My Investment Approach by Brian Langis, Seeking Alpha
My overall approach to investments.
I share some advice.
I hope you can share your investment approach too so we can become better investors.
Being labeled as the "investment guy" to my family and friends, I often get hit with questions that go something like this: "What's your investment philosophy, approach? How do you invest? What formula do you use? Or tell me what stock to buy so I can make money". The frequency of questions and discussions grew overtime as my online persona developed due in part to my articles on Seeking Alpha and myblog. Those of you in the investment business know that you can't really answer it with a one-liner. The purpose of this article is to provide a comprehensive answer to some of the questions I occasionally receive. Another purpose is that maybe it will spark other people to share and discuss their investment approach.
When it comes to the question of what kind of investor are you? I don't like checking myself into a box but if I have to, I would have to check value investing. I don't believe that markets are efficient, I believe companies have an intrinsic value, I look for a margin of safety, I have contrarian characteristics, volatility is not a measure of risk, and I buy things when they are on sale. I don't speculate and I don't short. I guess that on paper that would make me a value investor. But I'm not a purist. I also incorporate some growth investment characteristics and I also keep an eye on special situations. I don't run an investment fund with strict investment boundaries, so my hands are not tied to a certain investment category. I'm free to go where the opportunities are. That's why I don't "categorize" my investment style.
Back to the question "what kind of investor am I?" I'm never really satisfied with the answer the "I'm a value investor" and so my questioner. The phrase "value investing" itself can be more confusing than helpful. It's like saying "I buy low and sell high". So what's a value investor? The short simplified answer is that it's an investor that buys an undervalued stock. He's looking to buy a dollar for fifty cent. Using that rationale then isn't everybody a value investor? Obviously nobody buys a stock or an asset because they think it's overvalued. Everybody thinks they are getting a bargain and it will be worth more. After all, value investing has become so broadly defined that everyone seems to be in this camp, and when everyone is a value investor, no one is a value investor. In other words, you can't be a contrarian if everybody is a contrarian. In value investing, there are many schools of thoughts and it has expanded well beyond the Benjamin Graham school of strict value investing. I'm not a disciple of any value investing tribe. I believe value and quality goes hand-in-hand. I'm not overly fixated on paying low multiples. It is rare to get a truly great business at dirt-cheap prices. Unless you get really lucky, you are not going to find a quality business with a large economic moat trading at a price earnings ratio of six.
At the base, when I buy a stock, I have a fractional ownership in the business. It might not be much, but a percentage of ownership in a company. This gives me an indirect stake in the assets and profits on the company. In today's digital age where you can buy and sell stocks all day by just swiping your mobile, it's easy to forget that shares represent ownership in a company that employs people, produces goods or services and, hopefully, generates revenue, profit and cash flow. I guess it's psychological. I see the same effect when playing online poker versus playing at a table. Online, there's a disconnect that happens in your mind that when you don't see your chips, you forget that's real money. Players are more "loose", throwing money at bad hands and chasing streaks. That same behavioral disconnect happens when people see their portfolio filled with stickers bouncing around. I feel that the stock market is a mood gauge. It tells me what mood people are in any particular day. I can tell if they are panicking, depressed, or overly optimistically greedy.
What you see bouncing around every day in your portfolio is price. It's different from value. Value doesn't bounce around. You need to develop your own opinion of value. Adding value requires one to see that the stock is mispriced. Share prices, you may have noticed, vary enormously over the course of a year. I keep seeing the same stat over and over again that the average stock moves around 80% from its peak to low during a 52-week period. I don't know how accurate the stat is, but by looking at my portfolio there's some truth to it. A business's revenue, profit and cash flow rarely change anything as much as its share price. The reason for this is that the price of a company's shares is only a reflection of what people are willing to pay for them at any given time. In other words, price doesn't tell you anything about a company's worth, but it tells you a lot about the popularity of the company with the crowd of investors. Sometimes, usually when prices are rising, they're greedy. When prices fall, they become fearful and rush for the exits. All this emotion can push the share price a long way from the intrinsic value of the underlying business.
I don't worry about volatility. And by the way, volatility does not equal risk. I'm more concerned about permanent capital impairment. If something is going to be worth a lot more in the future I'm going to buy it regardless of the volatility. I also try to take advantage of volatility. When you have strong period of volatility like we saw at the beginning of 2016, it can cause investors to sell and sometimes to do so indiscriminately. There's a Chinese proverb that goes something like "the greater the crisis, the greater the opportunity". Or if you prefer an English quote, Winston Churchill said "Never let a good crisis go to waste".
When looking at the investment merit of a company, I usually look for these four criteria:
The company needs to be profitable and a strong generator of free cash flow with a good return on capitalI'm looking for honest talented managementReinvestment opportunities (capital discipline + allocation)Valuation: I want to buy the company at a bargain but I usually I have to settle for a fair price (a dollar for 70 cents if it's an attractive company.)
You will notice that the first three criteria are dependent on others and that means management plays a key factor. You can't really have one without the other, over the long-run anyway. Good management will generate free cash flow and allocate capital in a disciplined manner. If point 1, 2, and 3 are solid, you probably wouldn't find the company in the bargain bin unless you are lucky. I mentioned that I would settle for a fair