Over the last few days, I have refined my investment strategy and decided to put it in writing. The idea is to get feedback from others, discover any holes/mistakes in the strategy and develop more commitment by making it public. So, here is the basic philosophy:
- The goal is get above average returns (compared to the market, or more specifically S&P 500 Index) after inflation and taxes
- Invest for the long term. No market timing or buying mediocre companies even though they are cheap. It also means, be prepared to handle low returns (or potentially negative returns) for an extended period of time (say, 4% real returns over next 15 years). This is important, because stock market has returned a huge returns in the recent past, and thus, it is likely to perform much more modestly over next many years.
- Don't loose money. Best way to do this is to look for margin of safety when buying stocks of good companies. However, to prepare for the worst, invest only after putting enough money aside for taking care of important needs and prior commitments (such as mortgages, insurance premiums, etc.).
- Invest in the companies that have strong competitive advantage (or in Warren Buffett's words, a wide moat). One sign of a competitive advantage is higher returns on invested capital. But the best sign is a history of price increases. If the company can consistently increase the prices of its products, despite of the competition (and even while competition is actually reducing the prices) then the company has got a wide moat. The company that cannot raise the price of its product will loose to the inflation.
- Another characteristics I am looking for is the low continued capital investment. If a company has to make heavy capital investment then you can bet that it doesn't have a wide moat. Many tech companies fall into this category. They have to keep investing in the R&D just to stay competitive.
- Honest and straightforward management. Look for simplicity and clarity in annual reports and other filings. Also, letter to the shareholders by the Chairman and CEO is critical. Mistakes should be acknowledged and there should not be smoothing out of the earnings. Management focused on selling the products and not the stock. Management focused on the long term business performance, and wiling to take short term hits. No excessive stock options and dilution. No buybacks just to increase the stock option compensation. Look for high insider ownership to ensure that management's interest is aligned with that of shareholders.
- Easy to understand business; good recognizable brand
- When to buy - Out of favor temporarily. Panic selling.
- Stay within the circle of competence -- consumer brands, retailers, etc.
Over the next few days, I will refine this strategy based on the feedback and review of the reference material. I will also post references to the articles, books, and other items, and also mention a few stocks that I believe fit the above criteria.