“It is the basics. It is focusing on selection, low prices, and reliable, convenient, fast delivery. It’s the cumulative effect of having this approach for 14 years. I always tell people, if we have a good quarter it’s because of the work we did three, four, and five years ago. It’s not because we did a good job this quarter.” – Jeff Bezos, 2009
The new year is always a good time to review your investment process. The other day, I read a post on Nate Tobik’s Oddball Stocks that makes a great point about “practicing”—basically stop trying to read everything under the sun and get out there and actually start investing—start valuing companies, make investments, learn, repeat, etc…
This post got me thinking because I am one who reads a lot. My favorite part of investing is the reading, thinking, and strategic aspects of portfolio management. I much prefer the strategic aspects (i.e. analysis, research, critical thinking) of the investment business over the executional aspects (i.e. making the actual trades and other administrative requirements). I prefer reading over just about any other investing activity, although I have more and more begun to appreciate the information and perspective you can get by talking to people—scuttlebutt. Anyhow, that’s a separate post. But I completely agree with Nate’s point—practice is the best way to get better.
Procedural Memory
A concert pianist gains proficiency at his or her craft by developing procedural memory—doing the same thing over and over again. You can’t learn to play Rachmaninoff by reading a book. For years, Phil Mickelson had the best short game in golf. His incredible talent was a necessary, but not a sufficient condition for his success—he got to be the best greenside player because his dad built him a green in his backyard as a kid, and Phil hit shot after shot after shot onto this green at a very young age. Mickelson’s chip shot on the 72nd hole that won him the 2005 PGA Championship was one that he said he had practiced “tens of thousands of times” as a kid.
Whether you’re playing the piano, hitting a sand wedge, shooting a jump shot, riding a bike, or even driving a car—the way you learned was through repetition. The same can be said for valuation. Reading books is fine, doing case studies is better, but actually valuing companies and making investments—practicing—is the best way to learn.
Developing a Process
As regular readers of my blog have probably gathered, I am very focused on developing processes. I’ve always felt that a process oriented approach to investing is one that will give you the best chance of being able to produce success over long periods of time. Investing is a long-term game. To produce superior results over long periods, you need a process that is replicable.
One of the centerpieces of my investment philosophy is to only invest in my very best ideas. I don’t find lots of great investment ideas on a frequent basis. Because I have a high hurdle rate and because what I am looking for is not available every day (quality businesses at cheap prices), I tend to make larger, more infrequent investments. There aren’t that many great ideas. So in order to find these good investment ideas, you need a system.
Focus on Process, Not Outcomes
I try to focus on implementing investment processes because I find it more productive to focus on processes than to focus on outcomes. I think this is especially true for investing. Your investment results in investing are due to work and effort that has been accumulating for years. Buffett was reading Bank of America reports for decades before ever buying a share. The work that I am doing today is not going to pay off tomorrow. It is going to pay off at some unknown time in the future.
Also, you rarely can attribute investment results to any one specific action. It’s usually a confluence of factors that come together over multiple investment events and multiple time periods that collectively produce results. Yesterday I read Disney’s 10-k and recorded some notes, I read the Wall Street Journal, and I talked to a few users of a product made by another company I’m researching. I have no idea if, how, or when any of these specific work activities will produce a result. I just know that if I continue to focus on my process, I give myself the best chance of achieving the long-term results I’m looking for.
Wells Fargo – Process Focused
My investment process has some similarities with the companies that I prefer investing in. My investment strategy puts an emphasis on durable companies that have predictable earning power. The stocks I buy come in all shapes and sizes, but one large well-known example is Wells Fargo. As I wrote about when I mentioned the bank warrants in a post a few weeks ago, there isn’t much more predictable than the deposit growth in the US banking system. Wells Fargo is extremely well positioned to continuously capitalize on that predictability.
They have a process—a relatively simple business strategy—that can be replicated over and over. They take in a consistent share of a steadily growing deposit base, lend out or invest these funds at higher rates, and spread operating costs over a large nationwide branch network. They try hard not to do dumb things (easier said than done in the land of big banking). Focusing on their process has led to very predictable results over the long-term for the company and its shareholders.
Get Better Each Day
As an investor, I am constantly trying to improve. One thing a cross country coach of mine used to often repeat is: “Try to get better today”. Running is a sport that I competed in at the high school and collegiate level. Long distance running has a lot of parallels with investing. You can’t wake up on race day and expect to force a great performance. The performance will depend on stringing together many months/years of daily runs—one mile after another. None of the miles will stand out much individually, but they collectively add up to produce a result.
I am using the new year as an excuse to refine and refocus my process, which I’m always trying to improve. I read the paper each day, but this year I am going to make it more routine and more deliberate. I’ll make notes and keep them in a file. I also will be focusing on writing more about individual ideas. I do a huge amount of research on companies that I end up either investing in or putting on a watchlist. I have found (and others have too I think) that writing improves comprehension and helps you retain more information. It clarifies your thinking. Basically, a short summary might help you wring more comprehension out of a given unit of effort. I keep a Word doc with hundreds of pages of notes per year on investment ideas, but they are mostly scratch notes. By organizing these notes, I hope to get a better understanding of the business and also have a file to look back on later.
Building a List of Great Businesses
Also, I am going to embark on a mini-project next week where I am going to go through all 3500 stocks in Value Line one by one to come up with a watchlist to study. I already have a watchlist of businesses I follow, but I am going to create a “best companies” file on a google sheet that will come from this project. I haven’t finalized exactly how I will do this yet, but my first idea is to go through the list and input all the companies that I think I can reasonably understand (which will narrow the list significantly). Then, I will refine it one more time by trying to pick out the best businesses from this list, as measured by the attractiveness of their economics and their historical financial results (consistent earning power, stable margins, high ROICs, growth, etc…)
My hope is to build a fresh list of maybe 50-75 durable companies that are compounding their intrinsic value at high rates. These are the horses you want to bet on over time. Some of these might be very small, others will be large. I think this will complement my current watchlist of businesses that I already follow closely. And I might even find a few bargains by turning the pages as well. I plan to report back on this effort here on the blog. Feel free to comment on your own ideas for processes…
These aren’t unique ideas. In fact, if I remember correctly, I got my the idea of building a “best companies” list by going through Value Line from something Stan Perlmeter (an original “Superinvestor”) did a long time ago. It doesn’t have to be Value Line. The point is I think that it’s a useful process to build a list of great companies. Then go through one by one and value them–determine if they are in fact great. Read about them, write down findings, and this will hopefully lay the foundation for a few great investments at some point. There is a lot of value in this process.
So none of this is original. Everyone talks about watchlists, processes, etc… And much of this I already do. I’m deliberately writing down my process this year, but I already am very process oriented. I’m just using the new year as a way to get refocused on taking these concepts and diligently implementing them in my day-to-day work.
Focusing on a process is much more important than focusing on a result. As Bezos said, a “good quarter” is the result of things they did 3-5 years ago. The same can be said for investing.
Happy New Year!
John
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John Huber is the portfolio manager of Saber Capital Management, LLC, an investment firm that manages separate accounts for clients. Saber employs a value investing strategy with a primary goal of patiently compounding capital for the long-term.
I established Saber as a personal investment vehicle that would allow me to manage outside investor capital alongside my own. I also write about investing at the blog Base Hit Investing.
I can be reached at [email protected].