Investing resources I keep going back to
Thinking that informs how I approach work as an investment specialist and life as an investor.
In the first part of this series, I went through books, articles and studies that shaped the investor that I am today. They all taught me something about myself and helped me to develop my investing approach. The second and final part of this series will go through a few more resources that I keep going back to.
The Outsiders: Eight Unconventional CEOs and Their Radically Rational Blueprint for Success, William Thorndike
The Outsiders is a book that looks at a group of eight successful CEOs. Thorndike defines success as the degree the companies exceeded the return of the S&P 500 during the CEO’s tenure. He also compares the returns to Jack Welch, the CEO of GE who achieved a phenomenal 20% p.a. over the 20 years he was at the helm of the company. The S&P 500 averaged 14% in the same period. When we look at these eight CEOs, the proof is in the pudding. They averaged 30%.
Thorndike explains in this book that CEOs need to do two things well. The first is run their operations efficiently. The second is to deploy the cash generated effectively.
CEOs have five choices for deploying capital:
1. Investing in existing operations
2. Acquiring other companies
3. Issuing dividends
4. Paying down debt and
5. Repurchasing stock.
We can categorise these choices in further: Investing in the business through internal or external activities, strengthening the balance sheet, or returning capital to shareholders.
They’ve got three ways of raising capital:
1. Tapping internal cash flow
2. Issuing debt and
3. Raising equity
When you break it down into those points, it makes their job seem simple.
This book is about how the 8 CEOs successfully allocated capital. The commonalities that we see between the CEOs is that they understood that capital allocation was the CEO’s most important job.
The capital allocation decisions that are made are based on the best utilisation of the capital to create value for shareholders – the owners of the company. This is not a static decision, and will vary based on the company, the industry and market conditions.
Generally, if you’re evaluating a more mature business, you would look at whether they’re returning the right amount of money to shareholders through distributions. For a growth business, you might look at their investments. If you’re investing, or you’re returning money, you want to ensure that you have a strong balance sheet.
Often investors get lost in markets and see their investments as tickers on the screen. The Outsiders is an important reminder that the investments that you make in the equity market is taking an ownership stake in actual companies. The success of your investments is heavily reliant on the ship being steered in the right direction.
As we are in the middle of earnings season, it is easy to get lost in the short term. This book is a reminder of the bigger picture. I keep going back to this resource in my work. It helps to understand how companies deploy capital and therefore the characteristics to evaluate with each share. It helps with understanding how the share will behave – whether it will throw off income, whether it is focused on growth. The book provided foundational lessons on gaining a simplified view of the decisions companies can make and how it will impact an investment.
Bloomberg’s ‘At the Money’, Masters in Business podcasts
Although my favourite podcast slot is already taken (are you allowed to say your own podcast is your favourite?) I really like the At the Money series from Bloomberg.
They are fundamental lessons – ideas that we all know of and try to put into practice, but explained in a concise way with pragmatic guests that speak directly to individual investors. These four episodes are good examples of the content that they focus on.
One up on Wall Street, Peter Lynch
Peter Lynch is as close as you can get to a superstar in the financial world. He managed billions of dollars in Fidelity’s Magellan Fund and wrote One up on Wall Street to share his security selection process with the world.
Peter speaks about how individual investors have ‘one up’ on professional investors – that individuals have proximity and understanding of the companies that they are investing in. They can often spot opportunities with companies before professional investors do.
He also speaks about the importance of ignoring the endless news cycle on market movements, interest rates and economic data. This is a particularly relevant lesson in this current environment.
I recently attended a lunch that brought together arguably, some of the best economists in the country into one room, including a former RBA Governor. They took turns talking about their forecasts for the next 3-6 months and the seriousness of the economic situation that we were in. I don’t disagree that the current situation is causing many people stress, anxiety and suffering.
I anxiously waited for my turn to say that little of this factored into my work with long-term investing.
In 20 years, the timing of a 0.25% increase to interest rates will have no impact on your portfolio. The impact of short-term movements for long-term investors are generally irrelevant. It may concern professionals because it is their job to be concerned. It should not concern you.
This advantage that individuals can gain by focusing on the long-term has a technical name. It is called structural edge. Structural edge is an advantage gained when there are no constructs that govern the way an investor goes about the investing process.
Professional investors have restrictive constructs. Their career progression, compensation and business goals ultimately influence the way that they invest. They have competing priorities. They are trying to support the company they work for and maximise their compensation. Sometimes, these two disparate influences align and induce wise investing decisions, and sometimes they don’t.
Professionals certainly have some advantages over individual investors. Getting paid to do a job and charging other people for that job means they must meet standards around education and experience. They all have support from other professionals, time to dedicate to the pursuit of investing and access to tools and data. It also comes with pressure to perform over short periods of time to maximise compensation and limit career risk.
Investors have no restraints that prevent a long-term focus. Every professional says that they are long-term investors, but a lot of these professionals operate in an environment that structurally discourages this. Many professionals are under pressure to outpace or at least match their peers over one-year periods. If they fail, the investor money walks.
In a study Morningstar conducted of US domestic equity funds, it was found that the turnover rate was ~63%. That means that the average holding period for stocks in that fund was 19 months. This certainly does not meet the definition of long-term investing and the transaction costs and distributed capital gains can eat into investor gains.
Individual investors don’t have any structural impediments to being long-term investors except their own lack of patience. This naturally leads to my next resource – the Psychology of Money.
The Psychology of Money by Morgan Housel
I didn’t grow up in an environment where I was exposed to investing. As an outsider looking in, investing appeared to mirror the portrayal in The Wolf of Wall Street, the Boiler Room, Industry and Billions. I found it completely unapproachable and designed to benefit the wealthy. Access to markets has come a long way in the relatively short time that I have been an investor. However, many people still share the perspective that to be a successful investor you need to be wearing a Zegna suit on a trading desk for 100 hours a week.
The psychology of Money focuses on the relationship between money, investing and human behaviour. This book is a reminder that successful investing is more about you and your behaviour than it is about the financial data at your fingertips.
Like One up on Wall Street, the lesson that I took from the Psychology of Money is that I, as an individual investor, have the ability to be a successful investor, and sometimes even have advantages over professional investors. That is, if I am patient and disciplined.
I wrote an article on the total return that you actually get from equity investments.
Fix your behaviour and you become a more successful investor. End of lesson. This is an easy thing to say. It is harder to do. The Psychology of Money shows how good habits can make a difference and our innate behaviours hold us back.
A large part of being a successful investor is knowing yourself and acknowledging this behaviour. This book made me reflect on my poor behaviour in the past and emphasised the importance of preventing it in the future. I do this through the way I invest. I invest in products that suit my temperament and circumstances (my investment strategy is laid out here). I have an Investment Policy Statement (IPS) that governs my investment strategy and when I can buy and sell investments, and the types of investments I will consider. I consider my regular contributions into my investments as mandatory, so I am not tempted to time the market. I have found that restricting poor behaviour will improve my investing outcomes and help me achieve my financial goals for more than constantly searching for the next hot share.
My colleague Mark LaMonica recently wrote about the lessons that he took from Psychology of Money.