Dart Throwing Monkeys ≠ Long Term Investment Strategy
In my view, as investors seek to construct a long term investment strategy that holds potential to achieve above average performance over the long term, it is critically important to take a systematized approach.
It has been rightly stated that investment success is measured with a calendar, not a stopwatch. Anyone can get lucky with stock picks over a short time frame, and even a blind squirrel finds a nut once in a while.
But investors who have been successful over the long term consistently adhere to a defined system of identifying the stocks they want to invest in, whether that is a focus on finding undervalued companies, high growth companies, strong fundamentals, competitive ethical advantages or what have you.
Whatever your focus, a proper stock selection process must have three characteristics: It must be measurable, repeatable and produce beneficial results.
No dart throwing monkeys allowed.
Measurable Long Term Investment Strategy
At the most basic level, the metrics used in selecting stocks must be measurable in an objective fashion.
Financial factors such as corporate earnings growth, discounted cash flow and debt to equity ratios are easy to measure and objective in nature. Numbers don’t lie (except when they do, but that’s another story). And many investors focus solely on these data for precisely that reason.
However, subjective analysis such as “a great leadership team”, or “unique products”, or “strong integrity” are all important investing criterion – and I would argue are even more important than financial metrics such as discounted cash flow because in reality, all of the financial data is derivative from these more subjective criteria.
Poor leadership, irrelevant products and unethical business practices are not qualities that make a great investment opportunity, neither from a moral nor a financial perspective. But there must be an objective measure of those subjective characteristics, otherwise they are unhelpful and we’re back to dart throwing monkeys.
So, how do you objectively measure the greatness of a leadership team, unique products, corporate integrity and other subjective criterion?
This is where a faith-based ESG (environmental, social and governance) factor approach to investing offers a strong value proposition to investors seeking to follow a long term investment strategy.
Converting Subjective Observations Into Objective Data
Let’s look at an example of how faith-based, biblically responsible ESG analysis can convert subjective observations into objective data that is useful to investors using the Inspire Impact Score methodology.
One of the many factors that the Inspire Impact Score takes into consideration is corporate ethical integrity, which is a subjective issue with many relevant effects on corporate productivity, profitability and therefore long term investment strategy success.
We begin the process of objectively measuring this category by collecting factual data regarding issues and events that correlate to corporate ethics. Instances of tax-related fines, political contributions, court cases, executive compensation controversies or reports from corporate watchdog organizations would be examples of items that might be looked at.
We then assign a numerical score to each of these issues according to a fixed formula and aggregate those scores to arrive at a total for that category. This numerical score for corporate integrity can then be objectively measured against those of other corporations within or across industries, geographies, market capitalizations or other categorizations to identify those organizations that have measurable patterns of ethical behavior, and those that have measurable patterns of unethical behavior.
If investors had that type of measurable data on corporate ethics prior to investing in Enron, WorldCom or any other scandal-ridden company, it is possible that those investors could have avoided a disastrous outcome for their capital accounts.
Repeatable Long Term Investment Strategy
The second criterion for a proper stock selection methodology is the ability to produce consistently repeatable results. It is not enough for an investor to be able to measure data and make a great investment decision today if that process cannot be repeated tomorrow, or next month, or next year.
Long term investment success requires a repeatable process that can be applied consistently over decades.
In my opinion, this is the primary reason most active managers fail to produce consistent outperformance. They do not have a systematic approach that is repeatable across market cycles and instead make decisions based on their gut.
Certainly they may look at financials, study price history and other analysis. But their shortcoming is that all of this objective data is then analyzed in a subjective fashion and results in a decision not based on facts, but based on the manager’s feelings about the facts.
Some investors have great intuitive sense and have had great runs operating this way. But when viewed across the long term — over decades, bull markets, bear markets and all manner of economic expansion, contraction, inflation and other myriad environments – even the best intuitive investors eventually hit a rough patch. Often that rough patch undoes any outperformance they may have achieved in their good years and they would have been better off just buying a plain vanilla index fund and accepting completely average results.
The lack of a truly repeatable, objectively measurable framework that creates precise results for conviction buys or sells is many an investors’ Achilles’ heel.
Beneficial Long Term Investment Strategy
Lastly, it doesn’t matter how measurable or repeatable your investment process is if the results it produces are not beneficial. Every investment strategy has its pros and cons, and every strategy performs better at certain times and through different seasons than at other times.
But some strategies just suck all the time.
Also, observe that there are different ways to measure how beneficial an approach may be, and an investor must decide how they will define “beneficial” for themselves.
It is my experience that many investors are quick to say that “returns are the only thing that matter”. But they don’t really mean it.
Consider this: If I could offer you an investment that had consistent returns in excess of 100% per year, would you buy it? And if I told you that investment was in a business that laundered money for the mob and smuggled illicit drugs across the border, would that have any bearing on your decision?
Of course it would…I hope.
The reality is that law abiding citizens routinely choose lower performing investments (relative to the black market) to satisfy their moral and ethical concerns, such as not breaking the law.
As such, it is obvious that returns are not the all-important measure of the merits of an investment. Morality, ethics, risk and other factors play not even an equal role, but a greater role in the beneficial measure of an investment. Only when all else is equal (morals, ethics, risk) do returns play the part of tie breaker as the last and least important factor.
When returns are positioned as more important than morals, ethics or risk, bad things happen. Like 2008, for example. “Better is a little with righteousness than great revenues with injustice.” (Proverbs 16:8)
For all of these reasons, I prefer a long term investment strategy that invests using rules based, objectively measured index methods built using the Inspire Impact Score to identify unique portfolios of stocks that demonstrate compelling financial attributes and align with biblical values to boot.
Past performance is no guarantee of future results, but such an approach is measurable, repeatable and has produced beneficial results both in terms of moral values and risk adjusted return characteristics.
Is your long term investment strategy measurable, repeatable and beneficial (really)?