Succeeding with Value Investing: Attitudes and Temperament Matter more than What You Know

It’s not what you know; it’s how you act.

Value investing is an incredibly profitable strategy when it comes to investing in the markets, but so much of the philosophy is rooted not just in formulas, ratios, and models but also in having the right temperament. How you act as an investor has a lot to do with whether you succeed or not.

Think Different

It’s not easy to be rational.

As investors, we have to be wary of being swept away by our emotions. One way to ensure you take the right actions is to be prepared for any eventuality. That requires being able to forecast possible scenarios and the associated actions required. It requires being able to think in terms of expected value.

Expected value is just the weighted average value of all expected outcomes. Imagine a coin flip where if you get tails you are paid $1, and if the coin lands heads up, you earn $100. The expected value of that flip is $50.50 (50% *$1 + 50% *$100).

Value investors would do well to think of investing in probabilistic scenarios. How many potential scenarios can you imagine and can you attach a probability to that scenario happening? Operating in this way forces you to think differently. Investors tend to apply a “what happened before will happen tomorrow” logic to investing which can blindside investors off-when events inevitably take a turn.

Use a checklist

You need a process.

Acting appropriately is important, but it’s also just as important to NOT act inappropriately. Sometimes you do worse by acting than if you had done nothing at all. Checklists are a great way to codify your investment disciplinary practices and make sure you follow them every single time.

Checklists are unique to each investor. Some investors know they are prone to emotional swings. Others know they get carried away every time Tesla’s stock is hyped up by the crowd or whenever the next Apple iPhone drops. Mitigate against your worst impulses by placing “green light” or “red light” items on your checklist.

Checklists work so well because they force investors to take a moment when they might otherwise rush through a simple yet important part of the process. Pilots and doctors use checklists all the time, to protect and save lives, so take a page out of their book and use a checklist.

Temperament is Key

High returns come from the actions you take in tough times.

Many investors know all about discounted cash flow valuation and can calculate the future cash flows of a company thirty-nine years into the future, but they still fail because they do not have the mental fortitude or discipline necessary for success.

Don’t do something just for the sake of doing something.

It doesn’t matter how much of a quant you are, if you have itchy fingers and need to pull the trigger, then you will only get yourself in trouble. An experienced value investor knows that he or she must commit to the process of value investing. That means sifting through stocks to find the one gem that might be worth buying. Once that gem is thoroughly vetted, the position is maintained no matter the overall market is doing. Unless the fundamentals change, the position remains.

That’s easier said than done. A genuine test of a value investor is holding on when things aren’t going their way. In cases like this how you act is more than what you know. If you are aware that the foundations underpinning your investment thesis are still sound and you do not have the conviction to hold firm, then your knowledge has not made you a better investor.

The right mindset can also serve you well when the market moves in ways that encourage herding behavior. You want to stay away from pursuing hot stocks of the day because anytime people are pumping up a stock it probably means that the company has already become overvalued and that is antithetical to the philosophy of a value investor.

Temperament can be learned, but it isn’t easy. You need to know your limits and foibles and put plans in place to protect your investments from yourself.

Concentrate

Investing in just a few companies that you know inside-out is better than investing in many that you only know a little about. When done correctly, portfolio concentration can also lead to magnified gains and superior long-term performance.

Value investors don’t do this because they think that diversification is “di-worse-ification,” rather it is the natural outcome when you believe in investing only in companies that meet the requirements of a value investment.

Be an Owner

The business owner mindset isn’t reserved for entrepreneurs. Applying this mindset to your investments will give you a different perspective.

Purchasing shares in a company represents ownership, however large or small, in that company. Thinking like an owner will force an investor to focus on the long-term rather than the short-term and can make the difference when an investment decision needs to be made.

Be an Infinite Player

There are two types of games: finite and infinite games. Finite games are games that have a terminus, something like chess or basketball. Infinite games, like the game of investing, never ends and has no fixed rules or boundaries. The point of an infinite game is to continue the game.

An infinite player is different from a finite player. The infinite player does not measure himself against the outcome of the game because he knows that the game always continues and the results keep changing. So while Microsoft might try to beat Apple at launching a new product, Apple instead focuses on creating the best product they can make, safe in the knowledge that success will follow.

It’s not just what you know that defines success in value investing. More often than not, it’s how you do something and the reasons behind it that separate the great value investor from the merely mediocre. Think deeply on these points and you might be able to incorporate them into your investing practice.

Further Reading

Athanassakos, George. “A value investor’s take on diversification and risk.” The Globe and Mail, The Globe and Mail, 25 Mar. 2017, beta.theglobeandmail.com/globe-investor/investment-ideas/a-value-investors-take-on-diversification-and-risk/article27266235/?ref=http%3A%2F%2Fwww.theglobeandmail.com&.

AtGoogleTalks. “YouTube.” YouTube, YouTube, 19 June 2017, www.youtube.com/watch?v=_osKgFwKoDQ.