The investment business is intensely competitive, full of talented and highly capable people, all striving to win. There is a fine line between winning and losing. Sometimes what separates the winners from the losers is simply how they approach the market.
To keep my decision-making process free of Wall Street's noise and clutter, I use a variety of mental constructs. I discussed a couple of them in a column earlier this year,
Think Cycles, Buy Variance. Here are a few more that have made me a lot of money. I hope they can help you, too.
The Real Estate Appraiser
As a stock analyst and money manager, I like to view my job as similar to the work of a real estate appraiser, the obvious difference being that I appraise companies. Of course, businesses are vastly more complex and much more difficult to value than real estate. But the utility of this construct -- and the impact on money-management decisions -- is multifaceted:
- Buy Decisions: If you find a piece of real estate that is clearly worth $100,000, but the owner is only asking $75,000, the buy decision is easy. Such wide divergences between value and price are uncommon in real estate. Not so with stocks: With the average
New York Stock Exchange stock fluctuating about 50% per year, the smart investor has many opportunities to buy low. Given a wide enough disparity between value and price, appraisals can make buy decisions easy.
Sell Decisions: If the appraisal is accurate -- the real question for both the real estate appraiser and the stock analyst -- then the sell decision is as easy as the buy decision. If you know what a stock is worth, then you know when to sell. Holding a stock that has reached overpriced levels in the hope that it'll become more overpriced is a loser's game.
Tough Markets: Unfortunately, I know a few people who panicked in September. Use of the appraiser construct can really help in tough markets. If you own a piece of real estate that you know is worth $100,000, you're not going to sell when offers fall to $80,000 or $70,000 in a panic. We're going to have a tough stock market again -- maybe this month, maybe in a couple of years. Know what your companies are worth, and you won't give them away in a panic.
Technical Analysis: My real-estate-appraiser construct calls into question the usefulness of some forms of technical analysis. Let's assume, for example, that the owner of a house worth $100,000 receives an offer for $100,000, followed by an offer from another party for $110,000 and then one more offer for $120,000. Remember, this house is only worth $100,000. In the parlance of technical analysis, this would be called a breakout, which should be bought. It's illogical, of course, for investors to buy breakouts in houses -- or stocks, for that matter -- without reference to the underlying valuation.
The appraiser construct works as well as the valuation work that underlies it. That's why the preponderance of my time and energy goes into valuation analysis. It is time-consuming and meticulous work, but it makes the decision-making process easy, especially in a tough market.
Survival of the Fittest
Darwin's concept of the survival of the fittest is an excellent construct that's commonly applied in the business world. But I think the concept is generally misapplied and misunderstood.
The concept of "fittest" is where the mistake is made. Survival of the fittest does not mean that the biggest or strongest will survive. Often, the survivors are only of average size or strength.
Black moths did not have an advantage over white moths in mid-19th century London until the Industrial Revolution dumped a large amount of soot in the areas where the moths hung out. The change in environment made it easy for birds, the moth's main predators, to locate white moths. It didn't take long for white moths to disappear, while the black moths survived.
The key point? The black moths were not bigger, stronger or faster than white moths. The black moths were the fittest in the sense that they best fit the environment.
The same is true in business. It's not the biggest, strongest or fastest that always succeed. Companies like
were dominant in their areas for a time, certainly the biggest and strongest. But the environment changed, and they didn't fit their environment as well as their competitors.
I think much of Warren Buffett's stock-picking genius is due to his selection of companies that operate in predictable environments. His long-term holdings, including companies like
, don't have to struggle with fitting into a changing environment. And it also explains, in part, his aversion to technology companies, which operate in an environment where change is swift and unpredictable.
Arne Alsin is the founder and principal of Alsin Capital Management, an Oregon-based investment advisor specializing in turnaround situations. At time of publication, Alsin and/or ACM had no positions in any of the securities mentioned in this column, although holdings can change at any time. Under no circumstances does the information in this column represent a recommendation to buy or sell stocks. Alsin appreciates your feedback and invites you to send it to