Investment process
It is not all about ‘stock picking’
Some highly successful investors are thought to be great ‘stock pickers’. You might think that is where their success lies. And that if you can’t pick stocks like these pro’s you are better off in index funds.
The theme I want to explore in this post is the idea that one’s investment process or what Ben Graham called Principles of Operation, are actually more important than skill in stock picking. Also right up there in importance is the avoidance of human foibles, i.e. investment psychology, which I written about here. I also want to make a few comments about stock picking.
My thought today is that it is not all about ‘stock picking’. Choosing stocks for your portfolio is important. But, as I think back on my investing success over the years I would say that stock selection was not the most critical factor. I think investment process and investment psychology were the most important things.
As Ben Graham remarked in a speech in 1974, investing does not require genius: “What it needs is, first, reasonably good intelligence; second, sound principles of operation; third, and most important, firmness of character.” (Lowenstein, Buffett, The Making of an American Capitalist. 1995, 2008) p.160.
Choosing an investment process
Ben Graham’s Principles of Operation are what we might call our investment process or approach to investing. There are some fundamentally different ways to come at the investment game. Call them different styles of investing. We can attempt a simple description. As to what they really mean is another question. The styles may be described as: buying great companies; buying growth companies; buying companies cheap; buying strong stock performers; buying steady stock performers; buying dividend stocks; buying dividend growth stocks; buying stocks based on business cycle (sector rotation); buying small companies; buying big companies; buying fallen stars; buying great companies cheap and so on. There are fundamental differences between these styles. There are also fundamental misconceptions as to what the styles really are.
This is not the place to describe in detail what the different styles are and what the strengths and weaknesses of each style is. This is taken up in the Motherlode. See below.
What we learn from the great investors
Since different investing styles and different approaches to stock picking have had different results in different eras, it is very useful to be aware of the different approaches used by great investors in the past and reflect on whether they are more or less applicable to investing at the present time. What worked in the period from 1980 to 2010, a period of steadily decreasing inflation, may not be appropriate over the next thirty years. We can learn something from the T. Rowe Price growth approach that was massively successful from 1940 to 1970. We can learn something from the international approach followed by John Templeton from 1950 to 1980 with outstanding success, and so on.
My point very simply
You may be the greatest stock picker in the world, but if you follow the wrong investment process/ the wrong investment style/ wrong Principles of Operation, your investing will not be successful.
Having said that, I would add that different investment styles may work for different investors. I suppose your process must fit your personality – different strokes for different folks. As well, one’s investment process develops over the years. You try things and they don’t work. You try something else and it does work.
Warren Buffett started off very much in the Ben Graham net/net school of value investing. His style changed through contact with Philip Fisher and Charlie Munger. It has continued to evolve.
What about stock picking?
Warren Buffett’s approach to stock picking has also changed. He used to dislike banks, airlines, tech companies, foreign companies and auto manufactures but has subsequently invested in them.
Very little is written in stone. Times change. Fifty years ago the economy was dominated by industrial companies. Today, service and technology sectors are a major part of the economy. The nature of corporate assets changes from era to era. Today, corporations are carrying proportionally very much greater amounts of intangibles including goodwill on their balance sheets. And even more important, today many companies have massive intangible assets that are not even shown on the balance sheet. Accounting rules and regulations change. Banks in the 2010s are more closely regulated than before.
John Templeton said to never adopt permanently and stock selection method. One has to remain flexible. (Proctor & Phillips, The Templeton Touch, 1983, 2012) That said, some ideas are relatively immutable.
Where I stand today
My own approach (my principles of operation) is to purchase shares of companies with excellent businesses (or well along the road to becoming excellent businesses). I like companies that make lots of cash and have growth opportunities to invest that cash at high rates of return. I like to buy them at very advantageous prices giving me a substantial margin of safety. Management are co-invested. The investments are made for the long haul. Some would call it ‘value investing’. Warren Buffett considers the term ‘value investing’ redundant. It’s really an amalgam of growth and value.
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Readers wishing to dig further into the subject of investment process, take a look at the Motherlode Part 4: Principles of Operation
The Chapters in this part are:
24. Business objective
25. Investment Styles
26. Buying with a margin of safety
27. Sound Principles of Operation
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To read more about stock picking take a look at the Motherlode Part 6: The Hallmarks of Superb Businesses
The Chapters in this Part are:
31. General Approach to Choosing Common Stocks
32. Sectors and Company Attributes to Avoid
33. Thoughts about the Different Sectors and Groupings
34. Bottom Up and Various Qualities
35. Capital Structure, Strength and Economic Performance
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You can reach me by email at rodney@investingmotherlode.com
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Check out the Tags Index on the right side of the Home page that goes from ‘accounting goodwill’ to ‘wisdom of crowds’. This will give readers access to a host of useful topics.
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There is also a Table of Contents for the whole Motherlode when you click on the Motherlode tab.
Want to dig deeper into the principles behind successful investing?
Click here for the Motherlode – introduction.
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