As the pace of change in the modern world gets ever quicker, some old ideas fall by the wayside. But a lot of investment principles that worked well a century or two ago can be just as useful when investing today. Here are five that I use…
1. Stick to what you know
For centuries, people have been putting money into exotic industries they do not understand in distant lands. For just as long, some of those people have been losing money.
Billionaire investor Warren Buffett emphasises the value of sticking to a “circle of competence” when investing. That makes it easier for me as an investor to assess a company.
I can lose money even when investing in firms inside my circle of competence. But I think the likelihood goes up when investing in companies far outside it.
2. Don’t just invest in people
Having a great management team can be very helpful for a company. If I invest in a business, I like it to have proven management. Sir Martin Sorrell’s experience at WPP has increased my confidence investing in S4 Capital, for example.
But I never invest in a company just because of its people. They can leave at any moment. I always make sure that I am investing in a good business, not just a business currently benefitting from good management.
3. Spreading risk
No matter how good a company may seem to be, things can go wrong. As an investor, it is easy to fall in love with an investment idea and want to go after it in a big way.
But no matter how good an idea I think I have, I always make sure to keep my portfolio diversified. That help reduces my risk if things turn out disappointingly.
4. Valuation is critical
Imagine someone offered you the chance to invest in the most profitable business the world had ever known. Would you take it?
I do not think it is possible to answer that question without knowing an additional piece of information – the price. Buying a great business is only part of being a successful investor. We also need to buy at an attractive price. Even a great business can make a lousy investment if we overpay for it.
5. Investment is different to speculation
It is over 180 years since Charles Mackay’s classic book “Extraordinary Popular Delusions and the Madness of Crowds” was published. What is remarkable reading it today is not how much has changed about human psychology in the interim period, but rather how little.
Mackay looked at economic bubbles such as tulip mania in 17th century Holland. People bought tulips not because they were valuable but simply because they thought they could sell them on at a higher price.
The story is the same today except the tulips have been replaced by other things. Speculators hope to make money thanks to someone paying them more than they paid for something. It is a game of pass the parcel — and the music can stop at any moment.
By contrast, investors put money into businesses they think have underlying profit potential that is not fully recognised in the share price. As an investor, I try to ignore speculative fads and instead focus on finding shares in great companies.
