The Long and the Short of It (International edition): A guide to finance and investment for normally intelligent people who aren’t in the industry

by John Kay

The 80/20 per cent hypothesis – that the world of business and finance is best understood with the aid of models that are partly true, partly false, is at the heart of this book.

There is probably no worse investment strategy than following the conventional wisdom with a time lag,

Be very wary of sustained individual price movements that seem to have no explanation. A falling share price may be the result of inside knowledge; a rise that cannot be accounted for may herald a possible takeover.

Like the efficient market hypothesis with which it is closely associated, the random walk model is illuminating but not true.

The modern company is best viewed as a collection of capabilities. It is defined by its brands and its products, through its internal systems and its relationships with customers and suppliers, by the resources to which it has access and the operating licences it holds, and by its reputation with the public, governments and prospective employees. We have capitalism without capital. When the company’s most valuable assets descend in the lift at the end of the month, they take their pay cheques with them. The ability of the company to generate returns for shareholders depends on its ability to add value to its employees through its own capabilities. In a competitive market-place a business can add such value only if there is something distinctive about these capabilities that yields a competitive advantage.

Fat tails are a particularly troubling problem for people who are modelling risk in financial markets, because they suggest that these models fail in precisely the extreme situations in which they are most needed.

For the intelligent investor, risk is a characteristic of a portfolio, rather than of the individual security.

The ‘mind your portfolio’ principle implies that you should look at the expected return from individual assets and their correlation with your overall portfolio. Your objective is that every single investment you buy should significantly diversify your portfolio.