I have been spending my summer weekends catching up with some classic reads. 2 weekends ago while visiting Iowa I read The Intelligent Investor. This book is a 600 page classic of the Value investing theory put forth by Benjamin Graham and so successfully executed by Warren Buffet.
My good friend Graeme called me up the other day about investing and I explained some things which may be useful for people. I have decided to blog about them so that others may benefit.
Many people think of investing as about picking a winning race horse. It really isn't it, is about understanding the difference between price and value in effort to first protect your purchasing power and hopefully over time to enhance it.
A lot of people believe that if they are inundated with stock price quotes, they can be better investors. Nothing could be farther from the truth. Price moves around like a drunken sailor. Occasionaly it bumps into value and then moves on. I am originally from Iowa and like to think slowly and move slower. This works well investing, horribly in trading.
An investor is someone in for the long haul who is going to stick it out.
To paraphrase Graham," in the short term the market is a voting machine and in the long term it is a weighing machine."
Voting is pretty much like popularity, remember how popular dot com shares were in 1999. Now think long term, a lot of those companies didn't create value (make profits). The premise of value investing is simple.
- Firstly ignore the price of an asset.
- Calculate its economic value.
- Now take a look at the price and see if you can buy value at a good price.
This astounding revelation :) that people use when trying to buy a used car flutters away in the complex matter of acquiring shares and investments. Stock markets and brokers make money with activity. You make money by sitting for the long haul and thinking for the long term. That means buying quality businesses at an affordable price.
Here is an example of what most people do when buying a share. They look for a fast and exciting horse. Apple computer with its iphone release sounds exciting. Of course having an exciting product tells us nothing about the value of Apple computer as a company.
If Apple is trading at $120/ share is that low or high? Most people look to the charts and see if it looks low or high relative to the past. If it was trading at $60 is that good? It it was trading at $200 is that better? The fact is, it doesn't matter what the price was in the past or even today, unless one understands value. You are buying an economic asset today that is supposed to generate economic value in the future. Depending on the economic value produced we can assess a "fair" price for that asset today.
For example if a person is truly a long term investor and they buy shares in an internet company at $100 and the next day those shares trade for $50 how should they feel?
If they truly understand the value of the business and believe in management they should be happy. They valued an economic asset and it is now half off. If they wish they can buy more of it. After all investors buy for the future and acknowledge that price fluctuates in the short term.
"A cynic is a man who knows the price of everything and the value of nothing" (Oscar Wilde)
A silly investor is the same thing. They will track price to the millisecond and have no idea of underlying value. Caveat the situation may be different for a true trader.
Basically an investor is looking for the market to misprice value. It is like buying a $1 bill for $.50 Here is an example of the returns from doing that.
There is of course a lot of other smart work to be done, but basically understanding value is the important part of the equation. Price is readily available to anyone.
I would strongly recommend that anyone with more than $5k to invest read the intelligent investor. It will take most people about 20 hours. Depending on what you learn from your reading, it may be the best hourly paying job you ever have. I will be writing a few more articles for the "investor under the finance section of my blog" I will provide some basic tools highlighting why 95% of you should invest in index mutual funds and the value of sloth (deferred taxes and minimal transaction cost) when it comes to investing.