Updating My Process

16 Jan

I am always reading. Be it blogs or books or news or almost anything that I believe will help me either acquire new knowledge or challenge and solidify the opinions and knowledge that I am already acquainted with. I recently read this post on Greenbackd that drove home some advice I received from one of the asset managers in South Africa whose views and opinions I highly respect. He once told me that I should always be willing to change and improve my stock selection criteria and process while maintaining my philosophy. Something, it seems, that even Benjamin Graham and Warren Buffett embraced. They both, however, retained their value investing philosophies and the margin of safety concept.

Reading The Intelligent Investor it is obvious that Benjamin Graham was an advocate for one thoroughly researching and analysing a company before buying a stake in the business. This view seems to have changed towards the end of his career as he gave an interview in 1976 where he laid down a simplified set of rules for selecting value stocks: buy stocks that are trading at P:E ratios below 10 and have Debt:Equity of less than 50%, then to sell the stocks after they have appreciated 50% or have been held for 2 years (whichever comes first). I am personally not a fan of those rules as they sound more like trading than investing to me. The 2 year holding period clause is the one I have the most issues with. The last time I checked, profit realised from selling a security in South Africa was taxed at the normal income tax rate for those holdings held for less than 3 years, while those held for longer get taxed at the lower capital gains rate. I think the threshold is 12 months in the USA. I also do quite enjoy reading the annual reports of the companies I want to invest my money in as I want to know how my investment is being handled and by whom.

Warren Buffett’s change was not quite as drastic, but I believe it was a Brobdingnagian improvement and have significantly contributed to the man that is currently considered to be one of the greatest investors to ever live. In The Essays of Warren Buffett: Lessons for Corporate America, Warren Buffett admits in one of his letters that he used to simply buy securities that were cheap, but one very expensive lesson drove home the point that the quality of the management should also be considered. He now preaches the purchasing of great companies run by a great management team. That is something that resonates deeply with me as it results in longer holding periods of the securities. A time frame that I believe is more suited to my personality.

Now it is my turn to alter my process (and in all likelihood not for the last time as I am new to this). Those that read an earlier post of mine that outlined my process in detail will know about how I follow the five conditions that Benjamin Graham laid out in The Intelligent Investor. Well since then I have started using the “Graham number” a bit more often, but that is solely to check how undervalued this formula says the stock in question is, and only after all the other conditions have been met. I am also yet to find a share that is trading at less than 120% of net tangible assets and still does not trade below the “Graham number”. I have also started using intrinsic value as part of my analysis of the shares I am considering buying. What I have started calling the “Lynch Rule” (a company must trade at a P:E that is not higher than the earnings growth that the company is currently achieving) is something I have started toying with when looking at a company, but I am yet to implement.

Right now, buying shares in my favourite companies that operate in my favourite sectors is where I am strongly leaning. This obviously brings with it some issues that those professionals who preach diversity would advice against, but I am willing to work through them. The most obvious is that this will result in a highly concentrated portfolio (especially early on) as it will take time to build a good enough relationship with the companies that I will be putting my money in. I will have to build this portfolio over many years, and so there could be instances where I will own shares in maybe one or two companies for years at a time. I am just currently not a fan of the idea of forcing myself to purchase overpriced shares of companies I might not know, just so I can practically track the Top40 (and underperform after factoring in transaction costs). I am a major fan of buying shares that I believe that at a discount and thus provide me with a significant margin of safety should any of my calculations be wrong.

 I accept that this will require some emotional maturity on my part but I believe I am up to the challenge and am looking forward to the ride. After all, it is my money, my portfolio, my lessons and my journey. 

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