Investment Process - a Template

Many shall be restored that now are fallen, and many shall fall that now are in honor. — Horace, Aʀs Pᴏᴇᴛɪᴄᴀ

So begins Graham and Dodd's seminal work Security Analysis – alluding to the impermanence of good fortune in investments (and life in general). In many ways, value investing as a discipline attempts to increase the likelihood of profitable outcomes from selecting securities that are currently out of favor and avoiding those that are richly valued.


As in life, there is no "one-size-fits-all" approach/process in investing either - we all have different temperaments, time horizons, risk appetites, return expectations, portfolio preferences, etc. As such, this post provides an overview of our preferred investment approach, which could serve as a template or perhaps inform some elements of your current process. Our preferred investment approach can be summarized as:


Investing in high-quality companies with strong balance sheets and robust business models at prices near their more certain sources of intrinsic value and with ample margin of safety.


Here is a quick outline of one of the ways in which it can be put into practice using the Cognitive Quant platform:

1. Searching for investment candidates: Our preferred approach is to start with a preliminary set of investment candidates obtained by screening for the top 30% of high-quality firms that are in the cheapest decile of earnings yield (EBIT/EV). In times of market dislocation when opportunities abound, a more restrictive screening could be used (such as top 20%). Depending on individual preferences, these candidates can be sifted further using qualitative and quantitative risk factors to further narrow the list. Read further about the screening capabilities in our platform in this blog post.

 

2. Conducting due-diligence:

An investment checklist can then be used to efficiently conduct preliminary due diligence on the above candidates. The checklist establishes an explicit set of steps/checks and associated minimum thresholds for relevant parameters and also helps prioritize and focus attention on key due diligence areas.


Our investment checklist includes both quantitative and qualitative factors. The quantitative checklist items are based not just on a firm's current quantitative snapshot but also on its historical record across the business cycle. Very few firms will likely pass all checklist items, but checklists will help you more methodically and efficiently assess risks to enable better and timely investment decisions. Read further about improving investment outcomes with a checklist in this blog post.

 

3. Avoiding cognitive biases:

It is important to be mindful of cognitive biases throughout the due-diligence process and to carefully consider not just quantitative risks but also qualitative risk factors. The qualitative risk factors in the platform have been developed by leveraging progress in Business Reporting Standards along with advances in NLP, AI, and other text analytics capabilities. This blog post covers some of the common biases in investing and how our platform has been structured to help overcome them.

 

4. Assessing intrinsic value

Relative valuation will not protect an investor from overpaying and it is important to consider the firm's valuation taking into account the business cycle.


We prefer an Earnings Power-based segmented valuation approach as it provides a better assessment of value by separating more certain sources of value (assets and current sustainable earnings power) from more uncertain sources of value (i.e. from future growth). Patient preparation and disciplined investing in high-quality companies at prices near their more certain sources of intrinsic value and with ample margin of safety can be very profitable. Read further on assessing the intrinsic value of firms in this blog post.

 
The person that turns over the most rocks wins the game. — Peter Lynch

Even though the process may come across as linear, it is bound to be iterative in practice. The Cognitive Quant platform has been purposefully designed to minimize distraction, overcome cognitive biases, and nudge investors towards a more deliberative approach. In addition, we have ordered the flow of the analysis page from high-level analysis to progressively deeper analysis to help users efficiently conduct due diligence by enabling faster elimination of less appealing investment candidates. Please reach out to us with your questions/comments below or use the contact form on our website.


Subscribe to access all the platform features and see for yourself how it can help improve your investment process.


 

Additional resources:

The investment approach discussed in this post has been informed by a number of books, and recurring patterns observed from backtesting as shared above. We found the following set of books especially helpful across different aspects of investing and decision making:

On Investing (in general):

On Searching for Investment Opportunities:

On Making Better Decisions:

On Avoiding Mistakes & Manipulations in Investing:

On Valuation:

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