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Monday, 27 April 2020

What to invest in, and when (Low Rates High Returns Podcast, Episode 3)

Stock picking

There's nothing wrong with investing in individual companies to invest in, and we still do this today.

But we have learned from painful personal experiences over the years that trying to pick the 'next big thing' can be fraught with danger when the growth wagon stops.

Even the biggest growth success stories of recent decades (think Amazon) have experienced enormous drawdowns, making it deceptively difficult be a successful stock picker consistently, and to stick with the selections through thick and thin. 

And making a mistake can result in a permanent loss of capital.

If rule #1 of investing is 'don't lose money', this is of course what we want to avoid.

Market mispricing

Instead of looking to pick the next big growth stock, we instead look for a market mispricing.

That is, the opportunity to buy a dollar for 50 cents, or as close to 50 cents as possible.

This in turn tends to lead us to the big, mature, and profitable systemic companies, which will throw off huge income streams between now and doomsday.

If you can look towards out-of-favour sectors in out-of-favour countries then this can lead to you to some very lucrative long-term investments.

For example, at the time of writing you might look at telcos, energy, tobacco, consumer staples, or healthcare companies, with the opportunity to harvest consistent 6 to 8 per cent income streams. 

Companies with high leverage or levels of gearing may be best avoided, to manage risk.

Much of Buffett's great genius over the years has simply been displaying the wisdom and patience to look for such proven performers, and the opportunity to buy them at an attractive price. 

And remember the Lindy principle: if a business has been around for 50-100 years and has proven itself to manage capital prudently profitably through multiple cycles, then it's a fair bet that it can continue to do do for another 50-100 years.

Risk hierarchy

The good news is that you don't need to be a stock picker these days if you don't want to be, as you can use indexes or ETFs to invest in countries or sectors. 

Generally speaking, we look towards countries and sectors that are cheaper than their long-run average, rather than more expensive, for obvious reasons.

If you take a global approach there will always be opportunities to buy low (and, later, sell high), every year. 

But as discussed in the previous episodes, it's critical to observe the macro environment, particularly with regards to the US market. 

The US accounts for about half of global market cap and is known to be the single biggest influence on equities markets around the world.

Thus when the US is expensive you need to be aware of the prevailing downside risks and adjust your asset allocation according to your plan. 

When the US market is cheaper, then generally speaking the macro risks for equities may be lower.

Low Rates High Returns podcast

You can listen to Episode 3 of our Low Rates High Returns podcast here at Apple iTunes (or by clicking on the image below): 

You can also tune in at Spotify, Stitcher, or Soundcloud

By the way, you can download a free chapter of our book here (or by clicking on the image below), and pre-order a copy of the book from Dymocks here: