Over the holidays I spent time with family and friends, took some worthwhile R&R and reflected as I always do on the past year to gauge my growth as a person both personally and professionally. After many visits, presents, phone calls, greetings and 1600 kilometres of travel in under a week, I found myself reflecting in the presence of a beautiful young woman on my right, an empty bottle of wine between my feet, a warming fire on my left and in the forefront through the bay windows a clear moonlit winter night sky. My thoughts ranged from having spent too much money or time on gifts for my family and girlfriend to conversations over the past year with old friends, new friends and many words of wisdom from mentors.
I decided to open an envelope then from Charles which I’ve come to expect each year as a handwritten page of riddles for self reflection on life and investing. There were the usual praises from him on my growth as a young man, compliments to the woman at my side and a simple quote at the end of the page which is so often his hallmark:
The greatest ability of any mentor is to challenge the mentee to develop their own unique thoughts and practices rather than simply adopting those taught from the teacher. The purpose for each challenge is to strengthen the critical thoughts needed for the student to grow into something much more by expanding their thoughts and abilities. No single success I’ve enjoyed from a stock can be directly linked to advice from Chuck, but rather through the lessons that indirectly have allowed me to develop the discipline that I can currently execute and continually adapt.
The reference to value in the quote made me smile because of how it applies to my approach with investing and the foundation of our friendship. Value for me has always been the balance you weigh between a benefit and a cost. Yet the value in a product, service or stock can be much easier to calculate than the sum of value found in a person. The quote was to remind me that success is not solely measured by intangible objects or great achievements, but by the quality of the person who attains them.
Value, as an equation, is about balance more than the inevitable outcome. Whether it shifts in one direction to favour a benefit or a cost the balance that you attempt to attain is the key in achieving consistent success in anything that you do. My Value Portfolio as an example is not successful strictly due to the stocks I research, buy, hold or sell but rather through the balance that I focus on. In any of my assessments of a company there is a continual focus on balance between the benefits and costs, qualitative and quantitative factors, fundamentals and valuation and how it fits into the grander scheme of what I am trying to do. Short-term success, whether outstanding or not, takes a secondary role to my initial objectives of growing these investments over the long-term at a consistent pace.
Whether I accumulate an astounding amount of wealth in any tangible form in the years to come is secondary to the priorities I have for family, my career, myself or for others. Money is nice, but it certainly is not everything. My intention is for it to provide greater flexibility for me to do the things I wish to do in life. When I passed on lucrative opportunities out of business school to pursue a career in nursing my intent was that it would provide me this flexibility and I intend to hone my approach & style of investing to help accomplish those feats. Higher returns on an annual basis simply put me that much closer to an intended goal for financial freedom and allowing me to work for myself rather than anyone else.
The past nineteen months have been a humbling experience to say the least. 2007 was the first full year for both the Value & Health portfolios and in May I set out on a third portfolio focusing on Dividend Growth. When I consider the energy and time I had spent over the past five years on researching strategies, developing tactics, gaining a better understanding of investing theory and forging my Value Rules I have trouble gauging the full distance I’ve come from where I was when I began journaling my thoughts & experiences. In early May of 2006 I set out with my first purchases for the Healthcare Portfolio, followed in August with the Value Portfolio. It’s hard not to look back on the past and this progression to where I am today and wonder if the next five years will hold a similar or greater expansion of knowledge.
I can’t complain about any of my successes or failures because there are honestly too many to count. I missed some opportunities and took advantage of others, defied the market in certain moments and made the mistake of following during others. The most influential lesson learnt from 2007 was a greater appreciation for the importance of patience. I always talk extensively about this but I gained a much better appreciation for the need to exercise patience during both the ups and downs in the market this year. The market at times will show moments of logic, rationality and calm only to later be taken hostage by chaos, emotion and inevitable volatility. Stocks will be oversold, value will emerge and having the convictions to stick to your guns will test your will time after time.
The exclusion of emotion was another valuable tool I learnt to harness this year by often selling just short of potential maximized gains and sticking to target prices regardless of ascents or declines. With many of my M&A stocks there was a potential for an additional 3-5% upside from the market price to the buyout price. I decided instead of waiting until the transaction date to book my guaranteed return at the time and sit in cash waiting for other opportunities. In creating a value equation I realized that no 4% upside could create meaningful value in contrast to a 20% downside if the buyout didn’t go through. In the event that didn’t conclude, I would be position to potentially buy back those same shares at much lower market price and hold for the long-term with a much higher MoS. Having cash also allowed me greater flexibility in two situations where I made key purchases after accumulating cash that I wouldn’t have been able to do if not for selling shares as early after a M&A announcement.
Along with emotion comes pulling the trigger without passion. On multiple occasions this year I set out a specific buy target for a stock only to see it barely miss by a few cents during large trading volumes. At times emotion can get the best of any investor as during these times I questioned what a few dollars or cents really meant in the grand scheme of picking a stock that was clearly undervalued. What I found was that often only days or weeks later the stock dropped into my buy range and I was rewarded by my earlier patience. At times I missed a stock completely, but by not allowing the emotional turmoil of missing out on potential value from affecting my decisions I didn’t overpay and ultimately found that the market would discount it further below my target price on occasion anyways. Even in this current environment of doom & gloom I’m not easily inspired to buy stocks nearly 20% off their 52-week highs. If I miss the opportunity than it will be a lesson well learnt, but understanding the importance of patience and excluding emotion may in turn provide a much greater lesson over time.
There is one lesson many investors can recognize from 2007: there is no substitute for quality. We’ve seen company after company writing off billions in losses related to shady activities in debt markets and questionable risk management policies. Many corporations are now revealing positions that many shareholders would never condone regardless of the potential upside to the bottom line and many investors are now focusing more towards quality than the abundant quantity in the market. Investors know that quality is less abundant than quantity and very rarely gets cheap enough for an investor to take advantage of. When opportunities such as recently arise, investors beat down stock markets broadly during specific events and value is created in specific stocks. Factors such as management, strategic focus, core competencies or branding are often secondary in the minds of investors to the bottom line and difficult to quantify in any meaningful approach, but come to the forefront in times such as this.
This year alone has helped me to create a greater appreciation for the set of Value Rules I’ve painstakingly designed to help me locate investments of value. Whether the market over prices a company based on fundamentals, core competencies, value of assets, strength of management or any other factor never concerns me; only when a miss pricing occurs that offers value beyond a margin of safety through which putting my money at risk is minimized greatly. Far too often the market will lose patience, disregard or fail to recognize key strategic advances of a company of considerable quality. These are the opportunities I target and specialize on.
2007 also brought about my decision to begin publicly documenting my activities, thoughts and beliefs concerning investing, the markets and strategic business behaviours. While some value investors concentrate selectively on P/B, P/E, NAV or some other metric, I instead chose to concentrate on a properly diversified arsenal of analysis that allows me greater flexibility in assessing investments of varying differences. Through conversations with peers I’ve tried to help bring a greater focus towards qualitative and quantitative factors as equal partners in financial analysis. Qualitative factors are never as easily put into context as corporate earnings, book value, return on equity or other sources of financial information. Qualitative factors can range from evaluating management’s ability to execute a focus, creating greater brand awareness amongst your consumer base or simply doing what you do best in order to grow a company consistently over the long-term.
Regardless of commodity prices today ships will at some point continue to transport raw materials well above their operating costs across the globe, regardless of the housing crisis and sub-prime losses in the US market consumers will at some point continue their traditional purchases of furniture to furnish their dwellings and regardless of any economic downturn consumers will continue to take hot showers, pay their auto insurance premiums and invest the majority of their savings in high MER mutual funds through trusted advisors.
Although cash may only return 3-5% in high interest savings accounts, t-bills or GIC’s; Cash is King. Cash does certain things which many other asset categories have difficulty doing: offering flexibility, speed and the ability to quickly act at a moment’s notice. In the environment an investor finds themselves looking at today, cash doesn’t appear to be that poor of an asset allocation choice if your view is to invest over the long-term.
Over the past six months I’ve learnt to focus on events that hold the potential for generating considerable collateral damage due to investor oversight or the market turning a blind eye to solid long-term fundamentals in comparison to short-term difficulties. I’ll post more on this in the New Year as I finish writing a post on a recent stock purchase, but sometimes you find value in the oddest of places where everyone else sees destruction.
Regardless of what 2008 might bring, investors should focus on identifying their own requirements for success and not looking back in the past to previous returns, but ahead to the challenges and opportunities which will present themselves in the coming months.