The Big Boys, page-305

Orwell, that's a lot to cover and respond to but I'll try and address a few of the key points you've made.

So, say 100 people invest in buy and hold quality shares and say 5% make a lot of money by happening to buy the right shares at the right time. You could hence end up knowing 5 people who made a lot of money this way. But it doesn’t necessarily follow therefore that a implementing a long-term buy and hold strategy investing in shares and dividends will lead to great wealth. The distinguishing factor here is "quality" shares that have the necessary features to create that longer term opportunity. I know this is a somewhat nebulous term but it would be an essay to describe it in full, so I'm banking that you'll get the essence of what I mean. When I say, "buying high quality companies and holding on to them" I am certainly not referring to what fund managers and talking heads refer to as "Blue Chips" - far from it. It may be that some blue chips fit this quality profile that I look for but as you can see from when I posted my mid-cap portfolio holdings (which comprise the bulk of my portfolio) a stock does not have to have an mc >$1B or be in the ASX 50 (or even 300) to be a quality stock to hold on to. Mispricing of equities occurs far more often at the smaller end of the market, where analysis is much thinner and people like us can take meaningful positions before large funds are mandated to be able to. From what I've observed so far, if you take this approach and have an intermediate understanding of how to value a company, the rewards come and the 5% you quote becomes much, much higher. But I fully appreciate that many investors use the buy & hold approach in an entirely passive and disinterested manner, which is completely at odds with what I am describing. My approach implies a certain level of investment theory and a semi-active approach to maintaining that portfolio, i.e. a Lynchian approach, rather than a passive index approach.

I’ve been mulling over the key points in your post. I thought you were initially making an argument about fundamental investing versus TA. But then I thought you were making an argument about long term investing versus short term, but actually from your examples I’m not sure. Nope. The argument is FA vs TA - not timeframe. The length of hold depends entirely on the ability of the company to maintain it's "quality" status. If a stock loses its economic moat, if earnings begin to decline in an unsatisfactory manner, if mgmt fail to use capital in a desirable way - in short, any number of reasons - then a stock is sold; and that's regardless of whether we're in a Bear or Bull market. There's certainly no room for complacency and unbridled love where you never let a stock go once it's in the stable.

You say all the examples of people you know that built wealth in the stock market were long term investors and use this as an argument against technical trading and charts. Ok. But I also know people and of one in particular who lost millions in the GFC crash due to his margin loans, who was a long term share investor who’s never heard of charting. I also know of a successful long-term share investor who uses charts as a primary tool in guiding entry and exits. Well, I can't speak for an individual's use of leverage, which entirely shifts the goalposts and turns an investment where the owner has no obligation to sell - no matter how crazy the market gets in the short-term - into a function of ST volatility and a bank's risk mgmt policies. The best investors I've encountered have usually played a more active role in their portfolio and thus hunted down the quality stocks and held until proven otherwise. Accounting/investment theory isn't rocket science, that's for sure and the "gut feel" thing comes with a bit of experience. Another benefit of these smaller stocks is that leverage is generally not available against them, so you cannot make the foolish move of increasing your beta beyond the underlying equity. But look, even the less active investors have generally done extremely well over the years if they buy and hold stocks, reinvest the dividends and ideally, seek the assistance of a savvy professional (not a Main St financial planner, who gets paid to throw your money into sponsored funds) who can reassess their portfolios at various intervals.

It doesn’t necessarily follow that shares = fundamental analysis= long term =great wealth. I would say that it does, with the caveat that the shares must be high quality and that you only hold them until they no longer meet that criteria. Importantly, this doesn't necessarily have to have anything to do with being "fully" valued. In many instances, a stock may be trading on a high PE multiple but you do not sell because you feel that the growth trajectory can be maintained (e.g. DMP, ALU, GBT, VTG, BKL, etc)

For me the conclusion from your commentary appears that you have to buy the right assets at the right time, and then I’d argue exit them if they are fully valued and heading down again, to maximise your gains. Absolutely not! Timing is much less important than buying the right companies, with the right characteristics. There's nothing wrong with buying a good stock after it's gone up 300% if it has the traits that are likely to make it a long-term, income paying, capital growth, investment. CAJ comes to mind. MBE is another, although without the divs. MOst who use this approach will agree that if you look after the quality issue, the rest takes care of itself. And if, for whatever reason, something breaks the chain of quality, then you bounce it, as always, taking into account any CGT implications.

But the result doesn’t necessarily matter whether you bought an asset because of FA, TA, Intuition (see Pisces post above) or luck. If you buy any asset at the right time and sell at the right time and reinvest at the right time, you’re going to build that significant wealth. In theory, yes. But as mentioned before, I've never met anyone that's been able to achieve this timing luck, which is why I am totally, 100%, against selling good companies, just because a chart says that the market meets the necessary criteria to label it a Bear. Conversely, I've had lots of mates, acquaintances and even some clients who have said "I'll get back in later" and either never got back in, or timed it in a manner that does their portfolio a disservice.

If you asked your successful equity investors for their valuation spreadsheets on companies, how many of the retail one’s could do it? Maybe they actually used charts to guide investments!. More likely they just thought the companies were quality business because someone or the financial media told them they were and they bought on a bit of intuition or luck. The more engaged ones with at least a rudimentary understanding of valuation theory did the best. There's also (despite the bad press) some damn good advisors out there and some clients who are fortunate enough to select quality investment managers with integrity, can certainly take a lot of the responsibility away from the client. Retail investors who want to go it solo just need to get up to speed with some basic accounting and investment theory and spend a bit of time in the market. The greater the effort, generally the greater the reward, like most things in life.

Volatility:

First some basic maths. If your Portfolio goes up 50% Year 1, 50% Year 2 and then falls 50% Year 3, then you’ve made a total 3 year return of 12.5%. That is about 4% p.a. or roughly a term deposit. So a portfolio that bounces around a lot, with big wins and big losses is going to going to have pretty modest longer-term returns compared to a steady, incremental, compounding investor.

I think that’s part of why traders get a bad name, they mainly follow daily charts (being the highest volatility), enter shorter term trades, get stopped out, jump in and out of trades etc and the volatility of returns means they get a very modest outcome.

Those long term investors in larger cap shares where it’s fairly forgiving and stable, where they don’t have stops but just hold through corrections and allow the stock to play out can presumably sometimes get really good returns. But it’s not necessarily about whether you entered on FA, TA, Intuition or luck or even because you were in dividend paying shares. Success rather appears to me to be about creating low-volatility, consistent returns, allowing portfolio returns to compound by avoiding big drawdowns or losses, whatever the asset class or entry/exit approach.

To reflect on all of the above, volatility really doesn't interest me, except that it can create heightened mispricing opportunities, especially in smaller and midcap stocks. A stock is held until it isn't, based on its quality profile. I realise assets that are priced daily can appear more volatile than, for example, a residential property or a share with low StdDev but all that really matters is the end goal, which is doing the groundwork (selecting the good stocks) and holding until they no longer fit the bill. The rest will take care of itself. Doesn't mean you get every one right (some never play-out, some never end up paying a div, some just go down) but you don't need to get every one right and even if only 2/10 go from a 5c to 50c stock (or higher) or $1 to $10, you'll do very well and by the time some of these companies introduce a dividend, the yield for those who got in early and own a lot of shares can be phenomenal.

Shares go up say for arguments sake 10% a year if they are in a bull phase. If you are investing in shares, then you need time in terms of years for the asset to really play out. So you need to buy at the right time (low), on what-ever basis (FA, TA, Intuition, luck), allow time appropriate to the asset class for it to become fully valued, and then sell when the asset has matured and reinvest in the next growth asset. Not, really. You're lumping all equities into the broader market profile, in which case you may as well just buy an index ETF. Different shares do lots of different things and at varying times to other shares and the broader market. As discussed, timing is much less important than getting the stock right and letting it do its thing. I can only keep repeating that I've never seen anyone get wealthy from trying to time markets, although I fully understand it can be tempting to try and do that. Meanwhile, you miss the dividend income stream while you're out, potentially generate a large CGT liability and then have the onus of having to time your way back in. Just never seen that work.

Alternatively for my TA trading, which is all derivatives (Options), I’ve reflected on how I apply the concept of consistent, low volatility returns to make technical trading with charts successful. The answer which I apply is: trade bigger picture monthly and weekly charts (lower volatility than daily charts), longer holding time frames appropriate to the security being 3mths to 2years, (compared to shorter-term day traders or multi-year share investors), correct position sizing in order to smooths portfolio returns (so no swinging big hit single trades that risk big single losses). There's no reason that sort of TA trading approach can’t build significant wealth vs buy and hold share investors. (I haven’t been trading long enough this way to prove it). Well, if I was going to use charts to try and make money that's the approach I would use too.

So it may be that neither FA or TA, or trading or investing, or shares or derivatives are necessarily the right or wrong answer in terms of the best way to build significant wealth from markets, but rather whether you can develop and apply an appropriate strategy for your asset class of choice, suitable for all market conditions, that can create consistent compounding returns. Yeah, look, I know it will sound boorish, saying the same thing over and over but I honestly, hand on heart, haven't met anyone that's got wealthy from charts. Even the really good prop and commodity traders I've known haven't used charts to any real extent when it comes to investing their own money. In contrast, I've known plenty of people with fairly unremarkable intelligence who've got the basics of valuing covered off, what to look for etc and shown some diligence in maintaining the portfolio and made very big sums! Several of these have been small business owners with limited education but a real thirst to understand what good companies look like and back them in.