Seven simple lessons from decades of investing

Investment professionals have an unfortunate tendency to overcomplicate matters, which is ironic because complexity and indecision are common bedfellows.  

In our experience, while investing is never easy, it certainly helps if you start simple and stay simple. To that end, we have developed some straightforward investment principles which have helped us avoid mistakes, challenge our assumptions and decide which companies to back. 

1. Follow the cash  

Show an eternal optimist a 15-foot-high pile of horse manure and they will dive in, shouting “there’s gotta be a horse in here somewhere!” 

And so it is with shares. Show an investment manager a cheap share price and his or her appetite will be whetted. He or she might be tempted to find good reasons to buy it and ignore any red flags. Valuation can sometimes be the enemy of objectivity.  

This dynamic also plays out in the world of income investing, where we look for companies paying dividends¹. A high dividend can tilt the argument, which is why we view dividends as an outcome of our investment process, not central to it.  

Our North Star is cashflow, which is the money leftover after everyone else has been paid, including employees, taxes and any debts. Leftover cash is what companies use to pay dividends. It dictates how sustainable the dividend payment is and whether it can grow. We think cashflow offers a more objective picture of a company’s health than profits, earnings, accounts or anything else. 

2. Don’t follow the crowd  

Most investment trusts use a stockmarket index or benchmark to compare their performance against. We use the FTSE All-Share².  

But when it comes to choosing which shares to own, we ignore the benchmark because it tells you nothing about a company. Worse than that, deciding what to own and how much by referring to a benchmark is a slippery slope.  

By way of example, HSBC is the largest stock in the FTSE All-Share, worth 9%³. Some fund managers might think having 9% of their assets in HSBC is low risk. Their returns will probably be closer to the benchmark, but we still think that’s a huge bet. Almost 10% of their clients’ money would be at risk (or reward).  

This is fine if the fund manager has huge conviction in HSBC. However, let’s imagine that like villains in a Bond movie, we were able to seize control of the FTSE All-Share overnight and we halved the index’s weighting to HSBC.  

In the days that followed, we wouldn’t be surprised to see many fund managers selling shares, uncomfortable with the notion of suddenly having significantly more money in HSBC than the index. 

Ideally, how much of a company you own should reflect your confidence in it – rather than the comfort blanket of the index (although we do concede it is a mightily comfortable blanket). 

3. Think in years, not days 

Imagination is an under-rated investment skill, but while we see scant evidence of it in the stockmarket, there is plenty to be found in boardrooms.  

Corporate management teams have no trouble imagining how their business could develop over the next five years. When we meet them, it’s easy to tell how excited they are about their company’s future. 

By contrast, the day-to-day reality of stockmarkets, with share prices moving all over the place, is closer to a playground brawl than a serene place from which to contemplate the future. 

By and large, we feel the investment community has become too focused on immediate events, such as news headlines or company results. But no matter, as that creates opportunities for us as longer-term investors. We take a three- to five-year view of companies’ prospects and we see ourselves as owners not renters. 

4. Hotter or colder? 

An analyst’s common reaction after meeting a company is to go away and put what has been learnt into a model or spreadsheet. Fair enough, but while spreadsheets have their place, they are not renowned for their emotional intelligence, instinct or judgment. 

After spending time with a company, we ask ourselves a question that’s not in the least bit technical – do we feel ‘hotter or colder’ about our reasons for owning the shares?  

This is as simple as it gets, but the question enables us to articulate how we feel about companies and express our level of confidence. It helps us decide whether to buy more shares or reduce our exposure. 

As a result of discussions like this, we have a high batting average, which means we usually make more money on our winners than we shed on our losers. 

5. Don’t invest if the file’s too thick 

Another unsophisticated expression from our ‘lessons learnt’ repository is ‘when the file gets too thick’.  

You can tell a share isn’t a good idea when it involves too many meetings and there is too much complexity in the argument. There comes a tipping point when we conclude the ‘file’ is getting very thick for something which should be a straightforward investment idea. Regrettably there have been too many occasions when this was said with hindsight rather than foresight. 

6. Have a departures and arrivals board  

We continually try to improve and refine our investment process and one of the tweaks we’ve made in the past decade is to carry little cash. Therefore, if we have a new idea or want to add to an existing position, our weakest stock has to go. And when we sell something, we replace shares with shares, not with cash.  

Generally speaking, fund managers spend a lot of time searching for the next great idea and not enough time looking for their weakest link.  

7. Never stop questioning yourself 

Condensing more than two decades of experience into a handful of principles is no mean feat but we would like to believe these ideas will continue to hold true for the next quarter century. However, they should be subject to scrutiny, and we will be open-minded and flexible enough to evolve or even change them.  

A healthy dose of imposter syndrome and remaining aware that we will never know everything has served us well in the past and is our welcome guardian for the future.