Three Strawman Investing Strategies

Regular reader and commenter Strawman left an insightful and interesting comment on a recent post about cash in investing strategies.  It was such a good comment, and so central to the theme of this blog (the search for the ultimate investing strategy), that I thought that it deserved it's own post.

Strawman starts:

I also accept that the strategy of buying into quality companies when the price is good, but holding cash is only one way to make this happen.

All good so far. Strawman continues:

Basically your strategy seems to be:

STRATEGY1: 'Move my wealth from cash into X when the (real long term) P/E for X is really good'.

That's correct.  But let's just clarify a few things.  Firstly, the P/E in instantaneous, and changes over time.  Every time the market presents you with a price (P), you can calculate the corresponding P/E (based on either last years earnings (E), or sometimes, projected earnings).  Therefore, I don't really know what you mean by "real long term P/E".  Also, I think that you are trying to use "P/E" as a pure indicator of value, which is not quite right, as it depends on the growth prospects of the company.  However, let's assume that you can generate a "value indicator", and, to keep the language consistent within this post, let's call that value indicator "P/E".

Buffettology

Without a doubt, the best book I have ever read on investing is The New Buffettology, by Mary Buffett and David Clark.

I was excited to get this book, and was about learn and understand the investing strategy of the world's richest man (at the time).  The lesson was simple enough.  Buffett invested in companies with a durable competitive advantage.  The book explained that businesses that had a durable competitive advantage were the ones that were most likely to grow into the distant future.  It named quite a few of these companies - CocaCola, Gillette, H&R Block, etc.

Quality Companies and Simple Investing

One of the reasons that I started this blog was because I thought that I had discovered a simple and effective investing strategy, and that I wanted to explore it further, and share it with friends and like minded people.  As I've said before I think that the best investing strategy is to buy quality companies when they're cheap.  I've given some quality companies metrics before, and also hinted at what cheap might be, but in this post I want to keep it nice and simple.  I will explicitly list some quality companies, and give you and very easy way to determine cheapness.

Cash

I've tried to win this argument before - unsuccessfully - that "cash" is a significant enough concept that it should be a "first class citizen" in an investing model.  Finally, I found the words that I wanted, from an interview at Gold Money Research with Detlev Schlichter:

At any moment in time you can hold your wealth in three forms: consumption goods, investment goods or money. With money you can stay on the sidelines, you keep your purchasing power and stay ready to buy consumption and investment goods in the future.

They key point here is that "cash" - and I'm using that term, in this context, interchangeably with "money", does have the special power of enabling you to stay on the sidelines, while all other investments may be struck by volatility, cash's purchasing power will remain constant (in the short term) to consumer goods, and independent of the volatility of the investment goods.

Property buyers advocate nails investing rules

Enough people have already written about what a flop The Block was, but the article that drew my attention was the one entitled: Eight property rules broken by The Block, by Mal James, from James Buyers Advocates.

He lists the following property investment rules:

Rule No. 1: You make your money when you buy.
Rule No. 2: Buy the best position you can
Rule No. 3: Consider your target market, before you start.
Rule No. 4: Don't overcapitalise
Rule No. 5: Amateurs don't make money on renovations - they make money because they are lucky that the market happens to be in an upwards phase.
Rule No. 6: Don't think short term with property unless you like excessive risk.
Rule No. 7: Choose local selling agents who are experienced at your price range, and choose ones that can deal outside the auction process.
Rule No. 8: Substance v puffery

I couldn't help but immediately see parallels between James' property investment rules and my own value investing rules.

House prices (don't) always go up

At least, Melbourne house prices don't always go up.

From here: http://www.macrobusiness.com.au/wp-content/uploads/2011/08/image002-11.png we get monthly Melbourne house price changes: -1.2, -1.6, -1.8, -1.2, -2.1, -2.1, -2.7. 

That adds up to a whopping -12% for the first 7 months of 2011, some of which we have to account for normal winter seasonality. 

Share Prices - Significant factors affecting

I've recently had a go at trying to determine the most significant factors affecting prices of houses and gold and silver, but now it's time to tackle the difficult one - share prices.

One of the things that makes it difficult is that it's a different answer depending on whether we are talking about an individual company verses an equity index (eg. ASX All Ords).

Let's start with what appears to be the most obvious answer - profitability.  The most significant factor affecting the share price of an individual company, and perhaps even the indexes, are their profitability.  In general, the more profitable companies are, the higher price they can command.