In a recent video interview, Edward Roskill, lawyer, corporate financier, ex-JP Morgan Investment Banker, co-founder of Strata Partners and private investor, revealed four tenets that he sticks to for successful investing.
What he'd teach his kids
Mr Roskill reckons the most important thing new investors should appreciate is the way compounding works. It's no surprise then, that he favours investing in defensive businesses, ideally with recurring revenue models.
A focus on recurring revenue models means looking for things such as customers locked in by contracts, or a business that supplies something that people really feel they need, like medicines or cigarettes, for example.
By contrast, cyclical businesses often deal in goods and services that people tend to trim from their budgets when they're strapped for cash to spend.
Don't lose money
The first of Edward Roskill's tenets (my label) is, "don't lose money". This chimes with well-known US investor Warren Buffett's advice.
I reckon this aspect of investing can be overlooked, especially by young investors who are often exposed to conflicting advice on the web along the lines of, "take more investing risk when you are young, because if you lose money you have time to recover".
The laws of compounding mean that losses early on in an investing career can be destructive to the end result down the road. If you lose a pound, you also lose the many pounds that you could have compounded over a lifetime of investing. So losing, say, £2,000 when you're 21 could mean you end up being maybe £100,000 worse off when you retire.
Asymmetric risk and reward
Tenet number two is, "go for asymmetric risk and reward," which means making sure that a new investment has much more upside potential if things go right than it has downside risk if things go wrong.
Strong balance sheets and steady businesses can help to defend the downside, which is where Mr Roskill's preference for firms operating in defensive sectors comes into play.
The third tenet is a way of targeting stocks offering good value. Big investment funds and institutions have too much money to bother investing in small companies, so little firms can sit under-researched, misunderstood and undervalued on the stock market.
Edward Roskill sees his ability to focus on small firms as his investing edge and appears to typically hunt on the AIM market for potential investments sporting a market capitalisation up to no greater than £50m.
Small- and micro-cap investing is not for all, but I reckon Mr Roskill's philosophy can also be applied to larger out-of-favour stocks, which often move too far down when sentiment is against them, only to recover and prosper later.
The fourth tenet is to focus on the quality of underlying businesses. Quality is the supreme characteristic to look for in stocks, I reckon. A good quality operation can help protect the downside as well as driving the upside. Look for indicators such as decent profit margins, a record of rising profits and cash flow, good returns on equity, and think about a firm's activities and its position and opportunities in the market.
An opportunity right now
Edward Roskill's investing philosophies and the four tenets of good investing I gleaned from the interview certainly ring a bell with me. If you're keen to explore the under-researched lower reaches of the London stock market like Edward Roskill does I recommend that you download the Motley Fool's research report called 1 Small-Cap Stock From The Motley Fool.
The document is free, worthwhile, and you can get it right now by clicking here.