My Investment Principles

1. Stock is a share of a real business. Stock performance cannot deviate too much from the performance of the underlying business. Businesses grow for years and do not change overnight – so having a long-term investment horizon is important for successful investing. Focusing on business fundamentals and ignoring 'noise' from TV commentators is also very important.

2. Value of a stock equals the sum of all net cash flows that the company will generate discounted to present value. If reversed, this also means that your return from owning a stock would equal the ratio of a normalised (typical) cash flow divided by the stock price.

3. Price you pay for a company's stock and the future performance of the underlying business are the two key drivers of your overall investment result. The importance of Price diminishes with the growing holding period, while the importance of the underlying business grows with time. If you bought a business that generates 30% return on capital (measured as profit relative to the sum of all assets used to generate it) and if you owned that business for 50 years, then your investment returns will be very close to 30% regardless of the price you pay.

4. Risk is the permanent loss of capital, not the volatility of a stock. If one investor bought shares of a well-known global franchising company (e.g. McDonald's) and another invested in a similar company but privately (becoming a direct partner in the business which has no shares listed on the market) – then the first investor would see the price of his stock change every minute depending on market quotes. The second investor would not be exposed to such 'volatility' simply because the shares are not listed. But the risks for both investors would be very similar and related to the underlying business's performance, competitors' strategies, changes in regulation, etc.

Two primary sources of real risk come from leverage and technological innovation. Leverage is both – financial and operational. Financial leverage represents the total amount of financial liabilities that the business has to pay down eventually and regular interest payments that it needs to make on those liabilities. Companies in cyclical industries with low barriers to entry and no pricing power are more exposed to risks of leverage than businesses with established brands operating in sectors with high barriers to entry.

Technological innovation can make a product obsolete (e.g. Blackberry, Kodak) or disrupt the economics of an existing service (e.g. e-commerce vs physical shops).

Other risks come from changes in regulation, natural catastrophes, geopolitical conflicts and wars, general market cycles, fraud and misallocation of capital. Some of these risks affect all stocks (e.g. recession), and their exact timing is hard to predict.

To avoid risk, an investor should not predict when a bad event will happen but rather avoid stocks affected the most in an adverse scenario.
Well-known negative outcomes that could happen are often at least partially reflected in the price, which reduces the risk (e.g. if the market values a company at a discount because investors are concerned about potential fine, then when the penalty is issued – the stock would unlikely drop as its price has already reflected this outcome).

One of the most significant risks is not knowing all possible adverse outcomes and not knowing or assigning the wrong probabilities to them.

5. Circle of competence. To adequately assess the business and the cash flow it can generate in the future requires deep knowledge and skills. Without enough knowledge, any view becomes just a bet. We have a deep understanding of very few things or areas of life, so our investing process should focus on a few niches that we understand well. This also helps to avoid potential risks. As Warren Buffett says, 'I don't look to jump over 7-foot bars: I look around for 1-foot bars that I can step over'.

Many highly intelligent people do not achieve outstanding investment results because they tend to ignore their areas of competence. They are generally curious and eagerly analyse situations where they lack expertise, taking views on a wide range of problems. A person with a lower IQ can achieve better investment results if he acknowledges his limitations and focuses on what he knows best (e.g. residential property in a small town).

6. Contrarian. Opportunities to find great businesses selling at low prices are higher in less favoured places. With the rise of passive investing in market indices, certain stocks or sectors can fall simply because their weight in an index benchmark was reduced, which has nothing to do with fundamentals.

To borrow a quote from Charlie Munger, 'Any damn fool can see that a horse carrying a lightweight with a great win rate and a good post position is a way more likely to win than a horse with a terrible record and extra weight. But if you look at the damn odds, the bad horse pays 100 to 1, whereas the good horse pays 3 to 2. Then, it's not clear which is statistically the best bet…The prices have changed in such a way that it's tough to beat the system' [1].

Another world's best investor, John Templeton, used to say that 'it is impossible to produce a superior performance unless you do something different from the majority'. He also spoke on the importance of taking a contrarian view that 'the time of maximum pessimism is the best time to buy, and the time of maximum optimism is the best time to sell'.

7. Competent and honest Management with 'skin in the game'. There are many examples when skilful managers improved the performance of a business and generated superior shareholder returns (e.g. Satya Nardella as a CEO at Microsoft). Managers also play a vital role as allocators of capital which, in turn, drives the long-term returns of a company. When managers own a significant portion of a company or have a substantial part of their net worth invested in the business they run, they tend to make more long-term decisions to create more value and avoid unnecessary risks.

At the same time, managers can do little in a business that lacks competitive advantage or has fallen behind in the technological race. Buffett underscored the importance of a business over management skills when he said: 'You should find a business that even a fool can run because someday a fool will'. He also famously said that 'When a manager with a reputation for brilliance tackles a business with a reputation for bad economics, the reputation of the business remains intact'.

8. Patience. The importance of being patient is crucial for investment success. Patience is needed when a good business continues to sell at a discount until something changes (e.g. the market starts to realise the company's true value, a strategic investor comes with a takeover bid, the company launches an extensive buyback programme). Patience is also required in doing your research before buying shares and not following short-term ideas. Patience is a virtue when 'hot' stocks continue to rise, making random people richer every day while the stocks in your portfolio continue to stay out of favour.

One of the key reasons for Warren Buffett's success has been his ability to wait for the 'fat pitch' (using baseball terminology). 'The trick in investing is just to sit there and watch pitch after pitch go by and wait for the one right in your sweet spot'.

However, it is also important to remember Principle 5 (On the circle of competence). Patience can ruin anyone if it is followed for its own sake without a clear understanding of the true value of the business that investor owns, the industry's competitive dynamic, and its long-term economics. Only if you buy a company within your area of competence can patience add to your investment returns.

Two quotes from investment legends summarise the importance of psychology.

Ben Graham: 'The investor's chief problem—and his worst enemy—is likely to be himself. In the end, how your investments behave is much less important than how you behave'.

Peter Lynch was even more direct: 'In the stock market, the most important organ is the stomach. It's not the brain'.

Plenty of studies have proven that humans are not perfect in making rational decisions and in remaining consistent with decisions made.

In investing, it is crucial to keep this in mind. Our psychology can distort our decisions at every stage of the investment process: from choosing a stock for a possible addition to the portfolio, during the analysis phase, as well holding the stock and deciding when to sell it.

I see at least four causes for these shortcomings:

1. First act, then think. Humans have emerged in a wild world and quickly reacting to potential dangers was more important than whether the actual decision was correct. If our ancestors spotted something loosely reminding them of the ears of a lion, they would be far better off running away immediately, then taking extra time trying to confirm their initial guess. The downside from being wrong was some extra running, while the upside from being right – a saved life.


2. Social proof. In addition to living in a wild world, we also got used to being social animals preferring to live in a group than individually. We seek decisions that get social proof such as when buying popular stocks that everyone is discussing. It makes it painfully difficult to avoid those stocks and sectors when you see your friends and neighbours getting rich by holding the 'most obvious winners in today's economy'.


3. Look for order, avoid randomness. Somehow, our brains cannot handle randomness and seek to put things into order often looking for correlation and causations between events when there is none. This leads to various biases such as hindsight ('I knew this would happen'), 'illusion of knowledge ('the data and detailed analysis supports this'), overweight of 'experts opinions' and others. Our preference for certainty often makes us overpay for stocks with predictable and stable dividends. We also tend to buy stocks with clear 'stories' behind it.


4. We follow our emotions much more often than we think so. 'It is easier for us to say yet to people we like' is a famous advice from experts on self-improvement and relationships. The reason this advice works is that we often assess information not on its own merit but based on who we get it from. A well-spoken management can often 'sell' company's strategy and convince us faster even if reality is far more challenging and unclear.

We often assign higher probabilities to events that we can visualise better or which we just have experienced ourselves. Various studies show that people believe another natural disaster is more likely to happen if one just happened even if thousands of years lead to a different statistical probability.

Surprisingly at first, but even if the same information is presented differently – people tend to make different decisions. For example, studies show that individuals would likely choose to go ahead with some action (e.g. medical operation, construction) if they are told that 'there is 95% chance all goes well', while they are more likely to reject the decision if told 'there is a 5% risk of things going wrong'.

The whole field of Behavioural finance is full of various studies which have identified a list of all kind of biases and weaknesses in our decision making process. This list is worryingly long and includes some of the following ones:

- Loss aversion

- Anchoring

- Mental accounting

- Endowment effect

- Framing

- Over confidence

- Framing

- Hindsight bias

- Social proof and peer pressure

Various biases lead to all kind of problems like 'over trading', short-term investment horizon, focusing too much on TV experts, not doing enough fundamental research, over-paying for popular stocks with stable earnings and captivating 'stories', paying more attention to the final result rather than the process.

From my experience, the best books on this subject that are worth reading are:

• 'Thinking, fast and slow' by Daniel Kahneman and Amos Tversky

• 'Nudge' by Richard Thaler

• 'Behavioural investing' by James Montier (or a shorter version of it – 'The little book of behavioural investing')

• 'Fooled by randomness' by Nassim Taleb (as well as all his other books including 'Black Swan', 'Anti-Fragility' and to a lesser extent 'Skin in the game'.)

I keep thinking on how we can overcome our human's weakness to get better investment results sharing some of my findings on this website. Some of them include writing investment thesis, having your own checklist, creating simple rules (e.g. having a maximum position size), avoiding 'hot' stocks and widely known 'stories', asking 'How I would allocate my savings if I had all of them in cash?' rather than 'should I stick to this or that stock, reduce / add?', checking stock prices less often.

Ultimately, perhaps the most important advice although the one which is probably the hardest to follow is to never stop learning especially through reading books to keep expanding your circle of competence and accumulate knowledge.

Being mindful of your habits, practising meditation and having the 'right' circle of like-minded investors are also important steps to improve your decision making.

I can imagine an intelligent person reading the above points and thinking ‘Well, this is obvious’ or ‘Yes, it is a good summary of dozens of books on investing some of which I also read’. The challenge of course is applying these principles in real-world investing. Just like with some other processes – they are very simple when explained, but require practice and skill when practiced. For example, it does not matter who explains to a child how to ride a bicycle – you or Lance Armstrong – finding a balance, looking forward, sitting straight, pushing the pedals – all these steps are obvious but almost impossible to implement for the first time. It is quite similar in investing.

So one reason I decided to launch this website is to build a bridge between the theory and practice of investing so that anyone can start a journey from the safety of a library to the jungles of a stock market, avoiding pitfalls and maximising their returns.

I am also keen to meet like-minded investors to exchange ideas and find new opportunities, so please do get in touch here. And do not hold back any criticism you may have on my work – I am doing it because I want to improve my skills and achieve better results – so learning about my weakness and what I can improve is very important to me.