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Investing principles applied by legendary investors
By Kim Inglis
You don’t need to look much farther than the likes of Benjamin Graham, Warren Buffett and Peter Lynch to learn about value investing. Legends in their own right, they wrote the code for successful portfolio management and, although each established a unique style, their core philosophies are consistent.
The first common thread: do your homework. Learn as much as possible about the company whose shares you are considering. Study its business model, learn about its industry, examine its competitors, and determine its prospects for growth. As Lynch said, “The person who turns over the most rocks wins the game.”
If you still don’t understand the company’s fundamentals, don’t buy its stock. “Staying within your circle of competence” is a virtue that Buffett has upheld. He famously avoided technology stocks during the high-tech boom while peers criticized him, but when the bubble burst he emerged a winner.
Don’t be afraid to go against the grain, to be a contrarian. Lynch commonly used institutional ownership as a gauge. The higher the institutional ownership the less likely he was to purchase a stock because interest typically peaks when most of the gains have already occurred. If you buy when the Joneses do, you’re not likely to see much upside.
Another common element between all three investment gurus is the focus on quality. Look for businesses that are consistently profitable, with good prospects for continued growth. You should also take into consideration a company’s debt levels.
Examine the company’s competitive advantage. What are the barriers to entry? Are there patents to block competition or sufficient brand power to sustain long-term growth? As Buffett put it, “I try to buy stock in businesses that are so wonderful that an idiot can run them, because sooner or later, one will.”
When assessing quality, Lynch would often examine a company’s inventories. If inventories have built up, it usually points to underlying issues. Red flags should also arise if there is excessive corporate waste, such as unwarranted executive perks.
Always look for a good deal. As Buffett says, “Whether we’re talking about socks or stocks, I like buying quality merchandise when it is marked down.” Using the Graham approach, you should look for good quality stocks that meet fundamental criteria and are trading below their intrinsic value; creating a “margin of safety.”
Once invested, control your emotions. Benjamin Graham said, “Individuals who cannot master their emotions are ill-suited to profit from the investment process.” As Lynch put it, “The key to making money in stocks is not to get scared out of them.”
All three investment experts would agree that their approach does not mean buy-and-forget. Investors must monitor their investments and know when to exit positions. If a company is fully valued or if the business takes a turn for the worse, it’s probably time to pull the trigger.
– Kim Inglis, CIM, PFP, FCSI, AIFP is an Investment Advisor & Portfolio Manager with Canaccord Genuity Wealth Management, a division of Canaccord Genuity Corp., Member – Canadian Investor Protection Fund. www.reynoldsinglis.ca. The views in this column are solely those of the author.
