Investors with the best long-term investing track records tend to have value investing at the core of their strategy. When I began investing, I researched who had consistently outperformed the norm over the decades. This group had one thing in common: they all researched in detail the company underneath the share, and used value investing principles to analyse it. Therefore my philosophy is built on studies of the successes of many other investors including Warren Buffett, Seth Klarman, & Peter Lynch.

What’s the point of buying an investment? To make money — or, to put it another way:

Investing is buying the rights to the cash flow of an asset.

I strive to understand the businesses in which I buy this fractional ownership. I see the stock market as a way of owning great businesses you can understand, in the same way as you would any business you intended to own or manage.

Through my experience in starting my own businesses I learnt what a good business for the long term looks like, and I realised that creating one to these businesses is hard. Via the markets you can invest in great businesses that have real potential to compound capital over the long term.

I aim to invest in exceptional companies that can compound a high return rate, and buy the shares at prices that offer a margin of safety, when based on the fundamental valuations of net asset values and discounted cash flows. As protecting the downside is critical, I try to limit the negative impact of my mistakes by requiring this “margin of safety” in every investment to allow for when I get my thesis wrong. Sometimes this is provided by competitive edge, and at other times by a very strong asset base. I prefer businesses that generate significant cash flow for their owners, rather than businesses that consume such cash flow for ongoing operations.

The stock market is a fascinating group think experiment.

It makes rational people do all kinds of irrational things. Understanding the psychology of the market allows it to provide opportunities for the longer term, rather than dictating your actions in the shorter term.

The long-term view gives an edge

Trying to work out the what a stock price will do in the short term is a hard game to play. Temporary shocks, hype and unrelated news can affect the price of the shares. Most money managers play the short-term game to meet client expectations for quick growth, and their own bonus targets. This generally leads to below-average returns and higher fees.

Not many investors choose or are able to play the long-term game, even though in many ways it is easier — not least due to the need for fewer trades and hence cost. With research we can make a really good estimate of what the future looks like in certain industries and businesses — and, for long term investors, the “if” is more important than the “when”.

What I’m thinking about when researching an investment

1. Risk is always to be avoided
  • Risk is always to be avoided, Risk is defined by a permanent capital loss in the business, not a drop in share price.
  • Don’t gamble. Great growth for ten years, followed by a zero is still zero. Permanent loss of capital resets everything.
2. Key signposts
  • Great company
  • Great people
  • Fair price
3. Invest in what you understand
  • Investment not speculation, it requires detailed research.
  • Great businesses make you money, and the passage of time can make them even greater.
  • Can this company be killed, how?
4. Be active in learning and research not watching the share price
  • Activity is your enemy. Research and patience is your friend.
  • Each time you trade, you pay: broker fees, spread fees, stamp duty, and capital gains tax — therefore, trade little!
  • Buy stocks or other investments that you are happy to hold for life.
5. Strive to understand the investment deeply…

…but remember it is better to be roughly right that absolutely wrong.

What do the “owner earnings” look like, what will they look like in five years time, and what is the probability of this estimate being correct?

  • An investment is worth the discounted sum of the owner earnings it makes in the next 50 years (or a lifetime for really exceptional companies).
  • It is easier to value a business today but much harder to value it in the future. Therefore look for businesses where things don’t change, and the management will invest wisely, or return the excess capital to the stakeholders in a tax advantageous way.
  • Valuation: Discounted cash flow of the business. This comes down to how we can estimate the future earnings of the business. The better your understanding of the market, and that industry sector, the closer your estimate on value.
6. Invest in companies with the right attributes
  • Look for exceptional management with a track record of excellent capital allocation and aligned interested, e.g. large personal holders of the stock.
  • Look for businesses with a high return on capital over the long term. This is a sign of a sustainable competitive advantage and the ability to reinvest earnings at a high rate of return.
  • Invest in businesses that require little capital expenditure to grow and have the ability to reinvest to make this growth happen.
  • Look for companies that have, over a long period, sustained growth of the “owners earnings per share”.
  • Look for companies with signs of long-term exceptional capital allocation by management.
7. Beware of the psychological influences and have methods to combat them
  • You are neither right or wrong because the market either agrees or disagrees with you. You are only right if your investment thesis plays out as you expect.
  • Understand why the current owner is selling to you. Ideally buy from distressed sellers, with a reason you can identify and evidence.
  • Be mindful of confirmation bias: Prove your thesis by disproving the other possible outcomes.
  • Buy only when there is a margin of safety on the valuation, either through discounted cash flow, or underlying assets. Your analysis could be wrong, so only buy when there is plenty of safety in place.
  • Listen to your own research and inner voice to value a business, not the price that the market dictates at that time. The market is not an optimised machine, it is efficient, so use it to you advantage.
  • The CEO. Who is the boss, and do they have a track record of trust? Can you trust them to report on the company properly and do they have a history of this? How many years have they been with the company?
  • Most of the time, the market is right. Only be selectively contrarian with good reasoning backed up by research.

Tim O'Shea
Follow me

Tim O'Shea

Fund Manager with 15 years' experience as a successful business owner-manager. Passionate about helping people benefit from the power of long-term investing.
Tim O'Shea
Follow me
Are Governments Bonds Safe? Your Investment Choices Explained.
Should we work together?