When there have been major events such as we experienced this past year in the public equity markets, I find it’s a good time to reflect on observations, mistakes or lessons learned.
Consider macro-economics. You often hear that investors are either top-down or bottom-up. Both are very important. You cannot ignore macroeconomics because these factors will influence your results. Historically, public markets do not totally bounce back when the Federal Reserve is increasing interest rates to combat inflation.
Quality is always the most important thing. Most businesses don’t have something special or unrivaled, so why own them? I’ve made mistakes where I couldn’t pass up a good deal and ended up with a value trap or quality trap. Remember, the earlier in the business cycle, the more significant the execution risk.
Valuation matters. Although quality is always the most important part of investing, valuation is also essential. Ignoring high valuations is a potential disaster. If you own an asset that is significantly overvalued, perhaps it’s time review the valuation, sell or trim, and redeploy that investment into something more attractive.
Take your losses and move on. I sometimes increase my losses by adding more to a loser. Perhaps I get my average cost per share down, but I increase my total losses. I have often added to some of my weakest investments just because they have gone down and appear more attractive.
Too much offense (potential returns) and not enough defense (potential risk). Many great investors start off trying not to lose money rather than trying to make money. Making up losses is often much harder than avoiding them to start with.
Speculative growth is not durable growth. Durable growth companies are proven. Young companies can be easily disrupted. Knowing the difference between durable and speculative growth is very important. In speculative growth, there are too many challenges and execution risks. It’s much easier buying proven companies that are already leaders with attractive valuations.
Focus on what you understand. Another weakness is a fear of missing a great opportunity instead of focusing on what I understand. Investors acknowledge they will miss an awful lot, but just a handful of winners can make them hugely successful. When I thought I was being patient, I was actually being stubborn, not wanting to admit a mistake. There is a very big difference.
If too challenging, put it aside. There are some businesses with steady results that are easy to predict. There are also businesses that are on a good trajectory today, but are very difficult to predict long term. Putting the difficult-to-predict companies to the side is the first step in risk management.
Allocation is very important. Seventy percent of Warren Buffett’s public assets are his top five or six investments. Some of the greatest investors overallocate to their best proven ideas. Diversification is a defensive strateg; concentration is an offensive strategy.
Profitability matters. Great businesses are very profitable and will continue to be so. Speculating on an unprofitable company that is hopeful is more like gambling than investing.
As I continue to invest, the more experiences I will have, leading to more opportunities to identify lessons learned. Sharing a good way to learn, understand, improve, reflect and grow. ●
Umberto P. Fedeli is CEO of The Fedeli Group