What kind of investment system does the average investor need to build to simplify the complexity?

The periodic market frenzy always makes people think “this time is different”, but history always proves: in fact, this time is still the same.

What kind of investment system does the average investor need to build to simplify the complexity?

Periodic market frenzy always makes people think “this time is different”, but history always proves: in fact, this time is still the same.

Historically, investment is a complex matter with a high threshold, involving the economy and politics at the macro level, industrial evolution and competition at the meso level, and corporate governance, financial status and quality of management at the micro level. There are only a few legends in the history of global investment that can be called legends, and those who can exceed 20% annualized returns for ten consecutive years can be called masters. Those who can achieve some success in investment are not a combination of talent, hard work and luck.

But for the majority of people, do not have such talent and luck, and can not penetrate the knowledge of finance, economics, psychology, accounting and other disciplines. So, how can an ordinary investor simplify and master the essence of investment?

In his book “The Simplest Things in Investing”, Qiu Guolu, founder of the $100 billion private equity firm Gao Yi Asset, gives a simple but effective investment system in terms of investment philosophy, investment methods, investment risks and investment psychology.

What kind of investment philosophy should an ordinary investor uphold?

A good investment philosophy is the way for investors to survive in the investment market. What kind of investment philosophy, there will be what kind of investment behavior.

First of all, we should make investments with an industrial vision. This is the same meaning as Warren Buffett’s “buying a stock is buying a part of the company’s equity”. As an investor, you have to treat the stocks you buy as if you were in the business. This also requires asking yourself, “Are you choosing a good business?

A good industry is more likely to produce good stocks. Those who chose banking and real estate twenty years ago and the Internet ten years ago are equivalent to riding the elevator, and even if you don’t move, you’ll be able to climb the stairs faster than most people.

Of course, the capital market sometimes favors “bad business”, such as those with low moats and low industry concentration. The irrationality of the market will give such companies dozens or even hundreds of times the valuation, but in the long run, when investors wake up from the frenzy, throw away the “bad business” is the only choice.

The second question to consider when investing in business with your own money is whether the business model is a good one? Is there a sustainable cash flow?

Cash flow is the life of the enterprise and the source of business, there is sufficient cash flow to have the possibility of development, there are too many profitable but because of cash flow tension and bankruptcy of the enterprise in history. Take the film and television industry as an example, in 2019 China produced more than 1,000 films, about 500 were released, less than 100 with box office over 100 million, less than 10 with over 1 billion, and even fewer that can be recognized by consumers. With less than 1% chance of a product being recognized by the market, it is undoubtedly an extremely difficult task to succeed. In addition, a movie has to go through a series of processes such as writing a script, hiring a director, building a crew, hiring actors, shooting the film, distributing, promoting, releasing, and dividing, etc. for a few months or a few years, and it may not always recover the cost, which makes its cash flow and profitability very uncertain.

Unless it can be achieved like Disney with virtual actors who never increase their salaries (Disney Princesses, Incredibles, etc.), and a universe of stories that are compelling enough (Marvel, Star Wars, etc.), film and television can hardly be called a good business model.

The third question is, does your company have any particular strengths? The comparative advantage of SF is that it is fast and on time, so SF is able to stand out in the price war of express delivery and has pricing power over its own products. Maotai’s value is that even if the price of Maotai wine is raised by 50%, its consumers will still not find it expensive. The capital market always favors those companies with special advantages, and if it can become an oligarch in the market segment with this comparative advantage, the market is more willing to give it higher expectations and valuations.

In addition to the industrial vision to do the concept of investment, followed by the “people abandon me, reverse investment” concept. Warren Buffett said “others fear I greedy, others greedy I fear”, Munger said “must think backwards”, are the same reason. This kind of reverse investment thinking is often an important source of above-average investment, to achieve excess returns.

If you can buy index funds in the early 2020s, when the epidemic is causing a panic decline, you will be able to make good returns on most of the underlying investments. If you were able to buy airline stocks after 9/11, you could have been equally profitable.

Of course, reverse investment thinking should not be used indiscriminately, buying on the decline is like “catching a falling flying knife”. For those sunset industries, or has been the advanced technology out of business, the more down the more buy, is likely to buy more down, and finally fall into the value trap.

Finally, cheap is the hard truth. Low valuation does not necessarily mean that the enterprise is worth buying, but to a certain extent has a higher margin of safety than a highly valued enterprise. If you buy at two times the PE, you can sell at four times the PE and still be cheap and still make 100%. But if you buy at 50 times the PE, you need to have to look high to 80 times the PE of the “fool” to take over, and only earn 30%, and the people who are willing to be fools are always a minority. And countless facts prove that people are always prone to overestimate their expectations, pessimism will be more underestimated, optimism will be more overvalued, the actual performance will be more likely to combat the high valuation.

Of course, the establishment of investment philosophy is only the most basic thing in investment, but also needs the appropriate investment method. This is like Warren Buffett’s “value investing” concept is well known and understood by everyone, but few people can achieve investment success with this. An important reason for this is the difference in investment methods.

Three questions that summarize the investment approach

Qiu Guolu summarizes his investment experience over the past decade or so, and summarizes his investment approach into three questions to be answered.

The first is valuation, i.e., how much is the business worth?

Valuation is the easiest to grasp. It is easy to see at a glance whether a stock is cheap or not, by looking at a series of indicators such as PE, PB, PS, PEG, etc. You only need to compare horizontally and vertically to find a cheap stock.

Graham, the father of value investing, called this type of investing “cigarette butt investing”, that is, looking for cigar butts all over the place, taking the last puff and then throwing them away. Instead of finding stocks that have the potential to become industry leaders, this approach requires buying third-rate companies at fourth-rate prices, or second-rate companies at third-rate prices, and the market is full of such companies.

In reality, we often want to buy great companies at reasonable prices. But in reality, great companies are hard to find, and more than 99.9% of people lack the ability to find “great companies” in advance. On the contrary, in most cases, those “great companies” that are praised to the sky will be disproved when the bubble bursts, and are not so great.

The second is the quality of the company, the company is good at what?

Everyone can know whether the price is cheap or not, but it is obvious that the cheap is also easy to produce “fake”. Therefore, the most important thing is to find out the quality of the company. If it is a company with accounting fraud and financial fraud, then obviously, no matter how cheap it is, it is not worth buying, because the end is likely to be insolvent, and the money will be lost.

There are many indicators to judge the quality, the core is “is this a good business, there is no pricing power, is not a business easy to make money”. The industry with too many competitors and fierce competition is generally not a good business, at least not at this stage.

Like bicycle sharing, when there are hundreds of companies in the market, the industry will only fall into vicious competition and end up with the result of multiple losses. But when there is only one or a few companies left in the market, it becomes good business again.

Third, the timing of buying and selling, why buy now?

If valuation is the science (mathematical calculation value), the evaluation of the quality of the company is the methodology, then the choice of investment timing is the art, there is no standard, can only be imagined, not spoken.

Some technical schools try to summarize various timing rules from historical stock price movements, thus inventing various “timing indicators”, but only a very few professional investors are well versed in this art. Foreign research shows that it takes 54 years to judge whether a person has the ability to pick the time, because timing is just a two-choice choice of up or down, to judge a correct timing of people because of the ability or because of good luck, it needs to accumulate many years of data to be able to have enough sample size to distinguish.

For the average investor, it is almost impossible to successfully time pick. What can be done is to reverse the selection by the level of market valuation and the sentiment of investors in the market.

It is important to note that this approach, which reduces investment analysis to three issues: valuation, quality and timing, is neither the best nor the only approach. However, it is a proven, simple and feasible approach for the average investor, and is the sum of the experience of many successful investors who have successfully practiced it in various countries at different stages of development.

While mastering the investment method, you also need to focus on the risks involved in investing. No one can win every battle, not Graham, not Warren Buffett, not Peter Lynch, not even the average investor, but the difference between the two is how to see and deal with the risk in investment.

How to deal with the risk in investment?

It is often said that high risk is high reward and low risk is low reward. But the reality is that risk and reward are often not proportional. For example, if you take a 50% risk of losing money, you may not get a 50% return. Successful investment is to identify the risk of “true or false”, avoid the real risk, bear the false risk.

When the stock market rose from 2,000 points to 6,000 points, the real risk is rising, but for optimistic investors, think that 10,000 points is not a dream, the perceived risk is decreasing. Conversely, from 6,000 points down to 2,000 points, the real risk is declining, the perceived risk is growing, because investors feel that it has been falling down, buy it will fall.

For investors, it is often easy to fall into two kinds of traps, and thus ignore the real risk in investment.

One is the value trap.

Some investors have learned the value investing concept of “holding on” and “buying at a lower price”. But there are stocks that should not be bought even if they are cheap. For example, those companies that have been eliminated by new technologies, such as digital cameras out of film, SD cards to CD-ROM, optical drive replacement, smart phones to feature phone replacement. These stocks will deteriorate due to their fundamentals, resulting in the market to give it a lower valuation, a “Davis double kill” (earnings and valuation decline), only to buy the more down.

The other is the more easily ignored growth trap.

Many people believe that buying a stock is buying the future, and that corporate growth is the hard truth, so buy growth stocks. But typically, growth stocks can be more risky.

For example, the valuation is too high, which is the characteristic of most growth stocks, high valuation match high expectations, but the reality tells us that only a small number of companies can continue to meet such high expectations, once the expectations do not match, the company will appear in a short period of time a tragic “kill valuation”. There is also a technology gap, many technology companies are faced with the choice of technology routes, even if the technical advantages are similar, once a technology breakthrough and quickly occupy the market, other technologies face the possibility of being eliminated. Typically, such as mobile payments in the barcode payment and NFC route of the battle, even if NFC has more secure and convenient features, but the barcode payment with cheaper and larger market share in the short term to achieve beyond. Besides, pharmaceutical and consumer companies also face new product risks, such as R&D failure, less than expected effect, and unrecognized products, etc. Once this happens, companies will have serious risks in the short term.

In general, the commonality of the value trap is the unsustainability of profits, and the commonality of the growth trap is the unsustainability of growth. To buy emerging industries at high valuation and fall into the growth trap is to indulge in “not yet obtained”, and to buy sunset industries at low valuation and fall into the value trap is to indulge in “already lost”.

The only way to succeed in investing is to properly examine these risks and to stop losses when they do occur.

These ideas and methods are not always right, even the idea of value investing. For example, during the tech stock bubble of 1995-2000, Warren Buffett consistently lost the market, and the stock price of Berkshire Hathaway, which was in charge, fell 40% as a result, and Buffett himself was even questioned by the magazine’s blatant humiliation. Even in the recent past, there have been cases of Charles, the legendary value investing fund manager, jumping off the building because of the failure of his value investing strategy.

But in the long run, these are the things that have been proven over time by many successful investors, that touch on the essence of investing, that are regular, that don’t work every year, every time, but that work most of the time.

Although the periodic market frenzy will always make people think “this time is different”, but history always proves: in fact, this time is still the same.


Qiu Guolu, The Simplest Things in Investing, China Economic Press, 2020.03

This article was originally published by the Suning Institute of Finance and is authored by Huang Dazhi, a researcher at the Suning Institute of Finance.

Posted by:CoinYuppie,Reprinted with attribution to:https://coinyuppie.com/what-kind-of-investment-system-does-the-average-investor-need-to-build-to-simplify-the-complexity/
Coinyuppie is an open information publishing platform, all information provided is not related to the views and positions of coinyuppie, and does not constitute any investment and financial advice. Users are expected to carefully screen and prevent risks.

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