What does it take to be a competent investment analyst?

A competent analyst is one who has an above-average ability to generate satisfactory investment returns (well know examples will include Ben Graham, Walter Schloss, Warren Buffett etc.).

While I am too young into the industry to be passing pronouncements on ‘what it takes to be a competent investment analyst’, I have written this post to focus on things that I have learnt from those more experienced and accomplished than I am. Hopefully, this post will help other young analysts in setting their priorities:

1)

The first and most important requirement is a passion for learning and for business/economics. While obvious, it is worth reiterating that an absence of this trait is enough to guarantee failure while a presence of this trait alone can take you a good deal towards success.

2)

The second requirement is an ability to read to lot. While intuition (or trader gut feel) can theoretically overcome this requirement, it is far too easy to confuse a bull market with good intuition. Most successful investors have stressed the importance of reading. When asked at Columbia on how to be a successful investor, Warren Buffett reportedly pulled out a stack of filings, annual reports etc. from his bag and said, ‘Read 500 pages like this a week’.

At a more personal level, one very successful analyst/investor at my previous firm confessed that the secret to his record lay in his willingness to invest weekends into reading as many offering circulars, prospectuses, annual reports as he could. Of course, you will not be able to do this unless you have a passion for learning but being interested is not enough – you should be able to quickly read and process information.

3)

The third requirement is being able to think / act rationally and independently. Unlike most other professions (including much of Wall Street), being an introvert/loner is not a handicap in successful investing. In fact, it is often an advantage because generating strong returns requires an investor to be both contrarian and right consistently. This is because the consensus opinion is already baked into the price so being right when everyone else is, will generate scant returns.

4)

The fourth requirement is an understanding of pre-calculus math, especially of compound interest. Albert Einstein called compound interest the ‘eight wonder of the world’. Compound interest is not as easy as it appears. The iron-rule of investing, ‘Don’t lose money’ is really an illustration of compounding because losing 50% means that you need to earn 100% the next year to reach par. To give another illustration, an investor earning 15% for 9 years and then losing 30% in the tenth year would have fared worse than an investor earning 10% for ten years. On the other hand, a Wall Street trader generating 15% returns for 9 years and then losing 30% in the tenth year would have earned far more in bonus and career enhancement than another trader who generated 10% for 10 years.

Competent investment analysts are rarely in a position where their capital is down 30-40% due to big losses / poor risk-management. They understand the power of compounding over several years. They also think and act independently and do not follow the crowd into an investment that has generated 15% for the past nine years and will likely generate a deficit of 30% (or even more) in its tenth year – it will likely generate a deficit because no investment grows to the sky (and compounding quickly causes the final value to reach the sky) so that past success almost always carries within it the seeds of future failure. An understanding of other pre-calculus math concepts (such as arithmetic, ratio and proportion etc.) allows you to quickly make basic calculations regarding margins, turnover, growth etc. in your head (as you are reading a filing) and not create a spreadsheet every time you look at a new business.

5)

And finally, the fifth requirement is an ability to understand accounting and familiarity with economic history. Accounting, as Warren Buffett said, is the language of business so it is difficult to grasp what the annual reports are communicating to you unless you understand its language. Lax and lenient accounting often precedes crises so the understanding is crucial in avoiding such disasters. A familiarity with economic history is important because there is scarcely anything new in the financial industry and mistakes of past often offer helpful guides in avoiding similar mistakes in the future. Reading economic history will allow you to appreciate the importance of business/economic cycles, the tendency of markets to form bubbles and the psychology that drives asset prices in the short term.

These are the five key attributes that I believe are necessary for anyone to become a competent analyst. If you disagree or if you have other suggestions, then I’d be keen to know your thoughts.