Keep it simple…

Keep it simple…

For many investors, the sharemarket seems complicated, daunting and impossible to understand. One day the market is down on fears that interest rates might rise, that Greece will default and leave the Euro zone, or that China is slowing. The next day, it’s up because Greece never defaulted, because is China is slowing and they put in a range of circuit breakers to prevent their stock market from spiralling well and truly out of control.

In our experience, confusion amongst investors exists at least partly because of the human tendency to complicate matters. That, and the fact that many experts being replied upon, simply end up being wrong and the media tend to pile onto a story each and everyday making you think that it’s a bigger deal than it actually is.

The tendency to make simple things difficult – coupled with a plethora of daily news to be distracted and influenced by – ensures obfuscation rather than clarity is the environment in which investors find themselves operating in. Of course, it doesn’t need to be this way.

At Montgomery, we have over the years built and refined our investment framework large based around the application of Occam’s Principle of Parsimony – more commonly known as the the KISS principle.

Creating a framework that every team member in the office can appreciate helps us to deliver the satisfactory returns we have achieved to date. There really are only two key ingredients to its application (like I said, simple):

1. We must buy businesses within our circle of competence and then from those, only the businesses with bright prospects for growth.2. We like to think about share price volatility a little differently to most.

It is fair to say that while successful sharemarket investing is not easy, intelligent investing is not complex either. There is room for many to do well in the market and you don’t have to be an expert on every company, or even many, to succeed over the very long run.

All that’s required is the ability to evaluate companies within your circle of competence. And the size of that circle is less important than knowing your circle’s boundaries. Once you understand and appreciate your limitations, simply avoid the temptation to stray outside the circle, and fill your portfolio only with those you do understand. The benefit of such discipline is that you will know if the companies in your portfolio have bright prospects for the future and you can monitor them closely for any change to that thesis.

Your goal therefore becomes a rather simple one: To just purchase for a fair price a business that you understand and that you are confident will grow its profitability or earnings over time.

That’s it for the first ingredient, which brings me to the second. Our approach towards price volatility is perhaps the more difficult of the two to adhere to once an investment is made.

Accepting that returns will rise and fall daily with the market is the very first step to approaching the sharemarket. The alternative is to simply turn it off to avoid being distracted by its daily noise.

If you choose to watch share prices swinging around daily, and in turn, their impact on your portfolio and your dollar value position, your emotions will constantly chip away and dismantle your sound investing framework. Trust me; I’ve seen it happen to everyone.

Accept that returns in the short run will always rise and fall with the market.

When investing,  most believe when they buy a share, it will go up. As you have heard here countless times, betting on ‘up’ is no different to betting on ‘red’ or ‘black’ and yet many who wouldn’t dream of gambling unwittingly do so on the stock market every day.

Treating shares merely as a coloured line wiggling up and down on a screen and hoping the next wiggle goes up is no more an investment strategy than flipping a coin. Even a series of heads cannot ensure your long term outperformance and without your framework you are bound to land on your tail. Many investors obsess over share prices, but prices simply reflect what someone else, perhaps foolishly, is willing to pay that day.

Instead, treat the stock market as a place to purchase, for a fair price, a business that you understand and that you are confident will grow its profitability or earnings over time. If you have done your homework and indeed truly understand that what you are buying and how it will complement a portfolio of businesses whose earnings you are sure in aggregate will march up over the years, rather than getting emotional, make share market falls a time of great joy – much like discovering, for one day only, that the car you’ve always dreamed of is $20,000 cheaper than it was 6 months ago.

Many years ago, we discovered that these two basic tenets are the foundations to successful long term share market investing. They are genuinely easy to follow, and combined, enormously profitable over the very long run.

Every professional discipline has a set way to approach a problem. Investing is like any other profession. To excel at it, you have to understand the underlying structure and frame your own approach to follow it unswervingly day in and day out.

Russell Muldoon is the Portfolio Manager of The Montgomery [Private] Fund. To invest with Montgomery, find out more.