John Reese is chief executive officer of Validea.com and Validea Capital, the manager of an actively managed ETF. Globe Investor has a distribution agreement with Validea.ca, a premium Canadian stock screen service.
If there’s one lesson to be learned from observing the habits of some of the most successful investors over the years, it’s discipline.
This sounds a lot easier than it is in practice. Human nature is emotional, and its instinct is to flee danger. Despite good intentions, it’s easy for investors to chase hot stocks, react impulsively to market swings and make rash decisions that end up being costly mistakes. Along the way, long-term goals get kicked to the side and the most carefully constructed plan can get derailed.
Investing for the long-term means resisting short-term reactions.
Value investing, embraced by greats like Benjamin Graham and Warren Buffett, requires patience, discipline and an aversion to risk. In fact, value investing is the definition of risk avoidance. Mr. Graham wrote about finding stocks that had a “margin of safety,” the idea that they were priced so low, the investor buying them had minimized the risk of them falling even more.
It’s hard to ignore the power technology stocks, like Facebook, Netflix and Google, have had in the current stock market. The FANG group has led the indexes higher for more than a year. Some have argued that their valuations have grown so much they can’t be considered cheap at current levels, even if they’ve fallen in recent days.
But investors are tempted to buy into them anyway, for fear of missing out.
This is when investing discipline breaks down. Buying many of today’s high flying stocks means abandoning value discipline. As the gulf between the top-performing tech growth stocks and the underperforming value sector grows ever wider, the temptation to bail on value investing intensifies.
When stocks are hot, investors tend to believe that more of the same will follow. The same case is true when stocks are undervalued. Investors avoid them, when they should be doing just the opposite.
Investors can also get wrapped up in their own biases, as research into a field known as behavioral finance has shown. They tend to place a higher value on what they own than what they don’t, and they become reluctant to cut their losses and part with underperforming investments. Both tendencies make investors stray from a plan based on fundamental analysis and disciplined decision making.
Mr. Buffett stuck to consumer product companies, beverage makers and banks even when the rest of the world was piling into internet stocks in the late 1990s. He steered clear of technology stocks except for a few exceptions in the time since then, too. It was only very recently that Berkshire Hathaway began buying Apple, after the company had grown so dominant in its sector and so flush with cash that it took on the characteristics of a value stock more than a hot growth story.
But that right there should tell you something: Mr. Buffett has a view on investing and he sticks with it. He has long preferred stocks of companies that make things, move things and finance things over stocks of companies that have a promising idea but haven’t demonstrated they can make money consistently. He searches for well-valued stocks of solidly run companies that dominate their sectors.
This discipline requires an investor look beyond today’s headlines to focus on a company’s fundamentals. It resists knee-jerk reactions, which Mr. Buffett views as an attempt to market time. Instead, investors should resist the human urge to predict, or move in and out of markets based on what they think might happen.
It is not a get rich quick approach, as Mr. Buffett has often noted. “Investing is an activity in which consumption today is foregone in an attempt to allow greater consumption at a later date. ‘Risk’ is the possibility that this objective won’t be attained,” he wrote in his 2018 letter to shareholders.
The key lesson for investors is that no strategy will be winning all the time. That’s why we build strategies based on long-term track records that investors can hopefully believe in and stick with even if they aren’t winning all the time. Here are some stocks that score highly on Validea’s models, which were designed to track the investing style of gurus like Mr. Graham and Mr. Buffett.
Citizens Financial Group (CFG-N) – This regional banking company has a low P/E of 13.6 relative to the market’s P/E of 26 and EPS growth near 18 per cent in a sector that should be poised to benefit from rising interest rates.
Deluxe Corp (DLX-N) – The stock of the largest check printers in the U.S. is down over the last year, but our value models, including the Buffett and John Neff quantitative strategies, are finding value in the shares in light of the firm’s underlying fundamentals.
BHP Billiton (BBL-N) – The global commodities producer has strong cash flow relative to the market and a high dividend yield at 5.86 per cent.