What is the most important thing to keep in mind as an investor? This is a question one of my students asked the late Walter Schloss, a legendary value investor, a few years ago when he talked to my value-investing students at the Ivey Business School. His reply was “do not lose money.”
Schloss argued that once you lose money it might be difficult to recover. For example, if you go down by 50%, you must then go up by 100% to break even.
Unlike other investors, value investors place a greater emphasis in avoiding losses than making money. In the words of Aristotle, “the aim of the wise is not to secure pleasure, but avoid pain.”
The following checklist, adapted from Walter Schloss’ writings, helps investors avoid losing money, and will go a long way towards achieving financial success.
1.Before investing, try to determine the value of a stock. A share of a stock represents part of a business; it is not just a piece of paper. Since buying a stock is tantamount to buying a piece of the company, one therefore needs to understand a lot about the company.
2.Compare price to value. How far below value is the stock trading at? That is, is there a margin of safety?
3.Examine the quality of the balance sheet. Be sure that the company is not over-leveraged in relation to the norm in the industry. If it is, you may risk permanent loss of capital.
4.Have patience and a long-term perspective.
5.Do not buy on tips and never make impulsive decisions. Do your own homework first and be independent; everyone has a conflict. It is your job to watch your back, no one else’s.
6.Do not sell on bad news as this information tends to be already reflected in the price and, especially, because markets tend to overreact on the downside (also on the upside).
7.Do not be afraid to be a loner and a contrarian, but always look for weaknesses in your thinking.
8.Have confidence in your judgment, especially in the face of resistance and criticism, once you have made a decision.
9.Have an investing philosophy and an analytical process of when to buy and when to sell a stock, and try to follow it with patience and discipline.
10.Before selling, try to re-evaluate the company given current information. The level of the stock market, the direction of interest rates, changes in P/E ratios and pessimism or exuberance by market participants should be factored into your analysis.
11.When buying a deep value stock, try to buy at the low of the past few years. This is because a stock may go to $100 and then decline to $50, which one may find attractive as an entry point. But what if, a few years ago, the stock changed hands for $10? This shows that there is some vulnerability in a decision to buy at $50.
12.Better to buy assets at a discount than to buy earnings. It is easier to find deep value stocks and identify/expect a catalyst than to understand whether the company has a franchise and whether the franchise is sustainable. Besides, earnings can change dramatically in the short run, whereas assets change slowly. One has to know a lot more about the company if one buys based on earnings.
13.Listen to advice from people you respect, and examine what they do. This doesn’t mean you have to accept their advice or do what they do. While you need collateral evidence to support your own thinking, listening to people you respect helps solidify your thinking.
14.Do not to let your emotions affect your decisions. The worst enemy in investing is usually within yourself. Fear, greed, impatience and lack of discipline are weaknesses of human nature and emotions that work against success in investing.
15.Stay invested to take advantage of compounding. If you make 12% a year and stay invested, you’ll double your money in six years.
16.Stocks are better compounders than bonds. Bonds have limited upside; inflation erodes the value of bonds and reduces your purchasing power.
17.Beware of leverage. Risk is not volatility, but the probability of permanent loss of capital. Investing using leverage may result in a permanent loss of capital as you may be forced to sell at a time you did not wish to do so.
These rules worked marvels for Walter Schloss. Over a 49-year period of managing money, there were only two years during which he lost money, and he beat the market by 5%. The rules can work for you, too—but are you disciplined enough to follow this checklist? The answer to this question will determine how successful an investor you will end up being.
* First published April 08, 2020 in the “Money Sense”.
