- By Jasvir Biriah
- August 30, 2021
- 12 mins
'At certain times in a market cycle, the public and private markets have the habit of taking their eyes away from what quality investing truly is'
This idea of quality investing tends to leave our minds during booms and busts. Being human means we play the never-ending game of 'riding the wave of opportunity' or 'escaping the claws of fear'. Investors seem to chase short-term momentum as a sign of success, and our mood changes with the ebb and flow of both public markets and the contractions and expansions in private market valuations. If we take some time to really think about this, we’ll come to appreciate that the system is set up to play on our five sensory mind, which stops us from anchoring to the reality of real businesses and what valuation discipline truly means.
If we look at the modern-day market, let's say from the 70’s and 80’s till today, the stock market has evolved ‘by design’ for traders and short-term speculators. If you want proof, look at the tools available to the general public and how democratised the buying and selling of shares has become. Look at how the TV channels report the markets accentuating every up and down move like a soap opera, technical indicators that are all backwards looking and meaningless, and leveraged investment products offered to the retail market that tend to play on human greed rather than provide a long-term source of wealth creation.
In the private market, we sometimes see bloated valuations at certain points in the cycle which are driven by the investment banks. This goes beyond valuations and it becomes a pure pricing game, which is great for the seller of the business cashing in, but not so much for the buyer.
The further we dig the more we realise the modern public market isn’t naturally designed for a long-term investor. The design of the system encourages a very different mindset, which is to chase short-term returns, and there are narratives pushed by media outlets that tend to play on action and activity as opposed to the prudent allocation of long term capital. One of the obvious culprits that provide fuel to the fire is the reporting schedules of businesses and governments. Businesses tend to have quarterly earnings releases, whereas governments have weekly jobs and housing numbers, and the central banks have frequent interest rate meetings all over the world. This data moves the market regardless of what the true value may be.
All of this encourages action and takes the attention away from what truly matters, which are the fundamentals of businesses and the longer-term outcomes for the economies in question. Roughly 95% of participants are short-term traders or investors all making decisions through this complex lens. The irony in all of this is that public markets were originally designed to provide investment capital for worthy businesses, this was designed for long-term investing. Investors many decades ago really did hold onto shares for the long term.
so where did it all go wrong?
For anyone who has spent time in the markets will understand that this has more to do with the investor's psychology and learnings over time than it does skill, and the institutions stand ready to provide solutions to fit the short-term needs to boost their revenues. Even though skill sets are important, the capital markets prove time and time again that behaviour and temperament are more important. We sometimes forget that there are millions and millions of people making simultaneous decisions based on emotional fear and greed. Everyone has their own narrative and this is what dictates the mood and momentum of the ups and downs in the markets.
The reality is, that investment excellence has various layers to it, the fundamentals of a business don’t always correlate to what the wider markets are showing and vice versa. It takes real-world understanding and hard work to solve the human psychology equation. It’s not easy, this means constantly accumulating knowledge but also working on your mental capabilities every single day to negotiate the temptations of fear and greed. This isn’t a part-time endeavour.
Not only does the investor need superior business analysis and share-picking skills, but they also need to have the courage to stand alone with their investment ideas when the world chases euphoria or the next best tech stock. In times of euphoria, traders and short-term investors become predictors of the future (ego) and tend to stand with the crowd (irrational biases). You'll see that anything that isn't in fashion must be a useless investment, THEY are winning and YOU are losing, but in our opinion, boring and valuation discipline can be good too. The bigger point loops back to the fact that we sometimes forget what it means to be a quality investor for many generations into the fututre. Anyone can be good for a few years, but it takes something different to be good for the next 50 years.
Here’s the catch with predictions. When things go wrong nobody seems to have the answers or the rational thought to know why things went wrong? Panic or fear sets in or the speculator has succumbed to leverage, or they simply didn't understand what they were investing in. My point is, that we should always be comfortable when the markets fall or when private valuations contract. We should understand what we bought in the first place, right? We should never compromise on independent thought, and we should make it a sin to chase the noise and what others think is in fashion. We need to do the work instead, and even if a good business falls in price because the markets have fallen, a true value investor only looks to dig deeper to recalibrate reality from the noise. Falling markets and the falling price of a business should be seen as two mutually exclusive events. However, the irrational human brain sees it as one event in a very linear fashion.
Having the courage to travel the path less explored
Investors sometimes forget that some of the best opportunities exist where people aren’t looking, but of course, this requires a reasoned approach to valuing a proposition and it takes forensic research, a lot of time and effort to quantify, and naturally, this isn’t the road many people are willing to take. Human beings are designed to pick comfort zones and ease, over pain and vulnerability. This is why the juggernauts such as the FAANNG stocks seem to be the staple diet of many portfolios around the world. Conforming with the crowd is a protection against our own ignorance and it gives the comfort of belonging rather than standing out. This herding behaviour is synonymous with all investing markets, both public and private. It can also be seen as a drug, kicks of dopamine can be addictive when everyone rushes towards the same opportunity with the huge fear of missing out. Who likes being left behind when it comes to making money, right? All logic seems to be thrown out the window. It’s a recipe for wealth destruction, not preservation and growth.
So, you can see why we lose the idea of quality investing during the journey. Quality is different, patient and reasoned. All are anchored to the valuation discipline of the craft. It takes a deeper intellectual honesty within, and I feel it’s the industry's job to enable investors to make more informed decisions, not to chase short-term trends of every up and down of the market.
Since the pandemic, we have seen the so-called ‘meme stocks’ and cryptocurrencies rise and fall on pure mood and momentum with no rational reasoning. I’m not condoning these types of investments or trades, every short-term investor or trader has the right to stand by their decision to see their wealth grow, but it’s not a place where I’d be qualified to make a high-conviction decision. So naturally, I’d stay away.
My number one rule is simple, no matter what the buzzword is, or the next hot stock that is the talk of Wall Street, it should never reduce the integrity of my investment mindset, this means reducing all noise to near zero, and having the ability to make decisions with clarity that fit my mental models, not those of someone else.
This includes the big banks, in my early days as an analyst there were certain circumstances where I did not understand the price targets being set by the institutions. When recommending equities institutions tend to give upgrades and downgrades based on short-term moves. Upon reverse engineering some of their metrics you can see where they may have exaggerated certain figures, or in some cases understated them. These are the traps waiting for a novice investor going into any investment blind. Independent thinking means ruthless independent thinking, and yes, this may mean digging deeper than the average investor and you may be standing alone with your thesis until the business quality proves you right.
Intelligent Investing – This doesn’t mean you’re intelligent
Investing excellence isn’t something an investor should bathe in, It shouldn’t inflate the ego, rather it should be a push to obtain a higher purpose beyond performance, with a well-defined process contained in a stable psychological framework. All intelligent conversations should be geared towards the inputs of the valuation process, and the outputs should take care of themselves. Practising a sense of detachment to the outcome really puts an emphasis on the love for what you do, the destination you arrive at will be a consequence of the various inputs along the way. Intelligent investing isn’t a higher ground over other investors. If an investor understands the process, the difference between price and value, and the journey that it takes to analyse a company, it isn't a competition against anyone. They will realise that quality investing lies in the intention behind the core principles and not the noise and momentum in the market, or the superficial trappings of wealth and money.
Markets are irrational because humans have a tendency to be irrational.
Successful Investing – A Behavioural Framework
Be ruthlessly independent in your thinking. If you don’t own the process you can’t control it. It’s that simple, I’ll let you read into this how you please. If you are getting advice, at least understand the psychology of the person managing your money. Investment philosophies and the way capital is deployed is highly important.
Self-Awareness. Be honest with yourself by understanding your ego and biases. It is a vital trait to long-term success. It has to become a way of life so its sustainable for decades. Having the courage to know what you don’t know is a superpower. Not knowing everything is fine, but thinking you know everything can disable your progression.
Understand the hardwiring in your brain. Decide who you are and what you stand for. It helps to know who you are in your personal life first. Are you a trader or an investor? Never pretend to be an investor if you are short-term orientated. There is nothing wrong with being a trader, ultimately you are in control of your capital. For a long-term investor, traders are an important counterbalance in the markets and provide greater liquidity over various time horizons. I have no objections to what you choose. However, be sure you know who you are and what you are trying to achieve, and it ties in with your goals. Ask this question too. Are you looking to make money? or build wealth? Be true to yourself, these are two different ways of looking at your capital. Understanding your mind, ego and biases is a lifelong challenge, so start early in your journey and spend time with like-minded investors that encourage this mindset. This will add to the sustainability of investing over decades, especially if you find passion in what you do.
Learn to think long term and focus on your inputs in the investment process, rather than the outputs. Practise the deliberate detachment from the outcome. If you’re in it just for the money, greed will kick in at some point.
Senior leaders that are new to Amazon are often surprised by how little time we spend discussing actual financial results or debating projected financial outputs.
To be clear, we take these financial outputs seriously, but we believe that focusing our energy on the controllable inputs to our business is the most effective way to maximize financial outputs over time.
Understand fear and greed, rational and irrational behaviour. This means the wider market participants and within yourself. This is a lifelong process, for it to become natural it needs to be mentally practised over time, with intensity. Do not be lazy in the pursuit of your internal truth, it really does matter when there is real capital on the line.
Learn to live with a paradoxical mind every day. Lead with humility in the process and execute with aggression in your investing when the opportunity arises. Even with conviction, always know that you can still be wrong, but being wrong is not a bad thing, it could mean buying more at discounted levels. You want the price to move up, but you would rather it fall more. The world is saying buy, buy, buy, but you are saying no, even though it may be at a fair value and may warrant a buy. This is all a paradox. One of the hallmarks of great investors is constantly questioning the decisions from as many angles as you can without losing confidence in yourself or the process it took to arrive at the initial decision.
Have the courage to study risk-taking, not always risk management. Sometimes the best form of defence is attack, right? How about attacking with a strong defence, midfield and attack? The idea is to build moats and engineer risk appetite into the investment proposition itself. Ben Graham called this a margin of safety. Why can’t we build many margins of safety into our investing? It is possible and we sleep easier at night. The more intimate our understanding of risk and where it resides, the higher the courage and conviction to stand alone when entering an investment. Risk is not always defined as volatility and macro market events like the institutions state. Once you understand this you will start seeing risk in a completely different light. Never stop learning the fundamentals of risk.
Not buying for months, the patience to be idle, but never stop working hard. If you are twitching to invest or trade for the fear of missing out, you are in risky territory and you are deviating from investing. It’s not only knowing ‘when to pull the trigger’, but it’s equally as important to know ‘when not to pull the trigger’. In war, a sniper's job is ‘shoot to kill’, but rarely do people appreciate the skill of not shooting. Not shooting saves lives and minimises casualties, it takes laser focus and extreme rational behaviour when it matters most. This is a far bigger skill than shooting to kill. The stock market is an auction-driven market, and it gives you a price every day. Whether you take the price or leave it is a combination of your skill sets and your temperament.
Predicting is overrated. Never try to be a fortune teller and lead with blind emotions or biases, or let your ego convince you that you know what’s going to happen over a smaller time frame. The same applies to economic forecasts and the wider market consensus. Ask yourself, do you want to be making the same decisions as the consensus anyway? Everyone wants to predict everything, it's this sense of precision that everyone is after. There is a danger of confirmation biases and cognitive dissonance with this type of thinking and we all know that intelligent investing requires work in analysing the business, not worrying too much about what the wider market predictions are.
Evaluate your information properly. Ensure your information is accurate and thorough. When modelling and estimating cash flows you can never be 100% precise. Not being precise doesn’t mean being lazy. If investors are lazy and inaccurate in quantifying interest rates, discount rates, and top and bottom line figures, there is no point in doing a valuation as your outcomes will be skewed with a huge deviation. Never solely focus on aspects of a business that can be measured, ensure you are focusing on the unseen, attributes that may add to growth or destroy it entirely. These insights require vision and forensic research.
Creating the right investment environment. This is something that took me many years to understand. With experience and time, this is possibly one of the most important elements for me that really contributes to investing success, especially if you are involved in it commercially. Being able to think clearly without clutter in a low-octane environment is a superpower of sorts. Being in a major city like London, the plethora of people you meet and the next best investment idea pollutes the investor mindset with lots of noise. There are hundreds of opinions on making one right decision. Therefore, the right kind of environment is of utmost importance and it will help investors think rationally without any outside cognitive biases or narrative.
Dream big and do the work, it’s worth it. Dreaming big beyond the borders of your home country and knowing the companies that you own is hard work. If you don’t dream big you’ll only ever stick to the main index top 10 juggernauts and you'll never find the limits of how successful investing could be for you. Not everyone will enjoy the time and effort it takes, and sometimes it can be a very monotonous process. The type of work where it’s intense, maybe boring, it requires laser-like focus, evaluating hundreds and hundreds of companies, just to say no to 98% of them. Those who run towards pain, and embrace pain, will eventually make it their friend, and in time they will be rewarded for their grit and determination to figure out the investment puzzle. Dreaming big, putting in the work and being intellectually honest is a great starting point for success.
Final Thoughts
For Intelligent investing to be successful the power needs to come from your conviction, not your authoritarian ego. Arrogance could be seen as having enough knowledge to give a sales pitch on an idea, but there needs to be more substance to add real value all the way through to execution and to sustain it 50 years out. Having a deep understanding of the moving parts of an investment is a vast study that gives the investor conviction and confidence. There is a fine line between simply knowing and understanding.
Mastering the craft of investing is a lifelong journey. We must be open to learning every day and open to reasoning with conflicting arguments to a thesis with an open mind. Investing is a paradoxical world where you are continuously manipulating the brain to go against what would normally be a standard human state of mind. It’s tough at first but you soon find it becomes a part of who you are and your world views change accordingly. Maybe this is what they call a contrarian? For me, it’s a highly nuanced way to think. Not only does your thinking become a part of the way you invest, but it also becomes the way you live your life. For me, at this stage in my investing journey, there are no lines between my value systems and mental models in life, or the ones I live by when serving my investors.
This brings me nicely to the execution part of investing. The ‘last mile’. No matter how much research you do, you'll always reach a point when you are required to pluck up the courage to buy or sell an investment. Not only having the gumption to execute under pressure, but sometimes dealing with vast sums of capital can lead some investors to collapse under pressure, no matter how solid the conviction is. Irrational behaviour can creep in. This can be dangerous.
The fact is, investing is hard work, no part of the process is easy, but it’s the ability to master one's self and the temperament that really gives the investor the edge. It's partly patience, and understanding the gift of deferred gratification, this takes discipline and lots of consistency in one's actions. The inputs are a lot more important than the money you make. You have to be willing to wait and witness the brilliance of compounding, but unfortunately, we live in a world where everyone wants it now, the majority of the market activity takes place over the short term, and therefore carries the highest levels of risk propelled by greed. There aren’t many investors looking far out into the horizon beyond the mountain ranges. This isn’t a very crowded place and I’d like to think, with the long runway, not only does this reduce investment risk, but I’m happier being here waiting patiently for the right investment proposition to reveal itself at the right price. Building equity takes time and there aren’t many playing this game.
This is why I have the courage to stand alone, it’s a minority sport for a reason, and if I stand firm with my values and philosophies I know my investors will succeed. It's not a question of ‘if’, but ‘when’ the returns will be delivered.
Author’s Disclaimer
The information contained in this post is for educational purposes only. The post should not be relied upon as advice. If shares or strategies are discussed, they should not be deemed as a recommendation to buy or sell any share, product or fund. We may have an interest in a strategy we discuss, and our advisory clients may be beneficiaries of our proprietary methodologies and investment tools. Consult your advisor before making any buying or selling decisions. Past peformance provides no guarantee for future returns.
