This article is sourced from: Sixiang Gangyin
01 Stock investment also has a profit model
I once met a fellow stock investor who was particularly fond of purchasing high-quality companies impacted by negative industry events.
I believe many people have had similar investment experiences. Most individuals merely remember these experiences and assess whether to act when opportunities arise. However, only a few can conduct detailed opportunity analyses of such experiences, summarizing the conditions under which they occur, the methods for establishing positions, position control, and other factors into a unique strategy, or even form an investment preference.
This is analogous to the profit model in business operations. Nearly all profit models evolve from operational opportunities occasionally discovered by corporate leaders.
At the core of an investment system lies one or more profit models.
I previously introduced four profit models. In reality, just as with business models, profit models can evolve from a few basic forms into countless variations, provided they align with the company’s values, resources, and product characteristics.
Although the concept of a profit model may sound abstract, the essence of stock investment remains straightforward—buying low and selling high to make a profit, without much complexity. The main approach is rather simple:
1. Identify relatively successful cases from your past investments;
2. Extract replicable methods from those cases;
3. Apply these methods consistently in practice, drawing lessons along the way.
4. Some conditions and steps of this method should be solidified - preferably quantified.
Therefore, the core elements of profitability are 'profit analysis' and 'model summarization'.
02 Attribution Analysis of Successful Investments
'Profit analysis' refers to conducting an attribution analysis of past successful investment experiences.
There are many perspectives for analysis, but the most important is the question I raised in my previous article: In an investment that has brought you substantial profits, did you make money from valuation or earnings?
In this article, some readers suggested aiming for a 'Davis Double Play,' which involves earning from both valuation and earnings. However, this statement lacks proper attribution. In a 'Davis Double Play,' profit derived from earnings growth is your target and also the basis for action, while an increase in valuation is an additional bonus - it may or may not occur. Many stocks see no change in valuation or even a decline after their earnings rise. Therefore, the essence of a 'Davis Double Play' remains profiting from earnings growth.
Under these two major directions, we can focus on certain types. For example, I will use the four types from my 'Profit Model' series:
Profit Model One: Turnaround from adversity.
A good company in a good industry encounters 'bad luck,' leading to temporary operational difficulties and a drop in stock price. Investors can seize the opportunity to buy and wait for the business performance to reverse.
As analyzed earlier in the 'Davis Double Play,' it essentially still earns from earnings growth, with valuation improvement being an additional bonus.
Profit Model Two: Growth-based Position Accumulation.
When we identify a company with an 'expectation gap,' we first purchase a partial position. As the company’s operations improve in line with our expectations, we continue to add to our position until reaching the pre-set maximum allocation.
What profits are generated through 'Growth-based Position Accumulation'? Before growth stocks show signs of accelerating performance, their valuations typically rise first. This is followed by the earnings realization phase, during which valuations gradually decline to normal levels. Under this profit model, early gains come from valuation increases, while later returns stem from actual earnings growth.
Profit Model Three: Value Benchmarking.
The returns from stable-growth blue-chip stocks consist of two components: one part comes from the continuous rise in earnings, and the other from valuation shifts driven by market sentiment, moving from undervaluation to overvaluation.
This profit model has two distinct approaches. If you focus more on the steady upward movement of the stock price benchmark alongside earnings, then you are earning returns based on performance. However, if you wait until the company enters an undervalued range before investing, then your profits mainly come from valuation adjustments.
Profit Model Four: Industry Trends.
Identify the most significant technology industry trends in the coming years, locate the companies that best fit these trends and have the strongest potential for delivering results, invest before the trend fully forms, and realize profits during the earnings realization phase.
This profit model also includes two different strategies. If you prefer companies with high certainty of earnings delivery, then your main source of profit will be earnings growth, as such companies often have relatively high valuations before the trend emerges and limited upside flexibility. On the other hand, if you favor companies with vast future potential, pure concepts, but uncertain earnings realization, then your profits will primarily come from valuation changes, as these companies often experience a cycle of moving from extreme undervaluation to excessive overvaluation within the trend.
Attribution analysis of successful investments is challenging but essential. At a minimum, it is crucial to understand what your target goals are versus what are merely 'bonus' outcomes; which factors during the investment process are within your control and which are not; and how the risk-reward ratio, probability of success, and frequency of action align...
Another challenge in attributing successful investments is that nine-tenths of the success factors in a single stock investment are due to luck, and only one-tenth to effort. Only by establishing an investment system can you reduce the influence of luck. Therefore, it's crucial to distinguish between temporary gains that will eventually be taken away by fortune, and the money you permanently retain through your own abilities.
For example, a friend’s record of investing in Gree Electric last year showed substantial profits, but it is difficult to call it a success. The investment by Hillhouse Capital was an unexpected factor, and even the shareholding reform itself carried significant uncertainty. In fact, Gree Electric not only failed to overcome its difficulties last year but instead fell into greater challenges, widening the gap with Midea in 2020. This profitable investment should thus be categorized as a failure case.
03 Three Key Points of the 'Model Summarization'
The purpose of 'analyzing profitability' is to 'summarize a model,' which refers to the sustainability, replicability, and upgradability of profits. A good profit model requires you to allocate most of your resources and capital toward it, allowing you to consistently generate returns over the long term using this method.
I have summarized the requirements of 'model summarization' into the following four points.
First, the ability to continuously identify opportunities while ensuring stable profitability.
For instance, the 'Net Profit Breakthrough Method' involves selecting stocks that exhibit a price gap after the release of earnings reports. If the stock price subsequently receives support at the gap level, it indicates that the market has recognized the sustainability of valuation and profitability, suggesting further upward momentum. At this point, it represents the optimal buying opportunity.
This approach essentially builds on scenario-based operations like 'growth-based position scaling,' a method validated by various strategies. Given its relatively stable profitability and continuous opportunity identification, it can incorporate a series of 'operational procedures' such as opportunity discovery, position management, and stop-loss/stop-profit mechanisms to establish an effective profit model.
On the other hand, some investments may appear impressive but lack replicability. For example, a profitable investment in Moutai based on fundamental analysis would have very low replicability because Moutai's resources and brand are unique and irreplaceable. If it were a trading opportunity, then specific evaluations would apply.
There are also methods whose profitability stability is questionable. Many approaches based on a few...Technical indicatorsMethods that rely on financial data for investment, when backtested across different time periods, yield vastly different results. Some methods are contingent on the number of users; too many or too few can lead to failure. These approaches, which lack stability in profitability, cannot constitute a viable profit model.
Second, your existing resources can support this method.
Resources for stock investment include your position size, research effort, and time. Some methods effective for institutional investors are beyond the resource capacity of individual investors.
I have seen someone summarize an investment methodology that combines detailed and comprehensive grassroots research to forecast the next quarter's earnings report of listed companies, integrated with long-term qualitative fundamental analysis. The theory is impeccable, and many institutional investors also use it, but this method has significant limitations:
First, it cannot track companies engaged in 2B order-based businesses; second, it cannot monitor companies with extensive room for financial statement adjustments; lastly, it demands excessive energy from investors, involving a great deal of repetitive low-intelligence labor.
Therefore, this method can only be occasionally applied by individual investors and cannot evolve into a profit model.
Among the four profit models mentioned earlier, the "value anchor" requires fewer research resources compared to the other three, making it more suitable for non-professional individual investors—both in terms of returns, where long-term growth generates basic gains and capturing undervalued opportunities yields excess returns, and cost efficiency, where investments focus on high-certainty blue-chip stocks, requiring relatively less research effort to achieve above-average returns, forming a highly actionable profit model.
Third, continuously upgrade your profit model.
When I first started investing in stocks, I began withKDJ、MACDThese methods initially proved profitable and could be fully upgraded into a profit model. However, after a small bull market in 1996, I began to feel that the methods were losing effectiveness. Later, I understood there were two reasons: first, too many people were using them, so the investment psychology represented by the indicators no longer existed; second, the emergence of stock manipulation models led to distortions in volume and price signals.
It is not justTechnical analysismethods; most investment strategies are based on the characteristics of investors and companies during a specific historical period. Over time, these methods will inevitably become obsolete. For example, various profit models based on small market capitalization and low-priced stocks that were highly effective before 2015 have now mostly lost their effectiveness.
Therefore, continuously upgrading one’s profit model to align with the demands of the times and constantly seeking new profit models constitute the path to sustained profitability.
Fourth, it should align with your personal circle of competence and investment values.
Earning returns from performance requires a profound understanding of how enterprises create value. Hence, Charlie Munger once said that one cannot truly understand value investing until the age of fifty. Earning returns from valuation essentially involves predicting others' behaviors, which is a typical game-theory scenario, and many lack the ability to understand group psychology.
Investors cannot consistently make money using methods they dislike or are not proficient in, even if these methods can generate profits. This consideration is also an important factor in evaluating profitability.
04 Investing Should Be a Boring Activity
Investment is an activity characterized by a high degree of uncertainty. Therefore, almost all sound investment approaches focus on enhancing the certainty of profitability rather than the scale of profits. Consequently, a stable investment system must be built upon one or several reliable profit models.
Many people may imagine dramatic, movie-like scenarios for making money—heart-stopping moments, narrow escapes, buying at the bottom and selling at the top, going all-in. In reality, the process of truly making money is often very boring, simply finding a system, continuously losing small amounts and earning larger sums, slowly compounding wealth like rolling a snowball.
The process of individual trades requires enduring short-term ambiguity, closer to an art form, but an investment system should resemble science, pursuing long-term certainty—designing a good investment system through the coordination of three metrics: odds, win rate, and frequency of execution within a profit model.
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Editor/KOKO