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Chapter 2: A Common Sense Approach to Investing

The application of common sense

As Warren Buffett once pointed out, investment is not a subject in which the person with the highest IQ will do best. I for one take great comfort in this view. I have always thought that investment is a relatively straightforward subject that is best kept simple.

It constantly amazes me how many people who are successful in their business lives seem to struggle when it comes to investing money. They should analyse why they have been successful in their own fields. Very few will have been technical experts. Most will have had a general interest in the area of the market concerned and would have adopted what many would describe as a common sense approach.

It seems to me many forget these principles when they enter the world of investment or decide, wrongly, to delegate the management of their money to people who are less able than they are.

Back to basics

Let’s go back to the very basics before we draw up some simple guidelines that hopefully will help.

When you buy shares in a company you become one of the owners of that business. The extent of your ownership is dictated by the number of shares you own compared to the total number in issue. The total value of a quoted company is referred to as its market capitalisation (often abbreviated to market cap), and this is calculated by multiplying the total number of shares by the current share price.

What’s in it for you?

As the part owner of the business you are entitled to two financial benefits:

1 A share of the current capital value of the business represented by the current share price.

2 A share of the annual profits. A proportion of these is often paid out each year as an income and is referred to as a dividend.

This being the case, you should ask yourself what type of business you would like to own. If you were buying the entire business you would undoubtedly think very carefully about this. You should do the same when it comes to buying shares.

Invest in what you know

Warren Buffett talks of this as the investor’s circle of confidence. It’s obvious, and only common sense, that the investor should focus on areas or sectors that interest them and they know best. At the very least the investor should appreciate what a company does and how it makes money. Often when I speak to investors about their shareholdings they have no idea what a company they own actually does!

The American investor, Peter Lynch, had a similar idea when he recommended investors to invest in what you know. He believes that the individual investor has an advantage over the professional fund manager because he believes they have more of a normal life than fund managers stuck in Wall Street. He records the fact that he has found some of his best investments when he was just going about his normal life.

I agree with Lynch’s thinking. If you keep your eyes open and your brain turned on when just living your life, you can spot great stock market opportunities – long before the figures become visible even to the most perceptive of stock market professionals.

Examples

Let me give you a few personal examples that illustrate that good investments are not only found in the Financial Times or broker’s reports:

1. ASOS [ASC]

The first involves an old favourite of mine and goes back to April 2005. I came in from work and found my three young teenage daughters gathered around a laptop. I asked what was so interesting and they replied ASOS! I asked them a few questions about the company, more out of politeness than real interest.

I thought no more about this until the next morning when I was waiting to do a training presentation in Glasgow to a largely young female audience of new recruits. While waiting for a few latecomers, and more to break the awkward silence than for any other reason, I asked had anyone heard of ASOS. The majority of the girls put their hands up and spoke in positive terms, as my daughters had the night before, about the company’s website, the style of clothes and the prices.

After the session I checked the company out on the website and I liked a number of things about it. It also had a low PEG [explained in a later chapter], which helped me make the decision to buy some shares for 51p on 19 April 2005. I then bought some more at 77p in November of that year, and more in July 2007 for £1.23. Subsequently, on three separate occasions I sold part of my holding to take profits, but I still hold some shares – currently priced at over £18.

There is no doubt in my mind if it wasn’t for seeing my three daughters huddled around the laptop, and the reaction I got to my questions the following day in Glasgow, I would never have even heard of the company until the share price was at least eight times higher than the level at which I first bought at.

2. easyJet [EZJ]

Another example of spotting investment opportunities in everyday life would be easyJet.

In 2008 I had cause to fly with them for pleasure and business about a dozen times. I had only used them a few times before so my regular use in this year was sheer chance. Although not every aspect of the service was a joy (Speedy Boarders!), overall it was a very positive experience and attractively priced. I noticed that the flights had very few empty seats, in-flight food was purchased at every row and staff on board seemed to appreciate that customers have a choice (not always the case!) This made me think it was a business in which I would be happy to be a co-owner.

I bought shares in December 2008 at £2.52 and took profits from half of the holding just one year later at £4.60. Although the share price has been a little erratic since (due to ash clouds, snowed-in airports etc.), it still stands a fair way above my purchase price.

3. Straight [STT]

The final example focuses on wheelie bins!

I noticed that the number of different bins we had at home had increased from one to three. I then stayed with a friend in Motherwell and noticed they had four, all in different colours! I travel a lot for business and driving around, keeping my eyes open, it appeared that wheelie bins seemed to be growing on every street corner faster than a triffid in a compost heap! It wasn’t just the bins, but the whole concept of recycling that caught my imagination. I made some enquiries and discovered that Straight was a company with a significant stake in the wheelie bin market and was growing both by acquisition and organically.

I bought shares in the company at 67p in June 2009 and today they are priced at 115p (hopefully with more growth to come as I still own them).

The lessons

All three of the above examples are investments I originally discovered when I was just living my normal daily life. Obviously, I researched them properly after they had come to my attention, but the fact is they only came to my notice originally when I was chatting to my daughters, flying about or just driving around my local neighbourhood. It pays to keep your investment brain switched on even when you are away from your laptop!

Keeping it simple

Another point I want to make, which in a way is closely connected in conceptual terms to Buffett’s “circle of confidence” and Lynch’s “investing in what you know”, is the idea of focusing on simplicity when you select the companies you invest in.

The point I want to make here is that some businesses are a lot easier to understand than others. I suggest you make things easier for yourself by vetting out the difficult investment opportunities early in the selection process. The more straightforward the business of a company, the better.

Look again at the three example investments I gave above; they were involved in selling clothes, transport, and making wheelie bins. None of that is very sexy or complicated – just simple, solid businesses.

The greater the clarity in a company’s operations and how and where it makes money, the more attractive as an investment proposition it becomes. I find that opaque is not a good style for a company to adopt for its business plan if it wants me as a co-owner. Nor for the great Warren Buffett, who famously said:

“never invest in a business you cannot understand.”

Nevertheless, some companies seem to go out of their way to muddy the waters. Very often this happens when a company grows by means of multiple acquisitions over a short period. I think you need to be very careful when this happens, as it becomes almost impossible to make comparisons or judgements on a like-for-like basis. They seem to never stand still long enough to do so.

Let me give you an example of a company that I believe achieves the clarity that I seek.

Medusa Mining [MML] is a high-grade, low-cost gold producer based in the Philippines. It is actually one of the world’s cheapest gold producers as it currently produces it at a cost of less than US$190 per ounce. It sells it for more than US$1300. How is that for a simple business case?

Why would you not want to be the co-owner of a business that digs something out of the ground and sells it on for 650% more than it costs to dig it up?

I believe companies with business cases as straightforward as this are ones to put on your investment shortlist. Make life easier for yourself by taking the complicated ones off!