Constantine Lycos

Constantine’s Investment Philosophy

I believe that the best way an individual can create wealth for themselves is through ownership of highly profitable businesses. Here is why: Clearly it is easier for an individual to end up with more wealth by helping make the “wealth pie” larger rather than by attempting to increase their share of the pie (when the pie stays the same size) because that will mean taking away other people’s share. Great skill will be required as other people will fight to keep their share. Gamblers and speculators participate in this zero-sum game, where one’s gains are someone else’s losses.

So how can one help make the pie larger (i.e. create wealth)? Wealth creation is the result of the appropriate mix of resources (like raw materials, and tools), hard work, know-how, innovation and technology and capital to make this production process possible. Owners of capital may choose to become investors in the production and wealth creation processes by providing the capital. Conservative investors will provide loans to governments that will invest in a country’s infrastructure and labor force, or directly to business owners. The business owners are the profit maximizing investors that choose to own the process so that they can create more wealth for themselves. Of course, for most people lending means holding government or corporate bonds (or bond mutual funds) and owning means holding stocks (or equity mutual funds).

Does this mean that profit-maximizing investors should own all stocks at all times? Clearly, buying businesses where there is no expectation of sustainable profits within a reasonable time is speculation, and speculation, being a zero-sum game, should preferably be avoided. It follows that wealth-maximizing investors should only own quality businesses. Here is what we mean by quality businesses: highly profitable, consistently profitable and financially strong and with good future prospects. While all businesses are cyclical, investors should generally prefer more stalwart, consistently profitable businesses. Companies whose success is dependent too much on external factors, such as commodity prices should generally be avoided as their profits are too unpredictable, making them hard to value and generally painful to own. Their shares often become vehicles for speculation, increasing their volatility even more. This would include shares of most resource based companies like gold, forestry, oil & gas, mining companies, etc and highly economically sensitive businesses like airlines. The only criterion an investor needs to use to determine whether a business is too cyclical for their comfort level is this: would the business’s profits be stable enough to handle their income needs if the business’s profits were their only source of income?

Now the only questions that remain are what price investors should be willing to pay to buy these quality businesses, when they should consider selling them and whether the businesses they own conduct themselves in a way that is consistent with the owners’ sets of values. When the price paid requires unreasonable expectations of future profits before such investment becomes profitable, then that investment ceases to be an investment and becomes speculation. (This is exactly what happened in the late 90’s with the .com fever.) Profit maximizing investors should not buy such businesses. If they already own them they should sell them to the speculators willing to pay the unreasonable prices. Therefore, profit-maximizing investors should buy good businesses at good prices and hold them for as long as they remain good businesses, and sell them if and when speculators are willing to pay high prices.

Rule 1: Buy good businesses. Good businesses are able to consistently increase their net worth and therefore their intrinsic or fair value through time through earning good profits year after year. Is that enough? No, because I do not wish to hide behind partial ownership or diversification. I invest in a company only if I would be comfortable owning and operating the entire thing. This means I would only invest in a company if the business’s set of values agrees with mine.

Most professional investors (from financial advisors, investment companies and private wealth managers to traders, money managers, mutual fund managers and hedge fund managers in particular) treat stocks as meaningless pieces of paper (or these days electronic records of ownership rather than share certificates). Institutional investors (such as pension funds and endowments) suffer from benchmark-itis, a disease that has taken over the institutional investment world whereby portfolios are only allowed to deviate from a chosen market benchmark only slightly. They do not consider the greater impact of their investments nor do they care. They believe that in the name of diversification a portfolio MUST include “exposure” to all sectors and industries. I beg to differ. Investing is all about understanding change and trying to be positioned to benefit from change. I see the future as being better (“greener”, healthier, etc.) and therefore our looking forward approach looking for innovators will be very profitable for our clients.

Rule 2: Don’t pay too much. Good businesses don’t necessarily make good investments. If you pay too much for even an appreciating asset you might have to wait a very long time before the asset that you bought is really worth what you paid for. What I try to do is simple. Buy good assets at a discount and sell them, if mispricing occurs, at a premium. If there is no selling opportunity I hold on to them for as long as they remain good assets. Therefore, the behavior of portfolios I construct is likely to be significantly different than that of the average portfolio or a stock market index. When the index is moving higher from already high levels I will likely not participate in that, but when the market is moving lower from high levels I will not participate much in that either. So normally I can expect our portfolios to do worse than the market when the market is moving higher than is warranted and better than the market when the market is moving lower.

If this makes sense to you and could be interested in having me manage some of your investments for you please email me at constantine@lycosasset.com

 

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