Quality Investing! A Worthwhile Investment Strategy that focuses on Roots & Wings to Pick Stocks
Every high-performing strategy in sports, business, or life in general, always has a strong underpinning to anchor it in good and bad times.
Especially during the bad times, because that is when the conviction in one’s ideas and approach gets tested. This is even more true in the case of investments because one is exposed to a constant barrage of news about companies, markets, the economy, domestic politics, geopolitics, etc.
Also, one’s investment portfolio is a number that always stares in the face of a nervous investor, and with all the noise around, the triggers to sell and run are omnipresent.
Did a new variant of the virus cause a sudden spike in infections in a country? Did the central banker, whether the Federal Reserve’s Chairperson or Reserve Bank of India (RBI) Governor, say something again on raising interest rates? Did that cause yet another round of concern in the stock markets?
In these turbulent times, the prudent investor is well served with a philosophy that keeps calm amidst the chaos. This is possible only with a high-quality portfolio that enables one to sleep well, even if the markets were to shut down for some time.
Peter Lynch once remarked, “Success depends on the ability to ignore worries of the world, long enough to allow your stocks to compound”.
Without a principled investment philosophy that guides their decisions and keeps them focused, investors are likely to succumb to the mentality of the herd which can take them over a cliff.
In the Indian markets, we are seeing how herds are swarming around a particular group’s stocks driving its price-to-earnings ratios into several hundred, even as most of the group companies carry debt far in excess of their equity base.
A philosophy that enables ‘Quality Investing’ is more important than strategy or tactics. A strategy can change over time whereas philosophy is underpinned by strong principles that guide in decision-making.
There have been several cases of promising stocks that show sudden spikes, only to suddenly fall when the market inevitably corrects. A prudent investor studiously stays away from such stocks. Without a clear philosophy, that would not be possible.
The biggest benefit is the control over one’s emotions, to eliminate the daily noise the market and media throw at you so that you focus on what matters long term.
Because a 1,000-point drop in the Sensex is just a small dip in its long-term chart. Fretting over the short-term will only aggravate the concerns that an investor may have and cause them to bail out early on a promising investment.
Nassim Nicholas Taleb, in his book “Fooled by Randomness”, shows that “a 15% return with a 10% volatility (or uncertainty) per annum translates into a 93% probability of success in any given year. But seen at a narrow time scale, this translates into a mere 54% probability of success over any given single day”.
An investor is well-advised not to track portfolio performance on an hourly or daily basis. It is best to look at the portfolio once a quarter, provided one invests in quality stress that frequent checking takes is very high and has serious implications on one’s health. In the long run, how much wealth one has accumulated is not as important as the journey one has taken to achieve it and the ‘total cost’ (emotional stress, loss of health, relationship erosion) one has paid for it.
With respect to investment strategy, one can have multiple approaches to reach one’s goals. One may buy stocks of a certain market cap classification – say large-cap only, index funds only or small-cap only, or choose one from value, growth or momentum approaches.
We recommend sticking to strong roots (debt-free companies with a consistently high return on equity and owned by aligned promoters) and wings (companies with growing sales, operating income, and cash flows).
Applying this yardstick, one finds that certain debt-prone sectors like utilities, airlines, and telecom may be less preferred.
Capital efficient and consumer-focused sectors like consumer staples, manufacturing, e-commerce, technology, financial services, and pharmaceuticals tend to have strong roots and powerful wings.
This does not mean that money cannot be made in other sectors. We are only interested in one that relies on the quality and allows one to sleep well.
Once the quality investment strategy is in place, one can have various tactics to take advantage of market opportunities. No, we are not talking of timing the market here.
Tactics could also exploit market anomalies such as mispricing or a sudden information asymmetry that a studious investor comes across and pounces on before others.
Based on the situation the investor may choose to either “panic early or double down late”. It’s difficult to strike a balance between conviction and adaptability.
Conviction comes from the broader high-quality investment strategy and it is only experience, past mistakes, and learning that can make one adaptable.
More than anything, durability is key in investment strategy. Almost everyone knows how Warren Buffet built his phenomenal wealth by sheer compounding, with most of the portfolio getting added over the last two decades in an eight-decade career.
This ability to endure, i.e. durability is what leads to financial independence and the ability is what leads to financial independence and the ability to live life on one’s own terms. When an investor starts, he/she may get scared with the market volatility, but, over time, start seeing volatility as an opportunity.
This is because they would have, over the course of a decade or so, developed their own compass, or found a trusted advisor who becomes their investment compass.
