And to win this battle, an investor needs to have a clear set of investment rules, that can help her make the correct investment decisions.
With over 20 years of experience at Liontrust Asset Management under his belt, Cross is among a very few fund managers, who have spent more than two decades at a company.
“I am a great believer that this is a really long game. If you quietly build your investment returns and your own brand, eventually people will recognise that and start to put money with you. It can take a long time. Often people jump in too early, but they should stay put,” he said in an interview with a financial website.
Anthony Cross joined Liontrust in 1997 having previously worked at Schroder Investment Management as an analyst.
Sharing his views on what changed in his two decades of investing experience, Cross says managers now get access a lot of information easily, which has levelled the playing field to a great extent.
“Information is now released fairly to everyone. So we now have just as good information as fund houses, who are a lot bigger,” he said.
Revealing about what investors should look for in a company before investing, Cross says one should try to spot companies that can compound growth over time. “Any company we invest in must demonstrate either strength of intellectual property, strength of distribution network or high contracted recurring income of at least 70 per cent of turnover,” he says.
He says one should invest in companies that have spent a lot of money on research and development, have built superior world class products which are easily protected, and have sold those products throughout the world.
During his career spanning over two decades, Cross developed a number of simple investing rules and beliefs which can help investors generate better returns and avoid big mistakes in investing. Let’s look at some of these rules.
- Avoid making emotional investment decisions: Cross says investors often fall in the trap of making emotional decisions while investing rather than remaining patient and unfazed by the noise in the market.
He says investors often rush into buying decisions and show impatience while executing a trade in times of market volatility. On the other hand, while making a sell decision, investors tend to react in the opposite way and are not willing to sell very easily even if their investment has gone sour, as it hurts their ego and they get into denial mode.
“No one likes to crystallise a loss and selling will underline that an intellectual mistake has been made. Denial is frequently the default response that leads many investors to continue holding the stock,” he says.
Cross believes if investors can create a set of investment guidelines that they can follow every time, then they can make better investment decisions and would be able to avoid emotional judgements while investing.
“When a company we have invested in encounters difficulties, we need to judge whether it is suffering from a general industry downturn or whether we should be questioning its long-term possession of competitive advantage. If there is evidence that its competitive advantage is undermined, then it is better to sell,” he says.
- Stop predicting macroeconomic events: Cross believes it is quite difficult to predict macroeconomic events successfully as exogenous economic shocks are unavoidable and unpredictable.
Cross says it is better to concentrate on the selection of companies capable of outperforming over a business cycle rather than predicting macroeconomic outcomes.
“The Covid-19 pandemic has really illustrated that some events with huge economic significance can’t be predicted or pre-empted by investors. During such a crisis, as in all others, it is important to focus on a company’s ability to trade through a downturn and its potential to emerge on the other side in a position to take advantage of any subsequent upturn,” he says.
- Look for companies having high pricing power: Cross says investors should look for companies that have the ability to maintain prices and profit margins in a crowded and competitive market.
He says if one can spot companies with high pricing power, then they should prefer to invest in them during periods of economic uncertainty, when consumer confidence and spending is low.
He says one of the clearest and simplest ways a company can possess substantial pricing power is through the value of a brand. “In simple terms, a company can maintain prices and protect profit margins in the face of competition or cost inflation. In more jargonistic terms, we would say that the company’s demand is relatively price inelastic,” he says.
- Make full use of your valuation toolkit: Cross says investors often make the mistake of relying on one-dimensional valuation metrics. He says although some of the valuation tools like price/earnings (P/E) ratio are quite simple to use, they also have their limitations.
“While easy to calculate and very intuitive, price/earnings (P/E) ratio’s most obvious limitation is that it is only as good as the ‘e’ – the earnings estimate used. Earnings are hard to forecast. Because we look for companies whose barriers to competition allow strong earnings to be sustained for longer periods than is expected, actual earnings often turns out to be higher than the forecast used in P/E ratios. This means a company’s shares may be less expensive than what the P/E ratio suggests,” he says.
Cross advises investors to make full use of their valuation toolkit exploiting the strengths and recognising the weaknesses in order to make better investment decisions.
- Conduct in-depth examination of valuation metrics: Cross says it is better to buy a company with characteristics of high quality such as good cash flow returns on capital invested than one that looks attractive on a simple valuation metric.
“It’s far better to buy a wonderful company at a fair price than a fair company at a wonderful price,” he says.
He feels investors should carry out an in-depth examination of valuation metrics to identify key business characteristics in a company, so that it becomes easier to make investment decisions.
“Some companies possess intangible assets which act as barriers to competition. This should allow them to sustain earnings growth, which will serve to erode ‘expensiveness’ and generate good long-term share price returns,” he says.
- Buy high quality companies: Cross says investors should aim to buy high-quality companies with defendable barriers to competition. He feels investors should watch these companies very carefully to make sure the barriers remain intact and the financial performance is as expected.
- Avoid sectors lacking competitive edge: Cross says there are certain sectors of the stock market that are more likely to possess the competitive advantage characteristics that investors try to identify in companies. But he feels if a company or whole sector fails to provide the competitive edge that investors are looking for then they should be happy not to own them.
- Pick long-term ‘outperformers’: Cross says professional and amateur investors both struggle to consistently play ‘winners’ in the short term. “By attempting to pick consistently the best performing stocks over any particular short time period (a week, month or quarter, for example) – the equivalent of trying to play a winner in a game of amateur tennis on every point – one might pick a few stocks that shoot the lights out, but it is likely to come at the cost of a number of failures,” he says.
He says the best approach investors can follow is to pick stocks that they believe will outperform in the long term. “The best approach is to keep things simple, play your own game, concentrate on your defences and avoid the costly losing shots… or in more conventional investment terminology, pick stocks that you believe will outperform in the long term,” he says.
(Disclaimer: This article is based on various interviews of Anthony Cross.)
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