3 lessons from a master investor

Picking winners is important – and so is avoiding losers. One of the best investors of our age has shared three mistakes we can learn from.

a woman

You’re reading a free article with opinions that may differ from The Motley Fool’s Premium Investing Services. Become a Motley Fool member today to get instant access to our top analyst recommendations, in-depth research, investing resources, and more. Learn More

Australia tends to take its economic and investing lead from the United States – and fair enough too. The US is the world's largest economy and has been for decades. It is the home of many of our household names – think Ford (NYSE: F), Nike (NYSE: NKE) and Walt Disney (NYSE: DIS) – but also many of the latest and greatest from the last 20 years – companies like Microsoft (Nasdaq: MSFT) and Apple (Nasdaq: AAPL). The United States is also home to many heirs-presumptive, such as Facebook, Groupon (Nasdaq: GRPN) and Zynga (Nasdaq: ZNGA).

Perhaps because Wall Street, New York is the spiritual home of capitalism, we have also learnt many of our investing lessons from Americans. Benjamin Graham is considered the father of modern equity valuation and his best-known student is Warren Buffett. Peter Lynch popularised a new perspective of buying what you know, and the power of growth.

However, the United Kingdom also has its share of world-leading businesses and investors. The FTSE 100, London's premier stock index – is home to Rolls-Royce (LSE: RR), Vodafone (LSE: VOD), pharmaceutical giant GlaxoSmithKline (LSE: GSK) as well as beer and spirits behemoth – and Bundaberg Rum owner – Diageo (LSE: DGE).

The Brits also claim their version of Peter Lynch in the form of Anthony Bolton – a star fund manager who delivered a 20% annualised return over the space of 25 years running the Fidelity Special Situations Fund, compared to an index return of a little over 7.5%.

Bolton has written a couple of books and in a 2008 article outlined three areas that had been responsible for many of his worst mistakes – poor balance sheets, poor business models and poor management teams.

Cash is King

Bolton was clear that of the three, poor balance sheets were by far the most common. For many years during the 1980s and again in the 2000s, analysts and investors decried what they called 'lazy' balance sheets. They agitated for increased levels of debt, allowing companies to return so-called 'surplus' funds to investors.

The folly of this approach was brought into stark relief when economies slowed and credit markets froze – companies caught with high net debt were forced to go cap-in-hand to their bankers and the equity markets just to stay afloat. Property trusts such as GPT Group (ASX: GPT) were forced to raise highly dilutive capital, with the number of shares on issue almost tripling in the space of three years.

Built to Last

Jim Collins and Jerry Porras wrote an entire book, called Built to Last, on what separated some of the best companies from the less successful or those that fell by the wayside. One of Warren Buffett's better known quotes refers to the fact that he is a better investor because he is a businessman, and vice versa.

The key theme here is that successful investing is more than just the numbers. Looking beyond the balance sheet and income statement, investors should seek to understand the sustainability of the business itself.

Who are its customers? Competitors? Is its market growing? What are the key threats to the company's products? Can its business be easily replicated or undercut by someone else? Can it earn a reasonable profit for its shareholders?

If you can't answer these questions convincingly, you should stay well away. Airlines such as Qantas Airways (ASX: QAN) and Virgin Australia (ASX: VAH) and steel makers like BlueScope Steel Limited (ASX: BSL) and OneSteel (ASX: OST) are in that basket for me, as are small unproven businesses whose future is too uncertain.

If you don't know jewellery, know the jeweller

This marketing slogan, employed by Buffett to spruik Berkshire Hathaway (NYSE: BRK-A, BRK-B) subsidiary Borsheims – unsurprisingly, a jewellery retailer – has some application for investors.

A management team who ends up being inexperienced, incapable or imprudent can destroy even the most attractive business. These types of managers make bad decisions, are too slow to respond to the competition or – quite often – let a company's culture decay.

Even if managers don't destroy the company outright, slowing sales or profit growth can see investment returns stagnate or decline. Individual investors won't be able to secure meetings with company managers, but company information such as annual reports, press releases and analyst meetings (now often webcast) can give us a glimpse. Track records, or lack thereof, are also irrefutable evidence of management ability, the quality of the business model, or both.

Foolish take-away

We spend much of our investing lives looking for the next big thing – and the compound effect of many years of high returns makes that aim very worthwhile. However, you need to have a lump sum to compound in the first place – and that means avoiding the losers is an integral part of successful investing.

Anthony Bolton's advice is clear – and his returns make him worth listening to – if the companies in your portfolio have poor economics, poor management or a weak balance sheet (or worse, a combination of the three), that mountain becomes much – and unnecessarily – harder to climb.

If you are looking for ASX investing ideas, look no further than "The Motley Fool's Top Stock for 2012." In this free report, Investment Analyst Dean Morel names his top pick for 2012…and beyond. Click here now to find out the name of this small but growing telecommunications company. But hurry – the report is free for only a limited period of time.

Scott Phillips Is The Motley Fool's feature columnist. Scott owns shares in Microsoft and Berkshire Hathaway. You can follow him on Twitter @TMFGilla. The Motley Fool's purpose is to educate, amuse and enrich investors.This article contains general investment advice only (under AFSL 400691). Authorised by Bruce Jackson.

More on ⏸️ Investing

A white and black robot in the form of a human being stands in front of a green graphic holding a laptop and discussing robotics and automation ASX shares
Technology Shares

Joining the revolution: How I'd invest in ASX AI shares right now

Advances in artificial intelligence (AI) could usher in a new industrial revolution. Here’s how you can invest in it.

Read more »

Close up of baby looking puzzled
Retail Shares

What has happened to the Baby Bunting (ASX:BBN) share price this year?

It's been a volatile year so far for the Aussie nursery retailer. We take a closer look

Read more »

woman holds sign saying 'we need change' at climate change protest

3 ASX ETFs that invest in companies fighting climate change

If you want to shift some of your investments into more ethical companies, exchange-traded funds can offer a good option

Read more »

a jewellery store attendant stands at a cabinet displaying opulent necklaces and earrings featuring diamonds and precious stones.
⏸️ Investing

The Michael Hill (ASX: MHJ) share price poised for growth

Investors will be keeping an eye on the Michael Hill International Limited (ASX: MHJ) share price today. The keen interest…

Read more »

ASX shares buy unstoppable asx share price represented by man in superman cape pointing skyward
⏸️ Investing

The Atomos (ASX:AMS) share price is up 15% in a week

The Atomos (ASX: AMS) share price has surged 15% this week. Let's look at what's ahead as the company build…

Read more »

Two people in suits arm wrestle on a black and white chess board.
Retail Shares

How does the Temple & Webster (ASX:TPW) share price stack up against Nick Scali (ASX:NCK)?

How does the Temple & Webster (ASX: TPW) share price stack up against rival furniture retailer Nick Scali Limited (ASX:…

Read more »

A medical researcher works on a bichip, indicating share price movement in ASX tech companies
Healthcare Shares

The Aroa (ASX:ARX) share price has surged 60% since its IPO

The Aroa (ASX:ARX) share price has surged 60% since the Polynovo (ASX: PNV) competitor listed on the ASX in July.…

Read more »

asx investor daydreaming about US shares
⏸️ How to Invest

How to buy US shares from Australia right now

If you have been wondering how to buy US shares from Australia to gain exposure from the highly topical market,…

Read more »