(09/18/12) Invest Like Buddha...and Ben Graham

If you're a resource investor, it pays to stay disciplined, know your goals, and find the right time to buy what makes sense...and many times that's easier said than done, writes David Galland of Casey Research.

While I have read certain works on the life and ponderings of Buddha, I claim no deep knowledge of his philosophy.

Note that I didn't use the word "religion," because Buddha himself claimed no supernatural powers, and even begged his followers not to deify him after his death. Hardly had he drawn his last breath some 2,500 years ago, however, when the deification began—though most Buddhists won't claim it as such.

Even so, there are Buddhist practices that I think are useful in this hectic world of ours—practices that don't involve dressing in robes and refusing to swat flies. For example, I rather like to meditate from time to time. Nothing too involved, just ten or 15 minutes of quiet, deep breathing as part of calming the mind and all that.

I also find a lot of wisdom in the training of the Zen archers, who seek to clear their minds of all internal dialogue not related to the simple process of releasing the arrow at the target. Simply put, they strive for only one goal—perfect form.

Thus, they clear their minds of all others, even those that might be considered complementary to the task at hand—for example, getting a pat on the back from the instructor or plopping the arrow closer to the bull's-eye than the next person down the line.

Of course, as humans are wont to do, Buddha's successors have taken the man's simple approach to life and wrapped it in gaudy and self-important rituals. But that shouldn't take away from Buddha's core beliefs. Especially the bit about simplifying and focusing your goals.

That idea has always seemed to me to have relevance for a wide range of pursuits, from the putting green to the stock market. Based on my many interactions with investors over the years, I have concluded that there are really just two types. There are those who have clear goals, and those who don't.

Those who do make the money. Those who don't provide the money to those who do (investing is a zero-sum game—for every winner, there is a loser).

This thought was made more tangible to me in recent days, based on a personal experience. Long story short, I had invested in a pre-public company years ago. It wasn't a big investment, and it took longer than anticipated to ultimately go public. When it did, it had a fairly good run, but as the reason I bought it in the first place was still ahead of it, I hung on.

Well, as is so often the case, the company missed a hurdle and came tumbling back to earth, with the stock trading hardly at all and for just a few pennies a share.

Lo and behold, the company's management reinvented the company as targeting rare earths and managed to acquire a project of merit. The investment that I had written off as worthless soared on high volume.

Now, if there is one thing that anyone with experience in small-cap resource stocks will tell you, it's that the time to sell is when there is someone to sell to—because absent volume, getting out of a decent-sized position is not easy.

Which Would You Do?
So, there was the dilemma—would you hold on in the hope that the surprise home run turns into the sort you bestow on your grandchildren? Or do you secure your gains by selling and moving on?

At the point of such a decision, the mind gets very un-Zenlike. Visions of untold riches dance in the head, followed by fits of fretting as the stock pulls back. Next thing you know, you are tossing and turning in the night, conflicting thoughts chasing each other around like cats.

In the final analysis, I recalled the old adage that "pigs get fat, but hogs get slaughtered."

The Zen Answer to Investment Dilemmas
I sold enough to take my initial investment off the table and guarantee a healthy profit—holding on to a modest position to enjoy any further upside. Having done so, the internal dialogue came to an abrupt halt.

Now, the funny thing is that after a brief pause, the company is again moving up—but I have no intention of second-guessing my decision to sell when I did.

On a percentage basis, my returns were in the moon-shot category—the sort that only the junior resource sector can produce—so it would be just plain churlish to gripe. More to the point, the stock could just as easily have peaked and once again collapsed, in which case I would really feel like a dolt had I not taken an exit.

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All of which delivers me to the point. Namely, that it is very important—especially for the resource investors among you—that you actually have a firm goal in mind for each investment you make...and that you remain single-mindedly focused on that goal.

Do you own gold or silver as a protection against inflation? If so, then why even bother checking the price on a daily basis, let alone every few minutes?

Or do you own it as a speculation? If so, what is your specific profit target? Don't have one? If not, then it seems to me a bit like setting off on a journey without knowing where you want to actually go.

Do you know exactly why you own the resource stocks you do? What hurdle are you betting they will clear next, and by doing so ratchet the price higher? Is your goal to get your original investment off the table on a double? Or do you have a specific price target in mind, at which point you will close the position entirely and move on to more fertile ground?

This idea of keeping an easily understood, single goal in mind for each of your investments is hugely important, because without it you are going to be susceptible to the fears, fantasies, and folly that ultimately cause investors to end up on the losing side of the equation...by selling good companies on pullbacks, holding on to positions well past the point of reasonableness, or chasing stocks after they've spiked.

Probably the most successful investor I know—I won't give his name, because he might not like my pointing out that he has tucked away close to a billion dollars, thanks primarily to investments in the resource sector—has a well-deserved reputation for selling too early.

While it is remarkable that he has made so much money in this sector, what is more remarkable is how he did it, which I would sum up as follows:

First and foremost, he follows a process—almost mechanically.

He buys low, with a specific objective in mind, both in terms of hurdles he expects the company to clear, but also in terms of the returns he expects to get on his investment.

When his return objectives are met, he sells—maybe enough to get his original investment off the table, maybe the entire position, depending on his reassessment of the company’s potential to clear the next hurdle. But he always sells at least enough to get his original investment off the table, no matter how much exciting news there is and how much optimism others may feel about the stock.

He only buys on his own terms. If invited to participate in a private placement, he will do so only if he is completely comfortable with the terms. If the company is offering a warrant with a one-year expiration term and he thinks the development work will take two years, he'll ask for a two-year warrant. If the company won't budge, he moves on, confident in the knowledge that there will always be another deal coming down the pike.

He’s careful with his money. As he likes to say, if you spend your dollars, they can't mate and make you more dollars. He's not afraid to concentrate investments, but again on his terms, and only when he has done the due diligence needed to be confident that the potential reward warrants the level of risk involved.

If those principles and practices sound simple, it is because they are. But following that process is also incredibly effective.

Interestingly, this process rhymes with the finely honed investment methodologies of the late great Benjamin Graham, author of The Intelligent Investor and mentor to a small cadre of close associates that include Warren Buffett, Jean-Marie Eveillard, William Ruane, and Irving Kahn—all of whom used what they learned from Graham to become billionaires, or close to it.

Let that sink in for a moment. One man, Graham, developed a methodology for investing—and it's actually a pretty simple methodology—that the people working with him were able to duplicate in building their own fortunes. Following a proven process works.

And while Graham wouldn't have touched a junior resource stock with a 20-foot pole, his methodology was focused on balance sheet analysis, not a strong point for junior exploration stocks that have no E in their P/E—the principle of following a specific process that mitigates the odds of a loss holds up well. The proof in the pudding is the success of my aforementioned friend and many others I know who are similarly disciplined.

With all of that said, do you know why you own what you own? Do you have a clear goal in mind for each of your positions? Do you know how much of your portfolio is allocated to speculative resource plays, and are you comfortable with the idea that those stocks have historically suffered extreme sell-offs?

Warren Buffett, whose investment acumen is hard to argue with, likes to quip that the two most important rules for investment success are:

Rule No. 1: Never lose money.
Rule No. 2: Never forget rule No. 1.

While it is almost impossible not to lose money along the way while investing in resource shares, it is equally true that once you have scraped your original investment off the table, it is impossible to lose money. Sure, you can give back your profits—but you can't lose money.

All of which is, I think, worth reflecting on as you aim your next arrow.

And if you aim your arrows just right, small-cap resource stocks can give you great leverage to the underlying commodities—such as the precious metals.