The Investor’s Dilemma

There is a porblem with investing that will not soon be solved. You might want to think about it.

The investor’s problem

How much do you need to know to invest well?

Larry Swedroe is Chief Research officer at Buckingham Strategic Wealth. He is constantly looking for ways to enhance the returns in funds the Buckingham Group operates. He is good at his work.

In his spare time he has written books to help investors understand the advantages of evidence-based investing.

Okay, so what’s the problem? Let Larry Tell us, “The problem for investors today is that in the academic literature, over 600 factors have been discovered. So, How is an investor to know which of the 600 are worth investing in?

I doubt you could name 6 of the 600 quickly. Does that make success as an investor improbable?

Could Warren Buffett name 60?

Probably not. The key is you don’t need to know everything. You do need to know a little though. What are the key variables?

It will vary a little by industry, but in general they are around predictability of the business.

The predictability of the market itself is a fool’s game. After all, most participants are not rational. Michael Mauboussin, another of the smart guys, offers this thought on that. “A collection of irrational individuals can create an efficient market because their irrationalities can cancel each other out as long as there is enough dispersion of opinion.” So a rational, evidence based investor could ignore the market itself so long as they were sure there is was a dispersion of opinion. That is likely easier to see than most people think.

Predictability of the business

There is a theory that claims no more than three large generalized businesses can exist profitably in any sector. It was developed when it was difficult to survive unless you had the resources to be competitive. The car industry in North America was one of the models. GM, Ford and Chrysler. The Big Three. Could a newcomer compete. As long as the cost to develop a new model was a billion dollars, no. Even Chrysler eventually succumbed. GM went bankrupt and rose from the ashes. Ford has had its ups and downs too. Toyota, Volkswagen, Honda, Nissan, and Hyundai and others are all competing in the generalized space. Not all will flourish.

Niche players can do very well. Porsche, Ferrari, and BMW for example. You might worry about their future if you see a Ferrari half-ton truck.

The first key is competitive. How hard is it to compete with you? Buffett talks abut a moat. Can a competitor enter your market at a price that is recoverable. For example, suppose you decide to compete with Dairy Queen. Easy or hard? Very hard. Widely distributed businesses are not easy victims.

The second key is margin control. Can you raise your prices as needed and/or can you reduce your cost to provide and even increase quality? See’s Candy, another Buffet company could do both and remains very profitable.

The third key is leverage. If a company owes a lot of money, they are more vulnerable when anything changes. Vulnerability is antithetic to predictability. Buffett again, “If you’re smart, you don’t need leverage. If you’re dumb, you shouldn’t be using it.”

The fourth is management. A company where the managers us company resources to gratify themselves is not worthy of your attention. The principal role of senior executives is to allocate capital. Ones who have a fleet of corporate jets, retreats in the mountains, and prime sponsors of golf tournaments and such, are suspicious. They might enhance business value, but none talk about the connection.

The fifth is innovation. No product or service lasts long. How often does Intel design and build a new processor? What version of Windows would you like to go back to? Maybe iPhone 3? Everything changes. Even seemingly simple things like razor blades and vacuum cleaners. A business cannot stay still.

Putting it together

Investors can, with effort, find businesses that suit their parameters. Their value is the present value of future cash flows. In simple terms, a business is worth what it will earn. Business valuation is not a trivial task. You can get better at it with some effort. You get a range though, not a particular number. There is no absolute.

The market will offer prices. They tend to approach fundamental value over time, but not necessarily in a day or a week. Even a year. The investor’s job is to buy when the market offers a bargain and sell when it is too enthusiastic.

Alternatively you can adopt the patient approach. Buy it and keep it until it cannot meet your requirement for a good business. Essentially ignore the market. It helps if there are every increasing dividends.

The bits to take away.

You can look at business instead of stocks. That makes investing easier. You have standards and can ignore a lot of the noise that inevitably arises.

Diversification is an odd idea. It matters if you look at the stock quotes regularly. It might not if you only invest in financially strong, well managed and hard to compete with innovators. You could argue either side. Diversity helps to manage you and to minimize emotional content.

Sound investing is a cold-blooded thing. Have standards and keep track of how your businesses are meeting them. As the used car dealers say, “Don’t fall in love with the inventory.”

It is possible to get management Alpha, but it is difficult. Most of us are better off doing what we are good at and letting a manger look after these details.

Knowing there are 600 factors is not helpful. Knowing more than a few is for special circumstances. Easy to misapply. Too much is at least as harmful as too little.


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I build strategy and fact-based estate and income plans. The plans identify alternate ways and alternate timing to achieve both spending and estate distribution goals. In the past I have been a planner with a large insurance, employee benefits, and investment agency, a partner in a large international public accounting firm, CEO of a software start-up, a partner in an energy management system importer, and briefly in the restaurant business. I have appeared on more than 100 television shows on financial planning, have presented to organizations as varied as the Canadian Bar Association, The Ontario Institute of Chartered Accountants, The Ontario Ministry of Agriculture and Food, Banks – from CIBC to the Business Development Bank.

Be in touch at 705-927-4770 or by email to don@moneyfyi.com

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