My Investment Philosophy

I was recently on the Sky News “Your Money Your Call” TV program with a fellow educator who suggested that investing money into companies that don’t make a financial profit is more akin to gambling than investing and that investors should only invest money into businesses that make a profit. Live on air, I harshly refuted his investment theory and challenged him to understand that making money in the market is not only related to a company’s profits, rather it’s about stepping into the opportunity flow on offer from all listed companies and about managing risk.

In the past I have challenged this same educator and asked what happens if the stock he invests in continues to fall in price, even though you think that it is fundamentally sound and it makes money? His response was along the lines of “I’ll just buy more.” This approach is a suicidal lesson that most investors only make once but for an educator to publicly make a statement like this, live and on air, I was shocked. Let me tell you, it does not matter how fundamentally strong you believe the stock you invest in is, what matters is that you have risk management processes that take into consideration how much money to put into the position and a well defined exit point that will limit a loss should the position go against you.

While our on air performance did get a little heated, it drove me to respond to an email I received from a prospective client who was interested in learning more about my own personal investment philosophy. His question said, “I listened to the business program tonight and I am worried about [the other panelist’s] assertion that your methods are a form of ‘gambling’. You argued that your methods are a form of risk management”.

Over the next two weeks I wish to share my background and some statements on how I see the investing universe:

1. I have a Bachelor Science degree where I majored in Mathematics and Computer Science and also studied Statistics.
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2. I started my investing journey as a fundamental analyst in 1990 and then added technical analysis progressively into the equation over the following few years.
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3. My fundamental grounding was based on the works of Dr Karl Posel, a former applied mathematics professor, and Richard Cluver, a long standing financial journalist, both of whom wrote many books on the subject. I then confirmed their principles with Jim Slater in his book The Zulu Principle and plenty of my own research. The challenge with conducting such fundamental analysis is continually getting access to timely clean historical company balance sheet and P&L data for all listed companies.
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4. I absolutely believe that fundamental analysis has a role to play in analysing companies in which to invest. That is why we have a product called Intelledgence which, amongst other information, produces a Fundamental List that is updated every month using timely clean historical company balance sheet and P&L data that we purchase from MorningStar. We analyse historical adjusted EPS & DPS data, debt to equity ratios and return on shareholder’s funds as our main filter criteria and update the Fundamentals List accordingly. Note that the raw company data is NOT distributed as part of our product, just the final analysed list.
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5. I realised during the mid 1990’s that the key skills goal of investing was to achieve consistency and objectivity and this had to be achieved in the following environment:
   1. Limited capital, in that not all the stocks in the market could be purchased within an individual’s portfolio, i.e. the stock universe had to be filtered to just a few at any given time.
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   2. The portfolio had to outperform the majority of managed funds and the market index by a decent enough margin to make it worthwhile for the effort exerted (unless it is just a hobby).
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   3. The process for filtering which stocks to invest in had to be productive & efficient enough to be easily repeatable in the future such that the investor could do all the other things in their lives that they want to do without the investing process consuming them.
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6. In the research that I have done over the years, starting with fundamental analysis from 1990 and then with technical analysis from around 1992 onwards, I have realised that:
   1. Different stocks in the market have different characteristics.
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   2. No single stock analysis approach should be used for all market types and all stocks all the time. This means that there are times that positions must be exited and some portion of capital put into cash (or ther asset classes), even all capital, for periods of time.
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   3. That there is a constant opportunity flow in the market at all times in all types of different stocks that can be tapped into by the investor that is prepared to aim for consistency and objectivity.
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   4. That Risk Management and Money Management play a far more important role than any stock selection process.
   1. This means that how much you put into individual stock positions over a large sample of positions is more important than the stock selections themselves.
   2. Also, the exposure you have to certain types of markets (rising, falling, sideways), as measured by the overall market index, is more important than the individual stock selections themselves. When markets fall stock prices fall in just about ALL listed companies, regardless how good their fundamentals are.
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   5. Sentiment has a far bigger bearing on the price movement than any analysis and the only way that sentiment can be measured is by analysing the stock price movement.
   1. Sentiment can be affected by countless variables that interact with any given stock at any given time. To view the potential for a stock price to rise or fall based on a single variable or group of variables, it’s fundamentals, is simply naive as there will always be other variables that are not accounted for in any analysis that will effect the price of the stock. This is why the movement of stock price MUST be used for limiting losses.
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   6. Using fundamental analysis to determine when to exit a position is far too delayed and too subjective and hence totally ineffectual for this purpose.
   1. This means that some form of technical analysis has to be used in conjunction with fundamental analysis if a timely exit strategy is desired. But technical analysis could be used entirely on its own for entry and exit.
   2. Fundamental analysis should be confined to determining when and what to enter.
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   7. Consistency and objectivity are achieved through applying rigorous and well researched processes that include stock selection, risk management and money management. Not just stock selection. Stock selection on its own also does not solve the problem of how to manage a portfolio of many selections with limited capital.
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   8. That there will be losses and there will be profits but through risk and money management of a positive statistical edge any investor can outperform the market over the medium and long term.
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7. I don’t see myself as a fundamental analyst or a technical analyst. I see myself as a risk and money manager in the environment of the market.

Next week I’ll share what I believe is gambling vs investing.