Despite the prevailing wisdom, to invest successfully over a lifetime does not require a stratospheric IQ. What is needed is an intellectual framework for making decisions and the ability to keep emotions from corroding that framework.
The margin of safety is the central concept behind this when deploying capital. In the current zeitgeist, where equity markets are getting pummeled, as interest rates march higher, investors (long accustomed to the free lunch of near zero interest rates) are seeing the chickens coming home to roost. From technology to crypto, there has been a rout, with more pain in the wings, as return expectations get recalibrated.
The manic depressive behavior of the market causes many investors to make bad decisions, especially as they give in to group-think ideas of ‘flipping’. In this sense, the worst enemies of investors’ are themselves, as they cannot detach themselves from the emotional roller-coaster of the markets, and inevitably succumb to its negative forces.
Essentially, what is needed are three basic principles for investing when it comes to capital allocation. Never invest in a company that does not make money. Technology, with its emphasis on disruption, gave investors the hope to pick winners, but the carnage of companies that were left behind every bust cycle is ignored. Secondly, every investment must generate a return. In capital markets, that implies a dividend yield. Just like in real estate markets, that yield in the rental cashflow that accrues to the investor.
When rental or dividend yields fall, assets have become expensive and flashing red signals. The third, and perhaps the most critical principle, is the margin of safety for when economic conditions take a turn for the worse. During this time, if companies and/or assets can demonstrate resilience in terms of their cash generation ability, those assets will outperform over the long term. If investors do not have a sense of these three principles, then they are the proverbial patsy in the game the market plays.
The UAE government has been proactive in determining the next wave of asset generation, from the freehold phenomena in 2002 to the current disinvestment programme that guarantees dividend yields by financially sound companies that are embedded into the very fabric of the economy. The government has played the role of the business-driven investor, matured the assets, and in the process simplified the decision-making process for the retail and institutional investors. From DEWA to FertiGlobe, Borouge, and Tecom, these are companies that have been steadily compounding capital through the vagaries of business cycles. Perfectly coinciding with the rising cost of capital, the companies being listed have a margin of safety that makes it impossible to ignore such investments.
Over time, as history attests, going all the way back to the South Sea Bubble, investors that have followed these basic principles have stood the test of time and made money above the rate of inflation. And through reinvestments have compounded their wealth, regardless of investment fads that have popped up. This perhaps is the most critical lesson of investing, a lesson that goes back to the South Sea bubble. In 1720, what happened was a true experiment, accompanied by speculation. It was something unfamiliar, as yet unexperienced.
The adverse consequences that occurred could be attributed to ignorance. Investors (including Newton) at the time may be forgiven for failing to anticipate a species of catastrophe that was brand new. Since then, we have seen waves of boom-bust cycles, with wealth destruction that has occurred every time by investors who have failed to learn the three basic principles of investing. And paid the price. The UAE government has once again offered an opportunity that adheres to these first principles.
We cannot claim the excuse of ignorance.