This article originally appeared on The DIV-Net July 12, 2008.
In my recommended reading post on Old School Value, I recommended people to read Ronald R Redfield’s notes on Seth Klarman’s book Margin of Safety – Risk Averse Value Investing Strategies for the Thoughtful Investor.
As I was going through it, it reminded me of many investing basics as well as investment principles and philosophies and I came to realize a couple of critical issues about my investing habits which I felt I had to evaluate.
- The man with a hammer mentality.
- Consider risks before gains.
Now I enjoy going to the gym and power lifting, but without reviewing my form, technique and fixing those little bugs, a short term gain is always there but over the long term, I’ll probably have a jagged spine or crooked knee. You get the idea.
The Man With A Hammer
“To a man with a hammer, everything looks like a nail.” – Mark Twain
I believe this quote to have been brought forth into the investing world most prominently by Charlie Munger and it seems like I have fallen into the same habit. I’m a big fan of spreadsheets and tools that help people become efficient in their activities, whether it be investing or in general. Many people that have downloaded my spreadsheets understand this, but it has come to a point where I find myself trying to apply the spreadsheet to every company.
The spreadsheet is my hammer, and every company is beginning to look like a nail.
A skilled and experienced tradesman knows which tools to use for a particular job. Investors should also be equipped with different tools to apply to different companies. This means looking beyond simply applying a growth rate to the Discount Cash Flow model.
Other aspects must be valued, financial statements must be torn through, not just looked through. Finding what the market is missing is also integral to the whole process and it has become something that I am spending less time on.
“You’re neither right nor wrong because other people agree with you. You’re right because your facts are right and your reasoning is right—and that’s the only thing that makes you right. And if your facts and reasoning are right, you don’t have to worry about anybody else.” – Warren Buffett
As a hot blooded male, psychologically, my mind weighs gains and risks quite differently. Until now, I was targeting a return and was confident that it would play out as long as I kept buying with a large margin of safety. Now, a better idea has come along and for me, it’s out with the old, in with the new.
Target risk BEFORE calculating investment returns, where risk is defined as “both the probability and the potential of loss”. Risk is not defined as volatility, trends or analyst downgrades in this case.
“Investors must be prepared for any eventuality.” – Seth Klarman
Another point is that an investor targeting specific returns over time, will make it difficult to achieve the goal as he/she feels the need to take additional risk or speculation in order to meet their “target return”.
“Targeting investment returns leads investors to focus on potential upside rather on downside risk… Rather than targeting a desired rate of return, even an eminently reasonable one, investors should target risk.” – Seth Klarman
Putting It All Together
Given such economic downtimes which equates to times of opportunity, now is the perfect time to put it all together and see whether it holds.
“A market downturn is the true test of an investment philosophy.” – Seth Klarman