Want to know how I’ve picked my shares and what on earth I’m basing my latest bonkers decision on? Here’s some sound principles and investing tips on which a sound investing portfolio is developed..
Do it yourself and trust nobody
Sorry to start off with something that sounds so negative – but there’s actually a constructive point to be made here, in that I believe in personal responsibility when it comes to investing my money. I don’t invest in funds or trusts, because I want to be able to make all the decisions myself and would resent paying the fees. I also don’t take tips, unless I’ve done all the research myself. And I don’t invest in passive tracker funds because I don’t want to put money into bad companies at the same time as the good ones. If I’ve lost money it’s because I’ve made a bad decision and nobody else. On the flip side, if I make money then I can claim all of the credit!
It’s just common sense, but you’ve got to spread your risk in case something unexpected happens to a single company or sector. (I always think of the many people who held a single set of bank shares, typically a windfall from a building society de-mutualisation, prior to the 2007/8 credit crunch and made huge losses). I think the optimum number of shares in a portfolio like mine is ten, all in different sectors – as you can see I’m not there yet, but I’m getting there. I also want a diverse spread in terms of the size of the companies I back – ideally half small and half large, although there’s always scope for something that’s in between…
Buy and Hold
I’m investing for the long term (I’m in my early thirties), so I aim to resist the temptation to chop and change unless there is a really good reason. I tend to favour either a) growth shares that will come good over a five to ten year time frame, or b) reliable income shares with a high yield, steady profits and a sound future. If a share fits one of these descriptions and I’m convinced by it, I’m not going to dump it just because the price takes a slide. Also I try not to hold shares simply for short-term speculation. Remember Warren Buffett’s maxim, “If you don’t want to hold a share for ten years, don’t hold it for ten minutes.”
Look to the fundamentals
I would describe myself as a fundamentalist investor – this doesn’t mean that I’m a religious extremist but rather that I believe the most important aspect of an investment choice is looking at the fundamentals of the company. Whole books have been written on how to conduct fundamental analysis so it would be foolish to try to summarise it in one line. Luckily I’m a fool, so here goes: the main elements I look for in a company are an earnings per share figure that grows every year, a strong cash flow, a low price-earnings ratio and low PEG, a reasonable asset position and low levels of debt, excellent directors who back their own companies, and a business model with great prospects. Easy…
Selection is more important than timing
I’ve borrowed this phrase from Jim Slater, author of The Zulu Principle, because it’s one that I believe in. Most of us don’t have the skill to time the market and so you shouldn’t be obsessed with trying to buy at the right time in the economic cycle. If you select the right companies, and buy them at a time when they are good value relative to the market conditions at the time, then you shouldn’t have to trouble yourself with judgments on the market as a whole. I take a ‘pound cost averaging’ approach: I invest money at regular intervals from month to month and year to year, so that sometimes the macro-economic winds will be in my favour and sometimes against, but over time it will cancel itself out.
A quick one this – I set my share dealing account to automatically reinvest the dividends I receive into buying more shares in the company. This will pay off in the long run because of the power of compound interest over several years – if you don’t do it you really miss out.
It’s only a great buy if you pay the right price
Even if you’ve identified a brilliant company, you could still lose a lot of money if you overpay for its shares. If the price-earnings ratio based on last year’s earnings slides up significantly higher than the share has traditionally traded on, it’s a warning sign, and if the P/E is any higher than 15 I would avoid it altogether. Buying a growth share at an inflated price and then seeing it go ex-growth is one of the quickest ways of losing your money.
Avoid excessive leverage
I would never borrow money in order to invest in shares, because it ramps up the risk involved if things turned against you. By the same token, I try to avoid companies that have borrowed too much money as they are also pursuing a risky strategy. Find out the total value of borrowings and compare to the value of the company – if more than about 30% is financed by debt then it is a danger sign. Another balance sheet check that I apply is to check that current assets are higher (preferably comfortably higher) than current liabilities – this shows that the company is pursuing solid financial management and guards against the danger of cash flow problems.