I believe in long term investing. Generally, I don’t pay attention to books which focus on trading or speculation. Few days back, I was going through one business magazine and I came across below quote from a book – “The Zurich Axioms”
“All investment is speculation. The only difference is that some people admit it and some don’t”
This quote made me think deeper on my investment practice. I found a grain of truth in the statement. Why would any investor buy a stock? An investor buys a stock because he/she thinks that value of business is more than its quoted price. While calculating value, he/she has to make various assumptions with respect to growth, margin, discount rate, etc. Even if investor is conservative in his/her assumptions, he/she is still trying to predict the future. Investor should accept that there is some element of speculation in investing as well.
As I started digging into the book, I realized that there are many such axioms of speculation which can be useful in investing.
I have tried to present few axioms which investors can apply in their investing process to maximize their returns.
The First Axiom:
“Worry is not a sickness but a sign of health. If you are not worried, you are not risking enough”
Investors diversify their investments into few stocks to reduce the risk. However, if one has to earn maximum returns one cannot be investing small amount in his/her high conviction idea. The same can be seen in below chart:
As we can see, investor will derive highest return, if he/she invests sizable sum in his/her high conviction idea (return of 26% with 30% allocation vs. return of 10% with 2% allocation). An investor has to have strong conviction on his/her investment thesis and most importantly courage to take the risk of allocating high capital to that idea.
The Second Major Axiom
“Always take your profit too soon”
Most of the investors say that, one should let the profit run or should hold stock for long run. But, sometimes there are events where, it is better to take profit. This brings us to the question of ‘when to sell’. Below are few rules on ‘when to sell’-
- When the stock is trading at exorbitant price relative to its value
- When investor notices that there is divergence between narrative and numbers (Read our article on Narrative and Numbers)
- When investor’s thesis turns out to be wrong
Below is an example where it took 10 to 15 years for the stock price like Infosys to reach its earlier highest price even though company was growing its business and profits.
Below is an example where stock price has never reached its highest price
Before buying, investor should put in place rules on ‘When to Sell’
The Third Major Axiom
“When the ship starts to sink, don’t pray. Jump”
Long term investors generally follow “Buy and Hold” strategy. They hold onto the stock even when facts about business model or management quality has changed.
Investors could have applied this axiom when Yes bank was falling. Instead of praying that big investor will come and will rescue the bank, investors should have got out of the stock when trouble started brewing in the bank.
Stock Price performance
Investors should follow “Buy and Research” strategy. So when the company is not performing as per investor’s expectations or there is permanent deterioration in business fundamentals, investor should get of the stock.
The Forth Major Axiom
“Avoid putting down roots. They impede motion”
Investor should have an open mind and should evolve based upon changed environment. Investors can learn the same from Warrant buffet, one of world‘s greatest investor. He evolved his investing style from cigar-butt investing to buying great business at reasonable price.
The Fifth Major Axiom
ON OPTIMISM AND PESSIMISM
“Optimism means expecting the best, but confidence means knowing how to handle the worst. Never make a move if you are merely optimistic.”
Instead of being optimist or pessimist, investor should be realist. His/her view should be backed by facts alone.
The Sixth Major Axiom
“Disregard the majority opinion as it is probably wrong”
Most of successful investor are known for their contrary investing style. As Warren buffet has put it succinctly on how to become rich – “Buy when others are fearful and sell when others are greedy”