It is Soccer World Cup time and you have to select the teams that will make it to the quarter finals. What do you do? To make your choice, you can only look at history up until the day on which you choose you favourite, so you will be forgiven for choosing Germany as one of the teams. They look good on paper and have been champions four times, so to make it to the last eight should be a safe bet. Then they are knocked out by Paraguay, a team that doesn’t look competitive on paper and you lose 12.5% of your chosen group. If you had the Netherlands on your list, you will be down 25%.
This is a lot like investing in shares. There are very clever analysts who spend their entire lives pouring over historical company results and writing long reports about which companies to invest in, just to see their choice knocked out by some unforeseen future event.
Looking at historical data can give you some idea as to where the company is coming from, and extrapolating that into the future is not completely wrong, but not the whole story. The reason why so many professional money managers don’t achieve better results than the average market, is because they are blinded by the historical data and focus on the short term, rather than standing back and evaluating the companies based on the following three things:
- The desirability of the product or service it delivers.
- The potential of such a product or service in the future.
- The quality of the management team.
Waking up one morning and deciding that you are going to become an investor in equities is as foolish as going to university and studying for five years to become an analyst. The secret sauce in becoming a successful investor is to gain experience by emerging yourself in the world of investing. Don’t get me wrong, it does help a lot to be able to do the calculations and understand financial statements, but sometimes the leap of faith taken by amateurs who get a gut feeling about some specific company is as powerful. As an investor you have to understand the ebb and flow of the companies you can invest in. It takes years of listening to people whose opinion you trust, understanding historic price trends and more importantly, recognising the future potential of a company. The successful investor will be the quiet person in the room. The one that can listen to all the experts who believe they are right, without saying a word; and then go out and distill all the information into something that is not driven by emotions or ego, but by probability and patience.