Three Factors In Good Investing

Books galore, articles, ads, etc. (good and bad) have and are being written about how to invest. Depending on your point of view and interest in the subject, there are a lot of ideas out there floating around that can be leading or misleading and produce misery or joy.

What there is not a lot of, are good ideas about how to go about using those ideas in a safe and productive way. The result generally is that many investors end up with random results and well over half the time do not even come close to most of the ‘averages.’

Yes, there are lots of good general wisdoms to bear in mind as you invest: look before you leap; follow due diligence; do not be overpowered by the ‘clarity’ of charts; never trust tips from unknown sources; and avoid any arbitrary rules that ‘always’ work.

There is, however, one useful method for going about how to decide when and how to buy something.

It is pretty simple to explain, but very complicated and difficult to put into practice. It cannot give you any kind of guaranteed result. But it can help you to think through the maze of often conflicting information you have to deal with to make investment decisions intelligently.

There are basically only three factors in all investment decisions:

1- The facts (whatever facts are?);

2- What you make of the facts (that means you alone); and

3- What ‘the other guy’ will make of those same facts.

How are the three different and why is that relevant?

Whatever the facts may be, they will look different to most observers. Remember the game telephone – that’s just human wiring. Each step along the way a different message is received, so your perspective will be one way – say ‘buy’. The next guy says to himself ‘hold.’  And the one after him says ‘sell.’ They may see different facts, they may have different priorities. That matters because even if you are right in your conclusion, if the other guy says sell you are unlikely to profit.

So the game of analyzing the facts has to include how others read the same story.

Despite today’s fascination with fake facts, there really are bed rock facts that can be quite easily and reliably accessed in today’s connected world. You can find for most public companies information about their managements, products, sales, balance sheets and what the history has been. Collectively those are ‘the facts.’ There are often a lot of irrelevant and misleading pieces. It will never be as clear as a completed jigsaw puzzle!

What you make of those facts is up to you. Is the management being straight with you? Are the products fulfilling a market need? Will the volume grow – at what rate? Are the operating margins appropriate by industry standards? What is the competition planning?

What THE OTHER GUYS make of those same facts in a similar way, is also quite easily accessed on the internet. There are dozens of publications full of their thoughts. You should assess their views carefully.

When a single person focuses on summarizing all three of these facets for any given investment, she/he naturally will tend to converge into a mushy bit of ‘on the one hand and on the other hand.’ And, that is often when a good investment process goes off the rails, moving from ‘truth’ to ‘fudge.’

I have been encouraging people to assign these three elements to three appropriate and different people and then lock them into a room together and not let them out until they reach a rational conclusion, one they are all reasonably happy with and can explain coherently and convincingly to civilians. Indeed, different people are as capable of creating mush as one person alone. But I believe it is worth the try?

This is not an altogether novel idea but it might be a better way of investing than simply giving up and ‘buying the market’ through various indexes. After all, it is movement in the value of individual companies that drives indexes to gain or lose value.

Financial markets have been accelerating into clumps of ‘like’ companies which relieve investors from having to value individual companies. The basic problem with that is that the market process really is about financing individual companies not groups of companies. If the most popular way to own shares directly in XYZ company is to own an index that includes XYZ, who is going to establish the value of XYZ and all the other companies and, just as important, how?

The move away from investing directly in separate companies into indexes may be a still invisible arrow aimed at the heart of capitalism. We should all be careful and wary.

And, we should never give up on valuing separate companies!


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