Tag: value investing

No, you don’t need a high IQ to be a successful investor

“A lot of people with high IQs are terrible investors because they’ve got terrible temperaments.”

Charlie Munger

Do you know your intelligence quotient (IQ)?
If you are curious and you want to measure it, just go to the Mensa website and take the test. I did it, it is a challenging experience.

Did you take it?
Are you in the best 2% percentile? Or in the best 5%?
Now please listen: it doesn’t matter!
YOUR IQ IS NOT IMPORTANT TO ACHIEVE SUCCESSFUL RESULTS IN INVESTING. At least, it is not important to be at the top of the IQ ranking.

It is a common mistake to assume that high-IQ people take the best investment decisions. The point is that good investments depend on the right “temperament”, not on a high IQ – which in some cases may even become detrimental, due to behavioral biases.

According to Wikipedia, temperament broadly refers to consistent individual differences in behavior that are biologically based and are relatively independent of learning, system of values and attitudes. But this definition is not useful for the specific topic of investments.
I found the book of William Green “Richer Wiser Happier” a wonderful source of examples of successful temperament, as he describes the distinctive traits of some of the world’s greatest investors – all of them being learning machines and nontribal freethinkers.
Just to give you a short idea of some of these traits as described in the book:

  • Mohnish Pabrai: cloning others’ best ideas
  • Sir John Templeton: a self-disciplined, nontribal investor
  • Nick Sleep and Qais Zakaria: focus on “destination analysis”, not on short term
  • Tom Gayner: adopting “directionally correct” habits
  • Charlie Munger: avoiding standard stupidities

As you can understand, these are all temperament competitive advantages, not IQ advantages.

Do you need to match 100% the temperament profiles of these investment masters?
No, you do not need to. But you should learn from them and selectively adopt specific habits or methods: you do not need to become like them, but you can improve yourself during your life and become the best version of yourself.

Are you going to follow my advice? Then, have a nice life journey!

Buy it for the long run

“If you aren’t willing to own a stock for 10 years, don’t even think about owning it for 10 minutes.”

Warren Buffett

Have you ever bought a hot stock, planning to sell it in a short time with a significant gain?

Do not lie. You did it.

When we listen to financial news or when we get a suggestion from a friend who is an expert, it is quite normal to get excited about a stock. Very often, our mind pushes us to action and we buy.
And in many cases the price of that stock begins to drop.

No, you are not unlucky. That’s normal.

A hot stock is often bought in the very wrong moment: after a nice good price run. That’s the moment in which our brain fools us, because it projects in the future the same recent positive trend.

What can we do to avoid that?
Just take a seat, grab a cup of coffee and try to be rational.
First of all, you have to be aware that there is a very high probability that the stock price will fall after you buy it – I am not aware of any worldclass investor who was able to buy stocks exactly at a price minimum point, so how can you be better?
Your best approach is to really avoid any “hot suggestion” and do your homework, which is to analyse any interesting stock by understanding the underlying business and its potential value, to see if it is cheap enough to buy or not. Value vs price, remember?
If you then decide to buy, then do it for the long run. Are you willing to keep that stock in your portfolio for the next 10 years?
To reinforce the quality of your decision you should also think of a no-sale rule and stick to it; my proposal is that when you buy a stock you should oblige yourself to avoid selling it at least for the next 2 years (unless the investment thesis changes, of course).

It sounds difficult, but it really helps.

Value vs Price

“Price is what you pay, value is what you get.”

Warren Buffett

Value and price are quite different things. Yet, value and price words are usually used as a synonymous, even by finance news writers.

Let’s try to understand the difference through an example.
Let’s imagine that you need a new smartphone, and you want a specific model of your beloved brand. You are hesitating, because the price is very high: after a brief check on online sites, you have realized that you should pay around 1000$.
Then Black Friday arrives and suddenly the price of that model drops to 600$ !

Did the value of the smartphone change?
NO.
The value of the the smartphone is always the same: same functions, same materials, same brand…. WHAT YOU GET is exactly the same

Did the price of the smartphone change?
YES.
The worth (or value) didn’t change, but the price decreased… WHAT YOU PAY has changed.

If you consider investing in stocks, things are pretty much the same: to GET a piece of ownership of a company which has a certain value you have to PAY a certain price.

To be a good value investor you have to behave like a business owner: you have to understand the company and you have to – after studying it – estimate its VALUE, and if you decide to make the investment then you buy a percentage interest in that business proportional to the number of share that you get.
To get a certain number of stock shares in a company, you have to pay a specific PRICE. For public companies, you pay when you buy from a stock exchange like the NYSE or the Nasdaq.

When you see all the crazy changing numbers ticking in red and green on your Yahoo Finance app or similar, you see the stock prices. Not the stock values. Do not confuse the 2 things.

Value investing consists in buying a stock when its price is (heavily) below its value. There are many implication of this; we will talk about the margin of safety and long-term impacts in another post.

Anyway, please remember: just looking at the price is not investing.

Why value investors do like stocks so much

“Auction-driven markets have this nuance where they either get euphoric or pessimistic, and they might do both in the same year. That’s what leads to distortions and mispricing, and that’s what we can take advantage of.”

Mohnish Pabrai

Value investing is usually focused on publicly traded stocks. There are a few reasons for this.

The asset class of public company stocks has historically outperformed other asset classes like bonds or commodities. The S&P 500 index (which tracks the stock price performance of the largest listed companies in the US) has in the average returned more than 10% per year in the last 50 years: we have already discussed about the power of long term compounding and so you can appreciate the importance of such a performance.

In addition to that, stock exchanges are auction-driven markets subject to boom-and-bust cycles. It means that these markets are subject to the impact of human psychology, and so stocks are often increasing in price during euphoric periods and heavily decreasing in price when pessimism is dominant. Just think of it as if a manic-depressive person called Mr Market would offer to sell you a stock for a very low price in a pessimistic day, while coming back to you the next day in an euphoric mood offering to buy from you the same stock of the previous day for a much higher price: this is the brilliant allegory used by Ben Graham, the “father” of value investing, to describe the irrationality of stock markets.

A good value investor is aware of the average long-term positive performance of publicly traded stocks and can obtain even better results than average, if able to use the irrationality of markets at his or her advantage in spite of surrendering to human cognitive biases.