VALUE INVESTING
Be A Cat

By Stephen Bland (TMFPyad)
September 20, 2002

I haven't written about such matters and their relevance to value investing for some time now but I do believe that a number of psychological factors are important to successful value investing, and many other approaches, particularly perhaps at a time like this in the midst of a serious bear market. By the way, this market is completely normal. Such downswings happen every so often and this is one. I've seen several in my life.

Learn to love loss for if you wish never to lose you will never win. If that's too poetic for you, the more curt, modern version is shit happens. A point that is especially relevant now because sometimes you will go wrong and this applies as much to value as other winning styles. No short term strategy wins every time and all investors have to face this somewhat unpalatable inevitability. You have to learn to live with losses. If that is unacceptable then investing is not for you. If your strategy is sound it will win in the end but not without some losses along the way. Of course if you make too many losses then it means that something is wrong with your strategy, but in my view that is not likely with a good value approach.

Be aware though that value takes much longer to work in a bear market simply because of the indifference that is prevalent to shares in general at such times. Interest in equities tends to dry up to a great extent, not dissimilar to football teams going through a bad patch when support tends to fall off amongst the less committed fans.

Another interesting psychological point is that people tend to filter information so that it conforms to their preconceptions, rejecting that which goes against and thus possibly fooling themselves. I had long noticed this from my own observations but some learned person has actually tested this idea. You can see this on company boards where people often want to hear only the good things that confirm why they were right to buy the share and sometimes become most indignant if anyone dare post anything to the contrary. Value players need to be immune from this, dispassionate, dissecting a share only to discover whether it might make a good investment, caring little for the nature of the products etc. That is why many readers have commented on the quality of the analysis on our value board, it is usually precisely in that style.

But even value players have to be careful, once in a share, that they don't start automatically filtering out news which suggests that they should get out and looking only for reasons why they should stay in. Falling in love if you like. It's not always easy, there is often information overload anyway which does not help. For me it's just the numbers. Do they still make value sense? If so I remain in and may buy further if the market offers me a good deal on a share I am holding which has fallen and I am not fully committed already. If not, I'm outta there whatever anyone says.

One point that had not occurred to me before, but which I read in some book recently, is that psychologists have found that people like to see patterns in random events. It is hard apparently for humans to accept that total disorder or chaos exists, so we may imagine patterns where none really occur. The good example given was of stellar constellations. The layout of the visible stars is purely random yet people are determined to see the Great Bear and the Plough and so on but you could see almost anything you wanted. The implication of this concept for shares is that people will sometimes over react to a piece of good or bad news that is really part of a string of unconnected events in which they see, falsely, a pattern. And in such activity can value be found by going against this trend. Similarly, some might data mine past share transactions, imposing patterns where none exist, or exist purely by chance for a period. The danger is in assuming the pattern will continue when it existed only by coincidence in the first place.

And finally the herd instinct. It is fairly obvious I think that people like the safety of numbers of their own kind. Largely but not exclusively, humans are sheep and not cats. This is why so few fund managers outperform, because of the risk of underperforming that goes with the territory of being different. Clearly to be better than the market you have to do something different to the market but if you blow it everyone will know why and your risk may therefore backfire on you. But if you are using roughly the same style as many others, then you always have the excuse that everyone is following that style so you can't be blamed personally should it not be too good. For those that like animal analogies, which I don't, to be a good value investor you have be feline not ovine. Sheep get eaten or sheared or both, cats in the main do not though they can suffer the occasional scratch or chewed ear. Cats are solitary, focussed, single minded, care little what anyone else does. They may take a long time lying in wait for their prey but once they have decided what to do, they just go for it and if they get it wrong, so be it, it was their choice alone.