Making the best investment decisions on the information super-highway

We live in a high-speed information culture. This makes it very difficult to make the best investment decisions when the pace of technology and our ever-increasing need for immediate information blurs our vision and makes it difficult to sift through this.

Valdon Theron, Head of Institutional Business at Prudential Portfolio Managers, warns that sometimes too much information can lure investors into a false sense of confidence and compel us to make more short-term decisions. “Consuming a vast quantity of information confuses investors, which in turn makes it increasingly difficult to focus on the fundamental information that determines the value of an asset,” says Theron.  

Information compels us to take action

The main problem with all this information is our human desire to take action. Theron highlights a thought-provoking article titled Beware of Action Man where James Montier uses football goalie statistics from penalty kicks to demonstrate this. Statistically, goalies would do better standing in the middle of the goal box as opposed to leaping to one side. But they feel the need to do something and they typically prefer to jump in a direction rather than stand still.

Investors also have this compulsion to act. Theron explains that investors feel compelled to do something for several reasons. Firstly, we live in a reward culture, and like to believe that by diligently seeking out information we have earned the right to act on it. This leads to a potential misallocation of effort – spending more time on ‘research’ versus thinking through your decision.

Secondly, we are optimists. Unfortunately, this is often because we are essentially greedy. We want the information to help us, and we want it to work out ‘right’ so that we can make some quick money.

Thirdly, we love hearing information that supports our view.

Ultimately though, Theron believes our compulsion to act is based on fear. “We are terrified of missing an opportunity and of being left behind. This is because we forget that doing nothing is also a decision,” he explains.

So how do we make the right investment decisions?

Theron explains that the process at Prudential focuses on asking the right questions and to direct the focus onto those factors that determine an asset’s long-term value. “This is not as easy as it sounds. The bulk of the information that is readily available relates to the immediate past and future, such as stockmarket earnings. More ‘valuable’ information can be found by studying long-term trends and exploiting instances where a company’s current operating characteristics, such as return on capital, are significantly below or above its long-term trend.”

“At Prudential we believe that the right information, in the right context, is still critical to making wiser investment decisions,” continues Theron. He goes on to explain how they go about doing this.

1) Determine which information is relevant.

“Screening is critical to our process. We don’t waste our time on stocks that are clearly pricing in unobtainable future earnings,” says Theron.

2) Focus on financial statements as a starting point.

“These statements provide a sound and practical method of getting to grips with the health of a business,” he explains.

3) Understand the long-term return on capital that a business generates.

“This is especially important if current returns are far below or above a business’ long-term sustainable returns, causing mispricing opportunities. We study long-term trends of these returns (as opposed to forecasting) and specifically the underlying drivers (“fundamentals”) of these returns, such as profit margins, asset turn over and a firm’s capital structure,” he clarifies.

Be careful of forecasts and acting on the latest news

If you aren’t confident about your ability to filter the noise, get independent financial advice and invest with a manger that has a proven and disciplined ability and process to determine an asset’s long-term value.

“As prudent value investors, we work within a long-term investment horizon, discerning facts from opinions, being highly aware of the fallacies of forecasting, and focusing on information that determines and affects the long-term value of an asset. We also need to remember that not acting, and ignoring the mass of irrelevant information is also a form of action,” concludes Theron.