First I’d like to talk about what a stock is not. A stock is not a random number generator on your phone. It is not a squiggly line that bounces up and down. It’s not a lottery ticket. A stock is a partial ownership in the underlying business. And in the long run, the stock’s price will track the value of the underlying business. In the long run. But in the short run anything can happen. The two can diverge wildly. In fact, I can pretty much guarantee that if you own a particular stock for long enough, you will see it decline in price by 10, 20, 30, 40, 50%. And it may stay down for days, weeks, months, or years. If that isn’t something that excites you, then you shouldn’t own individual stocks.
Notice how I said that declines in price should excite you. That may seem counter-intuitive. Isn’t it a good thing when your stocks increase in price? No, not if you’re a net buyer of them. If you’re a net buyer of something, you should want the price to go down. If you’re a net seller of something, you should want the price to go up. What you want is for your stocks to increase in value. This may seem like a pedantic distinction, but it’s really at the core of value investing. Price is what you pay and value is what you get. In short, you want declining price and increasing value.
Someone once asked me why I thought long term. That’s because I cannot predict stock prices over a short-period of time. They’re essentially random. But what I can do, is find a handful of companies that I think will increase in value over the next 5 or 10 years. And if I don’t pay too much for those companies, I should do very well. In the next few episodes, I will get into what I look for in businesses, both from a qualitative and quantitative standpoint, and how I think about valuation. But for today, I want to focus on stock ownership.
If I were to go to a cocktail party, and someone asked me what I did for a living, and I told them that I owned a laundry mat or a car wash, no one would think I was crazy. No one would think I was risky. They’d just assume I was a small business owner. Or if I were a dentist and I owned by own practice, no one would find that particularly risky. Or if I had some 9 to 5 job earning a steady paycheck, no one would think that was dangerous. But I think all of those things are more dangerous than stock ownership. A laundry mat is a shitty business. You have to hire people to work for you, and keep the machines in order, and hire lawyers and tax accountants, and it really just seems like a complete headache. Or if you have a 9 to 5, most of the net present value of your future cash flows are wrapped up in that job, and you could be laid off or injured or something of the sort. A computer program could replace you. To me, that seems dangerous. But I don’t think owning a handful of superb businesses is dangerous.
I think owning Apple or Google is a lot less dangerous than owning a laundry mat, but if you told someone that you had over 50% of your portfolio in Apple they’d think you were crazy. They would say that is risky. That’s nonsense. If you look at the richest people in the world, most of them have most of their net worth in a handful of companies, and in many cases, a single company. Having a really great idea, and having the balls to bet on it, is how most people get rich. Most people don’t get rich off their 20th best idea.
And you don’t need to have more than one or two good ideas a year to make a lot of money. If you can find one amazing company a year, you’re doing fine. Figure if you have a portfolio of five to ten companies and your average holding period is five to ten years, then you just need one new company a year.
The problem a lot of people get into, is they sell out of their best ideas. People will buy a company and then sell it because the price went up. They’ll say you can’t go broke making a profit. But unless you’re taking that money out of the stock market, it has to go back somewhere. So what you’d end up doing is taking it out of a one stock and putting it in another. And maybe that next stock isn’t as good. Or some people sell a company because the stock price has gone down. They use stop-losses, for example. Stop losses never made any sense to me, it would be like if you had a house for sale for let’s say $1 million dollars. You tell your realtor, if someone offers you $950K, don’t accept it. But if someone offers you $900K, accept it. It doesn’t make any fucking sense. But people think that way. And some people will sell a stock because it’s gone sideways for too long. They get bored and want to move into something else. So what you have is investors who will sell a stock if it goes up, sell if it goes down, or sell if it goes sideways.
So when should you sell a stock? Well the simple answer is when something better comes along. Taxes are no joke, so you should account for them if you’re going to sell out of one stock to buy into another. I could probably do a whole episode on when to sell a stock, so I’ll save that for later.
One last thing I want to say about stock ownership though, is that I treat it as if it were a small business. I think of my small business as a conglomeration fo Google, Facebook, Amazon, and Take Two Interactive. Now clearly, I don’t have any executive power over those companies. I can’t walk into an Amazon Bookstore and start demanding changes. I have no control over them. And that’s fine, I don’t want control over them. What I have control over is where I put my capital. That’s my job as owner of my little business. I allocate capital. That’s it. If I think management is doing a good job, I may invest more capital in their businesses and if I think they’re doing a poor job, I’ll pull out my capital. It would be like if I divested from a failing division.
And I think stocks provide you with a way to own an amazing small business. If you had $100K, what kind of small business could you run? Perhaps the aforementioned laundry mat. Well with stocks, you can own a $100K microcosm of Apple. And you get all of the smartest people in the world working for you, and you’re paying them essentially nothing if you stop to do the math. You get to leverage that brand name and have global recognition of your products and services. It’s an incredible business, and you get to buy it with no contracts or legal fees. No real work is expected of you, other than just maintaining a working knowledge of the business. It’s really a goldmine of an opportunity.
I think stocks are the easiest way for the average American to live the American dream. Work hard, save, and invest. You won’t get rich quick, but you will get well to do eventually.
Also see:
How to Analyze a Company Qualitatively
How to Analyze a Company Quantitatively