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“The sillier the market’s behaviour, the greater the opportunity for the businesslike investor” (Warren Buffett, “The Intelligent Investor”, 2013)
Why adopting the “businesslike investor” mentality is key to long term investment success.
If the stock market disappeared tomorrow, would you feel confident enough to maintain holdings in today’s portfolio over the next five to ten years?
Every day, investors are bombarded with news and information that can cause them to second guess their decisions, or to chase trends and engage in activities that can be described as speculative. This is because, deep down, investors are hardcoded to capture gains and cut losses. This emotive drive can become particularly acute during periods of high uncertainty and volatility in stock markets. Succumbing to these impulses can lead to inefficiencies on multiple fronts.
Firstly, in questioning their underlying convictions, investors can make unnecessary tweaks to portfolios. This can lead to investors potentially pulling money out of the market too soon, thereby incurring unnecessary trading costs and potentially creating tax inefficiencies.
Secondly, engaging in speculative investments without appropriately assessing the risks either within the business or in the context of aggregate wealth can result in capital destruction. It is a downright gamble to simply hope that someone will pay a higher price in the future. One only has to look at the booms and busts of cryptocurrencies, ‘meme’ stocks or special purpose acquisition vehicles (SPACs) to see how damaging this can be for uninformed investors who are ill-equipped to deal with the ensuing volatility.
That aside, the unintended consequence of both actions is the interruption of the greatest facilitator of wealth creation: compounding.
“The first rule of compounding: never interrupt it unnecessarily” – Charlie Munger
Therefore, in an effort to preserve and grow wealth, individual investors can veer towards the very actions that can undermine capital creation.
One way to mitigate these impulses is to think like a businesslike investor.
A businesslike investor first looks at the qualitative elements before turning to a company’s valuation.
A businesslike investor focuses on companies’ business performance, rather than on short-term factors that can affect stock market movements. Of course, it would be a fallacy to state that the current macro environment and outlook are not important criteria in assessing risks during the stock selection process, but what sets businesslike investors aside from others is the focus on a company’s fundamentals rather than on noise.
Think of it this way; when it comes to placing money to generate capital returns or income, there should be very little distinction between deploying capital and buying a business. For example, writing a cheque to a local business that you only have partial ownership and no control over without (at least) seeing the balance sheet or meeting the staff would be totally illogical. Why, then, would you place money somewhere of equal (if not greater) risk without knowing the balance sheet, the management and the key competitive advantage of that particular company versus others? For many investors, the concept of business ownership is mentally divorced when owning a percentage of shares in a company but it is essential that this mindset be adopted when navigating global markets. The eventual outcome is that you will know exactly what you own.
Furthermore, by shifting attention to the underlying business, investors will naturally gravitate towards solid, well-capitalised, high-quality companies with solid cash flows that can survive current headwinds and market volatility while generating positive absolute returns over the market cycle. It just takes patience to assess the sustainability of companies’ competitive advantages in the long run.
Ultimately, the key to long term success lies in maintaining a disciplined approach over successive short-term periods. During bouts of market volatility, reducing equity market exposure as stock markets decline is, frankly, the opposite of what long-term investors should do. It is at these points that the businesslike investor takes the opportunity to increase their stake in great companies at favourable valuations.
However, the topic of valuation, and the impact it has on long-term returns, has many nuances and really deserves a space of its own to address it properly.
At this junction, it is critical that you know what you own, given that increasing holdings in loss-making companies just increases your exposure and therefore your risk.
Turning back to our first question: “Would you be confident holding the companies in your portfolio today for the next five to ten years?” answering with either ‘no’, or, ‘not sure’ is not a palatable response for investors focusing on absolute performance and generating sustainable, long-term returns.
