How I developed my Investment Philosophy.
My business investing approach has been carved and shaped by those who are deemed to be the greatest in this field of expertise.
My Approach is modelled around existing methods which have proven to be successful and significantly outperformed overall markets in the Uk and globally.
Significant influences on my Investment Approach include Benjamin Graham, Warren Buffett, Charlie Munger, Joel Greenblatt, Preston Pysh&T.I.P, Mohnish Pabrai and other very successful individuals.
My investment approach consists of FOUR CORE elements, in which all four must be met before an investment decision (stocks or bonds) can be given the green light.
1. Vigilant Leadership
The Management of a company must be carefully observant or attentive; on the lookout for possible danger, by definition.
This is assessed both quantitatively and qualitatively. As an investor, it is crucial that the company we decide to invest in is not only run by strong, able managers however also by individuals whom operate and think as business owners and are shareholder friendly.
Quantitatively: Assessing the levels of debt the management is allowing the company to hold. As well as the returns gained from asset allocation.
- Debt/Equity Ratio (Intra and Intercompany comparisons)
- Current Ratio (Intra and Intercompany comparisons)
- Return on equity (Intra and Intercompany comparisons)
- Return on capital (Intra and Intercompany comparisons)
- Return on net tangible assets (Intra and Intercompany comparisons)
Qualitatively: Assessing the management’s long-term incentives, aims and integrity.
- Management Incentives (Salary, bonuses, performance, integrity etc.)
- Management/Chairman letters during times of crisis (i.e. 2001, 2008)
2. Long-term Prospects
The key question here is whether we see the company to still be operating 5,10,15, 20 years from now.
Technological advancement proof:
One of, if not the, deadliest killers of a business is technological advancements. Therefore, it is imperative that my investment approach ensures successful companies are able to either withstand any future technological developments or grow due to them.
* This does not require foresight of any nature, here we are simply analysing what it is a company primarily operates and whether that will still be in demand over a long period of time. This is not a guessing game!
Sustained earnings and Capital Gains Tax advantages:
Investing in companies for the long-term will continue ti provide sustained earnings streams into our pocket. This could be through dividends or through intrinsic and book value growth.
Capital Gains tax is more favourable to long-term investors as it is presumed they have forgone the risk of holding an investment over a longer period of time and therefore are rewarded by paying a lower tax percentage overall. More detail can be found here.
3. Stable and Understandable Business Economics
The long-term stability of a company is very crucial when determining the potential long-term prospects, as well as its intrinsic business value.
I ensure the companies stability by assessing,
- Book Value (10-year trend)
- Earnings per share (10-year trend)
- Return on equity (10-year trend)
- Debt (10-year trend)
- Dividends (10-year trend) (This depends on the company in question)
- Management (Long term positions)
Understandable Business economics:
The most fundamental proposition for any type of investment is to fully understand what you’re investing in, this will ensure you remain within your ‘circle of competence’ !!!
The main things I look for to determine the understandable economics of a company:
- Supply and Demand of the industry and the specific company
- Market structure type the company operates within
- Revenue streams And costs of production for the company
- Main products, suppliers, customers, manufacturers etc.
- Rank in industry
- Most importantly, Competitive advantages!
* The list does not end here.
4. Attractive Price to Valuation
The Price of a security is meaningless unless it is compared with its indicated intrinsic value.
Intrinsic value can be determined in a multitude of fashions all depending on the type of company or industry.
To determine the indicated intrinsic value of a given company I use various mental models taking a holistic view of a given company and its industry.
This is accompanied with Four indefinite valuation models in order to create an intrinsic value range as opposed to relying on a single valuation number. These include (but vary between companies):
- Discounted Free Cash Flow model
- Discounting Earnings model
- Book value growth model
- Adjusted Asset base valuation model
I view the intrinsic value of a company holistically and only really view per share when making the investment. This approach was modelled from profound investor Warren Buffett
“I am a better businessman because I am an investor, and a better investor because I am a businessman.”
Thank you very much, I hope you enjoy the content.
Jordonlee W. Smith