Invest in Businesses, Not Markets
The major stock indexes are down today. Headlines attribute the drop to political uncertainty in Italy. “What’s that got to do with the price of tea in China?” you may ask – or, perhaps more appropriately, the cost of Apple shares on the NASDAQ, or JP Morgan on the NYSE? I could pretend to have a definitive answer and write about the potential damage that could be done to the Euro and on future earnings of European Union- based stocks. I could, but I won’t, because the truth is that I don’t know what is going to happen to markets in the short term. Years of trying by many tell us that.
You might think, “Wait, this guy makes a living advising individuals, trusts, foundations, and institutions about investing their money. If he doesn’t know what the markets are going to do, he should find a new line of business.” Before I start looking for a new job, I’ll defer to some people with more name recognition than me.
Peter Lynch is a legendary investor. He ran the Magellan Fund at Fidelity from 1977 to 1990 and, by all measurements, knocked it out of the park. The fund averaged over 29% in annual gains during his tenure. If there was an Investment Hall of Fame, Lynch would have been a unanimous, first-ballot inductee. So what did Mr. Lynch have to say about his ability to predict markets? He said, "Don't worry about predicting the stock market or economy. Trying to predict the market is a total waste of time." A total waste of time.
How about Warren Buffett? Everyone knows Warren Buffet. Surely he knows (or at least has a pretty strong idea) where the market will be a year from now. What does the Oracle of Omaha have to say on this topic? His take is, "I've never made a dime predicting economic activity." Not a dime. This is a guy who’s made a whole lot of dimes in his life, but when asked what the markets will do in the short term, he is steadfast about not being able to tell us what will happen in the markets tomorrow, next week, next month, or even next year.
Let’s check in with one more investment giant, Sir John Templeton, certainly another hall of famer. Did he make some serious money figuring out where markets were headed and applying that knowledge to his buying and selling of securities? Well, here’s a quote from him that came fairly late in his illustrious career, “We have been investment counselors for 58 years, and in all that time, we have never been able to tell our clients when a bear market will start or stop." His answer wasn’t “most of the time,” “some of the time,” or even, “once in a while.” His answer was “never.”
Three of the greatest investors of all time told us they couldn’t predict the market. That sounds discouraging. How can investors hope to succeed in an area where the greatest of all time don’t tread? The short answer is, you don’t need to. You’ll save a lot of time and energy that can be committed to what I believe is the key to success in the stock market – finding great businesses trading at fair prices.
Having an informed opinion about market direction is fine. Most of us carry one around with us at all times. The key, in my opinion, is to not take too much pride in, or to be indebted to, that opinion. Focusing on businesses – the stocks you want to own and how their present value compares to their projected future value is the sweet spot of investing in the stock market.
There’s more good news in choosing this focus. The stock market, in the short term, simply gauges the emotionally charged activity of buyers and sellers. This will inevitably be chaotic at times. History has proven that the madness of crowd psychology sometimes trumps otherwise rational behavior. Over the long term, however, the market is a trustworthy, well-calibrated scale that measures and rewards the heft of rising corporate profits, or punishes in their absence.
My colleagues and I are mindful that businesses have value that can be researched, evaluated, and projected, whereas stocks simply have prices that are mainly observed, like the weather. We seek to constantly expand our capacity for understanding business values. Stock price fluctuations are random in the short term and prone to being influenced by momentum swings; whether caused by programmatic trading systems, hedge funds, other vehicles that profit from price declines, or simply emotion-driven investor psychology. We view stocks as the partial ownership of a business, thus our goal is to keep a keen, unwavering eye on business values. Our perception of the influences on short-term stock prices is limited, and we expect that is where it will stay.
The prudent investor relies very little on talk about price movements or market forecasts, focusing instead on the fundamental factors that drive business success. The words of Benjamin Graham (professor, writer, and mentor to Warren Buffett) ring true, "You are neither right nor wrong because the crowd disagrees with you. You are right because your data and your reasoning are right."
To paraphrase Charlie Munger (Warren Buffett's co-chairman at Berkshire Hathaway), "It is remarkable how much long-term advantage people like us have gotten by trying to be consistently not stupid, instead of trying to be very intelligent." I advise against the temptation to hyper-focus on preventing short-term losses by moving haphazardly into or out of good quality assets. This type of action often subjects portfolios to the significant, longer-term risk of failing to achieve goals by interrupting the compounding process. Compounding takes time, and using time to your advantage in the investment process takes patience. Having a resilient portfolio means, to us, having the humility to admit that we don't know everything about the future, but also the confidence from having selected what we believe are the appropriate portfolio components with the long term in view.
Michael opened the Aspen office of the Boston-based firm East Coast Asset Management. His friend is the founder. He teaches Security Analysis at Columbia Business school - the same course that Benjamin Graham taught a young Warren Buffett while becoming his mentor. East Coast Asset manages investments for endowments (including working with a top-10 university endowment), foundations (including the Sir John Templeton Foundation), trusts, families, and individuals. Mike's a good guy who had been doing private investment work for almost 20 years before joining ECAM. He is passionate about helping people avoid potential pitfalls that arise when they are with managers who put themselves first. Michael has been very active as a backer, board member, and volunteer for several non-profits in Aspen and elsewhere.
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