The S&P 500 has gained around 42% in the past 11 weeks, but the economy’s outlook is still highly uncertain. Therefore, deciding how to apportion your capital is more difficult than usual, in my opinion.
Value investor Mohnish Pabrai (Trades, Portfolio) has experienced similar situations during his career. His focus on assessing company fundamentals rather than trying to predict the economy’s future, as well as his willingness to invest in a small number of ideas, could be key reasons for his long-term outperformance of the stock market.
Focusing on companies
Trying to judge how the economy will evolve is impossible. A more effective strategy could be to analyze companies, rather than the economy in which they operate. This will provide a guide to which firms are in a strong financial position to adjust their operations in an uncertain world where change is likely to be a constant.
As Pabrai once said, “It is the performance of the business that matters. It is hard enough to figure out the future of the business. Do not try to figure out the future of the country or the world; focus on the business.”
A circle of competence
It is easy for an investor to have bare-bones basic knowledge about every sector across the economy. However, this may be of limited value during an uncertain economic period. It may be insufficient to identify the most attractive value investing opportunities on a regular basis.
A better idea could be to focus your time and effort on a smaller number of sectors. You will build a greater depth of knowledge than many of your peers, which could give you a competitive advantage and an ability to more easily identify appealing risk/reward opportunities. It may also help you to avoid companies that initially appear to be attractive but have underlying problems that an investor with deep knowledge about the sector in which they operate is more likely to know.
As Pabrai once said, “The only way one should buy stocks is if you understand the underlying business. You stay within the circle of competence. You buy businesses you understand.”
Waiting for opportunities
Investing opportunities may now be more limited than they were a couple of months ago. The stock market has rallied from its March lows so that it trades just 2% down on its price level from the start of the calendar year.
Therefore, value investors may find they are unearthing fewer quality businesses with large margins of safety than they were just a matter of weeks ago. This does not mean that you should lower your standards or change your strategy in terms of seeking mispriced securities. Instead, you should adopt a patient stance and wait for the right buying opportunities to come along.
“We have to do what I would call anomalies: we have to look for strange things that show up once in a while," Pabrai advises. "They don't show up all the time. We have to be scanning the horizon, and doing that, once in a while something will show up that makes a lot of sense, and then you act on it.”
Read more here:
- Peter Lynch on Investing During an Uncertain Economic Period
- Does the S&P 500 Have Investment Appeal After Its 40% Rise?
- Benjamin Graham on Risk Versus Reward
Not a Premium Member of GuruFocus? Sign up for a free 7-day trial here.
