Principles to invest by
Published:Wednesday | August 3, 2011 | 12:00 AM
Be careful of snakes:
Though the economics of a business is key, the stewards of a company's capital are still important. Even wide-moat businesses can be poor investments if snakes are in control. If you find a company that has management practices or compensation that makes your stomach turn, watch out.
When weighing management, it is helpful to remember the parable of the snake.
Late one winter evening, a man came across a snake on the path. The snake asked, "Will you please help me, sir? I am cold, hungry and will surely die if left alone." The man replied, "But you are a snake, and you will surely bite me!" The snake replied, "Please, I am desperate, and I promise not to bite you." So the man thought about it, and decided to take the snake home. The man warmed the snake up by the fire and prepared some food for the snake. After they enjoyed a meal together, the snake suddenly bit the man. The man asked, "Why did you bite me? I saved your life and showed you much generosity!" The snake simply replied, "You knew I was a snake when you picked me up."
Bear in mind that past trends often continue:
One of the most often heard disclaimers in the financial world is, 'past performance is no guarantee of future results'. While this is indeed true, past performance is still a pretty darn good indicator of how people will perform again in the future.
This applies not just to investment managers, but company managers as well. Great managers often find new business opportunities in unexpected places.
If a company has a strong record of entering and profitably expanding new lines of business, make sure to consider this when valuing the firm. Don't be afraid to stick with winning managers.
Prepare for the situation to change faster than you think:
Most deteriorating businesses will do so faster than you anticipate. Be very wary of value traps, or companies that look cheap but are generating little or no economic value.
On the other hand, strong businesses with solid competitive advantages will often exceed your expectations.
Have a very wide margin of safety with a troubled business, but do not be afraid to have a much smaller margin of safety for a wonderful business with a shareholder-friendly management team.