We live in a very “noisy” world. The news media used to be on a weekly or daily publication cycle and now it is up to the minute thanks to widespread of social media channels. The actions to buy or sell securities used to be difficult and expensive, and required a telephone call to a real person. Nowadays, a few clicks on your cellphone you can execute a million dollar worth of transaction in your bedroom. On the high level, these developments are good because for people who really need to stay up to the second or execute a trade with low cost, these are possible now. However, is it really good for average investors in general?
Today’s technology and timeliness of news and information sometimes will put someone into a disadvantage. If you are a long-term investor, it may not add to your benefit if you are almost forced to deal with a famous “maniac” Mr. Market all the time. Many people don’t have the psychological strength to deal with these. Information overflow may trigger a lot of emotional stress, which leads to unwise actions of buying and selling, which is also made easier to brokerage firms so before you think it through, your trade is out in the market. This is a recipe for disaster.
What are the things that matter?
Through my years of investment experiences, and most importantly, years of making different kind of mistakes, here are the only things that matter to long-term investor. Ignore all the rest and you will do fine
Durable competitive advantage
This is essentially the moat. This concept has been explained many times by Mr. Buffett and I will not spend time to explain it more. If a company has to spend lot of effort to fend off competitors, they have a small moat. And their profits or competitive position is harder to maintain.
What is a reasonable price, you may say. My take is that it has little to do with the quarterly earning implied PE multiple that has been used so widely on Wall Street to value a company. A reasonable price should be the price point at which an investor can expect to earn a reasonable return on equity under the normalized interest rate and inflation assumption, based on a normalized earning power from long string of historical records (rather than one single quarter’s earning)
Although Mr. Buffett said the best business is a business can be ran by a monkey, you should never underestimate the amount of damage a mis-aligned management team can inflict to shareholder’s value. We should look for signs of management team aiming for the best interest of themselves instead of their shareholders. Personally if the business is controlled by founders, and if they have significant interest in the business, it is at least a good thing to begin with (not a sufficient condition, for sure)
Healthy capital structure
You never want to subject your survival to lender’s mercy. That’s the key consideration of capital structure health. There should not be too much debt on the balance sheet even the business is booming. The simple rule of thumb for us is to require long-term debt amount less than working capital of the company (Long term debt <= Current Assets – Current Liability) and cash and cash equivalents can cover short term maturing debt. Obvious there is no formula in investing and you have to make judgment based on individual company’s situation. But the rules above provide a good starting set of screenings.
Historical record of execution
This is an important aspect, however you also have to take a grain of salt when considering historical records. What you are looking for is not certain specific measures but rather a stable management team executing strategies successfully over various environments. Normally any company with less than 7 years operating history will not be on our buy list and if it can span over multiple economic cycles, it can provide more confidence to our judgment of the management team. Situation may be different when you are taking advantage of a “turnaround” story with a new CEO. In that situation, assessing the CEO is more art than science. But in anyway, a company with a culture of promoting talents within instead of hiring people from outside world is slightly preferred to us