Defense! Defense!

There’s a lesson from the LSU / Alabama game for investors: defense.

In the national championship game the Crimson Tide won because they didn’t allow LSU to score. I once had a football coach tell me that with a great defense, you will never lose a game. He was right.

The lesson for investors is to watch out for losses. In stocks, look for a margin of safety, for fundamental value. In bonds, credit quality and duration are critical. It’s not enough to get your money back. You need to be able to get it back when you want it back. And in this environment people are going out ever-farther on the yield curve reaching for yield. When rates do rise these longer bonds will see sharp losses.

A dozen years ago Money Magazine published a list of “Ten Stocks to Buy and Forget.” It should have read, “Buy and regret.” On the list were gems like Nokia, Enron, Nortel, and Morgan Stanley. The problem with their list is that it was based on price momentum, not fundamentals. There’s no safety in motion. Safety in stocks comes from fundamental value.

Fundamental value is driven by financial performance: consistent cashflow, a sound balance sheet, and growing profits. The beauty pageant of market sentiment constantly sways back and forth, as companies go in and out of fashion. But sound management can weather short-term crises, the kinds of problems that allow investors to buy companies for less than their intrinsic value.

Avoiding losses—the permanent impairment of capital—is the first step towards a winning investment plan. It worked for Alabama Monday night. And it never goes out of style.

Douglas R. Tengdin, CFA
Chief Investment Officer
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