Ultimately, we all invest to make money. Although there are many good strategies to do so, there's one particular approach I find simple, yet devastatingly effective. The four-step investment thesis spelled out in legendary hedge fund manager Michael Steinhardt's autobiography, No Bull: My Life in and Out of the Markets, strikes me as a great framework to apply to all investment ideas.
The quick and the dead
Steinhardt told his analysts that they should be able to explain their idea in no more than two minutes. In the investment world, complexity is your enemy. If a thesis relies on too many moving parts, it's possible that one of those parts won't move the way you want it to, which could ruin the whole thing.
Warren Buffett took only a couple of paragraphs to explain his billion-dollar bets on Wells Fargo (NYSE:WFC) and Washington Post (NYSE:WPO). It took just three letters and a number for Einstein to convey the theory of relativity. With the caveat that good things come in simple packages, here's how to construct an investment thesis in four quick steps.
1. The idea.
This is the "what" part of the thesis, explaining your basic argument. For example: "I think Countrywide (NYSE:CFC) will survive the liquidity crisis and prosper once the environment stabilizes."
2. The consensus view.
If you have an idea, you need to know what everyone else thinks. Keep in mind that the consensus can be wrong. Many centuries ago, everyone thought the world was flat, and that the sun revolved around the earth. If the crowd can be wrong about the big things, they sure as heck can be wrong about the stock market.
You can figure out the consensus view simply by reading newspapers, magazines, and other financial media, as well as seeing what Wall Street analysts think.
3. The variant perception.
Once you figure out what the consensus thinks, you need to have a variant perception -- something you know that others don't. After all, if your thesis is that Google (NASDAQ:GOOG) will grow sales at 25% for the next four years, and Wall Street analysts target 23% growth, your perception varies little from theirs. If that's the case, it's time for you to move on; even if Google does grow sales 25%, shares probably won't rise -- because that's what everyone expected anyway.
4. A trigger event.
In this strategy, knowing when is just as important as knowing what. If you can identify a stock that's 15% undervalued, and a trigger event that will occur in three months, you can realize your profits quickly. Quick turnarounds like that can be better than waiting several years for a 30% undervalued stock to finally rebound.
After all, from the minute you make an investment, the clock is ticking, and time is the enemy. Unless you're invested in a company that can grow intrinsic value at a rate commensurate with your target annual return, you'll need a catalyst to make sure you don't grow old waiting for something to happen.
To put it all together, you should start with a simple thesis containing a clear idea. You should be able to identify what everyone else thinks, why you think otherwise, and when everyone else will see things your way. These simple steps can help ease your attempts to profit from the market.
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