I realized early in my investment career that I neither had the mental horsepower nor the will power to apply complex mental models and robust 300-line item investment checklists, while also assessing whether I’ve fallen prey to a myriad of behavioral biases. Instead I’ve tried my best to replace complexity with simplicity. One of the ways has been to apply simple qualifying statements in a way that focuses me on what matters most.
In the articles, Don’t Be A Chicken and How Can I Hurt You?, I mentioned two such statements or questions that I use to assess the quality of a business. In this article, I’ll give you a third statement that you can apply to assess what new information, data, news is material to your investments.
Over a lifetime you will likely own 10-20 big winners and hundreds of failed impostors. Finding and buying potentially great companies isn’t the hard part. Holding your winners and identifying and selling your losers quickly is hard. In The Art of Holding, I concluded: If you’re invested in great businesses that continue to grow and earn more money, don’t let lulls in stock price and boredom scare you out of them.
Successful long-term investors have the ability to disconnect the business from the stock price. It’s why it’s important to focus on being a great business analyst, not a stock analyst. Active patience is the hardest skill-set to develop.
Active patience = diligently verifying your thesis and doing nothing until there is something to do.
As investors, we are under constant attack of information overload. Most of it is self-inflicted. On average, people spend 8.5 hours each day consuming some sort of media (Television, Internet, Radio, etc). What percentage of this actually makes you a better person let alone a better investor? Correct, very little. This deluge of information can make it difficult to focus and remain disciplined.
I’m not going to bore you with 1,000 more words on why you need to turn off the financial media outlets, stop watching stock prices, today’s politics, interest rates, currencies, jobs data, etc. You know what you need to do. Now do it. Clear your mind of distractions so you can focus on the long-term.
“Absorb what is useful, Discard what is not, Add what is uniquely your own.” – Bruce Lee
One of the negative side effects of constant exposure to short-term distractions is it causes you to overthink and overanalyze. You start believing everything is important, when in reality very little of it is important. A butterfly farts in Spain and investors are analyzing its effects. Stop looking for every and any excuse …..to act.
So how do you easily qualify what new information or data is material to your investment thesis? First and foremost, you need know your positions better than most so you can quickly assess a situation. Negative events, speed bumps, and glancing blows will occur even during the maturation of great companies. It’s your job to know the difference between a glancing blow vs knockout punch to your investment thesis.
Here is a simple yet powerful question that you can use to qualify new information:
Does any of this new information make a material impact on the relationship or bond the business has with its customers?
I recently saw a similar question by another investor and thought it was brilliant. The most important determinant of long-term business success is the bond businesses have with their customers. Investors that know their investments better than most, and specifically, understand what drives the relationship with their customers will ultimately be successful.
Don’t be lazy and make lackadaisical assumptions about this bond or relationship. “Well, their product is cheaper, better customer service, blah blah, done! I understand the bond.” No, no no. Talk to customers and ask them. Get the differential insights that will bring the relationship to life.
A few years ago, I was conducting scuttlebutt research into an investment of mine. I spoke to four customers representing the four customer categories the company sold its products-services into. These customers were in the agriculture industry. One customer was a ranch owner. I asked several open-ended questions. He communicated that he’d been using the company’s service for several years. He used it because it made him more money. When I asked about switching to a competitor he quickly said, “No, I’d probably never do that. The other company hasn’t been around very long. This company has been around a while now, and I know and like their people. I trust them.”
I then spoke to another customer and he mentioned the “Trust” word again. I pushed him, “I’m not really understanding what you mean by Trust?” and he quickly replied, “Let me explain it for you. If someone shows up on my property (he owned 60,000 acres) and we don’t know you, we shoot at you. If we know you, we invite you in for dinner.” I remember thinking to myself, “Well that explains the company’s 99% customer retention rate lol.”
This differential insight allowed me to tune my information filter toward anything that could disrupt trust within the company’s ecosystem. Such an occurrence could be disastrous. But even more importantly, prior to talking to customers I thought certain things were very important, and after talking to customers, my assumptions were wrong. Don’t be lazy. Do the work. No assumptions.
The relationship and bond that your businesses have with their customers is what matters most. Understand the bond so you know what drives them. Everything else is just noise.
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On the one hand, the human psyche is highly-complicated. On the other hand, investing in its highest art form is simple. Between those two facts, much mischief evolves.
I’ve often wondered if a portfolio manager couldn’t beat 99% of other managers by implementing a few very simple and easy to execute techniques:
1. Study the market tops and bottoms of the last fifty years — their characteristics in terms of AVERAGE price to book, price to earnings and price to dividend yield.
2. Determine the companies with the best five year average return on assets (operating income as a percent of assets).
3. Buy the ten highest return on assets companies in five stages when the market is trading at 110% of the indicated low value. Increase the position on every 2% decline in value.
4. Sell in five stages when the market is trading at 90% of its indicated high value, on each 2% increase, generally after a holding period of 10 years or more.
That’s it and that’s all. Very simple. But the human mind doesn’t work that way. It evolved in a scenario of small groups of hunter gatherers where doing nothing meant starving to death.
What Buffett does, or at least used to do, is more complex than that but is still very simple. It is a strategy built around the power of steady compound interest. If you can’t explain why you are taking an investment position in one paragraph, you may not know what you are doing orwhy. He used to study every page of the Moody’s Manual looking at financial statement trends and price to value indicated by earnings and cash flow. Very simple.
I often read of portfolio managers who state that they follow the Buffett investment strategy, and yet when I look at their portfolios I see lots of lower quality companies, lots of bets on change rather than bets on steady compound interest. What Buffett does, or used to do, is very simple, but the human mind isn’t naturally inclined toward that kind of simplicity, patience.
My favorite investment quote is by Pogo:
We’ve met the enemy, and he is us.
Rod, thank you for another thought provoking comment. Your four step technique would be very interesting to see carried out.
Your last paragraph is something I often think about. If the millions of Buffett followers actually did invest like him wouldn’t his form of value investing be the most crowded trade around?
I agree simple things are difficult to execute on because it’s our human nature to want to make it more complex to prove how smart we are. And it’s hard on the ego to just sit there and do nothing. You sometimes have to wait years until you are proved right. That is a long time for the ego to go hungry.
Yes, the ego. What to be afraid of, what to be proud of, how to get recognition from others that we are special. The need to belong. Impatience. Laziness, especially mentally-laziness, being unwilling to consider contrary points of view. The desire to believe what is convenient, what we want to believe.
These are not helpful traits in investing.
We’ve all got them to a greater or lesser degree. I have a close friend who has devoted his life to protecting wilderness. In support of that, in addition to meetings without end, he embarks on long solo wilderness treks and gives talks along the way about the importance of biodiversity. He doesn’t seem to have much fear or need for personal recognition, but I doubt he’d be a good investor. One problem is he doesn’t care about money, other than to buy and protect wild places, for which he’s raised many millions of dollars. So it’s not as simple as humility and clear thinking. Drive to succeed counts for a lot in everything, including investing and protecting wilderness.
But the emotional buttons, fear, the desperate need to belong, to be considered special despite all evidence to the contrary. That’s what con artists hone in on. Con artists and politicians.
Philip Fisher would be proud ?. Thanks for the write-up and we also enjoyed your interview with Patrick.
Stephen, thank you for your kind comment. Appreciated.
Thanks for the article Ian and for sharing all your knowledge constantly, it is very useful for starting investors.
I have also listened to your interview with Patrick more than three times already and I’m also enjoying it very much.
I would like to ask you a question if you don’t mind. I am having problems finding a real moat in companies. After getting familiar with the company sometimes is not clear to me whether the company has a moat or not( Unfortunately not all the companies are Amazon). From your experience, can you tell if a company has any moat just by looking at its numbers? For example some kind of ROC, or Gross Margin, etc
Thanks for the question. It can be difficult to find a moat just by looking at the numbers. Here are a few other resources on moats you might find useful if you haven’t read them already:
The Little Book That Builds Wealth by Jack Dorsey
The Vision To See Economic Moats
Measuring the Moat
Thank you very much!