The trouble with writing about investing is that it’s just common sense. It will sound self-evident, maybe almost trivial. And simple things are too boring to stick. Just to liven it up, I thought I’d tell it in a corny, facetious way.
In a profession where it takes decades to gauge competence, how does one get a start? Raise money? Raise more money before skill can be established? Land a good apprenticeship? Survive mistakes? Luck, luck, luck, luck and luck. To begin with, it’s all luck. Over the years, behaving well so as to not squander luck is the beginning of skill. Over decades, true skill may emerge through investing well. It will always be hard to tell, though.
Before outlining tenets of an investment process, it’s good to know what to expect from it. Answer: nothing. In the sense that nothing is guaranteed. Capital preservation isn’t assured. Neither is a decent return. Certainly not multi-baggers (if an investor uses this phrase, slap him). The only expectation, from a sensible investment process, is modestly better odds. Lower odds of bad things happening. Higher odds of decent things happening. That too, on average and over the long run.
One 4-letter word to rule them all. Here, risk pertains to existential threats. I’ll cover this in detail in a subsequent essay. Stuff like: I’m clueless; he’s a crook; neighbourhood’s tough; yuck, this frog’s no prince. If ruin isn’t in the picture, subsequent 4-letter words cover incremental risks.
Business exists to earn cash. No ESG. No stakeholder value. No hippie jargon. Sure, it’s preferable to earn it legally. If the owner’s long-term greedy, he may even earn it ethically. And cash is defined in an owner’s sense: how much cash can one get out for the cash put in. Unclear? Without quibbling, let’s go with return on capital as a reasonable surrogate. Deposits or bonds yield high single digits in India. Businesses better yield well over that to be worth any owner’s while. Whether this number is adequately high over decades is the only empirical determinant of a good business. If it isn’t, all one has is a story. That’s disqualified since it isn’t a 4-letter word. Most cheat by calling it a tale, though.
Past cash is nice, but what I really want is future cash. Forever, ideally. This takes me to moat. Why will incumbents stay rational? Why won’t customers take a chance on irrational newbies? It’s safe for consumers to buy established brands. It’s even safer for channel to plonk their cash into brands that consumers buy. Occasionally, there are network effects. Or a DNA of efficiency. Maybe switching costs, real and imagined. In financial services, an owner who doesn’t lose his head is probably a moat. Generally, moat ends up being a combo where I can’t really isolate individual factors. As was said of another 4-letter word, I know it when I see it. Most of the time, a business that passes the cash test passes the moat test. Especially, if its entire neighbourhood is drowning in cash. Occasionally, I am left scratching my head, unable to reconcile cash with strength of underlying construct. Then, it’s safer to assume that there’s no moat. This moat stuff is kinda fuzzy. So is investing. Deal with it.
In a season of fad diets, I call mine the Swiggy diet. Comfort food, 4.5+ rating, bought at a discount. Ditto in investing. Comfort arises when a business passes the risk test. Cash and moat yield 4.5+ rating. Then, I wait for a discount. You may call me cheap, but I prefer cost conscious. Sure, I’d pay more for Sante Spa Cuisine than for Matunga Dabeli. But I’d like a good deal on both. And I won’t take a chance on that 3.2 rated cloud kitchen, irrespective of discount.
If I have got a good deal on a business with low risk, tons of cash and wide moat, what’s the dumbest thing I can do? Give it up. Smartest thing? Give it time. Lots of time. Remember, the richest people in the world owned one good business for generations without selling a share. I get to own a whole basket of good businesses. Lucky me. I better not jinx it.
Whatever the problem, there’s a constant refrain of “Do something dammit”. Middle-east is burning. Cars aren’t selling. Kid is bored. I miss the good old days when benign neglect was the default state. If I had to print a slogan on a t-shirt for investors, I’d go with “DO NOTHING DAMMIT”. Not getting a good deal on anything? Do nothing dammit. Own a boringly fine business? Do nothing dammit. Wodehouse taught me that the rich get idle. Buffett taught me that the idle get rich.
Unlike with Swiggy, good deals in investing aren’t all cheery. They arise during stomach-churning times, when we lose all appetite. It’s nice to reminisce about the generational buying opportunity in late-2008, but while living though it, investors were curled up in a foetal position under Bloomberg terminals wishing they had become lift operators instead. Even in normal times, a business gets cheap only because of bad news: demand down, costs up, competitors closing in, existential threats looming. Sure, this is a knowledge industry and all that, but to excel, brains aren’t the most important body part. Aren’t you glad I stuck to 4-letter words?
When I said earlier that nothing is guaranteed, I lied. Fees are as certain as death and taxes. In technical terms, this is the difference between what your money earns and what’s left for you. In practical terms, it’s the reason why passive funds are a better deal. For the 2 and 20 crowd, I could’ve gone with a different 4-letter word: loot.
Investing is far from easy. It isn’t suited for most. It requires buggy humans to violate every bias and mental shortcut that they come hardwired with. Go against the crowd. Accept that outcomes are neither knowable nor controllable. Avoid stories. Ignore authority figures. Do nothing for years. At the risk of being politically incorrect, good investors are born not made. I’d go a step further. They’re mutants. Psychological mutants. Born with a peculiar nose for ruinous risk. Wired to endure years of inactivity without ending up in a padded cell. Gifted with the temperament to buy with conviction when the world seems to be ending. These mutants aren’t warring with humans. Just making money off them!
[Views are personal. Ideas are at best unoriginal and at worst plagiarized. For anything sensible, credit goes to people around me. For any nonsense, blame is solely mine.]
[PS. I first published this essay in Jan-2020 at https://www.linkedin.com/pulse/four-letter-words-investing-anand-sridharan/]