The Rules of Investing

I recently had the pleasure of being invited to listen to a presentation by Anton Tagliaferro which he delivered during the annual group conference of Alf Mizzi & Sons Ltd.

Few Maltese investors may have read about the success of Anton Tagliaferro. He was born in Malta but then moved to London where he completed his Bachelor’s degree in Accountancy. He commenced his professional career with Deloitte in 1981 and three years later he moved to Sydney also working for Deloitte. Anton Tagliaferro subsequently began working in the fund management industry in 1988 and set up his own fund management business in 1998, Investors Mutual Limited, specialising in Australian equities. Currently, Investors Mutual manages close to USD10 billion on behalf of various Australian institutional investors.

Anton Tagliaferro also featured in the publication ‘The World’s 99 Greatest Investors’ alongside some very well-known people such as Benjamin Graham, Carl Icahn, George Soros as well as Warren Buffett and Charles Munger of Berkshire Hathaway Inc.

During his presentation at the Alf Mizzi & Sons group conference, Anton Tagliaferro gave an overview of the dynamics of the Australian economy which he labels the ‘lucky country’ as a result of its vast resources and the country’s proximity to China and India. Australia’s two largest exports are coal and iron ore. He then went on to explain what he believes to be the 4 basic rules of investing.

Momentum vs Value

Anton Tagliaferro started off by explaining the difference between momentum investing and value investing. He explained that generally when prices of products go up, demand falls and likewise when prices decline, demand increases and people buy more of that product. This is very evident for example in the retail sector during the ‘sale season’ when many products are on offer at discounted prices.

However, the general behaviour of most retail investors on the stockmarket is different from that in everyday life with other products. It is very usual for investors to want to sell their shares when prices are falling and on the other hand, they are encouraged to buy when share prices are rising. This is referred to as momentum investing when investors follow the herd instinct by getting excited when stockmarkets are rallying and allowing fear to take over when share prices are correcting.

Value investors meanwhile carefully calculate what they believe to be the fair value of a company’s shares and seek to acquire at a level below this fair value irrespective of the general mood in the market. As such, when sentiment is euphoric and share prices rise above their fair value, it is generally a time to sell or ‘take profits’ and likewise when markets drop, it may be a good time to buy quality companies whose share prices dropped below their fair value.

Speculating vs Investing

Another important distinction which Anton Tagliaferro mentioned in his presentation to the Alf Mizzi & Sons group conference is that between ‘speculating’ and ‘investing’. Although very often these terms are used interchangeably, they have very different meanings indeed.

When investors simply buy shares with the intention of selling these shares in the short-term for a quick capital gain, their behaviour is mere ‘speculation’ rather than ‘investing’. Speculation generally brings about a higher risk of losing capital. He referred to the hype of bitcoin in recent years when people in his view were not really ‘investing’ but speculating that they can sell the cryptocurrency at a higher price. In fact, Anton Tagliaferro claimed that there is no basis for measuring the value of bitcoin since it does not generate any cash flow or an income stream. This is the same rationale used by Warren Buffet over the years for not including any gold in the portfolio of Berkshire Hathaway.

On the other hand, investing is buying real assets (such as shares) that generate sustainable cash flows. Anton Tagliaferro explained that at Investors Mutual they patiently accumulated a portfolio of quality companies that they believe can grow their profits over time and that can generate a sustainable and growing income stream. Good quality companies use the cashflow generated and retained in the business (after paying dividends) to grow the value of the company and therefore the wealth of all shareholders. During his presentation Anton Tagliaferro gave a very simple but effective example of how a company generating a positive return on equity can grow the value of their business through the power of compounding.

Information vs Knowledge

Anton Tagliaferro also told the audience to base an investment decision on knowledge of a company and not just rely on the vast amount of information very often available across news channels, emails, newsletters, etc. In order to build the required level of knowledge of a company so as to be in a position to make an informed investment decision, one must understand the company’s competitive position within its industry and its strategic initiatives to build shareholder value. An investor must also understand the main factors contributing to the success of a business as well as its profitability and analyse its financial position to gauge the amount of debt and how easily this can be repaid. The best way to gather the right information in order to make sound investment decisions is by going through the details found in a company’s annual reports and also questioning top management to try to gauge a deep understanding of the company and the overall sector.

Perception vs Reality

Another important rule is to distinguish between perception and reality. During the presentation, Anton Tagliaferro gave a very good example of how some share prices in Australia had dropped in 2010 and 2011 as a result of the fears across the eurozone that Greece would be defaulting on its debt. The reality was that this would have had very little impact on the Australian economy. The lesson to be learnt is that very often share prices fall even though they are not impacted by certain events taking place. Investors must therefore not blindly follow the herd but understand the reality of what the impact would be if certain events materialise.

Anton Tagliaferro’s investment philosophy is essential one of a value investor. I had written about the importance of following certain principles on various occasions in the past by also quoting excerpts from Warren Buffett’s investment newsletters.

Essentially, Anton Tagliaferro stressed on the importance to invest in companies with a competitive advantage, generating recurring earnings, run by capable management, that can grow over time and whose shares can be bought at a reasonable price.

He explained that share prices generally do not go up because they have to, but because their profits increase. He argued that this is what investing is all about. The more difficult question is what price to pay for that growth. Is the market being very optimistic on a company? Is the market pricing a share too high? Is all the good news already factored in?

Essentially, investors must seek good quality companies where there is a possibility for earnings and dividends to grow eventually leading to a rising share price.

Anton Tagliaferro also indicated that share prices do not all perform well at the same time. In line with the philosophy of value investors, investors must be patient and think of owning a company forever due to the recurring cash flow generation. As Warren Buffett says: “The stock market is a device for transferring money from the impatient to the patient.” The key is for investors to be patient and benefit from the rewards of equity investing over time. There has been ample evidence of this over the years even across the Maltese capital market.

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