It's hard to find someone who knows more, or has thought more, about investing than Charles Sizemore. As the founder and editor of Macro Trend Investor, and CIO of Sizemore Capital, he's tightly focused on markets and how to make them pay. He shared with us how to get started in investing, and how to form the most effective strategy.
What are some common misconceptions about investing?
I would say that the biggest misconceptions I see involve the understanding of risk. Investors are put off by short-term volatility and in fact, this is what most of the metrics used in the industry are based on. I would encourage investors to take a more holistic approach to risk. Short-term squiggles do not matter. What matters is the possibility of permanent or long-term loss. These sorts of losses can be avoided by simply using common sense and by paying a reasonable price for your stocks. And naturally, there are harder-to-quantify risks, such as the risks associated with NOT investing: not keeping pace with inflation, losing real purchasing power, etc.
Where should the rookie investor start? What should he or she be looking for?
First off, figure out your objectives. Obviously, we all want to make money. But you need to ask yourself serious questions: What is my time horizon? If I lost these funds, would it be devastating to my lifestyle? What is my tax situation, and how will a given investment affect my taxes? Do I need current income? Do not invest a single red cent until you've given some time to answering these questions.
Once you start investing, give yourself a good foundation in broad-market ETFs or mutual funds, preferably with a global focus. Once this is in place, feel free to expand into individual stocks.
And naturally, you should read extensively and form a network of fellow investors to discuss your investment ideas. And it never hurts to have a good professional financial advisor or two to manage at least a portion of your savings.
How do you assess an investment? What are you looking for before you put in your money?
I generally like to see four conditions in place. First, a company should be well positioned to benefit from a powerful and durable macro trend. A "macro trend" can be anything from the term structure of interest rates to rising living standards in the emerging world, but the keys to look for are predictability and a degree of inevitability. For example, the aging of the Baby Boomers is an inevitability, and finding companies that benefit from this trend is as simple as researching which products and services are favored by consumers of each age and stage of life. By investing within a major, durable macro theme, you give yourself a wide margin of safety. You can afford to be slightly off in your other assumptions when you're right about the underlying theme.
Next, the stock should be cheap. I am first and foremost a value investor, as the price you pay is ultimately the biggest single contributor to the returns you enjoy. Value can be measured in different ways, of course. You can use valuation multiples, such as price/earnings, price/sales or price/book ratios. You can go deep value hunting by doing a sum-of-parts analysis. Or you can use a discounted cash flow model. All can be useful tools under the right set of circumstances.
Thirdly, I like stocks that take care of their investors. Remember, if you own even a single share of stock, the company CEO is your employee. He or she works for you, though you wouldn't know that from the way that many CEOs behave. Two good measures of shareholder friendliness are, of course, dividends paid and shares repurchased. Ideally, a company will have a long history of raising its dividend and of judicially buying back its stock when market conditions warrant. As a general rule, I like to avoid companies that dilute their shareholders via excessive employee or executive stock options. I also like to avoid companies with a history of wasting shareholder money on value-destroying mergers.
And finally, I like to know who is investing with me. Ideally, the directors and managers of the company will have "skin in the game." I like to see consistent insider buying and ownership. This way, I know that management's interests are aligned with my own.
What are some warning signs that you shouldn't invest?
First off, always be aware of price. If a stock's valuation has reached bubble territory - and let's face it, that is where most social media and new tech stocks are today - you should sell and move on, or at least be prepared to sell at the first sign of trouble.
Also, watch the insiders. Company insiders are required to report their trading activity to the SEC. If you see insiders selling aggressively, you might want to follow their lead.
Finally, use common sense. If you don't understand what a company does, you have no business investing in it.
How should the individual investor be balancing risk?
There are a couple good common-sense rules to consider. First, no matter how much you love a stock and believe you understand it inside and out, never allow one stock to completely dominate your portfolio. If you own your own business, you can control your own destiny to an extent. But remember, when you own stocks you are a passive investor; unless you're a big enough investor to force yourself onto the board of directors, you have absolutely no say in how the company is managed. You would never sink your entire net worth into a private business over which you have no control; the same common sense rules apply to the market.
Also, be careful with employee stock ownership programs. Some companies offer fantastic incentives for their employees to invest in company stock, such as share-for-share matching. If your employer offers a generous program, by all means, take advantage of it. Just make sure that you regularly rebalance, and make a habit of selling off at least part of your shares when the vesting/restricted period ends. You already depend on your employer for a paycheck. You don't want to depend on them for your stock portfolio as well.
What trends in finance should we be keeping an eye on?
U.S. stocks are pricey right now. I wouldn't say that they are in "bubble territory," per se, but they are not priced to deliver strong returns going forward. Much of the rest of the world is, however. In my view, the investment theme of the next 10 years is this: underweight U.S. stocks and overweight European and emerging market stocks.
One other trend worth watching: I expect Japan to have a devastating financial crisis before the decade is over due to the country's excessive debts, aging and shrinking population and increasing need for external financing. So, if you have any investments in Japan, be prepared to sell at the first sign of trouble.