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Simple common-sense rules for wannabe investors

Jul 20, 2008 Management, Sunday Nation

When at a certain stage in my life I finally managed to generate some surplus cash (it took a long time), I immediately decided to invest in some stockmarket shares (as many do).

I started reading the financial press trying to seek out a real winner of a company to back. I noted that many analysts had “strong buy” or “out-perform” ratings on one particular company in the high-technology sector, which was also the darling of the financial media. The stock had doubled in value in recent months, and looked set to go much higher. I threw caution to the winds and sank all my hard-earned spare money into that share.

Three months later, the company issued a profit warning. After another three months, the CEO was forced to step down as it became apparent that the company’s success was achieved more with smoke and mirrors than strategy and leadership. Before the year was out, the company had effectively closed down. My shares were worth exactly nothing.

Did I go into financial hibernation, nursing my wounds and swearing never to dabble in things I don’t understand and keeping my money safely in the bank? Not a bit of it. I actually understood, through the loss and humiliation, that I had been given the best lesson an investor can ever receive: that of an early slap in the face.

I learned many things from that experience. I learned that the world’s financial media generally don’t have a clue about the companies they cover. I learned that you can’t make any real money by simply following the prevailing market sentiment – but you could lose a lot. I learned that you can’t analyse a share just by looking at its performance in isolation – you have to understand the fundamental position of the company itself, and you have to be able to place it its industry. I learned that regardless of hype, no one company is worth sinking everything you have into. And lastly, I learned that history does not offer many clues about the future, particularly in rapidly changing sectors and economies.

And so, once I had set aside some more money, I built a highly diverse portfolio of stocks and other investments, slowly but surely. I am by no means a rich man as a result, but I can at least take satisfaction in the steady appreciation of the portfolio, and hope to use it to educate my son and pay for my own early retirement.

I wish every Kenyan dabbling in the Stock Exchange could undergo a similar education: an early but manageable reversal of fortune. The learning would be quick and deep! And that learning is sorely needed.

I introduced this topic last week: that Kenyan investors are, on average, ignorant and easily led. In addition, we have extremely poorly governed capital markets, and the results have been obvious in recent months in the form of long queues of poor folk who have proportionately lost a great deal more than I ever did. Eliminating this ignorance will take more skills and knowledge than I have, but I would like to offer here a common-sense exposition of what to look for when buying into a business.

First rule: there is no real money in the crowd. If everyone is buying something, the chances of little old you making a fortune out of it are negligible. That is why I did not buy Safaricom shares at all in recent months (although I might do when you’re all looking to sell!). This is something we should all understand: big money is made out of scarcity. If there are many people jostling for space, or will be in future, forget about ‘supernormal’ returns. Big money is made by those who can keep the hordes at bay – not by undue force or advantage, but through the uniqueness of their skills, processes, business models or positioning.

Second rule: don’t buy any share if you don’t understand the underlying business. You must see very clearly why the business is successful, what unique value it offers customers, and why this advantage is likely to persist over time. Study the quality of the management team. Look for smiles on the faces of employees and of customers. If you can’t see any of those things, stay away.

Third rule: quick and dramatic returns are the exception, not the norm. We must not get misled by IPOs, where prices are set deliberately low in order to create interest. A great company will indeed deliver outstanding total returns to shareholders, but it will do so over time, slowly but steadily.

Apply these three rules, and you won’t go far wrong. Learn from the most famous investor of them all, Warren Buffet: buy a single share as though you were buying the whole company; if you wouldn’t buy the company, don’t buy shares. And don’t buy any share you’re not willing to hold for at least ten years.

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