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Investment Rules to Live By

When reviewing your portfolio and individual investments, there are a few things you should always consider.

First, consider the ‘blue sky”. Sometimes, especially when the market has been so harsh, investors forget about the good things that can happen. When you are buying shares in a company, you clearly don’t expect negative things to occur, so why not—every once in a while—consider how your stock might perform, if only (earnings accelerated/markets went up/a new product was a success/a new drug was approved//dividends were increased). Considering the good things can potentially save you a lot of grief, because, often, companies are doing exceptionally well, while their share prices languish. By focusing on the positive, you might see that—despite the gloom and doom out there—you’ve got yourself a winner. At the very least, positive thinking might help you avoid selling a great company just because the market backdrop is temporarily weak. At best, it might allow you to load up on a true winning company at give-away valuations.

Remember that stock analysts like to keep their jobs, and tend to be ultra conservative. Equity analysts tend to favour companies that might one day need to raise money, because they make greater advisory and investment banking fees from these types of companies. Also, investors need to keep in mind that analysts tend to have a herd mentality. If an analyst really really likes a company, then he or she need only have the highest earnings estimate on the street. If the consensus is $1.00 per share, the ‘aggressive’ analyst might have $1.05 per share, even though they might believe the company is capable of $1.25 or more. Most analysts, though, would never publish that high of a number because if they are wrong, then, they are really wrong. By staying conservative, a confident analyst can be aggressive (the high on the street), yet still stay conservative and keep their job if they are wrong (hey, I was only off consensus by $0.05, it’s no big deal). What this means, of course, is that companies that have truly accelerating earnings growth rates tend to always have analysts that are ‘catching up’ to rising earnings. Smart investors can take advantage of this by owning companies that have strong, consistent growth rates, and not worrying about analyst estimates and price targets until those company growth rates start to decline. With great companies, this can take years, and analysts are constantly revising earnings forecasts behind the curve.

Consider debt-to-equity re-ratings. Many investors, wisely-so, try to avoid companies that employ a lot of debt. Generally, a good idea, but it can of course limit your upside when markets and economies surge. One thing to remember, thought, is that when a company solves its debt issues, its shares often undergo a re-rating. Suppose a company raises $100 million in new equity to pay off a big outstanding debt. You might first think, ‘oh no, more dilution for me, more shares outstanding!”. However, an entire other group of investors is going, “great, now they have a clean balance sheet and can finally execute on their business plan without being constrained by capital. Plus, my risk has gone down, I’m in!” We see this all the time with industrial companies. A similar occurrence happens in the mining industry. Once a company is actually able to get financing to build a mine, then a large risk is removed from the stock, and it often works higher, despite having just raised millions of dollars. Remember, a stock that allows you to sleep at night is often worth more to a lot of investors.

Finally, don’t get caught up in short-term issues. We believe that brokers changing recommendations are only meant to drive trading commissions. Over the years we’ve seen hundreds of ‘flip-flop’ recommendations—a buy one week, a sell the next, on the same security. Always first look at the company fundamentals and performance before deciding any action. One fund manager is famous on TV for saying he will never hold onto a stock into quarterly earnings. That seems a bit extreme to us. If you aren’t comfortable holding on to a stock for ninety days, then in our view you probably shouldn’t own it at all.