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Thoughts on the Investment Process

March 04, 2014 | About:

Value Investing is a process. It's not a result. Although the result over the long term is usually satisfactory, that shouldn't be our goal.The reason why most value investors fail is not because value investing doesn't work; it's because they don't stay true to the process.

What is the SNCI investment process?

Search Strategy
Valuation
Risk Management
When to sell
Search Strategy

If you read my post "Fish Where the Fish Are: How to Find Bargains," you will know that I like to think of searching for stocks as fishing. You go to a specific pond, and you try to find the best fish in that small pond. It's easier to tell an elephant from a mouse when you have less to choose from.

To recap, here are a list of "ponds" I like to fish in:

Magic Formula stocks
Net Nets
Spinoffs
Mergers

Within most of these ponds, the pickings are slim, so it's easier to pick the really good ones, versus the ones that are value traps.

Valuation

As many of you may already know, I do not use projected growth equations when trying to estimate a firm's relative value. Instead I use comparative analysis: How cheap is this firm retaliative to the industry average? If the industry average over five years is times 20 earnings then I am not going to pay any more than 13 times earnings (35%). That's my margin of safety.

Now if a company isn't trading relative to earnings (if earnings are lackluster like with most net-nets) I instead will use NCAV or book value to determine the relative value of a firm. No healthy firm should be trading below NCAV, so either the firm should be liquidated (or bought out) or the market is mis-pricing this company pretty badly. Ether way it works out for us.

The name of this site is Simple N Cheap. The main goal of this site is to give an investment philosophy that an eighth grader can do and get rich off of.

Risk Management

What are the golden rules? Rule No. 1: Don’t Lose Money. Rule No. 2: Don't Forget Rule No. 1.

I manage risk two ways:

Buying in Bulk

By buying as cheaply as possible compared to relative value I want to buy my stocks like an Insurance underwriter writes insurance policies. By playing the law of averages (the numbers game) one can blunt the harm done by one (or many) bad ideas.

I also enjoy buying on sale. I don't want to pay full price for a stock; each investment has to have a solid margin of safety in order for me to buy it.

I want to buy my stocks like I buy my groceries. This doesn't mean that I won't buy a premium brand ice cream (Disney or Coke). It does mean, however, that I will want a nice 35%-off coupon.

When to Sell

We always talk about when to buy but never when to sell. Unfortunately there aren't any cool metaphors for selling stocks, and it's mostly three parts art, and one part science. Investing is best when its done most businesslike, so I try to eliminate emotion from selling, I do this by setting a hard rule for when to sell:

After a 25% increase or after two years.

Having my investments set up this way allows me to leave the emotion at the door, and make a sound decision of when to sell. Again I do have some buy and hold forever type of investments, but overall I mostly hold average to below average companies and below average prices, so having a selling system in order for those types of companies is needed.

Value Investing is an exercise in behavior finance. We fail because we are not machines. We fail because we do invest with our money and we don't want to watch the market eat it away. However, value investing has proven itself over the long term. If we as value investors adhere to the system we have in place then more likely than not we will have better than average returns over the long term.

About the author:

Jonathan Webb
I am a private investor who happens to enjoy sports, movies, and art.

Visit Jonathan Webb's Website


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