I am beginning to list down some of my rules of investing. The following points are not in any order, but over time, I plan to organize these better. For now, this is an incomplete, unordered and unorganized list.
Rules for Portfolio Management / Security Selection
Alpha is often associated with high return, and erroneously with high risk (as a heuristic), but this is not the correct way to think about it. Sustainable alpha comes from return derived with less risk (NOT from more risk) and this can only be done with appropriate security selection. Which, in a corollary, means we can’t have many securities in the portfolios because that dilutes alpha from security selection.
Rules for Overall Markets
- Markets are an efficiency process, not a state. As John Burbank says, markets are not necessarily efficiency discounting future cash flows, and rather are balancing demand and supply.
- People try to figure out what’s is “the truth”, and invest based on this. But, what we need to understand is we need to also account for the fact about what others would believe to be true based on what they know–e.g. a generalist may start dumping the stock based on bad headline because he/she doesn’t know enough about a given company/industry/regulations to make a proper calculated estimate of what the actual risk to earnings-power is.
Rules for Corporates
- Troubles show up on B/S before it percolates to I/S. B/S has large numbers and it is easy to load problem in one account over time, which the company may be forced to unload in one period on the I/S. If receivables and inventories are over 60 and 90 days, respectively, surely take a closer look.
- Follow managers’ compensation plan to the very last detail. Also, understand if the compensation arrangements tied to financial metrics pertain to GAAP metrics or company’s own pro-forma numbers. For example, many companies using LIFO pay their managers on Net Income that uses FIFO, not LIFO.
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