others which discuss how cheap the stock is and how it would do so well over time. If I had not bought into IBM, I would have likely bought more Accenture, which I understood better. But at least I learned a valuable lesson – never to follow anyone blindly. That being said, I think that IBM is cheap today at 11.40 times forward earnings and a dividend yield of 3.60%. The company could deliver good returns over time because everyone “hates” it today. This has pushed valuation down, and the yield up. And I do believe that the company can afford to pay and grow the dividend. If you are wondering how this can happen, you may like this article,

In my case, I have been able to stick to my guns on three separate attacks against holdings that I own. Back in 2010, Bill Ackman had a short thesis against Realty Income (O). It was pretty scary at first that a highly successful hedge fund manager was short the very same company I owned. I checked my thesis, and decided to stay with my stock. The main reason I didn’t sell is probably because there were obvious holes in his argument against Realty Income – one being the fact that the company hadn’t disclosed its list of tenants, when in fact the company had disclosed that. Bill Ackman sounded desperate. Plus, it must have been expensive to short a stock, pay a 6% dividend to stockholders who lent the stock to him, and also pay a short rebate as well.

In another case, there was a hedge fund attack on my shares of Digital Realty (DLR) in 2013. Shares were falling for several months, and I did add to them on a few occasions. I did that, because I believed that the short thesis was full of holes. I did re-check my thesis however first.

The third case is the bear case against Kinder Morgan (KMI), which lasted for two long years. Initially, we had Barron’s and Hedgeye throw in a lot of rocks at Kinder Morgan. The company refuted those. Everything looked great, especially after management decided to roll up all master limited partnerships under the Kinder Morgan Inc umbrella. Unfortunately, the company kept expanding pretty aggressively, even as the oil and gas producers in the US were experiencing the pain of low oil and gas prices. The debt rating was lowered after one such deal, and the dividend was ultimately cut.

Overall, I have found it important to understand what my goals as an investor are, and devise a strategy that would help me to reach those goals. That way I get to learn about investing, and manage to improve over time. This allows me to stick to my guns throughout all phases of the stock market, and not chase hot stocks, tips, strategies or experts. The best thing is that when I find a strategy that is best for me, I can stick to it, and enjoy my life.

Full Disclosure: Long O, IBM, ACN, KMI, DLR, BRK.B

Relevant Articles:

The work required to have an opinion
How to become a successful dividend investor
How to accumulate your nest egg
Dividend Investing Knowledge Accumulates Like Compound Interest
Successful Dividend Investing Requires Patience

Popular Posts