Francisco Paramés is widely considered one of the world’s leading value investors. From 1994 to 2014 he had an average return on investment of 16%, which is more than double the return of the Madrid Stock Exchange of 7.8% in the same time frame. Paramés is often compared to Warren Buffett while The Financial Times named Paramés the most successful fund manager in Spain.
To get to this success, Paramés followed a specific investment strategy focused on value investing. We have outlined Paramés investment approach below and provided some of our own observations on how to become a good investor.
Paramés’ three dimensions of value investing:
Apply the Austrian School of Economics approach to investments: this is a people-centric approach, with a particular focus on the individual creative entrepreneur and on rivalry among entrepreneurs
Invest in real assets with a long-term view – real estate, shares in companies, commodities, etc.
Meaningfully incorporate risk in investment decisions
To add to the three dimensions to value investing, Paramés also draws heavily on investment gurus such as Warren Buffett and Peter Lynch.
The Austrian School of Economics’ relevance for successful value investing
The two most famous scholars of the Austrian School of Economics are certainly Ludwig von Mises and, the 1974 Economics Nobel prize laureate, Friedrich Hayek. Other famous members of this group include Joseph Schumpeter, Fritz Machup, Gottfried von Harberler, and Eugene Böhm von Bawerk.
A central element in the Austrian School of Economics is the theory of human action, which gave rise to behavioral finance. The theory of human action can be broken down into nine main ideas specifically applicable to the investment process:
The market works and is reliable If needed, there is always the choice to exit.
The market is never in an equilibrium. Thus, allowing the investor to invest when the market is low and exit when the market is high.
Economic growth is financed by savings. It is best to invest in markets where the rate of savings is high.
A short-term sacrifice must be made in order to achieve greater economic value in the future. Having a long-term horizon is crucial.
The control of interest rates by the central bank impacts the nation’s currency. Stay away from investing in markets where growth is primarily a result of artificially low interest rates.
Deflation will occur when there is no artificial injection of the amount of money in circulation. Investing in housing assets, with little to no debt, is a good investment strategy in deflationary situations.
A currency will permanently depreciate in relation to real assets. Accordingly, always invest in real assets.
Product price determines cost. First calculate demand, then the costs necessary to meet the demand.
Production cost is subjective. Do not take cost as a given.
Investing in real assets
Real assets reflect ownership. Equity offers both greater returns and less long-term risk. Exposure to stocks, on the other hand, is attained either through passive management (via Index Funds or Exchange-Traded Funds) or through active management.
Successful passive management depends on:
Selection of low-cost funds.
Wise choice of advisors (and they are typically expensive!)
A thorough analysis of a fund, and, especially, of its performance.
Avoid the advice of guru investors.
Successful active management depends on the valuation of assets; for example, by applying the Capital Pricing Asset Model. When investing in funds, can an active manager do better than a passive manager? Active managers follow several key principles that enhance their success. However, in the end, Paramés believes that the best option is a combination of index funds, the investment choices of active managers and stock picks to “keep us on our toes!”
Outline below are rules of thumb from some of the most accomplished active investors:
Benjamin Graham
Buy shares in companies where the stock price is lower than the company’s liquidation value / intrinsic value.
Phil Fisher
Invest in stocks with a long-term growth projection, robust competition advantages (moat), and the capacity of sustainable growth over time. The price you pay is not that important; if the company performs well, it will be able to sustain a high multiple.
Joe Greenblatt
Look for quality shares at a favorable price. These will always out-perform other stocks. Quality is key!
Warren Buffett (and Charles Munger)
Invest in stocks as if buying the whole company with the ideal holding period being indefinite.
Buffett’s strategy prefers buying in the markets, rather than via IPOs. He invests in stable businesses, where there is a relatively low chance of major changes in market conditions. For this reason, he has typically stayed away from tech firms. Buffett generally focuses on quality businesses, i.e., companies with a high return on capital employed (ROE).
Buffett believes that there should be an appropriate separation between shareholders and management, with a clear delegation of responsibilities. Moreover, directors should own significant amounts of stock in the company where they serve on the board. Thus, incentivizing their renumeration through the company’s performance, rather than receiving large fixed renumeration in their capacity as board members.
Buffett does not put much emphasis on growth plans. He also warns against making acquisitions for the sake of growth. He warns to watch out for managers who overpay simply to gain mass. What matters is the quality of the eventual acquisitions.
As noted, Buffett’s focus is on the long-term, as a result, he typically does not have an exit plan. In line with this, he sees it as an advantage when there is a stable shareholder base.
Let us now turn to a discussion of companies to avoid. Paramés identifies nine factors that make companies less attractive:
An excessive growth-focus
Companies which are constantly acquiring other companies
IPOs
Businesses still in their infancy
Questionable accounting (and poor governance)
Over-dependence on one or a few key employees
Heavily indebted companies
Stagnating or falling sales in a firm’s business
Overly expensive stocks
What are the factors to focus on when determining a good investment opportunity? Ultimately, the only thing that matters is “earnings, earnings, earnings”, as Peter Lynch said. Paramés recommends the following criteria when assessing investment opportunities:
Careful analysis of a firm’s financial statements
Cash flow analysis
Credibility of the income statement
The balance sheet
Careful estimation of a firm’s normalized earnings
Where are we in the economic cycle for this firm?
Has there been a disruption to supply or demand, or is there a risk of this?
Is the firm still in its infancy?
Above all, one should focus on the inherent quality of a stock, have a long-term time horizon and a stable, predictable context within which to operate.
The concept of Risk
Warren Buffett defines risk as the possible loss of long-term purchasing power. To avoid this, he advocates analyzing:
A business’s long-term characteristics (customer, suppliers, competitors, the technology, etc.)
Management’s ability to optimize the business, and its ability to effectively reinvest earned profits as well as to remunerate shareholders.
The purchasing price.
Inflation and tax levels.
In Buffett’s opinion, these four factors determine risk, and not the share price volatility.
Accordingly, an investment’s risk is the possibility of a permanent loss of purchasing power as the result of making an error of judgement.
Final pieces of advice from Paramés
Look where others are not looking. Go beyond the superficial and commonplace
It is better to own assets than be a creditor
Invest in what you know and know your limits.
Have patience and think long-term. Often it is best to do nothing. Stick with your strategy and don’t let noise disturb you.
Focus on the quality of the business. Invest in companies you can hold for twenty years.
Study the companies and not the stock market. Buying a share should be like buying the whole company.
Prefer established businesses with a long, successful track record.
Speculators, volatility, and/or liquidity shortages, often lead to good purchasing opportunities and good value.
Buy what nobody else is buying.
Favour companies that are partly family owned. A majority of the companies Paramés invests in are family owned. Family owned businesses think for generations. They are long term and they focus on long term value creation.
When you find a company you like, you can start with a small investment. As your confidence for the company grows and you begin to trust the management, the company strategy and the financial growth and development, you can slowly begin to increase your investment.
Lastly, a final piece of advice: Invest all your savings that are not needed in the immediate future in shares.
With several decades of demonstrated performance to show for it, Paramès is credible in his advice. Experience counts!
In addition to what we have reviewed above, we also would like to turn your attention to some other aspects of investing that are important to becoming a good investor:
On Noise: In the world of today, with unlimited flow of information, it is easy to “be taken for a ride” and be influenced by the last piece of news read in the newspaper. Try not to be influenced by such noise. Store it, and consider it together with all the other information you have gathered and digested.
On portfolio construction: It is important to construct a portfolio that suits you and your family’s situation for the short-term and long-term. The less need you have for short-term dividend, the more long-term shares you can have in your investment portfolio.
On index funds: The authors of this article do not follow Paramés in his advice on index funds. Index funds are bound to invest in all shares in the index, even the most expensive and overbought shares. To give you an up- to- date example: would you be willing to invest heavily in TESLA shares at their current value? We guess not. However, if you were to invest in index funds, you would have to.
On following the herd. Don’t be influenced by what everyone else is doing. Make up your own conclusions after having studied the alternatives. Trust figures, especially historic figures. Most often figures don’t lie.
On moats: Historically, companies with good moats have had them for many years. But in today’s world, the moats do not last as long as before. For this reason, it is important that you focus on the company’s future strategy, the quality of its management, the company’s ability to reach its goals, and your own expectations for the company. Is the company likely to do well long-term and develop new moats?
On costs: Pay attention to the cost that your asset manager is charging. By paying too much for asset management services, you will lose return on your portfolio and, as the years pass by, the monetary loss will be considerable due to the compounded interest principle.
As a final remark, allow us to share our best advice on investing: That is to read. Read a lot. Read every day. Reading is one of the best investments you can do for yourself. As Charlie Munger put it: “Spend each day trying to be a little wiser than when you woke up”.
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