Investing requires a solid understanding of economics, business and human nature. Essentially, there are two main parts to investing — the science side (economics, business, finance) and the human-nature side (understanding our biases, controlling our emotions, understanding politics and having a good understanding of human nature).
I am certainly not an expert on every business or every aspect of investments or life. However, as part of my commitment to lifelong learning, I have worked on significantly growing my investment knowledge by reading, studying, following great investors and doing research. Here are some of the lessons I’ve learned to perhaps help others.
Many of these were learned while creating a more formal process, as opposed to my historical intuition-based style. It wasn’t easy, but developing a more focused investment process, creating a list of criteria and factors, and implementing a more rigorous and disciplined process has resulted in fewer mistakes and better performance. We back-tested over 450 of our individual public equity selections over a dozen years to see where our common mistakes were by categories. We studied what we did wrong, what did right and why. We looked for common factors in areas we consistently outperformed. Over 90 percent of my mistakes were in a few general areas.
We now have watchlists by categories with over 300 companies. We also follow nearly 100 13Fs from some of the most successful investors that we respect, and we read analyst reports from different sources.
I start with a first look, where if something catches my eye, we see if we like it on the surface. If it passes, we move to a second look, reading articles, reports and company presentations to determine if it is a high-quality business with a sustainable competitive advantage, trades at an attractive valuation and can achieve strong growth.
If we like what we see, we do a deep dive and read as much as we can, listen to past earnings conference calls and read company annual reports in depth. This simple process has been extremely beneficial. It has not only helped me avoid mistakes that I made in the past but made me a better, more knowledgeable and disciplined investor.
Through this method, we have identified the following practices and strategies that have allowed us to reduce risk and have better outcomes. We believe the best risk management is done at the individual stock level. Not losing money, or losing as little as possible, this is the real meaning of managing risk.
We have identified three strategies that are suitable for us. The first strategy is wide moat growth. These are the greatest companies in the world, run by outstanding CEOs, that have competitive advantages, high return on invested capital and will be the leaders in their industry for decades. In my opinion, these represent less than 1 percent of all the companies we look at.
The second strategy is durable growth. These are potential platforms or disruptive companies experiencing hypergrowth and have incredible scalability. From studying some of the most successful companies in this category, we have found 23 factors or criteria that exist, and we use this as a checklist when evaluating new opportunities.
The third strategy is income growth and capital appreciation. These are companies that increase their earnings, increase dividends and are what Peter Lynch called “growth bonds.” I don’t invest in bonds but use this category for income and it includes our private real estate investments, community banks, REITs and high-quality companies with increasing dividends.
In our next few articles, we will provide more details on each of our main strategies.
Umberto P. Fedeli is CEO of The Fedeli Group