Investing the Smart Way
An interview with Stephen Clapham
“It’s twice as painful to lose a pound than it is to gain a pound, so when you start losing money you get very stressed. The nature of the stock market is that the markets go up and down, so you will lose money from time to time.”
The next guest in Perlego’s ‘Author Spotlight’ series is Stephen Clapham. Drawing on 25 years of experience as a hedge fund analyst, he founded Behind the Balance Sheet, an investment research and training consultancy.
Stephen also dedicates his time to running a blog, a podcast and a YouTube channel. I wanted to learn more about his first book, The Smart Money Method: How to Pick Stocks Like A Hedge Fund Pro, which was published in 2020.
In your book, you outline a method for the entire investment process — from researching new opportunities to retaining and selling stocks. What would you say is the most challenging part of managing an investment portfolio?
The most challenging thing is keeping control of your emotions. You can do quite well in investing even if you’re pretty average — you don’t need to be super smart. But the most difficult thing is managing the stress, the emotional side of things; when you start losing money, it’s pretty upsetting. Most people approach investing in a very haphazard way: they don’t have a plan, they don’t know what they’re doing, and then they lose money and get very upset.
Being able to manage your behaviour is the single most challenging thing. I think that’s not just true of private investors, but it’s also something that professional investors struggle with. What often happens when your fund isn’t performing well is that you go into protective mode because you don’t want to lose more money, which means you can’t make money because you’re being too defensive.
It’s not complicated; the art of investing is incredibly simple. Obviously, there are a lot of extraneous factors that you need to take into account, so it’s difficult, but it’s not complicated. This emotional management, however, is a struggle. That’s why I believe that women make better investors than men — I think women are better at the emotional side of life.
How has the stock market changed with the invention and evolution of cryptocurrencies? Is investing more complicated as a result?
Well, crypto doesn’t have a huge impact on the stock market. It diverts some money away from equities into crypto, but people that make a lot of money in crypto are probably putting some of that back into the stock market. Coinbase is heavily exposed to the crypto world, and that’s one stock I’m studying at the moment — crypto’s quite interesting.
There was another sort of meme stock involving a company called GameStop, which sold video games in shops. The shares were rated very low. Then a bunch of kids got together on social media and aggressively bought the shares, sending them up to a ridiculous level. But this one hedge fund that had a big short in it didn’t close the short and lost a huge amount of money. This then became a kind of game; they were getting together on Reddit and they were called ‘the Redditors’ because they started attacking other hedge fund shorts. If you find a heavily shorted stock and you can force it up, you force the hedge funds to buy back their short. These kids were causing the pros to lose money, while making huge amounts of money themselves.
I think there’s a generational shift going on; there’s a change in psychology and it’s quite difficult for me, as a serious investor, to understand. Ordinarily, I can make money out of shorting, but it’s become too dangerous. I know several professional investors who have stopped shorting individual stocks because they don’t want to take the risk of being on the wrong side of the Redditors. If you think about it, it’s a slightly bizarre situation when amateurs are buying stocks at a ridiculous price and beating the professionals.
For sure it’s a fad, a short-term phenomenon… because, in the end, the stock market will correctly value businesses. But you’ve got loads of companies at the moment which are on daft valuations. You do get these periods — which we had in the late 1990s with the dotcom boom — where unsustainable valuations carry on for quite a long time, and the stock market can remain irrational longer than you can remain solvent. Don’t fight it, just try not to let it bite you.
What impact did COVID-19 have on the global stock market? Was this effect more pronounced in certain territories or industries?
In the last chapter of the book, I mention 10 things that changed because of the virus. But I wrote that chapter in April or May 2020, when we were in the depths of the virus, and it was actually hard to know if there would be a vaccine. I tried to think through what could change and I talked about things like supply chains but, in reality, not much has actually changed in the stock market. Obviously, the valuations of some companies have become much more attractive — they’re much higher. Companies like Zoom were re-rated incredibly quickly. At the time, Zoom was capitalised at $170 billion — it was very close to the peak. It’s now valued at about $70 billion, less than half of what it was. But, without COVID, Zoom wouldn’t even be worth that.
So, stock market changes are an economic manifestation of the changes that have happened in the world. We’re 20 miles from each other, yet we’re having a conversation on Zoom. We wouldn’t have done that pre-COVID; if you wanted to interview me, it would have been over the phone or in person. This is a pretty efficient way of doing it, but you couldn’t have forced that behavioural change without us all working from home. Stock market changes really do reflect changes in life.
The Smart Money Method claims to reveal insider secrets and industry leaders’ top tips. How did you go about collecting this information, and how is it presented in the book?
The book isn’t really about anything other than my investing philosophy. Basically, what we’ve done in the book is set up the framework that I’ve developed over decades as an investment analyst. I describe the process from the time that I find an idea in the stock market that looks interesting. I then go through how I check that it’s a good investment by auditing it. I explain how I look at the accounts and I go through techniques that, as an amateur investor, you would have no idea about. But I’ve looked at thousands and thousands of company accounts, so I figured I’d give some shortcuts and tricks. The book is really about trying to help people get to the right answer — and get there more quickly and less painfully.
We go through how to check accounts, what to think about the management strategy, and how to analyse the balance sheet, markets and opportunities for growth. We talk about evaluation, and then we look at how to build and monitor a portfolio. This is all very similar to my investment training school, which offers courses for private investors. The book is like a shortcut; quite a few people have read the book and then gone on to do the course to develop their skills and knowledge. I’ve done this for a long time; I was pretty successful and there’s no reason why people shouldn’t benefit from that, because the equity market is a great way of securing your financial freedom.
It’s also good fun — you don’t need a lot of money to play around in the stock market. My parents wouldn’t dream of investing in stocks because it was seen as a rich man’s activity, and the frictional cost of trading and commission was very high. Today, it’s almost free: you can buy £100 of Marks & Spencer stock and have £120 the next week. So, even if you don’t have a lot of money, it’s much more accessible today. And many more people are interested in it, but they often don’t know what to do. My objective with the book was to say, ‘Here’s a roadmap. I can’t teach you everything because it’s multifaceted, but I can give you tools, tips and techniques. And, if you think you’re enjoying this, you can join my investing courses and go to the next level’.
For somebody like me, being an investment analyst at a big hedge fund is the most interesting job. I used to fly all over the world, meeting the leaders of major companies and incredibly smart commentators who were queuing up to give me advice. You get to look at what’s happening in the world and every day is different — you don’t know what’s going to happen. You might come into work and find that you’ve lost $50 million in your stock overnight, and that can be quite painful. Or, you might find out that you’ve made $50 million overnight, and that makes it a good day before you’ve even opened the newspaper!
Can you offer 3 key bits of advice from The Smart Money Method for new investors?
With investing, you can’t just say, ‘Do these three things and that’s it’. I get asked this a lot in the context of reading balance sheets and avoiding fraud. For people who are interested in investing, the very first thing is to not buy a share unless you’ve understood the way it makes money. So, read your report and accounts.
The second thing I would say is that you need to build a portfolio, and that portfolio needs to be balanced. You don’t need hundreds of stocks — people tend to have overly-diversified portfolios and that’s a very bad idea, because it’s impossible to monitor all the companies. A very famous investor said, ‘Keep all your eggs in one basket, and watch the basket’. Just having everything in one stock is dangerous, but you don’t need more than 15–25 stocks. Keep an eye on them, but don’t watch them all the time — many enthusiastic investors watch their shares too closely and then you get this behavioural problem. It’s twice as painful to lose a pound than it is to gain a pound, so when you start losing money you get very stressed. The nature of the stock market is that the markets go up and down, so you will lose money from time to time. Recently, we’ve been in a big boom market so people have been making money rather than losing it, but that won’t last forever.
And the third thing is to invest in yourself. Educate yourself: read books, read good publications, do investing courses. Educating yourself is the best way to improve your skills and get better returns.