Sun Tzu on Value Investing

In 506 BC, the ancient Chinese general Sun Tzu was in command of a vast army of the Wu Kingdom, preparing for battle against the neighboring Chu.

Sun Tzu and his colleagues immediately sensed that the Chu army lacked the will to fight; so the general acted quickly and ordered the main attack to seize the initiative.

His surprise assault spurred a chaotic route of the Chu army, bringing an easy, low-risk victory for Sun Tzu.

This battle exemplifies Sun Tzu’s approach to military strategy, which he later outlined in his book Art of War.

Like all Chinese philosophy at the time (Sun Tzu was a contemporary of Confucius), there’s a beauty in the simplicity of his wisdom, all of which still applies today.

I was re-reading Art of War recently, and I couldn’t help noticing how much the principles apply to investing.

We’re living through some of the most insane financial conditions in modern history.

The Western world is drowning in debt, and entire nations are starting to go bankrupt despite interest rates being at record lows.

A multi-trillion dollar financial bubble in the second largest economy in the world has started to burst.

National pension funds are running out of money. Banking systems are dangerously illiquid and undercapitalized. Even central banks are borderline insolvent.

There’s clearly a tremendous amount of risk in the system.

And yet many western stock markets are crossing all-time highs with historically dangerous valuations, and retail investors are piling in like the good times will last forever.

In Chapter four of Art of War, Sun Tzu wrote that “he who is destined to defeat first fights and afterwards looks for victory.”

This is precisely what most retail investors are doing right now: they throw money at the market and hope that their stocks go up.

Expecting success from haphazard actions is as pitiful an investment strategy as it is a military strategy.

Sun Tzu continues, “The skillful fighter puts himself into a position which makes defeat impossible, and does not miss the moment for defeating the enemy.”

Victory comes from having a completely defensible position… and having the guts to seize the advantage when one is presented.

In investing, a defensible position is a strong, well-managed, highly profitable company with a pristine balance sheet and very little debt, and a stock price that trades at reasonable (or discount) valuations.

Better still, an even more defensible position is staying out of the market entirely, holding cash as you wait patiently to strike at the right opportunity.

(Chapter III- “He will win who knows when to fight and when not to fight.”)

As Sun Tzu wrote, it’s critical to not miss those opportunities to attack.

This happens from time to time when blood is running in the streets– the market presents no-brainer opportunities to buy high quality assets at a discount.

A great general will have the courage to seize the advantage. And a great investor will have the courage to buy assets that are widely despised and incredibly unpopular.

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sovereignman.com/Simon Black/August 3, 2015