Three key lessons for value investors
In my time at Montgomery, I’ve learnt many valuable investment lessons. Here, I want to share three key lessons that have been instrumental to the way I make investment decisions.
- The world is fluid, be particularly vigilant of low cost alternatives
One core part of value investing is understanding the competitive dynamics of a company. Does the company operate in a cosy oligopoly? In a fragmented competitive space? Is it a giant with scale advantages over smaller players?
Whilst an initial analysis of this landscape is critical, it is important to be cognisant that this too is dynamic. New entrants with significantly lower price points and new models targeting niche customers can be particularly effective[1]. We saw this with how aggressively outdoor media players picked up advertising market share from television broadcasters. Whilst disruption can be dismissed as tail risk (and thereby dubbed unlikely), it can be transformative in an industry. For this reason, we do many deep dives into specific disruption risk.
- Moats are incredibly powerful – but only when sustained
In assessing the quality of a company we pay particular attention to its barriers to entry and its competitive advantages. This is crucial in analysing the quality of a company. Higher quality companies with strong moats earn much more predictable earnings and their business model is more robust in the medium to long term.
This works very well for companies which have grown to be industry leaders. However, if they don’t continue to invest for the future, their moats, and thus their quality, declines. This makes their earnings less predictable and reduces the quality of their earnings. What is particularly commendable are companies who continue to invest into their competitive moats. This type of capital management creates high quality long term growth.
- Patience is a virtue – you can’t rush the market
The market is an efficient machine and your base assumption should be that everything is factored into the current share price. If your analysis yields a significantly different result[2]to the share price, it’s better to start with the hypothesis that you’re wrong and test your assumptions. If you have exceptionally strong reasoning to be different then, and only then, have you possibly found some alpha.
It is with a lot of hard work and patience that you can find opportunities which are mispriced. When you do find them, the market will eventually catch on and price it in. However, this may take weeks, months, years or decades. The key is to have the patience to let the thesis play-out, whilst being ever vigilant of changes to its probability or those of alternative outcomes.
[1]Clayton Christensen has some particularly interesting commentary on this thematic: http://www.claytonchristensen.com/key-concepts/
[2]Michael Maboussin’s book Expectations Investing has a great method of seeing what you need to assume to get to the current share price
This post was contributed by a representative of Montgomery Investment Management Pty Limited (AFSL No. 354564). The principal purpose of this post is to provide factual information and not provide financial product advice. Additionally, the information provided is not intended to provide any recommendation or opinion about any financial product. Any commentary and statements of opinion however may contain general advice only that is prepared without taking into account your personal objectives, financial circumstances or needs. Because of this, before acting on any of the information provided, you should always consider its appropriateness in light of your personal objectives, financial circumstances and needs and should consider seeking independent advice from a financial advisor if necessary before making any decisions. This post specifically excludes personal advice.
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