Digital Cog

Investment principles

Never buy anything that one would feel uncomfortable holding after less than a 50% increase in market price. Assuming unchanged fundamentals, if one feels that one should sell after say, a 30% increase in price, one paid too much for the asset in the first place.

It’s always ok to sell something for a cheap price if someone else is willing to sell one an equivalent asset for an even cheaper price. However, the perceived value difference should be large, both because of transaction costs, and more importantly as a disciplining tool to encourage rigorously determined initial decisions that avoid the need to trade out into even cheaper positions at a later date. The selling decision in this case (selling cheap to buy cheaper) should be made regardless of the current market price relative to the price paid. i.e. one should not give heed to whether the sell action generates a capital gain or loss, nor should heed be given to the magnitude of such gain or loss.

Commodities are not investments. Over the extreme long term, the value of all commodities has been dropping towards zero.

The profit is made when one buys very cheap assets, not when one sells. Gains are locked in the instant an asset is purchased at a large discount to a conservative valuation of said asset.

Rigorously resist price anchoring (though this will be almost impossible). In your spreadsheet summary of securities, only display ratios and historical movements in said ratios, never directly display the market price.

Something that has increased dramatically in market price may still be an incredible bargain, and something that has fallen dramatically in market price may still be terribly overpriced.

If you find the big whale, harpoon it with everything you have. The big whale will double in price and still be ridiculously cheap. One will need fortitude to continue buying it at this point.

Do not build the overall strategy around tax minimisation. Expend all of ones energy and fury on finding the cheapest assets.

Do not waste time trying to understand any of the underlying businesses that one invests in. Even the people running the businesses, the people who understand the businesses the most, will not be able to make any usefully accurate prediction about the future.

The value of an asset is determined by the dividends, interest payments and other cash flows generated, as well as the balance sheet metrics such as net cash, net current assets, book value etc. and the historical movements in such things. The market price has nothing whatsoever to do with the value of the asset.

If one desires to track progress, do so by tracking the receipt of investment income or by the change in book value of ones holdings.

The market price of a security does not command anything. The market price is an option to engage in a voluntary exchange. Utilise this option when it is advantageous to oneself, ignore it at all other times.

A good investment is an investment made when rigorous analysis indicates a clear discount to a conservative valuation is present. The ultimate profitability of the investment does not change this classification. Good investments can ultimately result in a permanent impairment of capital and still be good investments, because the investment was rigorously justified by the facts available at the time of investment. Equally, bad investments can be profitable, but the unjustifiable logic that they were initiated with stands eternally unchanged. It should be expected that, using the above definitions, overall, good investments will tend to result in better outcomes than bad investments.

Ownership of an equity security should be understood as actual ownership of the underlying entity and balance sheet. Ownership is not a slave to the market price, it is precisely the opposite. The balance sheet is real, the cash is real, the cash flows are real, the dividends are real. The market price is just an empheral, formless option.

A general fall in the prices of all investment assets is a highly desirable occurrence for any individual who expects to be a net purchaser (a net saver) of investment assets in the future. A general rise in prices of investment assets is an unmitigated disaster, but there is nothing an individual can do about this.

The concept of mean reversion is not useful. Waving the principle of mean reversion around as a wand to justify the purchase of a cheap asset with no clear exit strategy is an unnecessary rationalisation of a course of action that requires no rationalisation. The need to appeal to the future agreement of others with ones decision as manifested through a rise in the market price of the asset in question as a justification merely displays a lack of conviction and true understanding of the actual real value of the asset. One does not need an exit strategy when paying ¥5,000 for a ¥10,000 note.

Don’t talk oneself out of paying ¥5,000 for a ¥10,000 note. This is not a useful skill to have or develop.

In the case of two equivalently cheap securities with the only difference being the scale of the entities (as represented by say, an order of magnitude difference in the market capitalisation), always favour the smaller entity. Smaller entities are more likely to be bought out, have a larger limit to ultimate growth and depending on the size of ones empire, may be small enough that one can directly exert some form of control/influence (limited or otherwise) on the mechanical realisation of value.

Net current assets growing much faster than book value is a good sign of a semi-self liquidating business that is refusing to make poor return investments in real capital. Good things happen to people who own such entities.

Demand an additional margin of safety (cheaper price) for securities that do not pay a dividend, or pay only a low rate (less than 2%). An old aristocrat would rightly believe that If it doesn’t cash-flow, it’s not really an investment.

Don’t pay more than 90% of book value for anything.

People spend too much time looking for businesses where additional capital can be invested at high rates of return, and spend too little time looking for businesses where large amounts of capital can be extracted and returned to owners without significant negative impact to the business itself.

Nobody can find the cheapest assets for you. Start shoveling, start turning over rocks, start checking the numbers. It’s the only way.

Don’t read the news, or if you have to, read it with a 40 year delay. Ignorance of the vomit warblings of others is an advantage that one should refuse to give up.

There is no tradeoff between risk and return. The lowest risk assets, such as historically profitable equities trading at less than net cash, are also the highest return assets.

No asset is inheritantly low or high risk. The price paid for the asset determines both the risk and the return.

Sun, March 10 2013 @ 18:03 » Investing

2 Responses

  1. Daniel March 11 2013 @ 01:10

    “Vomit warblings.” Love it.

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