Smart Investor: reach for the low-hanging fruit

Accepting your limitations as a market analyst will allow you to focus on underlying value, says Smart Investor. 

Surveying the field

The range of different attitudes to investing never ceases to amaze me. Investing is incredibly subjective, and there are a seemingly infinite number of ideas about which companies to buy and sell.

For instance, some people look at only one company at a time, focusing their attention in an effort to understand how the business works and what makes it special. They will often examine the products or services a company offers, the markets the firm operates in, and at what price they sell their offerings. They will try to make an assessment as to whether the business model is sound, whether they themselves would operate the company as it's currently being run, and whether the future looks bright for the business.

Pro-forma analysis

Speaking of the future, other investors will try to predict the future performance of a company. They will conduct ‘pro-forma’ analysis in an attempt to generate a bottom line for next year and however many years they wish to look into the future. This is something that has always fascinated me – especially because it is often analysts working in the investment community who undertake this kind of guesswork.

The reason for my fascination is not in the method itself, but rather the fact that the predictions are nearly always wrong. Understandably, no human being is particularly good or consistent at predicting the future, so it not surprising that such analysis is incorrect the vast majority of the time.

However, the forecasts are still regarded as a worthwhile exercise in spite of their inaccuracy. Price-to-earnings ratios are often based on such forecasts, which I suppose in relatively benign trading environments could be of some limited use to investors, but in the current conditions such predictions really are a waste of everyone’s time.

Past performance does not guarantee...

Other investors will have particular views on regions, industries and sectors and will, again, try to predict which of these will perform well in future. This is often based on what is currently performing well – for example I constantly hear people talking about utilities being a good investment or saying that I should go into cash. These are only being considered because they would have been relatively successful had they been bought into a few months ago.

Many investors struggle to buy low and sell high because they are unable to overcome the emotion of fear when stock markets are low. This is a very common problem because people seem to forget that the time to buy is when share prices are low, and share prices are only ever low when there is some kind of major problem, either with the UK or most likely with the global economy.

Stock markets simply do not fall heavily without good reason.

Keep it simple and reap the rewards

This is, however, quite a straightforward problem to fix. The simple solution is to first accept that you are unable to predict the future. Once you do this, you will begin to see that ‘the market’ is actually a herd of people who are constantly chasing profit, but who are never able to step back and think about how to apportion their capital in a logical manner. In other words, they obsess over the short-term news flow and rarely consider where the long-term value lies.

By stepping away from the herd you will see that investing is simple, but not easy. If you buy sound companies at fair prices and have lots of patience to give them the time they need to come good, you are likely to find your capital increase at a faster rate than if you remain in the herd. You will probably sleep better too.

Investing does not need to be complicated. You do not need a unique talent or to be gifted in maths or any other subject. You just need to accept your limitations in terms of being unable to predict the future, focus on the facts and figures, and respond accordingly when the figures tell you to. Otherwise, buy yourself a crystal ball or some tea leaves and join the herd – they’d love to have you.