Triathlon (The Financial Athlete #115)

The triathlon is perhaps the most challenging of all sports. To be very proficient in two of the legs of the three legs (run, swim, bike) and mediocre in the third leg will not do to win.  An athlete must excel in all three legs.

Similarly, an investor should be proficient in analyzing trends on three levels: micro, fundamental, and macro. These trends are uncovered through research.

1. MICRO TREND

This covers developments within the company (or a real estate property). Financial literacy is the primary tool of analysis to determine valuation. Also, look for trends in revenue, earnings, working capital, leverage, and cash flow.

Because a stock may trade irrespective of company performance, technical analysis is not inclusive of the micro trend.

Most of what is written on investing concerns this level, because it is the most concrete. While essential, investors tend to become too myopic on the micro level. Investors must move beyond fixating on numbers to gaze upon a bigger picture.

2. FUNDAMENTAL TREND

“In the beginner’s mind there are many possibilities; in the expert’s mind, there are few.” — Shunryu Suzuki Roshi

Studying fundamental trends, we return to the beginner’s mind which seeks possibilities. We may go so far as to even break cherished rules.

A company riding the crest of a fundamental trend generally finds itself in the favor of the financial marketplace. For this reason, valuations for such a company may be considered relatively high. In a special case where a company has reached milestones on the path toward potentially enormous revenue and earnings, we may make an allowance to pay a premium for the stock.

Consider the investment strategy of venture capitalists. They target small companies believed to be best suited to meet an emerging fundamental trend, which can driven by a new technology or a change in consumer preferences. Most of their picks fail, but these losses are usually outweighed by large gains of the few winners. Remember, venture capitalists are supposed to be the professionals in spotting future winners. I do not recommend to mirror the investing strategy of venture capitalists.

Never be anxious to buy a stock once a fundamental trend has been discovered. Oftentimes, new technologies spring up years before the market is ready to adapt it in large numbers. This may not be due to poor marketing. Users may resist  change in the workflow. Therefore, it is wiser to skip being an “innovator” and wait to be an “early adopter” in the Financial Athlete Adoption Curve. For details on this, review The Adoption Curve.

All stocks in your portfolio need not be supported by a fundamental trend. However, a stock of a company operating counter to a fundamental trend should be sold. Such as company has an outdated business model.

Lastly, there is not necessarily a correlation between out-of-favor industries in the financial marketplace and companies whose business models are outdated. A smart contrarian strategy is to  gravitate toward the best-of-breed in an out-of-favor industry in the financial marketplace if and only if the business model is not threatened and customer demand remains intact.

3. MACRO TREND

Invest contrary to a market spellbound by “irrational exuberance” (coined by Alan Greenspan) and irrational pessimism. A market bubble in asset prices precedes an economic contraction, and a massive sell-off precedes an economic recovery.

To be a contrarian value investor takes patience. Irrational, economic behavior may last several years, as well as a recovery to fair valued prices after capitulation.

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