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What to do in a euphoric market? 10 tips from Wall Street’s ‘Super Mario’

There is no substitute for experience in investing. Plus, while patience is key, one needs to be aggressive when the time is right in order to swing it big.

Those are the tips for investing success from the ‘Super Mario’ of Wall Street. The legendary investor, Mario Gabelli, says patience and experience are the two most important qualities that make a great investor.

“Experience can be industry-specific that allows one to anticipate trends and changes before they occur. Or it can be experience of investing in general,” says the billionaire investor and founder of GAMCO Investors (GBL), well known for the invention of the Private Market Value methodology.

Gabelli also says successful investors are the ones who make plenty of mistakes, but have the ability to learn from them.

“Typically, successful investors are those who have made plenty of mistakes and have been able, or were lucky enough, to weather the consequences and learn from them,” he said in an interview with a financial website.

“An individual who has posted an impressive record without some accompanying level of adversity is more at risk of a sudden loss than the one who has struggled and won,” says he.

Gabelli, whose investment approach is a mix of the strategies followed by Warren Buffett and Benjamin Graham, made it to the league of investing greats by getting his fund, GAMCO, to deliver a steady average return of nearly 12% a year for the quarter of a century.

Investment philosophy
Born in 1942, Gabelli had a passion for the stock market since he was very young and is said to have bought his first shares at age 13. He launched his own firm in 1977 as a broker-dealer. The company has since come a long way and become a diversified financial management company with more than $40 billion in assets.

Gabelli uses a research-driven approach to investing and considers earnings per share and free cash flow minus the expenditures needed to expand the business as key parameters to assess a business.

“A rigorous assessment of fundamentals, focusing on the balance sheet, earnings and free cash flow” is very essential for an investor to study while looking for companies to invest in, he says.

Gabelli used his own theory of private market value (PMV) in his investment approach. PMV is the value an informed entrepreneur would pay to purchase an asset with similar characteristics. It is determined by a study of assets and liabilities (both on and out of the balance sheet) and free cash flow.

He then compares his research findings with actual transactions in similar businesses for a reality check. Thus, he focuses on companies that appear to be bargains relative to their PMV, which provides him with great upside plus a wide margin of safety.

After finding a stock that is undervalued in relation to its PMV, Gabelli looks for a pending catalyst to justify his findings. A catalyst represents the extra-potential upside in view of an investor doing the analysis.

“What would be the element [the catalyst] that would help narrow the spread between private market value and the stock price? A catalyst may take many forms and can be an industry or company-specific event. Catalysts can be a regulatory change, industry consolidation, a repurchase of shares, a sale or spin-off of a division, or a change in management,” he says.

Gabelli says the goal of his research is to identify companies that have the potential to deliver 50% return in two years. If a particular stock reaches its PMV or if an expected catalyst fails to occur, it is best to sell that stock.

Think like a business owner

Gabelli says buying a stock is like to becoming an owner of the business, as it enables you to think in the longer term. It also makes investors less likely to fall into the mental trap of buying speculatively, rather than on the basis of value.

“We’re not buying a piece of paper, when we buy stock. We’re buying a business. Think like an owner,” says he.

It is important to accumulate knowledge of industries over an extended period and that can help investors adapt to the changes quickly if the market comes down suddenly.

Investment tips that Gabelli shared are considered very valuable for investors to make good investment decisions.

  • Study financial data carefully: Investors should look at the details of the company’s balance sheet, gather data and interpret them wisely. One should have a bottom-up approach to stock picking and should try to find out the private market value of a company.

  • Find a margin of safety: Investors should try to find out the margin of safety for buying a company at a certain price. When investors buy assets with a margin of safety, they can make a mistake and still do fine as investors. In order to determine a margin of safety, one can ask three questions:

1.How much is it worth now?

2.What will it be worth in 5 years?

3.How far down can the price go?

“You approach stocks as if they were pieces of a business you want to buy at a discount. Why am I buying it? Because I have a margin of safety. Value investing works because it is founded on the notion of buying something for less than it is worth. The value investor has the best of both worlds: upside potential and the comfort of owning a business with a margin of safety,” Gabelli says.

  • Invest in companies with real economic value: Investors should focus on the activities that improve people’s lives, as it’s much safer to invest in companies that can create real economic value. Picking an industry that creates economic value is not enough. One also needs to pick the right company and buy the stock at a good price.

  • Cash is the king: Most investors lose sight on the importance of cash. The only unforgivable sin in business is to run out of cash.

“When an informed industrialist is evaluating a business for purchase, he or she is not going to put a lot of weight on the stated book value. What that informed industrialist wants to know is: How much cash is this business throwing off today and how much is he going to have to invest in this business to sustain or grow this stream of cash in the future,” Gabelli says.

  • Look for sound management: It is very important for investors to pick businesses that have good managements. “We believe that an average management running an above average franchise will do an average job,” he says.

  • Don’t invest in businesses you aren’t sure about: Some businesses can’t be valued with any reasonable degree of certainty. One great quality of investing is that investors can simply put a decision in the ‘too hard pile’ and move on. There is no premium for hyperactivity in investing, but there is a penalty.

“If investors remain patient, but aggressive when the time is right, then they can “swing big” just when the situation is most advantageous and the odds are substantially in their favour,” Gabelli says.

  • Understand a business before investing: If investors understand a business, then buying that business has less risk involved. “Risk comes from not knowing what you are doing. Risk is not a number and certainly risk is not a number that defines volatility. Volatility is certainly “a” risk but it is not the only risk,” he says.

  • Be prepared for market fluctuation: One can always get an opportunity to buy above and below intrinsic values, if one can spot the right opportunity. “Prices in the market will inevitably move rapidly and unpredictably up and down. Markets are far from wise in the short term,” Gabelli says.

  • Don’t try to predict short-term price fluctuations: Price and value are often different, because the market is not wise and the prices offered to buyers and sellers gyrate wildly in the short term. Investors should not try to predict those short-term price fluctuations, as they are set in the short term by a herd of highly emotional and psychologically challenged investors.

“Quality is quality, and just because the market allows you to buy a share of a company well below its intrinsic value, doesn’t change the underlying value,” he says.

  • Best time for investment: The best time to buy financial assets is when other investors are fearful. Most of the profit in investing is made in downturns and the trick is to have enough cash to invest in such times. The best investors have cash in hand for tough times, and avoid using it in the euphoric part of a business cycle.

“If you stay focused on buying assets at a margin of safety to intrinsic value, the cash will naturally tend to be available for investing when a period of market euphoria ends and bargains appear,” he says.

  • Avoid too much risk: Different investors have different emotional temperaments. If one is having trouble sleeping because of his level of investment risk, he has too much risk in the portfolio. “Always keep your portfolio and your risk at your own individual comfortable sleeping point,” he says.

(Disclaimer: This article is based on Mario Gabelli’s various interviews and speeches)

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