I've spent a huge part of 2016 analysing my own investing strategy, looking closely at the processes I go through and how it relates to the types of businesses I want to own going forward.
It's been a transformational period and has meant some tough calls; repenting for past sins and clearing out undesirable or underperforming companies. It has also been hugely rewarding.
The audit has led to a number of essential investing lessons which can be applied by almost everyone.
Psychology:
It's important to understand mental models to recognise your own limitations
Finding a great business is only part of the investing paradox. The rest comes down to understanding the view of other investors (the price) and recognising when to act.
But our decision making can be easily corrupted by faulty reasoning or biases. 'Anchoring bias' is one especially destructive mental model I find myself suffering. It involves bench-marking our expectations of price based on some random level which can delay us from both buying and selling, when all other evidence suggests we really should.
Another bias I've found myself succumbing to is what Berkshire-Hathaway's Charlie Munger calls, gloriously, "availability-misweighing tendency", a bias where we over-emphasise the importance of information which is readily available.
This can mean, for example, incorrectly judging a company's value by a glance at its price-to-earnings ratio, instead of rolling up the sleeves and digging into the numbers which drive cash flows and earnings. This can lead to huge mistakes for cyclical or growing companies.
Commodities:
Supply and demand is the number one law of commodities, and it can swing rapidly
By all means, invest in commodities. But if the industry's supply and demand is too difficult or time consuming to understand, strongly consider walking away.
One of the biggest traps with commodities (whether its almonds producers like Select Harvests Limited (ASX: SHV) or LNG producers like Santos Ltd (ASX: STO)) is not sufficiently understanding the cycle of supply relative to demand and investing at the wrong time.
Bargains:
Anything is a bargain if it is cheap enough
This is a lesson I took from studying the great Howard Marks, whose investment memos and book 'The Most Important Thing' I pour over like scripture. Marks, an astute contrarian investor, notes that the companies most investors 'won't touch at any price' can become the best bargains.
Clearly, some companies shouldn't be touched at any price such as Dick Smith. But there are always exceptions, like earlier this year when the share price of unloved oil producer Senex Energy Ltd (ASX: SXY) was made up of 70% cold-hard cash.
Senex Energy's share price has jumped back 67% since then.
