Good Investing

Inherently "good investing" is buying cheap and selling at a premium. Sounds easy… but it’s not.

When is something cheap? When is it expensive? The problem is, that apparent “value” is constantly changing.

Buying shares is buying business. Business is fluid and so too are the economies in which they operate. Some operate locally, while others are globally focused. Business ebbs and flows, and earnings grow or decline at different rates. All of this “activity” contributes to the perceived market value of any share, of any business.

When determining value, we need to consider: are we short, medium or long-term in our thinking? Depending on our response, value may be seen as cheap, or it may be expensive. If expensive, then presumably we’re accepting higher risk (because we’re paying more). Or, do we see the business (the share) as being fundamentally stronger than alternatives, which is also valuable and therefore we might pay more for that perceived security?

As you can see, the value or “price” can be argued either way...

The S&P500 is an index tracking the 500 largest companies listed in the US – just seven businesses make up 22% of that entire index and in recent times, these seven businesses have contributed 80% of the index’s return.

Three of these seven businesses are also preferred investments of ours:

Prices move constantly and so by the time you've read this; things will have changed again. Basically, in just over six months, we've enjoyed what we would ordinarily expect as a return over three to five years.

The Dilemma… We like these businesses. We think they’ll be benefactors of the AI evolution that approaches. The recently amplified tailwind behind these stocks is the market’s collective expectation that they will continue to experience substantial earnings growth (the “crowd” is a powerful force - it giveth, but it can also taketh away). We acknowledge that while we have enjoyed extraordinary gains in a very short period, the wise investor should take stock (profit) and maybe redirect toward cheaper options.

Art or Science… As a portfolio manager, we want to balance risk and return, but we also work for real people, with real-world needs, and so their preferences and prejudices will also creep in. The science of portfolio construction needs to be artfully considered, as we position each strategy for each client. It’s personal, because if it’s not, then we need only buy an “off the shelf” solution, where there is little flavour or choice. And so to make a difference, “rules of thumb” can be handy guard rails.

A good general rule of thumb is to avoid having more than 5% of a portfolio in any one single share (or having a very good reason for why you do - i.e. in smaller portfolios starting out with a bespoke approach, the available investment capital may not be of sufficient size to efficiently diversify, or in some “tailor made” strategies, and so it can be difficult to hold strictly to the same rules of thumb across every plan).

Today, in our larger more established strategies, where we have plenty of runs on the board, we have been trimming where we can, but we'll continue to hold positions in quality businesses that compound, with an expectation that this success continues. The temptation is to hold, but taking profit and redirecting to other discounts/opportunities is simply prudent, all the while intending to reduce overall portfolio risk in the process.

The views and opinions expressed in this article are intended to be of a general nature and do not constitute personalised advice for an individual client.