The Forgotten Simplicity of Investing by SG Value Investor
Investing is easy. Or rather, the concept of investing is easy – we are business owners and it’s nothing more than that. How much would you buy a kid’s lemonade stand for? When the single lemonade stand becomes a million stands, the decision becomes more difficult as we get caught up with other technicalities. Sometimes, these technicalities become disconnect from the fundamental idea of being a business owner. And even without it, the distinction between business owner and investor is usually blurred and forgotten, so I’m going to take it one step further to define business owner as a private business owner. What does it mean to be a private business owner?
Simplicity of Investing – Understanding the business
This is pretty straightforward and a much hackneyed definition – one should fully understand the business of what one is investing in. As a private business owner, one should also be in for the long haul. In his role as an investor, this means that he should also ignore short term price fluctuations as long as there are no changes in the fundamental appeal of the business.
Simplicity of Investing – There is no difference between stock returns and business returns.
This is one of my more startling realisations. As an investor, we value a company and derive an estimated return based on the entry price of the stock. You may have a stock with both ROE and FCF yield of 10% and yet, your targeted return can be 30%. This is the disconnect between an investor and a private business owner. It may not be wrong, but one should recognise the nuances in the different lenses of an investor and a business owner. Under the lens of a private business owner, it would be foolish to expect returns of 30%. As an investor, 30% is possible, but the excess 20% would be a form of absolute share return and nothing more. By that I mean that these returns are unlikely to be realised by a private business owner, an investor reaps these rewards only because of market action such as relative valuations. While it is not wrong, I think is beneficial to be aware of the distinction. Certainly, the best investments are the ones that combine both lenses i.e business returns equal to stock returns. This would also mean that we interpret stock price only as an entry; almost like a privatisation offer and pay almost no attention to having a targeted price, because private businesses do not have daily quotations on the value of their company.
Simplicity of Investing – Lower importance of catalyst
For a private business owner, the catalyst is only important if your business sits on valuable underlying assets but has lacklustre operations. Your returns then depend solely on the catalyst as you are unable to earn much from its operations until that Judgement Day. Therefore, as private business owners we should be looking for the ones with at least decent operations that will be able to generate returns in the meantime, rather than the presence of catalysts. It should be noted that this conclusion follows the Buffett school of thought (as opposed to Graham who considered companies dead rather than alive). Berkshire was bought at below net working capital, and Buffett considers it one of his worst investments. In the absence of any catalyst (whether he was expecting any or not), its deteriorating business was the nail in the coffin for any prospect of decent shareholder returns.
Simplicity of Investing – Valuation models
Very frequently, I get this question, ‘what is your valuation model?’ Truth be told, I don’t. Think about it without technological advances today, without excel sheets, great investors of the past were they capable of mentally calculating the bunch of formulas? Personally, I have worked on the valuation model taught at Columbia Business School and trust me when I say it is difficult. This quest for the holy grail of valuation models, at the end of it all, there isn’t any. To put it simply, value investing is just making an intelligent investment, based on logical and sound reasoning.
Simplicity of Investing – Conclusion
The points mentioned above no doubt represent a much romanticised form of investing. For example, a private business owner would be able to ensure that he enjoys the business returns by distributing dividends to himself. In reality, most of us will be a tiny part of a large shareholder pool; which is one reason why we often lose touch of the basic essentiality of business returns. Nevertheless, it pays dividends (get it?) to remind ourselves of the simplicity of investing from time to time. We should always be clear of the line that connects business returns to stock returns. As far as possible, we should treat shares only as a medium of entry; in that spirit, we are business owners first, investors second.
To wrap it up, I would like to share a quote that would effectively sum up the essence of this post – a statement in one of Graham’s final interviews. When asked about the Security Analysis, his response;
“They called it the “Bible of Graham and Dodd.” Yes, well now I have lost most of the interest I had in the details of security analysis which I devoted myself to so strenuously for many years. I feel that they are relatively unimportant, which, in a sense, has put me opposed to developments in the whole profession. I think we can do it successfully with a few techniques and simple principles. The main point is to have the right general principles and the character to stick to them.