Last week I wrote about the dangers of “resulting”, and why process is more important than outcomes. It’s something I tend to bang on about because, well, I just think it’s a key to a successful and enduring investing career.
But as a Strawman member pointed out to me recently, it begs the question: what actually constitutes a “good” process?
For me, a good process has to be rational and informed by an objective consideration of the facts. It cannot just sound good. It must be logically coherent and empirically demonstrable. If your process does not seek to identify characteristics that history has shown are typically associated with good companies, then you are just operating according to how you wish the world worked, not how it actually does.
This is not to suggest you need detailed statistical back-testing of quantitative metrics. That was a great idea thirty years ago. These days, any “alpha” that such an approach might offer has largely been arbitraged away by sophisticated, well-resourced actors. You are up against teams with PhDs and supercomputers who can prosecute those approaches over massive sample sets. You are bringing a pocket knife to a drone strike.
Rather, I am referring to a broader set of truisms that can help set your north star. The markers that tend to be associated with success. For example, a sustained rise in the share price is almost always underpinned by a sustained rise in earnings. High debt almost always confers higher risk. Pricing power is essential for maintaining margins etc. It is not about a precise set of instructions you could code into a computer. It is a set of ideas that help direct your attention to what really matters.
A good process must also be repeatable over a wide enough sample set. You might have a process that pushes your odds well beyond a coin-flip, but if it is so narrowly defined that it identifies a single buying opportunity every few years, well, it’s not very practical. In the domain of probability, you need to make sure you get enough shots on goal to ensure the maths works in your favour.
Next, you want your process to yield falsifiable results. If you can identify clear markers that let you know when a thesis is broken, you will save yourself a lot of heartache (and loss). This is vital because things often look favourable at one point in time only to fall apart later. If you cannot easily identify when the investment case no longer makes sense, you will be extra susceptible to all those nasty behavioural biases that push us toward poor decision-making.
I also think it is important to have flexibility. Your process should evolve, and probably a lot in the early stages of your investing career as you get a hang of the ropes. That is just a natural reflection of learning. The world is way too complicated, and our understanding of it far too limited, for us to be completely rigid. Just make sure that if you are adjusting the dials, you are doing so for a good reason and not simply because a few recent trades failed to deliver.
That said, while it is important to let the market inform you of the merits of your process, understand that you need to seek validation over a decent sample set and a meaningful period of time. A stock that drops 20% the day after you buy it tells you absolutely nothing about the merits of a process oriented towards long-term investing. (Almost all of my best investments have floundered for a good while after I first bought.)
Going beyond high-level concepts, it is incredibly helpful to formalise things. Write it down. A brief document that outlines your core principles and a simple checklist is an invaluable exercise. The act of producing it will clarify your thoughts and reveal inconsistencies. And it gives you a touchstone you can refer back to when things get sweaty in the heat of a market sell-off.
Last but not least, remember there is no single “right” process. There is only the process that works for you. It must acknowledge your skills, your experience, your temperament, and your goals. A strategy that works for a billionaire fund manager might be useless to you if it does not align with your personal situation.
I know much of this is still somewhat vague. If you’re after a precise formula for buying stocks or developing a process, I’ve not offered much help. Except, that is, if I have disabused you of such an (understandable but unrealistic) desire.
In investing, as I’m fond of saying, it’s far better to be roughly right than precisely wrong. You don’t need a perfect recipe for success (it doesn’t exist); you just need a reliable compass pointing in the right direction. And that’s what a good process is all about.
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