Read To Succeed: The Defensive Value Investor
Just like other disciplines, such as art, music, literature and so on, in- vestment has developed its own genres and sub-genres. Music for example has seen the rock genre develop into heavy metal, punk, grunge, glam rock and more exotic disciplines such as Krautrock and crossover thrash. In art we have seen impressionism spin off into post-impressionism and then ab- stract.
The most well known style of invest- ment, value investing, also has a num- ber of sub-disciplines, including deep value, turnaround and special situa- tion approaches. In The Defensive Value Investor, author John Kingham furthers his own approach by taking the main principles of the value investing genre and explaining how investors can com- bine them with a defensive approach in order to create a portfolio of shares which will produce decent rates of in- come and capital growth.
The main difference between “value” and “defensive value” is that the latter approach recognises that companies highlighted by basic value analysis may be cheap for a very good reason. For example, value analysis may flag up a stock which is very cheap on an earn- ings multiple basis but may ignore the fact that its wider industry is in decline – HMV in 2009 comes to mind. Defen- sive value investing thus combines value investing with defensive investing in order to identify companies which have strong and steady opera- tions but which can also be picked up for a bargain price.
The UK Value Investor
John Kingham has honed his invest- ment style over many years as a pri- vate investor and investment news- letter publisher. As with all books with their roots in value investment, it’s no surprise that he took inspiration from the classic tome The Intelligent Investor by investment legend Benjamin Gra- ham. But finding Graham’s rules a little bit too vague, Kingham used his pro- fessional experience in computer pro- gramming, and the logical processes it teaches, to turn what he has learned about investment into a systematic strategy.
The core of the book is split into three parts, with the first two focussed on how to analyse companies in order to find potential buying candidates. It soon becomes clear when reading Part One, covering the quantitative analysis of company accounts, that Kingham much prefers steady large cap stocks in comparison to fast moving small caps. In fact, his first “rule of thumb” – handy hints which intersperse the text – is to only invest in a company if it has paid a dividend in every one of the previous ten years. Not many small caps can claim that kind of consistency! He also likes shares with consistent growth, high profitability, and of course (where the value element comes in) low val- uations. Interestingly, Kingham uses a number of valuation metrics in this book which you won’t commonly find elsewhere. For example, there are a number of ratios introduced which can be applied when investing in banking and insurance stocks, and those with pension deficits.
Part Two is arguably more valuable as Kingham provides ways how inves- tors can analyse whether a company is cheap but cheap for a reason. This comes in the form of identifying value traps and a firm’s competitive advan- tages – two things which HMV inves- tors should have analysed deeply in the years prior to and during its de- mise. The final chapter gives a raft of tips on how to build a portfolio, includ- ing on how to diversify well and when to buy, hold and sell.
Not your typical invest- ment book
There are scores of books on the mar- ket which focus on value investing, the most similar to this one perhaps being Gervais Williams’ Slow Finance. But I thought that The Defensive Value In- vestor stood out for a number of rea- sons.
Firstly, it provides a “portfolio” based approach to investment, advising in- vestors on how to build up a basket of low-risk shares which should do well over the long term. There is none of the sensationalism you see in a mul- titude of lower-quality internet-based stock-tipping publications here. You won’t find any speculative small cap mining and oil stocks recommended in the book. And that is more often than not a good thing.
But what I like most about the book is the final “Rules of Thumb Checklist “section. This consists of all 43 guide- lines mentioned in the book which investors should follow when building up (and selling stocks in) a defensive value portfolio. While no company will ever fulfil all of the criteria (indeed some rules apply to firms in different indus- tries and certain special situations), the more they meet, the more likely they are to be a winning investment. There are also useful guidelines on portfolio diversification and construction, which include the sound advice to hold at least 30 companies, invest no more than 10% in any one sector and have no more than half of the portfolio’s rev- enues coming from any one country.
While John Kingham is a private inves- tor, his detailed and informed invest- ment agenda reads like it has been written by a professional fund man- ager. Indeed, if Kingham launched a fund based upon the principals in this book I believe it would attract a lot of interest from both retail and pro- fessional investors alike. But with the instructions being so systematic and clear why pay a fund manager to man- age your money when you can do it yourself?
This is not a book for traders: in fact Kingham advises that you should only ever commit to making an investment decision when the markets are closed in order to avoid the potentially dis- tracting buzz and excitement which af- fects investors. As a tip from the head of behavioural finance at Barclays this may come as good advice. But if you are looking to build up a steady port- folio full of low risk, high-quality shares with the potential for steady, long-term growth then this is the book for you.
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