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High Probability Strategies For Investment Analysis
High probability strategies can be employed by investors willing to do the investment analysis and who have the patience to wait for their rewards. We live in a world of instant gratification where we take short cuts that promise quick wealth. The vast majority of investors end up with investment returns that are far below average.
If you are interested in the thrill of big losses and big wins then you should probably stop reading this blog and consider the kind of gambling you desire. However, if you are interested in building wealth with a prudent high probability approach, then read on.
Most investors experience a behavior gap. In other words they do much worse than the market averages because of behavior that usually involves short term emotions. This is because they don’t develop patience and the discipline to stay focused on value.
Patience is a virtue that will allow you to greatly reduce your investment mistakes. The key to investing is to only invest when the odds are heavily in your favor. This means your investment analysis needs to be focused on strategies that are long term value oriented rather than focusing on instant gratification.
Investment Analysis for Individual Investments
Margin of Safety / Intrinsic Value
Margin of safety means purchasing investments for less than their real worth. Markets mis-price securities both above and below their true worth. Many times the mis-pricing is almost universal. In other words, sometimes an entire asset class is mis-priced.
If the asset class is overvalued it can take a great deal of patience to wait. If the asset class is undervalued you should take considerable care in picking those individual assets that are most undervalued and therefore provide the largest margin of safety.
Quality Investments / Dividends
Benjamin Graham, the father of value investing, found the biggest risk of buying bargains was purchasing low quality stocks or value traps. He contended that finding quality investments was the key to successful bargain hunting.
Quality Investing means finding companies with good management, stock balance sheets, an economic moat, consistent dividends, stable earnings, efficiently operated, and in the right time of its enterprise life cycle.
Sustainable Competitive Advantages
In order for companies to prosper in the global market they must have sustainable competitive advantages. Companies which have unique advantages are able to fend off competitors and provide above average rates of return on capital.
Sustainable competitive advantages might include being the low cost provider, powerful brands, strategic assets, having barriers to entry, product differentiation, etc.
Investment Analysis for Asset Allocation
Market timing for value investors is valuation timing. Valuation timing involves purchasing more of asset classes that are bargains and less of asset classes that are over-valued.
The upside of valuation timing is that it greatly increases your odds of above average rates of return in the long run. The downside is that it sometimes requires patience. It is time that makes valuation timing successful.
Probable Maximum Loss
Calculating a probable maximum loss can be one of the most effective means of controlling investment portfolio losses. Most investors are too aggressive, particularly when valuations are not favorable for above average returns. A risk management plan that avoids large portfolio drawdowns is the most underrated concept in investing.
Portfolio rebalancing and weighting are a critical part of valuation timing and minimizing portfolio drawdowns. Instead of rebalancing to a fixed asset allocation the astute value investor will make valuation the primary determinant of asset allocation decisions.
Sell those assets that are no longer bargains. Don’t fall in love with assets that have appreciated to the point they no longer offer a sufficient margin of safety. At the same time, don’t allow risk aversion to keep you from taking losses if you made a mistake.
Investment Analysis & Patience
All of these strategies require patience and thoughtful investment analysis. We can’t do what everyone else is doing because that causes us to overpay on the buy side and accept too little on the sell side (i.e. panic selling). These types of behavior doom investors to below average rates of return.
Yes, it may take patience to wait for the market to realize the true value of your investment. Yes, it may take patience to wait for favorable prices before taking aggressive positions; but it is the difference between below and above average rates of return.
Your investment analysis should include these high probability value strategies because they improve returns and lower portfolio volatility.
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