Success in investing does not come with overanalysing. It doesn’t necessarily come from overcomplicated strategies either. Although it is very marketable to demonstrate an extremely complex integrated system to make money out of the markets or excessive analysis before making an investment,these are hardly factors that define long-term success.
The point is not too much and sophisticated work but rather the right type of work, whether its value investing, trend-following or other systematic approaches.
Take value investing for example. The aim of value investing is to identify companies that are excellent durable businesses with sound financial characteristics and invest in them at times when their share prices are trading significantly under their intrinsic value.
It doesn’t take too much analysis to see that companies such as, for example, Coca Cola*, Johnson and Johnson*, Procter and Gamble* are great durable businesses with sound financial health, delivering exceptional cash profitability that has been increasing for decades in a fairly stable manner. Also, not much work is needed to see when such companies sell at bargain prices. Warren Buffett once said, “you recognise value when it screams at your face”. In March 2008, Coke shares sold for a dividend yield north of 3.80%! Each dollar of annual free cash flow generated by the Company could be bought for roughly $16 at the market, a cash yield of 6.25% and the lowest price going back decades. This is a company that has been paying dividends without interruption since 1920 and has increased the payout for the last 54 years! It doesn’t take much more to see that value screamed at our face back in 2008. It’s like being offered a hectare of prime land on Fifth Avenue for less than half a million dollars because the seller thinks the sky is falling.
Too much analysis beyond the objective facts can lead to a loss of focus from the obvious. Our systematic approach to the value investing component of our Program is designed with this kind of simplicity in mind. Our system looks at the crude, cold numbers as they were realised by each company constituent of the S&P500 index to identify the ones that are (a) excellent durable businesses (b) with sound financial characteristics (c) possessing long-lasting competitive advantages and most importantly (d) selling at an acceptable price. The systematic approach takes out of the equation any human bias we are all exposed to and leaves an objective result on which we build on year after year.
This approach means we will never place any money in the next “big thing”. Equally important though we will also avoid all the “promising next big things” that end up being a flop! Usually these, far outnumber the ones that make it.
The same principle applies to systematic strategies that attempt to identify rising or declining trends whether in the commodity, currency or interest rate markets. A system with too many parameters, all integrated and obsessively focused on trying to identify the exact second that a new trend will emerge in the markets, usually ends up being just a curve fitting exercise that hardly repeats its success during actual trading. The future, although it rimes with the past, it never repeats itself, exactly as it developed. Doing unbelievably long research to address every event and turn it into a trading opportunity ends up being counterproductive, although conventional wisdom would dictate otherwise.
This is not to say that complicated trading systems cannot be successful. There are plenty of investment management firms out there producing enviable performance consistently using highly sophisticated trading systems. The point is that complicated approaches are not the only way to succeed in the markets. Complex or simple strategies, the main common denominator for success is a focus on the right type of work and not volume.