There are those who give you fish and then there are those who teach you how to fish.
Prof Sanjay Bakshi is one of the best teachers in the field of value investing and behavioral finance. He never ceases to amaze me with his clarity of thought and his willingness to share the pearls of his wisdom selflessly to the whole world.
He just shared one of his discussions with another investor on ‘how to look for feedback on decisions on investing in high quality businesses’.
It’s too good not to share. So here is an excerpt (emphasis mine). Do join me in reading this …
1. Every once in a while I look at the business and ask if this is a high quality businesses or not. If, for example, the moat is getting impaired or is likely to be impaired, then I must consider selling.
Factors affecting the quality of the moat are many but keeping Porter’s five forces framework is helpful as is quantitative checks (operating performance as compared to competition, resilience of profitability during tough times, trends in balance sheet quality, return on incremental capital for new expansion projects being taken up by the business etc).
It’s important to recognize that doing this too frequently will not be a good idea. By definition, a really good business is very unlikely to be ruined in a quarter or two. So, there is feedback but I am not likely to get it on a daily or a quarterly basis.
Sometimes, of course a negative black swan event (e.g. an earthquake) could destroy the earning power of the business. Under those circumstances cogitating over a few quarters about where the moat of that monopoly hotel that now lies in ruins now is impaired or not would be funny and foolish! I cite this just as an example that sometimes shit happens and one has to act quickly but usually good businesses do not get destroyed in a quarter so one must try to avoid the noise in the short-term earnings announcements and focus on the big picture.
2. Every once in a while I look at the quality of the management and ask if it’s the same, better or worse than it was when I first bought into the business. A bit of caution here however. Once an investment in a great business run by an excellent management has been made, one should not become overly disappointed by a few mistakes, provided none of them can destroy the business. So this analysis is done keeping in mind Ben Franklin’s advice that one should keep one’s eyes wide open before marriage but only partly open thereafter.
Factors that go into the quality of the management bucket comprise of checks on operating skills, capital allocation skills and integrity.
There are some situations, however, when the management does something that is wrong from the perspective of the minority shareholders. under such situations the question to ask is: Knowing what I now know about the intention of the management, would this business pass the management quality test? If the answer is a no, then I must exit from the business. In other words, some things are to be tolerated, others not. It’s not physics. It’s very subjective and different people come to different conclusions.
It just helps to monitor the overall quality of management’s decisions over time and make the judgement using Ben Franklin’s Prudential Algebra framework.
3. Every once in a while, I look at the market value of the business and try to understand if it’s run up faster than fundamentals or is lagging the fundamentals. So long as I am satisfied from the feedback I get from 1 and 2 above, I don’t get overly worried about the former.
I know from studying the history of great value creators that there will always be periods when the stock outperforms the business and there will be periods when the reverse happens. One’s eyes should be on the playing field (covered in 1 and 2 above) and not on the scoreboard. This kind of thinking has really helped me a lot as an investors and has also helped my firm’s clients too!
‘When to sell?’ is one of the most difficult questions to answer in Investing. The above framework for ‘feedback’ will be very useful in finding an answer.
Remember our analysis on Business Quality and Management Quality? If we take Prof. Bakshi’s advise on looking for feedback, we should revisit those findings on periodic basis to check whether they still remain relevant.
To quote him again on ‘process’ and ‘role of ‘luck’ :
There is very good feedback in long-term value investing. If your process is good, then over time, you should get good results. Over time, the role of luck diminishes and process dominates. So all the feedback should be directed towards the validity of the investment process.
Additionally, I think its a very good idea to follow the Shane Parrish’s advice on writing up a decision journal because it forces you to calibrate your confidence level over time…