Why you should ignore the market

PORTFOLIO POINT: Forget what’s happening in the market. Your job as an investor is to buy stocks with super economics at attractive prices.

One of the most common reasons mentioned to me for not investing right now is that investors are uncertain about the market. Unwittingly, investors are timing the market and this usually ends in missed opportunities, if not worse.

Given that a portfolio of extraordinary businesses purchased at rational prices has been able to carve a path much different to that provided by the broader market, it is worth considering what is meant when one refers to ‘the market’.

For an investor in a business that is unlisted ‘the market’ is irrelevant. And so it should be for an investor in a business that is listed. The market will go up and it will go down, but business performance will rarely be influenced by it.

Your job as an investor is to ignore this omniscient being called ‘the market’ and simply to purchase, at attractive prices, a collection of businesses whose economics are superior. It really is as simple as that. The only way I can make it even more applicable is to suggest you look for equity that grows quickly through retained profits along with high rates of return on that equity.

Figure 1 is an example of what I am referring to:

Click to enlarge

Notice the businesses in the portfolio produced an aggregate level of profitability higher than the market average, that the level of debt is far below the market average, and despite these superior economics their price earnings multiple reflects that they are less popular than the market average stock.

In 2012, economists forecast doom in China, doom in Europe a recession in the United States, and they are now focused on a fiscal cliff (which we think will turn out to be more of a hill than a cliff). And yet despite these prognostications, the US S&P500 has risen substantially and a portfolio of great businesses bought at rational prices has done likewise.

My advice for 2013 is simple. Ignore the market and economic prognostications – invariably they will be wrong. And remember this; an investment of just US$40 in the early 1920s in one share of the Coca Cola Company is now worth many millions, despite many interest rate rises and falls, budget deficits and fiscal cliffs, recessions, assassinations and even wars.

Keep doing the same thing that successful value investors have been doing for decades. Turn your back on market timing for good, and instead look for and invest in businesses that have the markers of superior economic performance – high rates of return on equity, little or no debt, bright prospects and some clarity around whether they have a competitive advantage that is enduring.

Here’s my 2013 list of stocks to watch:

Codan, Breville Group, Cochlear, CSL, Silver Chef, Cash Converters, On The House, Webjet, Flight Centre, M2 Telecommunications, Seek, Decmil, MacMillan Shakespeare, The Reject Shop and Credit Corp and Ainsworth Gaming.

With that, a happy and safe Christmas to you all and for 2013; many happy returns!

Roger Montgomery is the chief investment officer at Montgomery Investment Management. If you would like the opportunity to discuss your portfolio and investment options with Roger or his team simply email office@montinvest.com.