Many investors appear to follow the old adage "if it’s not broken, don’t fix it" when it comes to managing their portfolio. They often stick with a specific investment strategy that has worked for them in the past – even if it no longer delivers significant outperformance of the wider stock market.
For example, they may pay attention to specific financial measures such as the price-book ratio when deciding whether to buy a stock. Or, they may focus their analysis on certain aspects of a company’s market position, such as the range of brands that it owns.
However, an investment strategy that does not evolve could prove to be problematic in the long run. The world economy has undergone major changes in recent decades, and is likely to continue to do so in future. Therefore, it may be necessary for investors to change their investment strategies to some extent during their lifetime.
Munger’s evolution
Berkshire Hathaway (BRK.A, Financial) BRK.B) vice chairman Charlie Munger (Trades, Portfolio) has sought to change his investment style over recent decades. Initially, he started out following the strategy pioneered by the father of value investing, Ben Graham. This entailed buying companies that were extremely cheap based on ratios such as price-book and price-earnings. The idea was that buying them at a large discount to their intrinsic values would lower risk and increase potential returns.
However, it started to become more difficult to find stocks that traded at large discounts to book value and/or earnings. Therefore, Munger needed to allow his strategy to evolve to take into account the generally higher valuations that came into existence during his career. This entailed focusing to an increasing extent on the quality of a specific stock, rather than only considering its price or valuation. This meant that Munger started to pay more for stocks, but ultimately purchased higher-quality businesses.
Munger has previously discussed the success of his evolving investment strategy. As he once said:
“If we'd stayed with classic Graham the way Ben Graham did it, we would never have had the record we have… Having started out as Grahamites which, by the way, worked fine—we gradually got what I would call better insights. And we realized that some company that was selling at 2 or 3 times book value could still be a hell of a bargain because of momentums implicit in its position, sometimes combined with an unusual managerial skill plainly present in some individual or other, or some system or other.”
A challenging evolution
Of course, changing an investment strategy over time can be a difficult process. It may be particularly challenging if an investor has previously enjoyed significant success with it. They may feel that, given time, it can again lead to significant outperformance of the wider stock market.
Therefore, in my view, it may be sensible to retain the core elements of an investment strategy over the long run. For example, investing in financially-sound businesses with low debt may be prudent, while companies that enjoy large economic moats may prove to be among the best performers.
However, adapting an investment strategy to take account of an evolving stock market and economy, such as in the greater use of new technology across many industries and in changing consumer trends towards environmental and social considerations, could be a prudent approach. It may allow a strategy to remain relevant as the world economy evolves.
Over time, this can lead to greater investment success. As Munger once said:
“Once we'd gotten over the hurdle of recognizing that a thing could be a bargain based on quantitative measures that would have horrified Graham, we started thinking about better businesses. And, by the way, the bulk of the billions in Berkshire Hathaway have come from the better businesses.”
