Lessons From Roger Babson
I’ve been practicing values-based investing for over a decade and...
I’ve been practicing values-based investing for over a decade. That never feels normal for me to say, considering that I am a 20-year-old college student. Over my investing career thus far, I’ve worked to build a set of values (pillars) to guide me. This isn’t a unique practice, and many of my pillars are inspired by those of successful long-term investors.
As a student at Babson College, I often hear quite odd stories about the school's founder, Roger Babson. There are many aspects of Babson that I do not wish to emulate. Still, he wrote an investment newsletter, was a successful entrepreneur/businessperson on multiple occasions, and practiced values-based investing guided by his “Ten Commandments Of Investing.” Today I’ll be discussing these commandments:
Keep speculation and investments separate.
I’m not sure this statement needs any elaboration. Speculation has no place in investing. There are countless examples, both recently and throughout history, of even the most intelligent minds falling victim to speculating in investments. Babson had a fascination with Isaac Newton, who in his life was a speculator in the South Sea Bubble of 1720, where we lost a significant portion of his personal fortune when the bubble inevitably popped. This is probably the best example of even one of the greatest minds being susceptible to the psychological pitfalls of investing.
Don't be fooled by a name.
While brands can be a valuable asset, they have their limitations. Especially today we see a brand or a name easily become over hyped. A name is not a thesis. Even if it has value, as an investor on the value side of the investment spectrum, how do you measure that value? Additionally, a significant reputation is not a guarantee of safety.
Be wary of new promotions.
New and exciting companies have made many people wealthy. This feature is what makes the technology sector so exciting, but this doesn’t make them exempt from risk. In fact, this increases their risk. When the ground is shifting, it can create new winners, but it can just as easily (and quickly) take them away. A short-term result is no signal of long-term results, and a positive trend is rarely proof of future success.
Give due consideration to market ability.
As modern-day investors, the technical aspect of this is less of a concern. Those investing personal capital can move in and out of most securities seamlessly. However, the idea of marketability is still an important one because it makes you think about the expectations of the company by other investors. If you find something attractive before others realize it, that is an opportunity. On the other hand, you may be the party with inferior knowledge. For example, if a stock appears to be trading at a discount and management has cash to deploy, why are they not buying back their shares? It could be poor capital allocation, or they do not believe themselves to be cheap. Either way, this is a key warning sign to steer clear.
Don't buy without proper facts.
This seems obvious, but there are many instances when there are unknown unknowns. When investing, be very cautious when making assumptions and constantly challenge those assumptions. Take nothing for granted and always look for evidence. The story of a business will only bring it so far and never far enough to be a quality long-term investment, without accompanying results.
Safeguard purchases through diversification.
This may be where I begin to “agree to disagree” with Babson at some level. Diversity is not a negative idea, but it can provide a false sense of security. Investors often find diversity in suboptimal opportunities. I see no value in diversifying into anything that lowers the average quality of your portfolio.
Don't try to diversify by buying different securities of the same company.
For many investors, this is not a core concern, but for those who venture into preferred and bonds, this is a more important consideration. This straightforward idea is important because stocks, preferreds, and bonds should all be looked at differently. The nature of each of the securities are structured to have different indicators of success. Therefore, they shouldn’t be held for the same reasons.
Small companies should be carefully scrutinized.
I would argue all investments should be carefully scrutinized, but small-cap and micro-cap investing is uniquely difficult. These companies often have less coverage. This can create large price-to-value opportunities, but there can be additional associated risks. As Ian Cassel says, “When you buy a stock, that's when the real work begins.” Investing in small companies can be very rewarding, but it is not for the faint of heart or the weak stomach. Having a deeper understanding on your investment can be crucial to maintaining confidence through large market cycles and volatility.
Buy adequate security, not super abundance.
While I can only guess at Babson’s deeper thinking behind each commandment, I would argue that this supports my point on diversification. Diversification is valuable as long as it serves its intended utility. Having multiple investments in different companies and sectors that maintain a level of quality and long-term returns is the goal of proper diversification. Any investment that meaningfully lowers the level of quality within a portfolio does not serve the purpose of diversification.
Choose your dealer and buy outright (don't buy on margin).
Buying on margin or buying with leverage has been a deadly sin for many investors. It exponentially increases the risk of any investment and has been a driving factor in the acceleration and scale of many bubbles, including the previously mentioned South Sea Bubble. You may look intelligent if you are “right” when you do this one time, but the assumed risk is not worth the reward. This is like a toddler playing near a cliff and saying, “No, it’s fine, I didn’t fall off.” I don’t know many parents who would feel comfortable in such a scenario.
I may not agree with all of Babson’s commandments, however, these were compiled a century ago. That being said, many have stood the test of time. I particularly enjoy the pillars that focus on the limitation of stupidity as opposed to the pursuit of higher intellect. Essentially, the Buffett and Munger idea of try not to be stupid.
I had to opportunity to be a guest on the Talking Billions podcast hosted by Bogumil Baranowski. I discussed the start of my investment career and some investing pillars. If you are interested, please give it a listen:
Other writing:
I find this piece from Morgan Housel in 2023 very timely. While major external effects are driving large market changes, we are also seeing some level of “Expectations Debt” being repaid. In a generally high-performing year in the sense of short-term results, expectations are raised. People, investors, and companies chase even higher performance just to maintain that feeling. When we hit a bit of turbulence, expectations get reset, and the mindset shifts quickly. This is the repayment of the Expectations Debt acquired during the boom period.
https://collabfund.com/blog/expectations-debt/
Until Next Time,
Soren