For meaningful returns you must invest like you mean it.
This article continues our series on The Principles of War.
You will make nothing but an almighty mess by banging on graphite sheets with hot hammers. If instead you place the graphite between anvils, heat it to 3,000 degrees and apply a pressure of 50,000 atmospheres you will be rewarded with the sparkle of diamonds.
This is concentration of force at its extreme, but follow this principle of war and you are much more likely to find ten carat investments in your portfolio.
You can control the intensity of two forces in your investing life: decision making and allocation of cash.
The harder I work the luckier I get
Let me be blunt. If you are not prepared or able to spend many hours each month on learning, selecting shares and following news then you will almost certainly do better to put your money in a fund, investment trust or an index tracker.
You don't have to be Andy Murray or Tiger Woods to do better than the average fund manager but a decent level of both skill and time is needed. Skill comes from innate aptitude, study and experience.
I enjoy reading about investing and commerce. From the age of sixteen, the first part of the Sunday paper in my hands was the business section. That's not normal, but a man should play to his strengths. If reading and thinking about shares isn't something you enjoy, then don't bother, hand your money to someone who does get a kick from it.
Red or green room?
Do you go for companies that are cheap and hope to outperform as they revert to the mean, or does profit growing get you going?
David Dreman brilliantly captured the two schools of investing in Contrarian Investment Strategies, likening them to a red room at a casino where sensible types grind out profits on boring shares, and the party-atmosphere green room where shoot-the-lights-out growth prospects lure punters to the tables. Hardly an even-handed description but illuminating nevertheless.
If you don't know which type of investor you are, and the prizes and pitfalls therein, then you have a lot more reading to do. And as for the 'bit of both' people, you wouldn't ask for Chateauneuf-du-Pape and Chablis in the same glass would you? If you haven't made that choice yet, you haven't understood the problem.
Next, when you are evaluating a share, you need to answer at least these six basic questions:
- What is fair value using an appropriate ratio for this sector?
- What is the visibility of earnings?
- Is the management competent and of high integrity?
- What threats are there to the business?
- If it looks cheap, why is it cheap?
- Is it a better buy than everything I already own?
How much is enough?
So you've spent a couple of hours researching a company and you're ready to buy.
Since you've probably rejected ten candidates for every one that's worthy of inclusion in your masterfully constructed portfolio, you have effectively spent twenty hours on the selection.
You deserve a good return on your precious time and that means buying a meaningful amount of shares. It doesn't have to be all at once -- maybe you don't have enough cash at hand, or you are buying a small cap and there isn't enough liquidity to get all the shares you want in one bite.
Unless you are a big shot with fifty different companies in your portfolio, there would be no point in putting only 1% of your worth into a share. It just isn't going to reward you enough for the time you put in, both in the initial research and in monitoring news. You would be better off buying more of an existing holding.
What you should look at is having different weightings for safer or riskier shares. You can hold two or three times the value in Tesco (LSE: TSCO), Vodafone (LSE: VOD) or Aviva (LSE: AV) to give the same potential for gains (and conversely chance of large loss) compared to a small cap like Lookers (LSE: LOOK) or a resource stock like Dana Petroleum (LSE: DNX) or Fresnillo (LSE: FRES).
"The excellency of every art is its intensity, capable of making all disagreeable evaporate." Keats
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