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"You've got to be very careful if you don't know where you are going because you might not get there." -- Yogi Berra
Arguably, the investment and asset-allocation processes can hold more weight and are more complex than nearly any other business decision. A host of variables, known and unknown, contribute to the investment alchemy. As well, subtle and unconscious influences and personal biases affect the process, as we all seek the market's metaphorical green jacket (like the one given to Phil Mickelson, this year's winner of the Masters Golf Tournament).
What follows are some basic tenets that form my investment consciousness, which are admittedly simple to write about but more difficult to execute.
Know Thyself, Work Hard and Don't Get Emotional
- If you don't know yourself, Wall Street is a poor place to find yourself. There is a reason why there was a church on one side of the old New York Stock Exchange building and a cemetery on the other.
- If you enter the hedge fund biz, remember Darwin. It is survival of the fittest, the smartest and the most practical. The hedge fund industry is populated by some of the most obsessive and idiosyncratic practitioners extant, most of whom are highly educated and possessive of a greater than normal cerebellum. Differentiate yourself by your process and by routinely working harder than anyone else (for example, my day routinely starts at 5 a.m.), for as John Maxwell wrote, "Successful and unsuccessful people do not vary greatly in their abilities. They vary in their desires to reach their potential."
- Do not get emotional in making investments, and however eloquent the strategy is, it is the results that count. The ecstasy of getting investment performance right is always eclipsed by the agony of getting it wrong. If you are uncertain or temporarily lack confidence, raise your cash positions.
The Investment Process Is Methodical
- If you are a fundamentalist, write a brief synopsis of each investment analysis/conclusion. It will serve to crystallize your investment analysis and is an excellent personal and investment discipline (it is the principle reason why I write "The Edge"). Moreover, an ex-post facto reflection on why one achieved past success or failure is usually illuminating, instructive and often leads to fewer mistakes. After all, as Benjamin Disraeli wrote, "What we have learned from history is that we haven't learned from history."
- If you are a technician, keep all your charts, just as the fundamentalist should write up a summary of each investment. Reflecting on past mistakes and successes is as important to a technician as it is to a fundamentalist.
- A combination of fundamental and technical input is usually a recipe for investment success.
- Regardless of one's modus operandi (fundamental, technical or a combination of both), logic of argument and power of dissection are the two most important ingredients in delivering superior investment returns. Common sense, which is not so common, runs a close third!
Stay Objective and Independent
- Neither be a Cassandra nor a Sunshine Boy! It is much easier to be critical than to be correct, as financial disasters are always impending according to the ursine crowd. Conversely, the outlook is never as perfect or clear as it is seen by the bullish cabal.
- Within limits, stay independent in view. Above all, remember that equilibrium is rarely observed in the stock market. To quote George Soros, "Participants' perceptions are inherently flawed" (at least to varying degrees).
Investment Discipline Is Key
- Let your profits run and and press your winners, as knowing when to seize opportunity is one of the basic principles of investing. But, stop your losses, as discipline always should trump conviction. Edwin Lefevre wrote in Reminiscences of a Stock Operator, "I did precisely the wrong thing. The cotton showed me a loss and I kept it. The wheat showed me a profit and I sold it out. Of all the speculative blunders there are few greater than trying to average a losing game. Always sell what shows you a loss and keep what shows you a profit." Woody Allen put it even better: "I don't want to achieve immortality through my work. I want to achieve it through not dying."
The Past Is Not Necessarily Prologue to the Future
- History should be a guide, but not a jailer. There is little permanent truth in the financial markets, as change is inevitable and constant. Do not extrapolate the trend in fundamentals in your company analysis nor the trend in stock prices. Be independent of analytical and investment conclusions, greedy when others are fearful and fearful when others are greedy, but always remember that holding on to a variant view has outsized risk as well as outsized reward.
Risk and Reward Should Be Assessed Properly
- In buying a stock, remember that risk/reward is asymmetric. A long can climb to indefinite heights and one can only lose 100% of the value of each investment. (Buy value, but only with a catalyst). When longs have high short-interest ratios, investigate the bear case completely.
- In shorting a stock, remember that risk/reward is asymmetric. A short can only return 100% (a bankruptcy) but can rise to indefinite heights. (Never make conceptual shorts without a catalyst). Avoid shorts when the outstanding short interest exceeds five days of average trading volume.
- Use leverage wisely but rarely, as financial markets are inherently unstable. While the use of leverage can deliver superior investment returns when the wind is at the back of your investments, it can also wipe you out when events fail to conform to your expectations. Only the best of the best consistently time the proper use of leverage.
Knowledge of Accounting Is a Must but Meetings with Management Have Little Value
- There is no substitute for a thorough knowledge of financial accounting. Accounting can be misleading, opaque and unaccountable, but free cash flow rarely lies.
- If you must meet with management, do so to understand a company's core business, but remember that managements infrequently, if ever, view their secular prospects with suspicion. In the late 1980s ,Warren Buffett wrote in a letter to Berkshire Hathaway's shareholders that "corporate managers lie like Ministers of Finance on the eve of devaluation."
Be Open to Others' Ideas but Rely on Your Own Analysis
- Always be self-critical, and once your view is formulated, be open to criticism from others that you respect. Take their criticism and test your thesis (constantly). Avoid what G.K. Chesterton once mused: "I owe my success to having listened respectfully to the very best advice, and then going away and doing the exact opposite." Bullheadedness will get you in trouble in the investment world.
Only Invest/Trade When Distractions Are Limited
- Invest/trade/speculate only if you are not dependent upon the investment profits to maintain your standard of living.
- A stable personal and financial life, outside of investing, is typically a necessary ingredient to investment success.
- Take vacations and smell the roses. When you return you will be rejuvenated and a better investor/trader.
- Be well rested and in good shape physically. "Investing is 90% mental. The other half is physical." -- another Yogi-ism!
- Keep your investment expectations reasonable and expect to make mistakes, as perfection is not attainable. Nevertheless, by all means try to chase perfection, as the byproduct will be investment excellence.
Read and Learn From the Best
- Learn from those investors that have excelled by reading and re-reading the classic books on investing.
Doug Kass is General Partner for Seabreeze Partners Short L.P. Until 1996, he was senior portfolio manager at Omega Advisors, a $4 billion investment partnership. Before that he was executive senior vice president and director of institutional equities of First Albany Corporation and JW Charles/CSG. He also was a General Partner of Glickenhaus & Co., and held various positions with Putnam Management and Kidder, Peabody. Kass received his bachelor's from Alfred University, and received a master's of business administration in finance from the University of Pennsylvania's Wharton School in 1972. He co-authored "Citibank: The Ralph Nader Report" with Nader and the Center for the Study of Responsive Law and currently serves as a guest host on CNBC's "Squawk Box."
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