I can see clearly now.

I suspect that, for most of us, if we are able to cast our minds back to when we very first embarked upon our adventures in the share market and, furthermore, if we are able to be totally honest with ourselves, we probably approached the market with a thought something along the lines of "All I have to do is buy shares and then sell them for more than I bought them for and I have made a profit - all good".


I am pretty sure that we would now look back on such a position of being one of naivety. We know that it is certainly not as easy as such a view implies and regardless of where we find ourselves today, would now realize that there is so much more to it.


I believe that, broadly, between us we would have ultimately found ourselves in one of three groups.

• Those who lost enough money to become discouraged with the whole "game" and moved on to other ventures. (The people in this group are probably not reading this blog).
• Those who found that they are in that very small group of people who have developed the skills, perseverance and tools to consistently make profits by buying and selling stocks (ie trading).
• Those who ultimately took a different path and became stock market investors. Just like the traders above, they developed the necessary skills to become investors.

As I say, the first of the above groups are unlikely to be reading this blog. I have seen figures that indicate that a distressingly high percentage of people "burn out" in this way - often within 12 months. It is interesting to consider what happened to their money - clearly the majority of it has gone to those in the second two groups above.

I am not a trader. There are a number of reasons for this - most of which would be tedious and boring (and probably boorish) for me to go into here. I offer no criticism of traders - if it works for you then all's well. I can't really offer you anything of value.

I consider myself to be in the third group - an investor. My apprenticeship (of multiple decades) is far from over. I suspect that in my dotage I will still be able to enjoy the thrill of an "Aha!" moment or two. 

I have seen many attempts to define "an investor" (usually done as a comparison to "a trader"). I don't think there is any one definition that can clearly define all of us who consider ourselves to be investors. Maybe that is as it should be - after all it is what we think of ourselves that counts in the end (in this and all things). However, if pressed, my definition of an investor (or at least me) is somebody who is interested in becoming a part owner of a business with the ultimate aim of receiving the financial returns that the business makes (this is important and hopefully will become a little clearer later in this article). That does not mean that I do not sell the businesses that I have bought - it just defines the reason why I bought the business. There are multiple reasons for selling a business, including; the business no longer is a good business in the investors' eyes; somebody is willing to pay a substantial amount more than the investor believes the business is worth; a better investment comes along; personal financial reasons; and so on. Certainly, the length of time that a stock is held does not make the differentiation between trader and investor. There is probably no reason why a trader could not hold a stock for several years and there is no reason why an investor might not sell an investment after one day.

The rest of this article is purely about investing in the stock market. (Traders may leave now, if they wish, and draw another chart)

After due consideration and much thought I have now managed to reduce the investing process down to two (yes, just two) simple steps. Basically, they are just two questions that need to be asked and answered.

1. Is this a good business?
2. Can I buy the business at a price that makes financial sense for me? (note the bolding of me - hopefully I will remember to address the importance of that later on).

Now, the above may seem trite at first glance. However, it is my hope that I can flesh that process out enough that you might even consider writing them on a piece of paper and tacking it to the wall above your desk. 

I should also say that none of this is revolutionary, new or even startling. It is, in fact, just the distillation of the knowledge that the greats such as Warren Buffett, Charlie Munger, Philip Lynch, Roger Montgomery and many others have been trying to push into my head over a number of years. Perhaps Roger Montgomery may be slightly embarrassed to be included in this list but I have included him specifically because he has demonstrated in his book "Value.Able" an ability to think clearly and better still, to explain his thinking and knowledge in an understandable and resonant manner. I don't agree 100% with everything he has to say but I would highly recommend his book to anybody that wants to really think seriously about the investment process. I hope to find the time to write a review of his book at some future time.

Back to the two step investing process. 

Is this a good business?

I do not plan, here, to tell you what makes a good business. The important thing - and this is probably the most important thing in this entire article - is that any determination of whether a business is "good" must not in any way include any examination of the listed stock of the company on the stock market. It is absolutely essential that we have a clear and unambiguous distinction between the business and the representation of the company on the stock market. If I could say this 100 times I would. If I could come around and shout it in your ear, I would. I even feel inadequate that I am unable to find the words and explanations that would make this resonate with you. Hopefully, one day, I will find the right words to convey this basic tenet. In the meantime, allow me to make some observations, some of which, hopefully will resonate with you.

The basic descriptors of a business' financial affairs are the Profit and Loss and Balance Sheet. Have a look at them. Is the Share price represented in them in any way? No, it isn't. Movements in the Share Price have absolutely no impact on the finances of the business. Therefore, movements in Share Price do not change the value of the business one little bit. 

The shares that are listed on the share market do not belong in any way to the Company. Listing a company on the share market is essentially a "one-time" operation. The shares are sold into a third party market (the share market) and from that point on the Company has nothing more to do with that third party market. The shares will change hands within that market at a variety of prices over time - this has nothing to do with the Company. It is entirely discrete from the business and from the point of view of operating the business in the best possible way should, ideally, have no impact. (In fact, a business that spends large amounts of it's time and resources in performing actions that are wholly designed to impact the share price, instead of running the business in the best possible way, may well be validly excluded from our category of "good" businesses.)

So, in assessing whether a business is a good one we must avoid looking at anything that is derived from the Share Price. We should not be interested in the current Share price, the historical Share Price, the price chart, Price/Earnings Ratio, Yield, "expert" price projections etc etc. It's not as hard as it sounds - it becomes second nature after a short while. In the meantime, just ask the question - "Does what I am looking at change when the Share Price changes?". If the answer is "Yes" then do not let it impact your consideration of whether this is a good business.

We can look at all of this from a slightly different perspective. Our aim should be to be smarter than "the market". That is, we want to back our view against the view of the market. As soon as we include the market view (ie the Share Price) in our calculation of the value of a business then we are accepting the view of the market as part of our considerations. It makes no sense to put the market view on both sides of the equation My View Vs Their View.

As I said, I am not planning, in this article, to tell you how to identify a "good" business. It is a big thing to discuss. There are many different ways of doing this and many different factors to consider and weight. I hope to address that in more detail in future articles. In the meantime, I can offer no better advice than that of Warren Buffett - ask yourself the question "Would I be happy to own this entire business". Once again, a statement that is easy to dismiss as trite, however, the exercise of visualizing yourself as the owner of the business goes a long way towards approaching your assessment with a clear head. (It also assists with that important task of dissociating the business from the Share Market in your mind).

One final observation that goes some way towards linking the above with the second question that follows. A crap business is still a crap business, regardless of the price that you can buy it for. That is, if the business does not meet your definition of a good business then your should not be interested in investing in it. The following question need not be asked. Move on. There are plenty of good businesses available - keep looking.

Can I buy the business at a price that makes financial sense for me?

Once you have identified a good business then all that remains is to find out whether you can buy it at a price that makes financial sense for you. Now (finally!) you can log on to your broker and have a look at the share price.

Again, the purpose of this article is not to take you through the process of deterministically answering that question. It is actually a fun topic and one that I want to address in a future article (I promise). However, here, we can look at this in general terms.

Let's not lose sight of our central aim of investing in the companies listed on the share market. It is to make money. It is to make more money than we could make by using our money in other ways that we might choose. As such we clearly need to identify how the investment is going to financially reward us and when. Our rewards (I'll stop saying financial rewards from here on) may come to us as our share of profits being paid to us (dividends) or through the value of the company increasing to the extent that we can find somebody to buy some or all of our shares at a price that it makes sense for us to sell them at. Most likely it will come as a combination of both. Of course one of our basic beliefs (that I have not explicitly expressed but have implied) is that the market often "gets it wrong". That error can be either way. It may mean that an increased value of the Company may not become reflected in the Share Price for a long time. It may also mean that there are times when the market is willing to pay more for the Company than what we consider the true value. Both actions of our investment, buying and selling, need to be made with those considerations in mind. Personally, my preference is to buy a company that will reward me excellently through the payment of dividends, forever. I've forgotten where the "Sell" button on my brokers' screen is. (My "other" two step investment strategy is: "Buy good shares; Lie on the beach")

Of course we now look at Yield, PE and so on. These tell us about the actual returns in our hand from the investment that we might make. Again, the purpose of this article is not to drag you through these (quite simple, in the end) calculations. If you can't wait for me to get around to doing that via my rather haphazard approach to this blog (you don't pay me enough to be anything else) then there are many other resources that will take you down that road.

I highlighted the me in the question that we are examining. i.e. Can I buy the business at a price that makes financial sense for me? The simple point that I am trying to make here is that the method and timing of returns from an investment suit each of us differently. An exaggerated example demonstrates this. 

A Company that requires that a significant proportion of it's profits for some time to come be reinvested back into the business with a promise of outsize returns some time in the future may be quite acceptable to a younger person who has a living income from wages. On the other hand, a retiree who is dependant upon receiving regular income in the form of dividends to be able to support their lifestyle would probably not find that to be an appropriate investment. 

There are many variations and nuances that make the investment considerations of each of us quite different. Each potential investment is quite different for each of us. I firmly believe that there is such a thing as a valid speculative investment. Often I see the speculative investment disparaged and somehow confused with a trading methodology. This is wrong. A speculative investment can be assessed via the very same investment process that I have outlined here. For the individual, any speculative investment may or may not make financial sense, depending upon the individuals' personal circumstances. This is no different from a "non-speculative" investment (if such a distinction can be clearly made). Of course we could very easily drift into a discussion of risk and risk/reward - topics that are often completely misunderstood (even by those who purport superior knowledge). I have some quite strong views on this topic that, once again, will have to wait for another time.

As always, comments welcome.