I only pay up for current tangible assets and high conviction stocks – Chris Rees

In this series, we’ve asked Covestor managers: “What is the single most important lesson you’ve learned about being a successful investor, and how do you try to apply that today?”

Author: Chris Rees, TenStocks

Covestor model: TenStocks

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It’s extremely difficult and probably unwise to narrow the process of investing down to a single best rule or element. I personally use a blended and balanced application of many different elements. But if I try hard I can perhaps chop these down to three main rules:

1. Maintain an investment portfolio that is not priced at more than one times net tangible assets.
2. Limit portfolio holdings to your ten highest conviction investments.
3. Invest at times of market or company stress.

Careful and disciplined application of #1 can go a long way to looking after #2 and #3.

I try to keep my investment portfolio priced at around one times net tangible assets. In an overvalued market, new investment candidates become harder to find and already owned investments tend to reach sell targets and get sold. I aim to pile up cash in overvalued markets, then re-invest in undervalued markets.

Many investors invest based solely on assumptions and forecasts about future earnings. If someone pays a price to earnings ratio of 20 for a stock, they need to be a very good fortune teller to get it right with any degree of consistency. My approach is different – I only pay for current tangible assets and thereby aim to get future earnings for free.  As Warren Buffett has said, “a girl in a convertible is worth five in the phone book.” (Berkshire Hathaway 2010 annual letter – http://www.berkshirehathaway.com/letters/2010ltr.pdf)

So where did this focus on tangible assets come from? Imagine the market as an elevator in a skyscraper. Tangible book value is the ground floor. Each floor you go up, the more risk you take and the lower your survivability becomes in the event of an accident. If the cable snaps and you’re on the ground floor, you open the door and go get a coffee. If you’re on a higher floor, they are scraping you off the walls.

Investing with a focus on tangible assets is all about managing risk. An investment portfolio can go up, down or sideways. If you concentrate on not going down, the alternatives take care of themselves.

How do you apply that lesson in your current investing? What do you find are the challenges to applying it?

I know there are many different approaches to investing and many of them will be outlined in this series. I can’t say I have the best strategy. But for me, when I started investing, I had nothing. I couldn’t afford to lose. So my priority and focus from day one was not on making money, but rather on not losing it. And this is one of the most important lessons I’ve learned about intelligent investing. The way to make money is first and foremost to strive to not lose it.

Psychology and emotion are probably the biggest challenges to sticking to an investment and portfolio discipline. You need to be mentally and financially prepared to invest when others are afraid to, and to have the discipline to leave the market’s wild parties early and sober. This is not easy to do, but I believe it’s the first law of investment survivability.

Also, I believe a portfolio needs to be put together like a jigsaw puzzle. Too many people think of an investment portfolio as merely a bunch of stocks thrown into a basket. A strong portfolio doesn’t work like that. In a strong portfolio, investments work and fit together. Entry points, allocation, sector, country and currency considerations all play a part. The concept of stock picking, in my opinion, is overstated. The importance of portfolio management and strategic planning  is understated.

A global perspective is also important in building a strong portfolio. It makes no sense to limit potential investments to one country, or one currency, or one sector. Instead, I seek the most compelling investment prospects I can, wherever I can find them, and then blend, diversify, fit and balance them together into a concentrated global portfolio that meets my overall strategic goals.