GMO 7 Laws Of Investing
GMO
WHITE PAPER
March 2011
The Seven Immutable Laws of Investing
James Montier
In my previous missive I concluded that investors should stay true to the principles that have always guided (and should always guide) sensible investment, but I left readers hanging as to what I believe those principles might actually be. So, now, for the moment of truth, I present a set of principles that together form what I call The Seven
Immutable Laws of Investing.
They are as follows:
1.
2.
3.
4.
5.
6.
7.
Always insist on a margin of safety
This time is never different
Be patient and wait for the fat pitch
Be contrarian
Risk is the permanent loss of capital, never a number
Be leery of leverage
Never invest in something you don’t understand
So let’s briefly examine each of them, and highlight any areas where investors’ current behavior violates one (or more) of the laws.
1. Always Insist on a Margin of Safety
Valuation is the closest thing to the law of gravity that we have in finance. It is the primary determinant of long-term returns. However, the objective of investment (in general) is not to buy at fair value, but to purchase with a margin of safety. This reflects that any estimate of fair value is just that: an estimate, not a precise figure, so the margin of safety provides a much-needed cushion against errors and misfortunes.
When investors violate Law 1 by investing with no margin of safety, they risk the prospect of the permanent impairment of capital. I’ve been waiting a decade to use Exhibit 1. It shows the performance of a $100 investment split equally among a list of stocks that Fortune Magazine1 put together in August 2000.
For the article, they used this lead: “Admit it, you still have nightmares about the ones that got away. The Microsofts, the Ciscos, the Intels. They 're the top holdings in your ultimate ‘coulda, woulda, shoulda’ portfolio. Oh, what might have been, you tell yourself, had you ignored all the naysayers back in 1990 and plopped a modest $5,000
WHITE PAPER
March 2011
The Seven Immutable Laws of Investing
James Montier
In my previous missive I concluded that investors should stay true to the principles that have always guided (and should always guide) sensible investment, but I left readers hanging as to what I believe those principles might actually be. So, now, for the moment of truth, I present a set of principles that together form what I call The Seven
Immutable Laws of Investing.
They are as follows:
1.
2.
3.
4.
5.
6.
7.
Always insist on a margin of safety
This time is never different
Be patient and wait for the fat pitch
Be contrarian
Risk is the permanent loss of capital, never a number
Be leery of leverage
Never invest in something you don’t understand
So let’s briefly examine each of them, and highlight any areas where investors’ current behavior violates one (or more) of the laws.
1. Always Insist on a Margin of Safety
Valuation is the closest thing to the law of gravity that we have in finance. It is the primary determinant of long-term returns. However, the objective of investment (in general) is not to buy at fair value, but to purchase with a margin of safety. This reflects that any estimate of fair value is just that: an estimate, not a precise figure, so the margin of safety provides a much-needed cushion against errors and misfortunes.
When investors violate Law 1 by investing with no margin of safety, they risk the prospect of the permanent impairment of capital. I’ve been waiting a decade to use Exhibit 1. It shows the performance of a $100 investment split equally among a list of stocks that Fortune Magazine1 put together in August 2000.
For the article, they used this lead: “Admit it, you still have nightmares about the ones that got away. The Microsofts, the Ciscos, the Intels. They 're the top holdings in your ultimate ‘coulda, woulda, shoulda’ portfolio. Oh, what might have been, you tell yourself, had you ignored all the naysayers back in 1990 and plopped a modest $5,000
References: to specific securities and issuers are for illustrative purposes only and are not intended to be, and should not be interpreted as, recommendations to purchase or sell such securities. Copyright © 2011 by GMO LLC. All rights reserved. The Seven Immutable Laws of Investing – March 2011 9 GMO