A Bright Future

As the investor awoke from his deep slumber, the masks he had been trying on for size during his European sojourn fell away to reveal his true self. The sun was rising in the sky as he stretched his arms high above his head and his now expansive vision of what was to come filled his mind with wonder, excitement and no small degree of trepidation.

There is now a fairly unshakeable belief in me that I can outperform markets in general by a wide margin over time. That belief (and the expected outperformance) is large with small amounts of capital and shrinks with larger amounts. I think that most professional investors would say the same thing, but few probably have personal investment accounts that show they have been able to actually do this. Sadly, only a minority will have professional performances that beat the market averages over time - especially once fees are taken into account.

It may sound egotistical to say you are better than the professionals at an activity, especially one regarded as being so difficult to master, however, for the enlightened at least, the investment game is surprisingly simple and easy to outperform in. That is, before you take behavioural biases into account.

Plato once said, "For a man to conquer himself is the first and noblest of all victories." This couldn't be more prescient in the field of investment management. The only way I know to overcome the inevitable biases is to stick with one strategy and not be swayed by the emotions of the market. Whether or not this will be possible is entirely dependent on temperament. By understanding exactly why you should have an edge in investing, and checking each time you make an investment decision against a list of credentials for making investments, you can alleviate many of the biases that lead to poor performance.

The simple process of finding undervalued stocks may involve a vast amount of hard work, but happily this will neither feel hard or like work if you love what you are doing. You only need to sit and think carefully for half an hour or so on a given company to have an edge on many of the people who will end up buying or selling shares in that company's stock over the next few years. Some will be depressed at it's prospects and offer you very favourable terms to sell you shares in the enterprise at a low price, and some will be highly enthusiastic about the future for the company and willing to pay you a compellingly high price for a share in its expected future profits. It is the induced hope and fear of others that creates such rich opportunities for those with the right temperament, who are also willing to do a bit of work, to profit from their folly.

Sadly, many investors decide to invest for reasons other than a perceived gap between price and value. Exploiting the difference between the two is the lynchpin of the value investing process and has worked over and over again through a variety of markets and with clearly understandable and repeatable results (perhaps more in direction than in magnitude). That few appear drawn to the process seems odd, but when you factor in career risk for professionals and the extreme short-termism of many investors, it is more understandable.

So, opportunities abound for those able to be reasonable at assessing the fair value of businesses, and then exploiting the difference between price and value by buying where a sufficient margin of safety exists.

I look forward to a future where I will be able to help people invest more wisely. I look forward to a future where I can help people by compounding their capital at rates of return that will warm their hearts by helping them to meet their goals and fulfill their dreams. I look forward to a future where I will be able to think about investments all day long and teach others of the plentiful opportunities available in markets; to help them understand the mechanics of valuing businesses and profiting from the market's inevitable bouts of greed, fear and folly.

The road to this point has been rocky at times, and I've had to learn from mistakes that thankfully were never so large as to divert me from the path which I am still on. I will definitely seek out people who I feel I can learn from, but in the final analysis the real rewards of fulfillment and satisfaction will arrive as long as I can immerse myself in an activity I take real pleasure from, and by performing well in an activity that I, personally, attribute value to.

A New Dawn

The sun gradually pushed out a soft light across the dewy hills. As the shadows appeared, our protagonist stirred and shifted, awaking from a deep and restful slumber. To the east a ball of light hinted at its imminent arrival, haloed over the jagged peaks, spreading it's rays over the upper sky. Slowly, but steadily, the ball arose and the rays fell, in perfect harmony. Light shone on the investor who had been roused by the appearance of daybreak. A new day had arrived, and he intended to live it to the full.

Whatever has happened is in the past, and all you can do is look to making your future as bright as possible. I've always known that my future is as an investor and not a trader, so it's with some disappointment that I reflect on the past few years of excessive trading activity, where capital has been created and destroyed. But underneath the gross volatility of my trading activities I have been developing a knowledge and skill base that I am increasingly certain is one that will significantly outperform over time.

It's all about Value, it always has been and it always will be. But my investing hasn't always been intelligent. To have almost proved the maxim that with a bit of capital and a high IQ you can lose a great deal very fast isn't perhaps an achievement I need to reflect on too deeply (or indeed share too often), but I have to admit to my mistakes and learn from them. Perhaps slowly, but I have to learn.

So, out with the currency trading, out with bond futures, out with options, commodities trades and the like and out with equity index punts. In with VALUE INVESTING. The way it should be and the way it needs to be.

It will be a gradual shift, but the portfolio is formed now and I've finally made the analysis of my performance that I had meant to do for a long while. In short I've made 55.4% since March 2005 versus the FTSE being flat and the S+P down 12%. Not too shabby. The annualised return is 10.0% since March 2005, which I can live with. And here are the current stars of the portfolio...

1) Berkshire Hathaway (BRK.B) - 20%

The one and only. After the analysis is done I have this as a 25% discount to fair value, so a potential 33% upside if it achieves that fair value in the near future. But the return on equity from this fantastically well capitalised business is a not stellar 6.6%, although probably over 10% on a normalised basis (excluding 2008 losses on stocks and derivatives). 10% on $109bn - not bad, sir! Once the only stock in here, now maybe on its way out, think it will have to go if the discount narrows to 10% or so.

Everything from Insurance to t-shirts and prefabricated houses. A holding company for a fantastic collection of 100% owned businesses and shares in fantastic publicly traded companies, bought either at fair prices or a discount to fair prices. Over time this business will grow and grow and continue to produce prodigious amounts of cash. Succession risk prevents the stock from shooting upwards, but it has an excellent returns to sleep ratio to it!

2) Hallin Marine Subsea International (HMS) - 14%

My best idea currently. According to my estimates, this company is trading at a 51% discount to its fair value. It returned 65% on equity last year and is on a P/E of 2.65x last year's earnings despite a 30% run up in the stock prior to tomorrow's earnings announcements.

The more I think about the business, the more I like it. A great management team providing excellent service to a sector with lots of cash available doing things that are difficult to do and winning new business at a steady pace.

HMS provides subsea intervention equipment and teams to the oil and gas and telecommunications industries. A lot of their revenue is earned out of their Singaporean hub, where the economy is on a much sounder footing than here in Europe. Growth at the profits line has been 120% annualised over the past 4 years... yes, annualised! They have managed this by starting out small, but they are still pretty miniscule at a market cap of £56m - although I expect that will change markedly over the next few months.

3) Man Group (EMG) - 12%

An association with the Head of Research of AHL (the futures trading arm of the hedge fund group) first introduced me to this company. In an industry in turmoil and in need of consolidation, I believe these guys have what it takes to come out not only in one piece, but shining.

I have them at a not-quite-enough-to-be-buying-here 22% discount to fair value. But they are yielding 9% on a well covered dividend. That's 9% from what I regard as a solid business when I can get around 1% in a bank. Returns on Equity are over 10% still based on last year's earnings, which look unlikely to be repeated for a good while yet, but even with normalised earnings of a little under $1bn per year the stock's market cap of $8.4bn isn't what I would regard as expensive for what I do regard as a business with a good future.

When to sell will be a dilemma, but I think with such tiny sums of capital to invest at the moment it will be a case of finding new ideas to invest in before selling ideas that still show up as value investments in my mind.

For completeness, here are the other protagonists in my motley crew of investments. In order of the value within the portfolio...

4) Interior Services Group (ISG) - 12%

5) Matchtech (MTEC) - 12%

6) William Hill (WMH) - 7%

7) Game Group (GMG) - 7%

8) Lo-Q (LOQ) - 6%

9) Umeco (UMC) - 5%

10) Severfield Rowen (SFR) - 4%

11) Staffline (STAF) - 2%

The one idea that I am least happy with is Umeco, and may sell out of this stock soon enough. They provide supply chain outsourcing to the aerospace and defense markets (unexciting) and also manufacture composite materials for airlines, wind turbine blades and Formula 1 teams (exciting). But margins aren't all that wonderful and the return on equity is around 8.5% versus 20%+ in most of my other holdings with the exception of Man Group and Berkshire Hathaway.

At least it is up 20% on where I bought it less than a month ago (the market has been strong this Autumn), so the discount has narrowed and the reasons for buying the stock have diminished somewhat. That leaves a question of what to do with the funds once the stock has been sold. There's not much bad news knocking about in my favourite stocks, so I'll probably add to the holdings in Lo-Q, which could be a fantastic investment, but it's hard to see if the business model is truly sustainable.

So, a new dawn has arisen in this investors outlook. I'm going back to London for work, but my heart will stay in the mountains. And my dreams of running a fund are still in tact, as you can probably see from the above. The counter on this blog has been ticking upwards recently, and I'm not sure exactly who is reading this, so if you have anything to add, please comment below and be as open as possible. Feel free to spread the word if you find anything useful here also - anyone buying my investments will only push the prices up and I'm pretty much fully invested now, so that's ok with me!

The true test starts now though, as my portfolio did not fully exemplify my value philosophy before the recent additions in August. I'm very pleased to have made such good returns in the past, but really it's 20% a year in good years and to not lose too much in bad years that I'm shooting for. Then again, with 2008 such a disaster for most investors, I think I have the right to feel pretty good about a 50% plus gain over a period when the FTSE has ended up where it started.