Don’t treat your companies like your footy team

I won’t pretend to be an impartial observer tonight.

My Roosters are playing the Dolphins in the NRL preliminary final, with a place in next weekend’s Grand Final on the line.

I want them to win. Preferably by enough that I can enjoy the last ten minutes.

And should the unthinkable happen, I’ll still be a Roosters supporter tomorrow. I’m not about to change teams because somebody else had a better night.

With the AFL Grand Final tomorrow, I’m hardly alone in getting a little bit carried away this weekend.

That’s part of being a footy fan.

But it can be a pretty ordinary way to be an investor. (It infects our policy conversations, too, but that’s a whole other rant!)

Now, before you think I’ve suddenly abandoned long-term investing, let me explain.

I remain devoted to buying good businesses, at sensible prices, and giving them time to deliver.

But there’s a difference between giving a business time and giving it an unlimited supply of excuses.

Between patience and denial.

Between owning shares and wearing the jersey (or guernsey, if you’re in our nation’s south or west).

Imagine two football clubs having disappointing seasons.

One has a young squad, a sensible development plan and players who are getting better. The results aren’t there yet, but you can see what the club is building.

The other keeps promising that next year will be different, while making the same mistakes.

Both might call it a rebuilding year.

Only one has given you a reason to believe it.

And that’s where our footy analogy helps. I bet if you’re a football fan, you’re already thinking of clubs that fit into each category.

That’s also the distinction we need to make with our investments. And, unfortunately, it requires more work than checking the share price.

A falling price doesn’t, by itself, tell you that the business is broken.

Nor does a rising price prove that everything is going wonderfully.

The price is what other investors are prepared to pay, right now. It isn’t a complete assessment of the company’s future.

It might be right. Or wrong. It might change tomorrow. Or not.

So, what should we look at?

You’re already ahead of me, right?

You need to look at the business. Not the three-letter code on your screen.

Are customers still buying what it sells? Is it maintaining its competitive position? Is cash coming through the door? Can it comfortably handle its debts?

And, where something has gone wrong, is there credible evidence – or at the very least, a high likelihood – that the problem can be fixed?

Consider a hypothetical retailer spending money on a new distribution centre. Profits might suffer while it gets the facility running. If customers remain loyal and the investment does what management promised, patience might be entirely sensible.

Now imagine another retailer losing customers because a competitor offers something better. Management keeps talking about “challenging conditions”, but the competitor seems to be doing just fine. Yes, I’m looking at you, Myer Holdings Ltd (ASX: MYR) and DJs.

Those are very different scenarios… and neither can be diagnosed from a red number on a screen.

The danger is that, once we own something, we can start looking for reasons to defend it.

We liked the company enough to buy it. Perhaps we told a mate about it. Selling would mean admitting we got something wrong.

Thing is… sometimes we do. I’d rather acknowledge a mistake than keep losing money because of it.

It’s also possible that we didn’t make a mistake at the time, but that circumstances have changed. We need to recognise that.

On the other hand, I’d also rather endure an uncomfortable period than abandon a good business just because the market has lost patience.

Holding on, out of stubbornness? Selling to cauterise the wound and stop the pain?

They’re both bad ideas.

The right approach? Become more honest about why you still own what you own.

Here’s the question to ask, even before share prices start moving:

“What would have to happen for me to change my mind about this business?”

Not how much the share price might move – but what would need to change about the company itself.

Losing a competitive advantage, perhaps. Taking on more debt than it can sensibly manage. Discovering that the opportunity you thought existed was smaller than you’d assumed – either because you sized it wrong, or because the company just didn’t execute (Remember Woolworths Group Ltd (ASX: WOW)’s short foray into hardware? Yeah, that.)

Write that down before you need it. Then revisit it when meaningful new information arrives, rather than rewriting the test to excuse every disappointment.

Long-term investing should mean giving a sound investment case time to play out. It shouldn’t mean refusing to notice when that case has changed.

Your job isn’t to prove that every decision you’ve ever made was right.

It’s to make good decisions with the information you have now.

So, enjoy the footy. Be hopelessly biased. Leave one eye closed, at least until the final hooter/whistle/siren.

(But also, lay off the umpires and referees, and congratulate the other team if they win.)

And yes, be loyal to your portfolio… but its long term potential, not the ‘players’ inside it.

Tomorrow’s Grand Final? I’m a New South Welshman, talking about a game in Victoria, played between a team from Queensland and one from Western Australia. Fair to say, I have no dog in that fight.

But tonight?

Go the mighty Chooks! #EastsToWin

Fool on!

The post Don’t treat your companies like your footy team appeared first on The Motley Fool Australia.

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Motley Fool contributor Scott Phillips has no position in any of the stocks mentioned. The Motley Fool Australia’s parent company Motley Fool Holdings Inc. has no position in any of the stocks mentioned. The Motley Fool Australia has recommended Myer. The Motley Fool has a disclosure policy. This article contains general investment advice only (under AFSL 400691). Authorised by Scott Phillips.