8 Investment Lessons from the Masters: Things More Important Than Market Trends

Red and Green Guide:

An effective way to avoid bidding in a crowd when buying is to have enough knowledge and courage to buy something worth its value when no one is interested. Another method is to know a certain type of company so well that no one can surpass you.

Author: John Train

Source: Barron's China, GES Wealth

Is it possible to catch the ups and downs of the entire market? Investment masters do not think this is a feasible method. Whether it's Buffett, Carret, Graham, Soros, Steinhardt, or Templeton, they all adjust the ratio of stocks and defensive assets based on market valuations. Fisher, Lynch, Templeton, and Wanger believe that this strategy usually does not make money.

So there is simply no universal rule.

For traders, especially those who use leverage for derivative trading like Soros, if they bet in the wrong direction for a long time, they will go bankrupt sooner or later. Therefore, they have no choice but to stay agile at all times to survive.

However, for a qualified stock investor, this is obviously wrong. If an investor, after a comprehensive analysis of a company, is convinced that its stock will grow 5x, 10x, or 20x in the next 20 years, even though it may occasionally drop by a third or more, he can and should bravely face the volatility rather than trying to make extra profits from market timing.

Traders like Lynch or Steinhardt can profit from frequent trading, but long-term investors like Price or Fisher (from a core holding perspective, Buffett should also be classified as a Fisher disciple) would think you are likely just being clever and end up outsmarting yourself. You seem to cleverly sell stocks to lock in profits and wait for the price to drop to buy back, but often the price starts to rebound sharply to an unattainable level, leaving you helpless.

I find that most excellent stock analysts are not excellent market analysts, and vice versa, just like batters and pitchers in a baseball game. But a poor market analyst can still succeed through stock analysis. In fact, the best sign of an undervalued overall market is finding many obviously undervalued stocks.

The most powerful argument against market timing is simple: if you leave the market during the critical three to five days (the bottom of market undervaluation), your investment returns will be ruined. The market often explodes from a major bottom or dives from a peak, leaving investors like Wanger's zebras unable to react in time.

By the way, the number of people who believe in market timing is itself a market indicator. In a bull market, no one considers timing, but at the bottom of a major drop, when people are facing their floating losses in despair, timing does seem very attractive.

Here are some principles favored by excellent investors I have observed:

1. Only buy good companies you understand well.

A stock is not just a piece of paper; you cannot expect its price to fly from $50 to $100 like a bird. It represents a small part of a company with certain business characteristics, just like owning a small share of a house.

Suppose you buy a week's ownership of a house. The dumbest way to spend that time is to call the real estate agent every hour or two and get anxious about what they say. The wise approach is to hire an appraiser to inspect the house, figure out how much it costs to repair and improve it, and maybe compare its value to other similar properties or even properties elsewhere.

You would want to chat with neighbors to learn about potential zoning changes and visit nearby schools, the mayor, the police, and the bank. Only by taking these actions will the week not be wasted, and your chances of making a wise decision are much higher than those who sit at home and only know how to pester the real estate agent.

In this sense, how absurd it is for investors to buy stocks without understanding the company's true value—whether the management is competent, R&D is effective, machines can keep up with the times, or the company is thriving or struggling—all these are highly related to the company's competitiveness.

Yet, in fact, very few investors truly understand the companies they hold, which is indeed very absurd. After buying stocks, they focus on the stock prices in newspapers rather than annual reports. They usually don't even bother to find out if the broker who sold them the stock really understands the company's business beyond the surface, but in fact, these brokers often know very little.

A good investor has a concrete and detailed understanding of the companies he is interested in, knows the value of the entire company, and thus knows how much 1% or 0.01% of the company should be worth.

2. Try to buy when no one is interested, especially in times of crisis.

An effective way to avoid bidding in a crowd when buying is to have enough knowledge and courage to buy something worth its value when no one is interested. Another method is to know a certain type of company so well that no one can surpass you.

3. Be patient and don't be paralyzed by volatility.

Stock prices fluctuate up and down just like the alternation of sunny and rainy days. It is particularly important not to sell just because a stock falls below your cost price or when it breaks even—your cost is just an accident. Stocks are not people; they don't know your cost, aren't trying to disappoint you, and their price doesn't affect the company's prospects. Remember, focus on the business, not the stock quotes.

4. Don't guess blindly.

The cost of betting on a series of seemingly plausible half-baked speculations is astonishingly high, not only in terms of actual costs (commissions, bid-ask spreads, and the cost of buying high and selling low) but perhaps even more so in opportunity costs. For example, trying to catch the rebound of an ordinary heavy industrial company with weak intrinsic growth is feasible for financial institutions that systematically study all industries and understand their value, but for retail investors, even without actual investment, just thinking about such things can make them give up buying an excellent company, which is precisely the best investment most of us can hope for. Only buy stocks you would be happy to hold even if the stock market closes for ten years—Buffett is obviously very wise on this point.

5. High dividends can be a trap.

The best companies to invest in are those that can deliver 15%, 20%, or even higher returns on capital. Leaving your money in the company to continue growing at this rate, rather than taking it back as dividends, not only avoids taxes but also prevents the money from being invested in bonds or other assets with much lower real returns.

In addition, many high-dividend companies are Ponzi schemes. If a company's long-term debt grows faster than its dividend payments, it's like running on a deadly treadmill—stopping is inevitable, and its stock will be hit hard.

6. Only buy bargains or stocks with fast growth and high certainty, so that they quickly seem worth the price paid.

Of course, sometimes you can have both. For example, if you buy an excellent bank stock at two-thirds of its book value and can be sure that through dividend reinvestment, the stock's value will grow at 15% annually and pay reasonable dividends, then your investment is on the right track. One day, the market will bid much higher than your purchase price. Of course, dividends should also double every five years or so, so no matter the market conditions, you won't be in trouble. This sounds simple and isn't actually that complicated or difficult—all you have to do is not aim too high and only do what you understand.

7. If stocks don't look cheap overall, don't buy.

Remember, the next bear market rarely takes more than two or three years to arrive.

8. Stay flexible.

As old principles become overused, they must give way to new ones, though not necessarily brand new. This is a fundamental secret of investment masters and the reason why the book begins with "Times are changing, and we change with them."