Three lessons for better investing

It has been a tumultuous time in the markets. The extreme volatility may not be over. But rather than focussing on the day to day movements of share prices and indices, I wanted to see what broad lessons I could learn to help me be a better investor.

Helpfully, three things that stood out for me fell into three areas – my own actions, management and the market as a whole.

Know thyself

As an investor, I’m somewhat of a contrarian at heart. I love finding a bargain amongst the unloved, unknown or oversold. I’m drawn to out- of- favour sectors, underfollowed companies and the lists of businesses whose share prices are hitting fresh lows.

I don’t believe in market timing, so I don’t try to pick the bottom for a company or the market as a whole. That said, the recent market volatility has reminded me of a couple of things.

Firstly, I need to remember to focus on quality. Sometimes turnaround situations can be great wealth creators, but many an investing ship has been dashed against the rocks of hope.

Secondly, if my investment thesis is still sound, further price declines simply give me a chance to lower my average cost base by picking up more shares as the price falls.

Candour is King

I read many company announcements and annual reports. There are plenty of pretty pictures and the printing (at least the front section) is often on glossy, high quality paper. For many businesses the annual report, analyst presentations and press releases are less about informing shareholders as to the performance and position of the company, and much more about spin and PR.

The solution is simple. I look for management I can trust. It’s not an easy task, but is one that with practice becomes easier over time. The simplest short cut is a question – how does management treat bad news? If the profit decline is hidden on page 3 of a press release, or management makes a habit out of reporting ‘adjusted’ profit more often than not, it may be a red flag.

Good news or bad, Warren Buffett’s Berkshire Hathaway regularly includes the following warning near the top of its quarterly earnings:

The limited information that follows in this press release is not adequate for making an informed investment judgment.

There aren’t many other companies who actively suggest their current or prospective shareholders dig deeper – it’s hard to escape the assumption that many actively prefer the opposite.

Irrationality Rules

Irrationality is always with us. Reactions to results announcements can be astonishing, especially on the down side. Share prices of companies who miss earnings expectations by even the narrowest of margins are often sent down for the count.

In addition, markets are also terribly short-term focussed. To imagine that a half-yearly or yearly result that misses expectations by a few percentage points can have a material impact on the lifetime value of a business is in most cases fanciful.

Yes, there are certainly results that demonstrate that an investment thesis is no longer valid, but for the most part a small miss on earnings or one bad year of sales is very unlikely to be terminal – either for the business or the share price. Often, opportunity lurks among the gloom.

Foolish take-away

In investing as in life, it is of great benefit to have a clear sense of where you want to go, and how you plan to get there. An investing roadmap or philosophy, well thought through and committed to paper, can help when times get tough and markets get jittery. More than once, such a plan has allowed me to stay the course, when it would have been easier to sell up and hide.

Of course, as John Maynard Keynes pointed out, dogma can also be dangerous, famously saying:

“When the facts change, I change my mind. What do you do, sir?”

Regular reflection is essential to make sure the facts haven’t changed, the chosen path is correct, and that we haven’t accidentally wandered off it amidst the noise of the market. The results can be very profitable.

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Scott Phillips owns shares in Berkshire Hathaway. The Motley Fool has a disclosure policy. This article has been authorised by Bruce Jackson.

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