If you don’t have an investment process, you’re rudderless on the market sea

A yellow small boat on the ocean

This morning, I got an interesting question from a reader.

Referring to one of my past stock recommendations, Karoon Energy (KAR on the ASX), he asked if he should sell because he was down 50%. In his words: “Purchased @ $1.22 in Oct 2017. Bit of a flop right?” (The price now is 60.5c).

You might see it as a “flop” too, looking on the scoreboard (the share price).

But, as I told him in reply, “Actually, I don’t see it that way.”

That’s because I’m looking not at individual share prices, but rather, at my process.

He was referring to a recommendation I made in The 4th Pillara deep-value investing strategy that I write about at Sovereign Man. I’ve also written about Karoon Energy here at Global Value Hunter.

At The 4th Pillar I have a clearly defined process which identifies and recommends for purchase shares that are trading under their net cash backing — as KAR was at the time of my recommendation, and still is.

So, it met the rules of my investment framework, and I recommended it in the 4th Pillar Model Portfolio, along with more than half a dozen other such stocks, all identified using the same process.

In the short and medium term, some of these stocks go up, some go down. Over the longer term, if you follow this process with a diversified portfolio of such stocks, we have demonstrated (as have many others — starting with Benjamin Graham, the patron saint of Value Investing) that you will in all likelihood make good money.

It is unfortunate that this particular reader was down on one position. He didn’t state whether he had bought any others, but The 4th Pillar strategy is not designed to identify single stocks to cherry pick. It is a process.

I judge my success, or otherwise, by whether:

    1. I have followed my process;

    2. my process continues to work and makes money, on average, over a period of years, on a diversified portfolio of stocks picked using that process.

Turning to the question of whether to sell KAR right now, which was what the reader asked about, my thought process is this:

Does KAR still fit the rules for holding / buying using my process now? The answer is it does. It still has net cash that amounts to much more than its current share price. So, to a deep value investor, it’s a buy not a sell.

In fact, I have reiterated the BUY recommendation on it several times in The 4th Pillar at prices lower than where the stock is now trading, meaning people who followed those suggestions have a lower average cost basis.

To call it a SELL when it is trading under cash backing violates the investment process I follow.

For anyone following a different process, however, it might be a sell. A technical trader, for example might only look at the chart. If the price had broken below a key technical support level, for example, they would sell.

An index fund or ETF basket containing KAR shares, sells every time someone pulls money out of the index fund or ETF. The sell order is triggered automatically via their passive, algorithmic investment rules, with no regard to value.

So, as you can see, there are many things that can drive share prices up or down at any one time. Not every trade in a stock is made by someone with the same reasons or motivations as you. That’s one thing that makes the stock market so unpredictable.

As an investor…

The most important thing is to HAVE a process

Otherwise, you end up with a portfolio full of random stocks you forget why you own.

In my answer to the reader, I was just telling him what I do, and what The 4th Pillar PROCESS does. Over time, it’s a process that has been demonstrated to work.

Whether people wish to follow my process or not is entirely up to them.

If you have a better process you’re following from another advisor, or one you have devised yourself, great. 

Follow that instead. There are many ways to make money in the stock market. (Though even more ways to lose it).

Going back to KAR, The 4th Pillar did take profits on the stock successfully in the past, when it ran above cash backing (as you would logically expect a stock to do):

It ran from our recommended entry price of $1.22 on 2/4/2016 to $2.31 on 2/11/2016 and we took 89.3% profits.

It ran from our recommended entry price of $1.44 on 2/5/16 to $2.31 on 2/11/16 and we took 60.4% profits.

Sometimes the market takes the share price where it should logically go pretty fast. Other times, it does not… and the market stays out of whack for long periods.

That’s why the process of value investing is hard for most people. It requires great patience and tolerance for pain. But, like the fable of the tortoise and the hare, as a value investor, I have always found that you will win in the end.

Value — especially deep value — as an investment style, has been a very frustrating space to operate in, in recent years. Very few deep value stocks have seen their value reflected by the market. They have instead stayed out of favour.

That happens from time to time. Things go in and out of fashion. Last time it was this bad for value as an investing style was 1998/1999. And it proved a very good time to buy.


Until next time,

Good investing!

Tim Staermose

P.S. Since this column arose out of a reader’s feedback, you may be interested to know that from the point of view of an advisor such as me, who is writing in cyberspace, I normally ONLY ever hear from people about their “losers.” (Which are always my fault).

Rarely does anyone ever tell me they’ve done really well on something I suggested. Sometimes, years later, I’ll meet a reader in person somehow, at an event or conference, and they’ll come up and say, “Thank you, I made so much money in XYZ.”

But, they never tell you at the time. So, as advisors in cyberspace we are often flying completely blind on the results people get. And without that feedback it’s sometimes hard to know if we’re being successful or not, or what we should be doing more or less of.

So, let me state for the record: I value all feedback, negative, and positive.

P.P.S. I’ve mentioned it before. But if you’re interested in learning more about how to build your own investment process, it’s worth picking up a copy of the book I helped my friend Mark Tier write, The Winning Investment Habits of Warren Buffett and George Soros.

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