Last week, I was at home watching England play the Test match against India.
It’s fair to say England’s cricketers have had a very disappointing run of results since last summer’s triumph against Australia. So much so that ‘experts’ in the media argued for some radical selection changes ahead of the latest match.
According to the commentators, we should have dropped captain Alastair Cook and considered resting leading bowler Jimmy Anderson.
The one thing everyone agreed on was that it was time for change.
From a contrarian’s standpoint, what happened next was entirely predictable. Cook led England to a convincing win, scoring heavily with the bat. Meanwhile, Anderson won Man of the Match!
Cricketers have a saying: “form is temporary, class is permanent”. I think this sentiment translates well into the investment world. Selecting a good fund manager or finding a first-rate CEO to back should involve a similar process to picking a sports team.
With that in mind, today, I’m going to show you how to identify the class acts.
Past performance is key
One of the sayings I hate most in investing is “past performance is not a guide to future performance”.
What a load of rubbish!
This bland disclaimer has appeared on adverts for investment funds for as long as I can remember. And because it’s always on everything, I suspect people stopped paying attention to it long ago – which is just as well in my opinion.
Past performance is one of the best ways of spotting real class after all.
Of course, it’s not as simple as just looking at the raw data. The England cricket selectors don’t just pick whoever has the best batting or bowling average – they analyse the context in which the runs have been made or the wickets taken. They judge the quality of a player’s technique and assess his character.
It’s a process we should aim to replicate in the investment world.
After all, it’s not enough being a top performing fund manager over a few months. The market conditions might just have favoured your particular style.
For example, all ‘value investors’ suffered during the dotcom boom and looked useless. They then topped the charts and looked like stars, as cheap value stocks roared back into fashion after the bust.
But the class acts are those who don’t come to too much harm when the market is against them while still managing to make hay when the sun shines on their style.
That’s the quality and consistency we’re looking for as investors!
Don’t judge a company on the good times
It’s exactly the same when I’m looking for quality shares to buy. We mustn’t confuse a temporary upswing in business conditions with the attributes of a great company.
For example, in a property boom all housebuilders are going to make good profits and look like terrific companies. The class acts are those that manage the cycles well. They’re the ones that conserve capital and don’t flirt with bankruptcy in recessions; as well as making tons of money during the good times.
Berkeley Group (BKG) springs to mind as the one housebuilder that has done just that over several cycles.
Just as with fund managers, you need to see how a company and its CEO perform in the bad times as well as the good in order to judge whether they are a class act.
What that irritating disclaimer should say then, is that a short-term snapshot of past performance isn’t a good guide to future returns. But judgements based on a long enough sample of data, which is then analysed in context, are the best guide we have to the future.
Class always wins out in the end
Now if you are really smart, you’ll only hold these top quality shares or funds during those periods when they happen to be in top form. That’s a tall order but it’s not impossible if you have the necessary time and energy to devote to your investments. Even the best long-term investments will spend time treading water or retracing some of their gains.
Of course, this can be a dangerous strategy.
There’ve been plenty of times when I’ve sold a good share and congratulated myself as it then drifted down in price. But in those cases where the stock was truly a quality company, the setback proved temporary and the uptrend resumed with me no longer on board.
So if you have identified a quality fund or stock, the best thing to do is stick with it. Class always tells in the end; on the cricket pitch and in the stock market.