Word
Gems
What is a
man but the sum of his thoughts?
- Investor or
Speculator:
- Which one are you?
Benjamin Graham, father of value
investing and mentor to Warren Buffett, liked telling this story:
An oil prospector died and found himself at the
entrance to the Pearly Gates. St. Peter greeted him
with the troubling news that although the prospector was qualified
to enter heaven, all the spots reserved for oilmen had been taken.
There was no room for him.
After thinking for a minute, the prospector asked if he might say just
four words to the present occupants. That seemed harmless to St. Peter. So the prospector
cupped his hands and yelled:
"Oil discovered in hell!"
Heaven's great gate burst open, and the oilmen rushed for the Devil's
headquarters. St. Peter was so impressed that he invited the prospector in.
"No," replied the prospector, "I think I'd better go
along with the rest of the boys. You never know, there just might be
some truth to that rumor."
Speculator or investor. Which one are you? What motivates you?
The thrill of finding that one-in-a-million chance to double your money overnight? or the
steady-burner investment that without fail delivers 12% a year?
One of the most helpful gems of investment wisdom from Warren Buffett is
the following statement:
- "I am a better investor because I am a businessman,
and a better businessman because I am an investor."
As reported in Forbes,
- "Buffett doesn't buy stocks; stocks are an
abstraction. He buys businesses."
When you buy a stock, what's happening inside your head? Are
you buying a business? -- an economic entity which you understand and have confidence in?
Or are you buying a stock, some abstraction, some piece of paper registering your name
somewhere by which you hope against hope will make you money through some magical process?
If you are buying "stocks" instead of "businesses" your
retirement-savings plans are very likely to be hampered:
Here's why:
Let's say that I told you that tomorrow the Federal Reserve will be raising interest
rates a notch; or that mutual fund managers, for short-term gain purposes, will be selling
certain industry-sectors; or that the threat of a new tax on certain products will create
general market selling pressure; or that certain companies will miss analysts' quarterly
earnings expectations due to increased capital expenditures in order to take advantage of
new markets -- Any of these may cause individual stocks or the general market to go down.
If you have purchased "stocks," those strange pieces of paper of
dubious value, you are far more likely to panic and sell today to avoid the
possibility of prices going down. "After all," you might say, "what
guarantee do I have that the price of those funny pieces of paper called stocks will ever
rise in value again?"
But if you purchased a "business," an entity understandable to you,
producing goods and services which people will buy on a regular basis, in good times and
bad, in your country and 100 others, then you will shrug-off any threat of price decline
because you know that the price decline will be temporary: People around the world will
wake up tomorrow and continue to buy soap, toothpaste, snack foods, utility services,
pharmaceuticals, etc. whether the market today is up, down or sideways. In fact, you may
look forward to a down-market event with some measure of good cheer as you anticipate
buying your favorite company-businesses at bargain prices.
Do you see the difference? Unless, philosophically
speaking, you are buying "businesses," you will not have the confidence to stay
with your companies over the long haul -- and that's how fortunes are made in the stock
market.
"Stock" is to "business" as "speculator" is to
"investor." Speculators buy stocks. Investors buy businesses.
One of my favorite articles from Forbes (6-20-94) is "Buy'em
Cheap and Hold'em," an interview with 99 year-old money manager Philip
Carret, who at last report was still actively managing portfolios. He began serving his
clients before the 1929 crash. Mr. Carret explained: "I have a very simple strategy.
I buy good companies [notice that he did not say "stocks"] at attractive prices.
Then I sit on them," as along as fundamentals remain constant. "Don't speculate.
Buy for the long pull." One of his companies was purchased in 1946, a small producer
of wooden barrels and other containers. Since then the stock has split many times. Each
share originally purchased at $15 is now equal to 40 shares each worth $1,505.
Short-term traders will never share in that kind of largesse.
Benjamin Graham, the first mentor of Warren Buffett, has a lot to say about speculators
and investors in his now-classic book, The Intelligent Investor. Therein he
offers this advice:
"Investment is most intelligent when it is most businesslike. It
is amazing to see how many capable businessmen try to operate in Wall Street with complete
disregard of all the sound principles through which they have gained success in their own
undertakings. Yet every corporate security may best be viewed, in the first instance, as
an ownership interest in, or a claim against a specific business enterprise. And if a
person sets out to make profits from security purchases and sales, he is embarking on a
business venture of his own, which must be run in accordance with accepted business
principles if it is to have a chance of success."
Over the years, I have often marveled at the nature of stock market comments and
questions coming from even corporate executives and business owners, those who more than
others should realize that buying a stock is nothing more than buying a small portion of a
business. Instead, more often than not, their comments are of this order:
- "What's hot right now?"
- "I like small stocks because they double
faster."
- "I heard that so-and-so stock looks good
for the next month."
- "My brother-in-law heard about this
company and..."
- "This stock I heard of just shot up 50%. Should I jump in?"
As Benjamin Graham said, it is indeed amazing to hear seasoned business people
talk this way. If they ran their own corporations with such disregard for sound
business principles, as reflected in the above comments, failure would surely seek them
out. Flavor-of-the-month and what's-hot-what's-not investing styles are recipes for
disaster. Is it any wonder most people make such a mess of their investment portfolios?
Investment strategy sinks to its lowest level when speculators view the market
as a lottery ticket. Warren Buffett, in his 1987 annual report to shareholders,
recounts Ben Graham's parable of "Mr. Market":
"Ben Graham, my friend and teacher, long ago described the mental attitude toward
market fluctuations that I believe to be most conducive to investment success. He said
that you should imagine market quotations coming from a remarkably accommodating fellow
named Mr. Market who is your partner in a private business. Without fail, Mr. Market
appears daily and names a price at which he will either buy your interest or sell you his.
"Even though the business that the two of you own may have economic
characteristics that are stable, Mr. Market's quotations will be anything but.
For, sad to say, the poor fellow has incurable emotional problems. At times he feels
euphoric and can see only the favorable factors affecting the business. When in that mood,
he names a very high buy-sell price because he fears that you will snap up his interest
and rob him of imminent gains. At other times he is depressed and can see nothing but
trouble ahead for both the business and the world. On these occasions he will name a very
low price, since he is terrified that you will unload your interest on him.
"Mr. Market has another endearing characteristic: He doesn't mind being ignored.
If his quotation is uninteresting to you today, he will be back with a new one tomorrow.
Transactions are strictly at your option. Under these conditions, the more
manic-depressive his behavior, the better for you.
- Mr. Market is there to serve you with his deep pockets;
but if he becomes your guide, he will lead you astray.
"But like Cinderella at the ball, you must heed one warning or everything will
turn into pumpkins and mice: Mr. Market is there to serve you, not to guide you. It is his
pocketbook, not his wisdom, that you will find useful. If he shows up some day in a
particularly foolish mood, you are free to either ignore him or to take advantage of him,
but it will be disastrous if you fall under his influence. Indeed, if you aren't certain
that you understand and can value your business far better than Mr. Market, you don't
belong in the game. As they say in poker, 'If you've been in the game 30 minutes and you
don't know who the patsy is, you're the patsy...'
"As Ben said: 'In the short run, the market is a voting machine but in the
long run it is a weighing machine' [in that, mounting earnings sooner or later
will be recognized in terms of a higher share-price]. The speed at which a business's
success is recognized ... is not that important as long as the company's intrinsic value
is increasing at a satisfactory rate. In fact, delayed recognition can be an advantage: It
may give us the chance to buy more of a good thing at a bargain price."
- In the short run, the market is a voting machine, but in the
long run it is a weighing machine.
If the greatest investors in the world are just that -- investors not
speculators, and purchasers of businesses not stocks -- why, apparently, are there so few
investors? The simple truth is that it's darn hard to be an investor. It goes
against the grain of human nature.
Patience may be a virtue, but short-term, gunslinging stock-trading is sexy. Never mind
that rich traders are as rare as Romulans in the Federation Fleet.
There are very few stock traders -- or CD holders, for
that matter -- who end up donating money for new hospital wings. But there are lots and
lots of investors who do just that! Warren Buffett's style is too
slow-moving, too unglamorous to receive much hype from the financial media, and that's why
you don't hear much about it.
Editor Mark Hulbert, who monitors investment newsletters, made the comment (Forbes,
1-2-95) that even though Warren Buffett has been the most successful investor of the
century, not one of the many newsletters under Hulbert's review has adopted Mr. Buffett's
techniques exactly! "You couldn't retain many subscribers with a letter that always
carried the same message: Ignore last week's big decline (or rally). Stay with the same
stocks. Have a good week." Definitely not sexy. But glamour has its price.
- "Ignore last week's big decline (or rally). Stay with
the same stocks. Have a good week."
Hulbert speaks further on the virtue of patience:
"Buffett is more interested in the 'magic' of
compounding over the long term than in looking for stocks that will double within a year...
Buffett believes that unless you can watch your stock holdings decline by 50% without
becoming panic-stricken, you should not be in the stock market." That's tough advice.
And that's why most people make such a mess of their investment portfolios.
- "Unless you can watch your stock holdings decline by
50% without becoming panic-stricken, you should not be in the stock market."
Consider this historical market research done by Wharton Professor Jeremy Siegel as
reported in his book Stocks for the Long Run. He finds that during the last 200
years stocks have delivered an amazingly consistent return of 6.5% - 7% over the inflation
rate. If one were to graph this rate of return it would become apparent that at times the
market rises above, sometimes dips below, this 6.5% - 7% trendline -- but it always
“regresses to the mean.” The very strong market of the last 15 years has been,
in fact, a catch-up play for the several bad market years during the high-inflation 1970s!
Right now the market is about 20% too high in terms of the long-term trendline -- but this
has happened before. Moreover, this extended condition can last for decades as it did from
the mid-1950s to the mid-1970s.
Learn to be blasé about manic market rallies. It’s all very
nice, well, and good to see the market rocketing along at 25% a year. But it’s smoke
and mirrors. The general market cannot generate sustained gains of 25% a year when the
average US corporation delivers earnings increases of only 8% - 10% a year!
This is why, as Peter Lynch has said, the experienced investor looks at his portfolio
with a 15 to 20-year timeframe. 15 - 20 years is likely to be enough time for many
“worst case scenarios” for the national or world economy to work themselves out.
If great companies are growing their earnings at 10% - 15% a year, average annual stock
gains will be 10% -15%. Some years will be down, but patience will eventually live to see
the share-prices reflect companies’ steady earnings; some years will be way up -- but
don’t get too excited. Prices will eventually level off and the 20-year average gain
will -- surprise! -- approximate the corporate earnings growth rate. There really is no
free lunch.
- the experienced investor looks at his portfolio with a 15
to 20-year timeframe
Here is more advice from Peter Lynch, one of the world's great
investors:
“When a correction hits and people around us are losing their heads ...we can find
reassurance in the following: What makes stocks valuable in the long run isn't ‘the
market.’ It's the profitability of the shares in the companies you own. As corporate
profits increase, corporations become more valuable, and sooner or later, their shares
will sell for a higher price. Historically, corporate profits have advanced by 8 percent a
year. This 8 percent, along with the [historic] 3 percent dividend yield, is what accounts
for the 11 percent [long-term] annual [market] return [or, a 7% real return, meaning 7%
above the average historic inflation rate of about 3% - 4%]... Corrections or no
corrections, that's what stocks produce, because that's what corporations produce. Even if
corporate profits grew at 6, 5, or 4 percent, stocks would still advance, albeit at this
lower rate. Adding in the 3 percent for the dividends, you'd get a 9, 8, or 7 percent
total return. That's still a better return than you'd get from bonds in most decades.
Ultimately, to be an investor in stocks, you have to believe that American business has a
decent future, as well as business worldwide, and that corporations will continue to
increase their profits. If you are as convinced of this as I am, then you'll never panic
in a correction.”
- Don't look at "the market" -- watch the
earnings!
Wise words. There you have it from one of the great money-masters of our time. I
couldn't agree more.
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