QUALIPORT
Key Questions For Long-Term Investors

By Maynard Paton (TMFMayn)
October 22, 2001

Carburton Street, London -- If you've read the Six Tips For Starting With Shares, then you'll know that one of the key guidelines for share picking is to form an investment strategy. And for most people, where the week is spent working for a living rather than monitoring a portfolio, a longer-term philosophy is often required.

Think like Victor

So, if you're a long-term buy and hold investor, there's one key question to ask when considering any share investment:

"Would I be happy buying this business in its entirety?"

Okay, so most ordinary investors may never achieve the wealth of the late Victor Kiam. But by thinking about buying the company as a whole, it puts you in the right frame of mind when approaching any share investment.

For starters, such an approach focuses your thoughts on a long-term investment horizon and the qualities of the underlying company. Without a market maker ready to take on your whole business whenever you feel like selling out, the research that goes into the investment decision should be all the more meticulous. That preparatory research will encompass three further questions.

All Greek to me

The first such follow-up question is:

"Do I understand this business?"

An obvious question to some perhaps, but many investors fail to ask it. Take Bookham Technology (LSE: BHM). The company describes itself as a "leading supplier of silicon integrated optical components for fibre-optic communication networks". Bookham's recent interim results included this statement:

"[Our] technology demonstrations included a Wavelength Selective Ring Interconnect (WSRI) and an Optical Performance Monitor (OPM).  The WSRI combines the functionality of two Optical Add-drop Multiplexers on a single silicon chip. The OPM combines ASOC with sophisticated DSP technology to extract key wavelength and optical signal to noise ratio (OSNR) information for the most advanced DWDM systems." 

While telecom engineers may understand the lingo, Bookham's statement could be written in Greek as far as I'm concerned. There's no shame in not being able to understand certain industries, companies or products. The fact is most investors would be better off drawing a strict circle of competence, rather than try to appear sophisticated by investing in exotic companies with fancy products.

Knowing what you don't know is essential to prudent long-term investing. Because when your company encounters trading trouble (as they all do from time to time), you need to be able to determine whether it's a temporary problem (and a possible glitch investment) or the beginning of the end.

Think like Warren

The reason why you have to understand what a company does is simple. You have to answer this next question:

"What is the sustainable competitive advantage of the business?"

Legendary US investor Warren Buffett had this to say in a 1999 Fortune interview:

"The key to investing is not assessing how much an industry is going to affect society, or how much it will grow, but rather determining the competitive advantage of any given company and, above all, the durability of that advantage. The products or services that have wide, sustainable moats around them are the ones that deliver rewards to investors."

You see, it's not good enough just to understand what a business does. Sure, most people can get a grip on how a ladies fashion chain or a toy manufacturer may operate. However, because retail fashion and children's toys have very fickle customers, it's difficult for any company involved to consistently develop a successful record. Long-term, this operating difficulty doesn't do much for a company's profitability, nor its share price.

What long-term investors should seek are companies with products or services that will keep ahead of the competition in years to come. It's no good dreaming about the possibilities of tomorrow when today's profits could be at risk  Peter Lynch once said: "Competition can be hazardous to your wealth". And he's right!

If you're in for the long haul (and being an imaginery owner of a private business, you will be), your biggest worry will be a rival permanently superseding your company's product. Trading difficulties caused by operational hiccups or an unfavourable economic climate can be resolved. But there's no guarantee that a company slipping down an industry's pecking order through product or service obsolescence will ever recover.

Switch off the market

The final question to ask when picturing yourself owning a whole business, rather than just a part-share, is this:

"What's the intrinsic value of the business?"

If you own a business outright, then there won't be a stock market quote to "help" you.  While there are many ways to put a price tag on a company, one of them isn't relying on what somebody else thinks, or second-guessing what they might think.

Owners of private businesses have the luxury of not being distracted by stock market tickers. They can only look at the financial performance of their business, its profits and so on, to set a valuation. Long-term private investors should act in a similar manner. Value your business without reference to the stock market. 

Summary

To reiterate, when approaching any share investment, imagining buying the company as a whole puts you in the right frame of mind. Such thoughts will help you focus on probably the three most important aspects of successful investing: understanding a business, understanding its competitive edge, and understanding its value.