5 of my biggest investing lessons
One of the things I love about investing is there is always the opportunity to learn. As each year goes by, the lessons (and mistakes) pile up, providing a chance to reflect, gain wisdom and (hopefully) improve.
This article is a potted summary of those insights, approached with the following lens: “what do I know now that I wish I’d known when I started out as an investor?"
Five big lessons stick out.
1. Find a great business first, then worry about price
The price you pay is important, but the biggest losses tend to come from being wrong about the business, not from overpaying for it.
For example, the late nineties was about the worst time to invest in Coca-Cola from a valuation perspective. At the end of 1998, the shares traded on a price to earnings ratio (P/E) of around 50 and offered a dividend yield of less than 1%. Today the valuation is around half that.
However, Coca-Cola was a good business in 1998 and has grown its profits and dividends strongly since then. Despite paying a very high valuation, long-term investors in Coca-Cola have still done reasonably well, earning a total return of about 350%.
Compare this experience to that of an investor in the fixed-line telecoms operator, BT Group. BT shares traded on a P/E of around 20 at the end of 1998, less than half that of Coca-Cola, and yielded around 3%. Yet BT is a much less profitable business today than 25 years ago, meaning the shares have made a loss of 40%, even with dividends reinvested.
The longer your time horizon, the more your returns tend to be driven by the quality of the business and the less valuation will matter. It’s why I always assess the quality of the business first and the valuation last.
Performance over the last 25 years
Source: Morningstar, 31/10/1998 - 31/10/2023. The graph shows total return with dividends reinvested, in GBP. Past performance is not a guide to the future.
2. Try to protect the downside
Any investment carries risks, but I think that this risk can be tempered by truly understanding a business.
I’ve learnt that if you look after the downside the upside tends to take care of itself. So, I focus first and foremost on risk and how much I could lose – not how much I could make.
Many investors focus largely on short-term growth. But if a business loses relevance or ceases to exist in ten years’ time, it doesn’t matter how quickly it’s growing – it will likely be worth a lot less in the future.
My 60-point checklist is designed to test the likelihood a business will still be thriving five, 10 and 20 years from now. It appraises competitive threats, economic sensitivity, the robustness of cash flows and the balance sheet, culture, as well as a company’s susceptibility to changing tastes and fashions.
But the most important question on my checklist is the very first: do I understand the business model? My biggest investing mistakes have invariably come from not understanding the business as well as I thought I did.
Legendary investor Warren Buffett talks about a circle of competence. It doesn’t matter how big that circle is – you just need to know its boundaries – and stay well within them.
I’ve found that my circle of competence has become narrower and narrower over time. Businesses I would have considered investing in five years ago, like banks and insurers, now fall on the ‘Too hard’ pile. Instead, I try to stick to companies I’ve followed for a long time, with business models and accounts I can easily get my head around.
Does this mean I miss out on opportunities? Almost certainly. But I hope it also reduces the chance of significant errors. And in investing, I’ve learned that is half the battle.
The most important thing in business, and investments … is being able to accurately define your circle of competence. It isn’t a question of having the biggest circle of competence. I’ve got friends who are competent in a whole lot bigger area than I am, but they stray outside of it.Warren Buffett (lecture to Notre Dame Faculty, 1991)
3. Keep things simple
Like many areas of life, less is usually more in investing:
- Less trading means lower costs and usually higher-quality decisions
- Less focus on stock markets and share prices makes it easier to maintain a long-term perspective
- Less time spent worrying about unknowable factors, like the economy or interest rates, means more time to think about business models and culture
99% of current news is noise, in my opinion. And it’s easy to get endlessly distracted by it. I try to ignore anything that isn’t going to matter in five or 10 years and focus instead on business prospects.
Even then, it’s easy to get lost in the weeds. For most companies, only a few things really matter.
For example, the success of the card payment networks – Visa and Mastercard – has primarily been driven by just two things. First, a steady shift from cash to card and digital payment methods. And, secondly, high barriers to entry, meaning other companies have struggled to compete. Their future success will probably depend to a large extent on whether those two factors persist. Virtually everything else is noise.
Number of cashless transactions worldwide (in billions)
Source: Statista. Chart shows number of cashless transactions worldwide from 2013 to 2021, with forecasts from 2022 to 2024.
4. Seek out behavioural advantages
There are three main ways, in my opinion, for investors to gain an ‘edge’:
- Obtain more or better information (an informational advantage)
- Have the ability to out-analyse others (an analytical advantage)
- Behave differently (a behavioural advantage)
The first two are very difficult – the investment industry is hugely competitive and full of very smart people. But the third is open to anyone who is willing to go against the crowd – I believe my edge, if I have one, lies here.
A behavioural advantage comes from understanding the essence of human nature, then having the courage and discipline to go in completely the opposite direction.
We are hard-wired to care about the here and now – and this applies when investing as well, in my experience. If, however, you can go against instincts and adopt a long-term investment perspective (at least five to 10 years), it could be a huge advantage.
You will be fishing in a much less competitive pond. It will help you filter out short-term noise and focus on long-term business prospects. You’re less likely to be scared out of investments at the first sign of trouble. You don’t have to make short-term predictions, like where the economy or stock market is heading. And above all, you stack the odds in your favour, by allowing time for compounding to work its magic.
Along with short-termism, there are many other biases and emotions that are very unhelpful to investors.
Human beings hate uncertainty, often ignore opinions that contradict their beliefs and tend to follow the herd. If you can embrace uncertainty (or at least become comfortable with it), stay open minded and avoid the most popular areas, you will put yourself ahead of 95% of other investors, in my opinion.
It isn’t easy. We’re all subject to the same behavioural biases and can easily let them influence our decision making. But awareness of that fact – combined with a constant effort to limit their impact –will go a long way in investing.
5. Keep track of your decisions
For as long as I can remember I’ve maintained a detailed journal of all my investment decisions. Why did I sell Company A to buy Company B? What was I thinking when I made the decision? How was I feeling?
It can be easy to forget why you took some investing action, in my experience. And often, the narrative in your head can change to suit the prevailing circumstances (I always knew that business would be acquired).
Without maintaining an audit, it can be easy to learn the wrong lessons. You might have had success or failure with an investment, but for reasons entirely unrelated to your initial thesis. What we attribute to good or poor decision making could easily be due to luck.
In investing, there is often a long feedback loop between the initial decision and the outcome. It might be five or 10 years before you know whether you were right to invest in a business. This makes it even more important to keep track.
When we launched the Quality Shares Portfolio, I wanted to make sure there was a clear audit of my decision making. I have an Investor Zone which explains my reasons for investing in every single company in the portfolio. I also write detailed quarterly performance reviews and monthly updates explaining my thought processes and decisions.
I hope investors find this useful. It certainly helps me to keep track of my decision-making, enforcing a certain discipline to stick to my principles, and should provide valuable lessons in the years to come.
6. Bonus – never rely on someone else’s interpretation (including mine)
It’s human nature to want to follow the ‘experts’. But with investing, you have to come to your own opinions.
I used to spend a lot of time reading analyst reports on companies. Now I don’t. I go to the source materials – annual reports, conference calls, company presentations etc, rather than rely on someone else’s interpretations.
It doesn’t mean I don’t listen to other people. But I always want to have done my own work first. It’s why I never meet company management until I’ve completed all the analysis I can on the business. That way, not only do I have a clearer idea of knowledge gaps, I also hopefully have less chance of being hoodwinked or sold a narrative.
There is no substitute for doing the groundwork yourself and learning your own lessons. There are so many different ways to invest and so many options, you have to find what works for you.
See five-year performance of the shares listed above:
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