Investing — Where to Start?
How can you find your own edge that generates out sized returns? Sometimes when screening for investment ideas, it is important to pick the most worthwhile industry to start your search. Some of the characteristics that I would like to see in an industry are as follows;
- Long-term prospects.
- Not monopolistic/duopolistic.
- Companies have control over their destiny (Minimum risk of intervention by external forces)
- Companies have different earnings prospects based on how they’re steering that destiny.
Doesn’t matter the industry
Of course, as the saying goes, the best industry is the one you know better than anyone else. I’ll admit that it is quite difficult to study your way into competition with people who have lived and worked in an industry for decades.
Even so, you can take some time off to learn and take a deep look at different industries that you are not familiar with. Think about it from a funnel perspective, you could start as a generalist and then learn about as many businesses / industries as you can. Through this process you’ll naturally find yourself attracted to certain businesses and industries. From that point onward you can decide if you want to “specialize” or stay a generalist.
Primers?
Sometimes, using primers helps you to value particular industries by using relevant key metrics.
For banks, I like to use P/B and ROE. These seem to be the most common valuation measure in financials. I would look into EV/Sales for software companies, or startups. In the early stages of a business, top-line growth matters the most. Hence, you find a company that’s trading for a cheap valuation relative to that top line growth. A lot of people use EV/Sales when working with SaaS companies.
EV/EBITDA is a favorite among value investors for its agnostic stance against capital structure, making it easier to compare companies with varying degrees of cap-ex and free cash flow.
Conclusion
As investors, it is important to understand yourself and your appetite for risks, as this will determine how much risk you are willing to take. The other half of the story is understanding how risky the investments you are putting your money into are.
Once you are familiar with the kind of risks you are taking, you can go about trying to mitigate it by employing a diversification strategy that suits your risk profile. This will further reduce the risks you are carrying in your individual investments.
You then have to keep to your plan for the long-term and not get swayed by emotions in the short-term. While doing this, you also need to monitor and make small adjustments to your portfolio as your risk appetite alters through the different life stages you go through.
Lastly, learn as much as you can, find what REALLY interests you and dive down the rabbit hole.
