Value investing is an intellectually and emotionally demanding discipline where the latter may be arguably more important than the former. Hundreds of hedge funds helmed by the leaders of the industry fall prey to the inefficient market when the financial crisis hit. Cycles after cycles, we possess the wishful thinking that “this time it will be different, Company ABC is far greater than its peers and it would continue growing, justifying its high P/E ratio”. However, time and time again, only with the onset of a financial crisis, do we see that value prevails.
In this article, we will explore the two key characteristics every value investor ought to possess to survive and profit from the bleakest point of the financial crisis.
Humans are emotional creatures, we thrive on emotional satisfaction. We feel happy when we are praised and desolated when we are seen as inadequate. As a result, more often than not, we seek comfort in numbers even though it is often not the smartest thing to do.
Well, if you are investing to feel good or bad and not to make consistent returns, then sure, follow the crowd.
However, if you are serious about generating profits year after year in the long run, you should cultivate the intelligence and judgement to know what is truly important.
The following quote by Larry Sarbit, chief investment officer of Sarbit Advisory Services sums up perfectly the influence of emotions in the financial market:
“[Investors] allow emotion take over their investment decisions. That is undoubtedly the biggest problem. They don’t think very much at all. There’s not a lot of thought going on and so therefore don’t be surprised if things don’t work out well. They’re their own worst enemy. Investors do more damage to themselves than anybody else could do to them. If they would just think like they were going to the grocery store, again that’s Ben Graham, if you think about buying stocks, like he said, like groceries instead perfume, you’ll do a lot better. But people don’t and there’s not a heck of a lot you can do for them. The truth is that most people are not going to make money in the stock market. The vast majority of people don’t make money. It’s unfortunate but it’s almost a law that that’s the way it is. The money comes in at the wrong time and it goes out at the wrong time. I can tell you right now we’re seeing the market turn south because of rising interest rates. If the markets keep going down or if they go nowhere for the next three years, I can see exactly what investors are going to do. They’re going to get out, they’re going to stop investing, and they’re going to get out.
They keep doing this over and over and over again, generation after generation, decade after decade, century after century. The behavior just repeats over and over and over again. Not much you can do about it. But that’s what creates the incredible opportunities to buy things. It creates it for us – it’s that people don’t think. […]”
“I have superior and one-of-a-kind emotional intelligence, can I now time the market?”
On hindsight, it may seem to make perfect sense to buy low and sell high. However, this proves to be a dangerous thought as there are many underlying assumptions. Even if you are immune to the psychological influences of the market where it almost seems like everyone around you is screaming at you to sell, any attempt to time the market is futile over the long run.
Firstly, in the short term, events that drive stock prices are completely random. If you manage a hedge fund trying to profit from predicting what President Trump would do the next day, you will probably be going crazy by now. Unless you have some private information that the public does not know and this is illegal and not something that one can consistently replicate to drive performance in the long term.
Secondly, it is a fruitless endeavor because the pursuit for short term returns is highly competitive. The holding period for stocks has ever been decreasing, it has been estimated that the average period in 2017 was just 22 seconds.
Lastly, it is due to its frictional costs. Each trade will incur commission fees and these amount to quite a lot for retail investors. Fees are silent killers that will slowly erode away the hard-earned profits that you worked hard for.
Even if you have developed the gut to stomach unrealized losses and act rationally, you will be lost if you are not clear about your own investing philosophy.
Without any reference point, you will be investing with no sense of direction. Developing a value investing philosophy is a lifelong journey that needs to be cultivated cautiously and continually.
A firm investing thesis will guide you through market turmoil and excessive optimism. Whenever you sense the tugging for you to buy or sell, a strong guiding principle will put these urges to test.
A successful investor is defined by how much returns he or she is able to consistently generate over the long term, not one that is always seeking social proofs and following the crowd.
Learning about value investing is like putting pieces of a huge puzzle together, the pieces you choose to take is entirely up to you our, whilst role is to provide you with a variety of ideas and tools for you to form your personal philosophy.
Here is another piece for you to consider: take a look at this article if you would like to know how we view risk.