Stick to proven principles of sound investing

LAST year was a year of mixed fortunes for investors, and, as such, it offers a number of sound investment lessons. These are:

1. Say no to the narrative, not the opportunity

It’s easy to get caught up in market narratives. When the news is good and sentiment positive, investors tend to buy popular securities at any price, paying little attention to valuation and risk. When the news is bad and share prices fall, fear of loss makes investors retreat – from real risks, but also those that may be unfounded or overstated.

Although it is important to avoid getting swept up in the prevailing hype or gloom, it is equally important not to ignore the narrative altogether. Some of the best investment opportunities can arise from strong negative narratives; in fact, they are a necessary pre-condition to finding quality companies at cheap valuations.

For example, following Brexit, the share prices of domestic-facing British companies – which are likely to bear the brunt of any potential economic fallout – fell dramatically. Although concerns about the economic implications of Brexit are understandable, it is likely that quality companies managed by capable individuals will continue to be good long-term investments if they are bought at sufficiently cheap valuations.

2. Capitalise on cash

When good opportunities arise, you need to have the flexibility and firepower to take advantage of them. This means holding cash in the absence of attractive investment alternatives.

In addition to narratives, negative events – such as a company scandal or the resignation of a senior executive whom investors consider essential to a company’s success – also create opportunities. When the share price of such a company falls, there is often contagion to other companies in the same sector. Adverse political or economic events can have a similar impact across a whole market.

These situations often create buying opportunities.

3. Don’t lock in losses

If you are losing money on an investment because of a negative narrative or event, be careful not to lock in the loss by selling prematurely or for the wrong reasons. Are you selling a good asset that is merely going through a bad patch? If so, the drop in the share could be temporary and could, in fact, be creating an opportunity to buy more shares in a good company at a lower price.

Markets go up and down, and, in the short term, there is little logic to how they reflect news and other information. So make sure your reasons for selling are sound.

4. Make sure you pay a fair price

If you are looking to capitalise on a potential buying opportunity, make sure the price at which the share is available is, in fact, fair. One way to determine this is to ask yourself what an astute investor would pay for the company if it were sold, and to translate this into the price of its shares.

The factors to consider include: • The company’s financial track record – does it have a history of making good profits?

• Is there a strong market for the company’s products and services, and if so, how sustainable is this market?

• What is going on in the environment in which it operates? Is it easy for other companies to enter the market, or does the company in which you’re interested a particular competitive advantage?

These are only a few of the many questions you need to ask. Calculating intrinsic value is no easy feat – it is even complicated for professionals, and sometimes they get it wrong. So, it makes sense to try to buy a share at below its theoretical intrinsic value – in this way, you give yourself a margin of safety if your calculations are a little off.

South Africa is in an uncertain political, economic and, therefore, investment environment, which makes short-term investment decisions difficult. However, if you stick to proven principles, it can be a good environment in which to make long-term investment decisions.

Anet Ahern is the chief executive of PSG Asset Management.