Last Updated September 5, 2013
I came across a new book the other day called Repeatability, by Chris Zook and James Allen of Bain & Company. Although the book is about building enduring businesses that can cope with constant change, what struck me was how applicable some of the ideas on building a great business were to investing.
Three ideas are particularly relevant as key pillars of a sound investment strategy:
It’s important for a business to differentiate itself from the competition, but this idea also applies to many of the most successful investors. It’s hard to beat the market if you’re doing exactly the same as everyone else.
With value investing, being different is a core part of the philosophy. Simply by buying those stocks that are relatively cheap, you are almost guaranteeing that what you’re doing is different from everybody else. Of course there are lots of value investors out there, but compared to the total population of investors, we’re a tiny minority.
Keep it simple
If knowing the ins and outs of a business, its industry and the wider economy were the most important aspects of investing, then CEOs and managers would be the best investors in the world; but they’re not.
One reason for this is that no matter how much you know about a company, its competitors, industry and the economy, there will always be far more that you don’t know – most of which you don’t know that you don’t know.
This is sometimes called the illusion of knowledge, the idea that if we know more about something then we can make better decisions. Sadly, this isn’t always true. In many situations there are perhaps only 10 or 20 pieces of information which dominate the subsequent outcomes, and the other few hundred pieces of information that you thought might be important turn out to have little or no impact.
Even on the occasions when some obscure bit of data does matter, the timing and magnitude of the effects are usually unpredictable which renders the additional information useless anyway.
The trick here is to know which pieces of information have the most impact most of the time, both in terms of the company’s prospects and more importantly, on the investor’s total returns.
Make it repeatable
It’s not enough to be a contrarian (implicitly or explicitly) with a simple core process which focuses on the most important drivers of equity returns. If the process is applied in an ad hoc manner by an investor who makes it up as they go along (perhaps using different financial ratios depending on how they feel that week) then there may be trouble ahead.
Companies which succeed are often those which have systems which they’ve really nailed down over the years and which can be applied to new stores or factories, or new markets and countries quickly and accurately with maximum impact.
The same applies to investing strategies.
Those strategies which are successful are often the ones that have been written down and refined over time, perhaps into an investment checklist with all the critical go/no go decisions in place so that nothing is missed and every lesson learned is built back into the system.
So whether you’re building your own investment strategy or judging the approach of someone else, remember to think about how its differentiated, whether it’s relatively simple and whether it can be repeated accurately, over and over, year after year.