“Perhaps the single greatest error in the investment business is a failure to distinguish between the knowledge of a company’s fundamentals and the expectations implied by the market price.” The world of investing and business has seen a great deal of change in the past 30 years.
This report shares thoughts on the ten attributes of great fundamental investors. Accounting is the language of business and you need to understand it to appreciate economic value and to assess competitive positioning. Investors face a slew of psychological challenges.
Perhaps the most difficult is updating beliefs when new information arrives. Position sizing and portfolio construction still do not get the attention they warrant. The substantial shift from active to passive management has profound implications for the investment industry.
In the time of difficulties and panics people should avoid falling in traps –
Lots of question on the steep fall in the last few days let’s address the key reasons afflicting world markets over the last one year
US inflation and fed rates: We are probably at the end of rate hikes by mid-2023, where the US will pause. Everyone knows that there are no surprises here.
Corona fears: It’s a known animal now unlike the last time. Even if it comes again, we are vaccinated, the impact will be lower. Treat it as a normal flu and move on.
Russia Ukraine war: Yesterday Putin expressed willingness to have diplomatic talks and resolve this crisis.
Commodity prices: All corrected sharply and at manageable levels.
Nifty earnings: We are set for ₹1000 nifty EPS next year. Nifty quotes at 18x which would be considered fair value. Nifty earnings growing 15% PE 18 we are a shade above 1 PEG which is not expansive by any standards. Normally anything less than 1 PEG is a screaming buy.
So don’t scream and get alarmed at such falls. It’s part of the journey. This will pass. Top up ok existing stocks in the portfolio. No need to look at new ideas when the existing ones are available cheaper.
When it comes to investing one should be ready with the homework i.e a crisp and detailed analysis about the business that they are invested in by considering these five attributes:
Be numerate (and understand accounting): To be a successful investor, you have to be comfortable with numbers. There are rarely complicated calculations but a feel for figures, percentages, and probabilities is essential. One of the main ways numeracy comes up is in financial statement analysis. Accounting is one of the main languages of business. Great investors are adept at financial statement analysis, which allows them to understand how a business has done in the past and gives some sense of how it will do in the future.
There are a handful of excellent books on accounting that are worth reading carefully. The goals of financial statement analysis are two fold. The first is to translate financial statements into free cash flow, the lifeblood of corporate value.
Understand value (the present value of free cash flow): The landscape of investing has changed a great deal in the past three decades. It is interesting to consider what about investing is mutable and what is immutable. The truth is that much is mutable. Great fundamental investors focus on understanding the magnitude and sustainability of free cash flow.
Factors that an investor must consider include where the industry is in its life cycle, a company’s competitive position within its industry, barriers to entry, the economics of the business, and management’s skill at allocating capital.
Properly assess strategy (or how a business makes money): This attribute has two dimensions. The first is a fundamental understanding of how a company makes money. The idea is to distil the business to the basic unit of analysis.
For example, the basic unit of analysis for a retailer is store economics. How much does it cost to build a store and fill it with inventory? What revenues will it generate? What are the profit margins? Answers to these and other questions should allow an investor to assess the economic profitability of a store, which he or she can then roll up to understand the overall company.
Compare effectively (expectations versus fundamentals): Comparing is a critical element of investing. Investors compare all day: Stocks versus bonds, active versus passive, value versus growth, stock A versus stock B, and now versus later. Humans are quick to compare but not very good at it.
Think probabilistically (there are few sure things): Investing is an activity where you must constantly consider the probabilities of various outcomes. This requires a certain mindset. To begin, you must constantly seek an edge, where the price for an asset mis-represents either the probabilities or the outcomes. Successful operators in all probabilistic fields dwell on finding edge, from the general managers of sports franchises to professional bettors.
Warren Buffett once said that it is wise for investors to be “Fearful when others are greedy, and greedy when others are fearful." So before you think about selling your existing holdings just analyse about the business and thesis while you bought them.
Shuchi Nahar is a Certified Research Analyst. She can be found on Twitter at @shuchi_nahar
Note: This article is for informational purposes only. Please speak to a SEBI-registered investment advisor before making any investment related investment-related decision.