Professor Price also taught us to stress-test investments.
In engineering, such as building a bridge, the structure is tested before put into full use. An example was the Sydney harbour bridge – 80 locomotives were driven onto the bridge, to ensure it could take the weight. The load was in excess of the usual expected load, because the structure needs to be able to withstand weight and use well beyond it anticipated use.
With investments, the same can apply, but is rarely taught.
We find a company that has strong financials superior management key indicators. Not one or two is enough, we need about a dozen indicators.
Then the potential investment needs to be tested if it will give a satisfactory return even if there are downward changes in
- growth of earnings
- market opinion of the company, or industry
- level of dividends
No one can know what change will occur and when, nor can anyone know the resultant effect, but as in the case of Wotif shares falling when Webjet announced a profit warning before Dec 2010, and industry can be affected by one major player. If changes are beginning to occur more slowly eg less use of telephone books over internet searches, camera film to digital, there is time to adjust investments if companies don’t adapt in a timely many that indicates they can change and keep viable.
For more information and examples of investing lessons, as well as whether self managed super is for you, come to a free meeting – see the up-coming seminar listed above for more details. See http://ow.ly/4olRZ .