8 investing tips from James Montier

With markets falling due to fears over China's economy – the ASX All Ords Accumulation Index fell 5.6% last week – no doubt many investors are watching their shares decline with increasing alarm.

At times like these it's always beneficial to ignore the media scare stories, remain calm and check that you're still on you way to meeting your investing goals. 

To that end, James Montier's book Value Investing: Tools and Techniques for Intelligent Investment offers some good tips for value investors:

1. Don't just take action for action's sake, particularly after losses. On seeing their stocks falling, the first reaction of many investors will be to sell to get rid of the emotional pain of seeing losses in their portfolio. This is just about the worst thing you could do. Investors shouldn't let fear and shock (or past mistakes) overcome rational thinking during market declines. Instead, analyse whether your stocks actually represent better value at current prices and if so, consider buying more.

2. Forced selling can create opportunities. Stocks can often become cheap for irrational reasons. If a stock is kicked out of an index or cancels its dividend, many professional investors will be forced to sell because they're no longer allowed to own such stocks. This can create opportunities for investors who aren't subject to these restrictions. Forced selling can also occur due to simple revulsion. This is contributing to falls in the share prices of BHP Billiton (ASX:BHP) and Crown Resorts (ASX:CWN), with many investors simply not wanting to have any exposure to an apparently tottering Chinese economy. Again, analyse whether the stock actually represents better value at these lower prices. For instance, holders of BHP and CWN should consider whether any negative impacts from China are already priced in.

3. Don't wait for the uncertainty to disappear. One of the reasons that cheap stocks become cheaper is that many investors don't want to catch a 'falling knife' and so wait until they have a clearer view of a company's prospects. The problem here is that by the time the uncertainty disappears, many bargains will have too as other investors pile into the stock before you get the chance to. Buying a cheap stock only to see it become cheaper is difficult but knowing that I'm unlikely to pick the bottom, I always make my initial purchase just a portion of my intended total investment in a stock. That way I have firepower left over to buy at lower prices and, if the stock rises instead, I get the best of both worlds. 

4. Focus on processes rather than the outcome. The influence of luck in investing – particularly over the short term – means that investors can never be certain a particular investment will be profitable. As well as justifying holding a reasonably diversified portfolio, this means you should focus on the process of analysing a stock rather than how the investment actually performs, not just when you lose money but also when you make money. Over time and as the number of investment decisions made increases, the influence of luck on your performance declines and the influence of skill takes over.

5. Valuation is what matters long term. The valuation of a stock and the relationship to its price may be ignored by investors in the short-term – such as in market booms or panics – but this is the primary determinant of returns over the long term. This is the case for both cheap stocks and expensive stocks, usually resulting in better outcomes for investors in the former compared to the latter. 

6. Ask what can go wrong? It's easy to think about how much money you can make but you also need to consider how much you can lose and the respective probabilities of each (the 'expected value', in mathematical jargon). Investors in stocks such as Bellamy's (ASX:BAL), Blackmores (ASX:BKL) and A2 Milk (ASX:A2M) appear to be ignoring this question. I think they should consider whether these companies' share prices already reflect their likely future growth while understating the risks they face. Will increased competition mean future returns are lower than expected? Will they encounter problems (such as supply issues or management errors) as they continue to grow? Or will they merely fail to meet investors' high expectations? As Montier notes, even if actual future growth turns out to be very high but still less than expected, high-flying stocks often become more reasonably priced over time.

7. Require a margin of safety. Montier defines this as buying a stock at a discount to the conservative estimate of its intrinsic value. This places risk management – with risk defined as the probably of loss rather than volatility – at the heart of the investment decision-making process.

8. Success often takes time. Finally, note that you can be wrong in the short term – as the stock you bought continues to decline – but correct in the long term as the stock price moves towards its intrinsic value. So it's not surprising that the successful value investors Montier surveyed had an average holding period of five years.