My Investment Philosophy
Through the years I have put together my own investment philosophy which I believe integrates the best from each of the reputable investment philosophies.
The most commonsense approach to investing is Fundamental Analysis. This is the philosophy endorsed by the so called “value” investors like Warren Buffet and Peter Lynch. They recommend finding your own investments by keeping your eye open for great companies.
For instance, there might be a great new restaurant in your part of the country. “In ‘n Out” is an example out here in California. Unfortunately, it is privately held. If they ever decide to sell shares though and embark on an expansion plan that would be well worth looking into.
Another company I found this way is Cheesecake Factory (CAKE). Living in LA after college I really liked this restaurant. When I did a little homework I discovered that they were public and that they were in the early stages of a nationwide expansion. I bought the company and doubled my money.
They also endorse reading a lot of business publications in search of companies. Early last year (2005) I discovered a great investment in Investors’ Business Daily. The Wall Street Journal, Barron’s, Fortune and many others are also great sources to learn about new companies.
Once you discover a company with a good product and business they recommend analyzing its financials.
You have to find out how much money the company is making.
You have to find out how fast earnings are growing and how volatile they are from year to year.
You have to find out how much debt the company has in contrast to its assets.
Finally, you have to decide if the company is a good value at its current price.
Fundamental Analysis is the foundation of good investing and any investor who wants to be successful spends a lot of his time doing this kind of analysis.
The problem with Fundamental Analysis is that it is a somewhat haphazard approach to finding stocks. The universe of possible investments is gigantic. If you’ve ever glanced at the stock pages of The Wall Street Journal you will have seen that there are literally thousands and thousands of stocks traded on the NYSE and the NASDAQ – and thousands more traded on foreign stock exchanges.
In your reading research you can maybe discover a few interesting stocks each day. These may be very good investments when you look into them.
But how do you know that there aren’t better investments among the thousands and thousands of stocks that are completely unknown to you? When asked where to look for good stocks Warren Buffet once said “Start with the ‘A’s”. But the truth is that nobody has the time to do that.
Many of the most successful investors in the world, Lynch, Buffet, Mason Hawkins at Longleaf Partners, are essentially pure fundamental analysts.
But I believe there is a better way. You simply can’t hope to look into each of the thousands and thousands of stocks out there. You at least need some clues about where to look, ways to narrow your search to where the excellent investments might be.
The Economy and Geopolitics
What you need is a Macro Economic Perspective. An overall perspective of the national and global economy gives you an idea about the sectors of the economy that are likely to do well and those that aren’t.
There are a number of important national and global economic trends right now that can help focus your search for excellent investments.
The biggest global trend affecting the global economy right now is the emergence of China and India as manufacturing and general economic powers. Each of those countries has populations greater than 1 billion. The population of the United States is about 300 million.
As their populations become more and more wealthy their demand for goods and services will expand. In addition, as their populations become more productive and educated that will effect the efficient global distribution of labor. Suffice it to say that this trend has huge ramifications for the global economy and provides a framework for finding good investments.
As a quick example, the Indian middle class is growing quickly. As people become middle class they start to want and be able to afford certain consumers goods like automobiles, televisions, computers, cell phones, etc… The companies in position to sell these goods to them should see rapid growth in the years to come.
One of the most important national trends is the housing boom.
Over the last 5 years, housing has appreciated tremendously, more than doubling in many places. Many people have seen their equity expand greatly and have tapped it via home equity loans to buy consumer goods and remodel their homes. If the housing boom slows down or reverses, home builders, construction companies, mortgage banks and banks with a lot of exposure to mortgages, home improvement companies and consumer goods companies might not do as well as they have in recent years.
A Macro Economic Perspective, then, solves the problem posed by a purely fundamental approach. It helps to narrow your search by focusing on the sectors likely to benefit from the big trends and away from those likely to be hurt. It helps make your search for good companies among the gigantic universe of stocks more manageable.
Technical and Sentiment Analysis
Fundamental Analysis and Macro Economics concern the realm of fact. But when human beings are concerned facts are never the whole story.
One must also consider the realms of perception and psychology. This is where Technical and Sentiment Analysis comes into play.
Technical/Sentiment analysis is concerned with gauging the sentiment of market players. Are people bullish on a stock or are they bearish? Bullish sentiment can push up bad stocks and bearish sentiment can push down good ones.
Even if you are right about the facts you can still lose money if there aren’t enough people who see things your way.
Homes, for example, have looked increasingly expensive for a couple of years now but have only started to lose momentum recently. As long as people were intent on owning their own home and believed that prices would only continue to rise, they did even if the fundamentals no longer justified it.
Over the years I have evolved an investment philosophy that combines the insights of all three approaches: Fundamental, Macro and Technical/Sentiment.
It is because of this investment philosophy that I chose the name Top Gun. Most other investors are adherents to one or the other school of investing. Their narrow perspective allows them to find some good investments but blinds them to many others. Top Gun’s comprehensive approach gives me a broader perspective that allows me to zero in on the very best investments.
[Written June 2006]
Founder and CEO, Top Gun Financial Planning
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