I have been thinking about some of the investment lessons the past few years have provided to me — and other investors.
One of the things I find interesting is that many of those lessons would have been the same 10, 20, or even 100 years ago. Here are three of them.
Red flags are red flags
Occasionally a share can look very attractive, except for one obvious red flag. For example, it may have a huge debt load or a key source of income that is going to expire when a certain business relationship comes to an end.
Guess what? Red flags are red flags.
A lot of seasoned and very successful investors, like Warren Buffett, walk away from a possible share purchase as soon as they discover something about it that they consider as a real risk to the investment case. They do not try to balance those against possible rewards – they decide that a single big red flag is already enough to decide against investing.
As Buffett says, there is never just one cockroach in the kitchen. Rather than trying to decide whether a particular red flag is a one-off or a sign of more concerns to come, Buffett responds by choosing not to invest.
Valuation is critical to returns
Does it always make sense to invest in a profitable, growing company with a great future?
Perhaps surprisingly, the answer is no. Financially, whether it makes sense depends on the price. If I spent £5 on a bottle of great wine, I would have got a bargain. But if I spent £100,000 on it, I would almost definitely not have got a bargain, no matter how spectacular the wine is.
The same is true for businesses – and shares are simply a small part in a business.
As a long-term investor, my return depends not only on how a company’s share price moves (and any dividends it pays), but also what I paid for those shares in the first place.
Investment and speculation are different
If lots of people say a share is going to rise and it keeps going up in price, should I invest even if I do not understand its business?
It is a trick question. In my opinion, putting money into a business one does not understand is not investment but speculation. I am not a speculator but an investor. That means that if someone tells me that alternative energy will be huge and so firms like Ilika or AFC Energy are the next big thing, I do not just plough ahead and buy shares.
I assess each company’s prospects and consider how buying the shares might fit with my investment objectives and risk tolerance. To do that, I need to understand a company and the industry in which it operates. If I do not understand it already, I can take time to learn about the industry and company. But putting money into a company without first understanding it is not investment in my book!
