#Losing money is worse than not losing money.
Some math makes clear why value investors act conservatively.
Picture a portfolio that realizes a 50 percent loss in a year. Not one that started the year with stock that just happens to have halved in price 12 months later. One that actually realized a 50 percent loss. One that began on January 1 with cash, bought stock during the year, sold that stock later in the year, and on December 31 had half as much cash as it started with. What would it take for the portfolio to get a fresh start?
It would need a 100 percent return the next year just to get back to zero. That’s hard.
Consider soccer. If a player takes a shot on goal and misses, nothing happens to the score. The player gets a fresh start with the next ball. But if soccer was investing, the player would get negative points for missing. Goals would be required just to get back to zero.
That’s why value investors behave with such restraint. We put capital preservation first. We do so because the mathematics of our missed shots is punitive.
#When capital preservation is underemphasized
When capital preservation is underemphasized, returns suffer.
Returns suffer because losses add up like weights.
This truth isn’t evident to those who believe in the risk-return trade-off. They see the subordination of capital preservation as a step toward outperformance. And those believers constitute the majority.
Perhaps that’s why the asset management industry has such staggering failure rates. Most actively managed equity funds—those that pick individual stocks—don’t beat basic market indexes.
Most. That’s the output of a blind majority.
#Repel Losses
Two practices help to preserve the value investing model’s ability to repel losses.
A. The first is to keep it current.
Think of the model as having three layers (Figure 21.1).
1. The top layer is the general guidance:
FIGURE 21.1: The value investing model
The top layer is permanent.
Knowing what to do, doing it, and not doing anything else is so durably commonsensical that one might even apply it to other endeavors.
But the bottom layer could change.
Both accounting standards and disclosure requirements will evolve.
B. The second practice is to think in percents.
One should focus on the total return expressed as a percentage, not on currency amounts.
Thinking in percents nurtures habits that perform faithfully over a lifetime.
When one thinks in percents, the absolute gains follow.
#Value Investing has other benefits too
But since I committed to it at the end of the last century, I’ve come to see that value investing has other benefits as well.
Turn on the serendipity spigot, and suddenly everything applies. Shopping, news, traffic—all become inputs just as worth processing as financial statements. The instants and fragments of everyday life become relevant in a vivid way.
It takes inherently hazy situations and chases the facts. What’s this thing worth? I see a realness in that.
It compels me to consider how enterprises will develop over time. Part of that drill is picturing civilization years forward. That carries an aspect of foresight that I like.
#Value Investing benefits at personal level
That long-term perspective applies on a personal level as well.
Making presentations, attending meetings, and flying overseas all get harder with age. But value investing requires none of that.
My younger loved ones are standing by to let me know when the first one plinks out.
It gives one the freedom to fully embrace what really matters. To be able to drop everything and lavish attention on such gifts, fearlessly, and at times of one’s choosing—That, I think, is what rich is.
Summary
1. Capital preservation is a value investing priority because of the mathematics of realized losses.
2. The risk-return trade-off blinds most asset managers to the primacy of capital preservation.
3. Most actively managed equity funds fail to beat basic market indexes over time.
4. The bottom layer of the value investing model is the part most likely to change.
5. Thinking in percents encourages habits that work over a lifetime.
6. Value investing has benefits beyond remunerativeness.
Reference:;
Good Stocks Cheap - Value Investing with Confidence for a Lifetime of Stock Market Outperformance.
Some math makes clear why value investors act conservatively.
Picture a portfolio that realizes a 50 percent loss in a year. Not one that started the year with stock that just happens to have halved in price 12 months later. One that actually realized a 50 percent loss. One that began on January 1 with cash, bought stock during the year, sold that stock later in the year, and on December 31 had half as much cash as it started with. What would it take for the portfolio to get a fresh start?
It would need a 100 percent return the next year just to get back to zero. That’s hard.
Consider soccer. If a player takes a shot on goal and misses, nothing happens to the score. The player gets a fresh start with the next ball. But if soccer was investing, the player would get negative points for missing. Goals would be required just to get back to zero.
That’s why value investors behave with such restraint. We put capital preservation first. We do so because the mathematics of our missed shots is punitive.
#When capital preservation is underemphasized
When capital preservation is underemphasized, returns suffer.
Returns suffer because losses add up like weights.
This truth isn’t evident to those who believe in the risk-return trade-off. They see the subordination of capital preservation as a step toward outperformance. And those believers constitute the majority.
Perhaps that’s why the asset management industry has such staggering failure rates. Most actively managed equity funds—those that pick individual stocks—don’t beat basic market indexes.
Most. That’s the output of a blind majority.
#Repel Losses
Two practices help to preserve the value investing model’s ability to repel losses.
A. The first is to keep it current.
Think of the model as having three layers (Figure 21.1).
1. The top layer is the general guidance:
- know what to do,
- do it, and
- don’t do anything else.
- understood,
- good, and
- inexpensive.
- the six parameters of understanding,
- the historic operating metrics,
- the cognitive biases, and so forth.
FIGURE 21.1: The value investing model
The top layer is permanent.
Knowing what to do, doing it, and not doing anything else is so durably commonsensical that one might even apply it to other endeavors.
But the bottom layer could change.
Both accounting standards and disclosure requirements will evolve.
- For example, the Federal Accounting Standards Board might mandate some new calculation of operating income such that ROCE has to adapt.
- Or perhaps the SEC will eliminate related-party transaction reporting such that the number of shareholder-friendliness indicators has to be trimmed down to three.
- The more time that has passed, the more important it is to be aware of such developments.
B. The second practice is to think in percents.
One should focus on the total return expressed as a percentage, not on currency amounts.
- A 20 percent realized loss is not okay just because the actual damage was only $1,000.
- And a $1,000,000 gain is not impressive if it represents just a 2 percent annualized return.
Thinking in percents nurtures habits that perform faithfully over a lifetime.
- Discipline learned in the early years of little capital works just as well in the later years of more capital. New tricks aren’t required just because of more zeroes.
When one thinks in percents, the absolute gains follow.
- They follow because value investing is remunerative.
- That provides most practitioners with enough motivation to stay with the strategy.
#Value Investing has other benefits too
But since I committed to it at the end of the last century, I’ve come to see that value investing has other benefits as well.
- For one, it keeps me engaged with the world.
Turn on the serendipity spigot, and suddenly everything applies. Shopping, news, traffic—all become inputs just as worth processing as financial statements. The instants and fragments of everyday life become relevant in a vivid way.
- Second, value investing is, at root, truth seeking.
It takes inherently hazy situations and chases the facts. What’s this thing worth? I see a realness in that.
- Third, it rewards a long-term perspective.
It compels me to consider how enterprises will develop over time. Part of that drill is picturing civilization years forward. That carries an aspect of foresight that I like.
#Value Investing benefits at personal level
That long-term perspective applies on a personal level as well.
- I hope to keep value investing long after other lines of work would have become difficult.
Making presentations, attending meetings, and flying overseas all get harder with age. But value investing requires none of that.
- I’ll do it for as long as I have all my marbles.
My younger loved ones are standing by to let me know when the first one plinks out.
- Above subsistence and below gluttony, there’s little correlation between net worth and happiness.
- But an absence of money can keep one from the great joys. And therein lies value investing’s promise.
It gives one the freedom to fully embrace what really matters. To be able to drop everything and lavish attention on such gifts, fearlessly, and at times of one’s choosing—That, I think, is what rich is.
Summary
1. Capital preservation is a value investing priority because of the mathematics of realized losses.
2. The risk-return trade-off blinds most asset managers to the primacy of capital preservation.
3. Most actively managed equity funds fail to beat basic market indexes over time.
4. The bottom layer of the value investing model is the part most likely to change.
5. Thinking in percents encourages habits that work over a lifetime.
6. Value investing has benefits beyond remunerativeness.
Reference:;
Good Stocks Cheap - Value Investing with Confidence for a Lifetime of Stock Market Outperformance.
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