VALUE INVESTING
K.I.S.S.

By Stephen Bland (TMFPyad)
December 5, 2002

One of the most famous memorable riffs in music, well rock music anyway, has to be the opening three notes of Smoke on the Water by Deep Purple, specifically by their great guitarist Ritchie Blackmore. But this may be dwarfed by probably the greatest opening of all time, the first four notes of Beethoven's Fifth Symphony, the first three of which are in fact the same note. I am not comparing the abilities of these two but mystics may observe that both their names begin with B and have nine letters. A pattern, and don't people just love to discover patterns. Is Ritchie the reincarnation of Ludwig? Perhaps. Roll over Beethoven. But the glaringly obvious connection between these two sequences is how utterly simply, and effective, they both are.

My topic this week is complexity, the unnecessary desire for, by many investors. Otherwise known as overanalysing, a word I coined regarding shares when I first saw, long before the Fool, the biblical sized share reports written by brokers for their institutional clients. How much information do you need to decide on a share purchase? Even a long term one, let alone a short term value play. Precious little in my view. A few basic fundamentals, decide whether you like the name and the general smell of the share and off you go.

For long term value related investing like a high yield portfolio, don't be misled by data on demographic trends, barriers to entry and that sort of nonsense when choosing shares. This stuff can mislead you into thinking, by attempting to take into account such factors, that you are a better investor than you really are. But they won't help in my opinion, may well prove negative, history being littered with the poor businesses that were bought on such considerations. Stick with loose value criteria like high yield, low P/E, low debt etc. as you see fit and diversify the sectors, avoiding duff ones like engineering and some others. That is all you need to do.

A long term portfolio is essentially an act of faith and you must start from the premise that you know nothing about the long term future and never will. You can't learn about it. But you can learn about the past and what wins, what loses. Don't allow yourself to believe that by studying some trend data that in consequence you will know more. You won't but the danger is that you think you do and consequently make poor choices. The long-term investor first convinces herself that she knows nothing about the future and accepts this. She in consequence avoids any methods of trying to find out about it. The question then remains, how to invest into a future where nothing is known? What Works on Future Street? Answer, same as What Worked on Past Street. And that is fundamental value, not demographics or anything else.

Another fallacious and complex fundamental approach to share selection, for which I reserve special loathing, is the present value or Discounted Cash Flow (DCF) calculation. A technique for valuing investments where the future flows can be estimated with some reliability such as bonds. But the long term future flows of cash or profits from shares are too uncertain. We all know how wrong analysts can be on merely the forthcoming year's figures, let alone many years into the future. I believe this idea is responsible for widespread losses amongst small investors, maybe big ones too. Yet you still see it suggested widely as a worthwhile approach to share valuation, both around the Fool and elsewhere. I understand that people actually set up spreadsheets to do this but me, when I hear the word spreadsheet I reach for my pun. Anyone finding the need to use a spreadsheet to analyse and select shares is probably already going wrong. I would rather use Technical Analysis (TA) than DCF.

Talking of TA you can apply the simplicity concept here too. I doubt many pure TA followers make good profits in the long run but anyway, there is simple TA and there is overly complex TA using the most obscure concepts. For those tiny few natural traders that can score seriously with pure TA over time, I suspect it is likely to be a basic version rather than the extreme stuff.

I have found that there are some people in life that always have to try and complicate their financial affairs, not just investing. You may know the type, typically has a large number of bank accounts when only one or two would be perfectly adequate. It is my experience that such individuals are not the most successful but somehow they feel that excessive complexity is clever and that having everything simple is rather amateurish. The reverse is more often the case and it definitely is with shares in my opinion..

You can boil all this down to KISS. Keep It Simple Stupid. If you find yourself getting into complex methods of share selection, stop and ask yourself whether they really improve your chances. Even though it might feel clever to have arrived at a share buy through some complicated reasoning, it does not follow at all that this makes it a better choice. The market just does not work like that.