Stock Investing – Know What You Own

“The common intellectual theme of the investors from Graham-and-Doddsville is this: they search for discrepancies between the value of a business and the price of small pieces of that business in that market… I have seen no trend toward value investing in the (65) years I’ve practiced it. There seems to be some perverse human characteristic that likes to make easy things difficult. The academic world, if anything, has actually backed away from the teaching of value investing over the last 60 years. It’s likely to stay that way. Ships will sail around the world but the Flat Earth Society will flourish. There will continue to be wide discrepancies between price and value in the marketplace, and those who read their Graham & Dodd will continue to prosper.”

Warren Buffett

I make no claim to be as knowledgeable as Warren Buffett, however, that doesn’t mean I don’t try to use his advice the best I can. 

For me, investing is primarily about risk management – as Buffett repeatedly comes back to – and secondarily, about trying to find asymmetric upside on enough of my investments that the risk I do take is worth it. 

I have found that the best way to manage risk is to stick to investing in good to great companies. I know this might jump out at you as common sense, but it is amazing to me that clearly more than three-quarters of investors do not really even try to only invest in good to great companies. 

Most investors try to invest in one of two ways.

The first way most folks invest is that they index. They might not know that they index, but that is what the vast majority of mutual fund investors are doing. Indexing of course is the surest way to take 100% of the risk in a market. Why is that? Simple, you own an entire market. By definition, that is 100% of the risk. I don’t like taking 100% of the risk of a market, so I don’t do this. 

In addition to taking 100% of the risk of the markets they are in, most mutual fund investors don’t come close to getting 100% of the gains, due to expenses. Only a few actual index fund companies can come close to about 99% of the gains due to lower management fees and fewer trading costs. Most mutual fund investors are using much higher expense managed funds that aren’t actually index funds. But by owning six or seven managed funds, those investors are essentially indexing without even knowing it, just at more expense.

The second way that some people invest is to trade. The vast majority of traders are under-trained, under-experienced and over-emotional. They generally rely on some sort of system they don’t quite understand and are reduced to gambling. What we know about most gamblers is that ultimately they lose. 

While I know some day traders (their trades last days) and a handful of swing traders (their trades last weeks or months) beat the markets, IRS statistics tell us that about 80% of traders do not beat the markets. Those who do beat the markets, are either savants, lucky for awhile or better professionals. If you aren’t in one of those groups, you probably shouldn’t trade much.

Here at Fundamental Trends, the first step to investing is to find the good to great companies. I use what I call my “Core 4” Investing Method for finding companies for my universe of companies to possibly invest in. 

Only about 5% of the stocks on the U.S. markets make my cut. That’s not a big percentage, but it is still 200-300 companies at any given time. Once I review more information I cull the universe down to a galaxy of about 100 companies that I believe can lead in the next decade called “The Very Short List.”

The Very Short List or “VSL” is then broken down to the Dividend 30 and the Growth 30. As the names imply, the Dividend 30 are dividend paying stocks and the Growth 30 are high growth stocks. A very special handful of companies make both lists.

So, that’s a the short of it. If you are a subscriber, you are finding more and more reserach and notes in the Forum. Regardless, the processes on asset allocation, security selection and trading I have laid out above are a good set of premises to start with for any investor.