Do you ever find yourself
wondering if some stock goes up or down in the future? When you do
this, can you also see that you are right for some time? Did you ever
started to think what an investing genius you were? And suddenly, the
price has gone fast to other direction without any reason. You have
probably experienced this at some point of your investing career.
Some people might even stop investing at this point. These kinds of
mistakes are familiar even for the most experienced investors. And
these mistakes can be fatal. The best cure for these kind of mistakes
is seeing yourself as a business owner.
Stock market is not a
roulette wheel, where you can choose from the red, black and green
colors and expect to win with the correct color. It look likes that
in the short run, but in the long run it is a whole another game.
Thinking stock as a share of a company´s future profits and the
possible future appreciation of its assets is the best way to play
this game. At least, for most of us. Some people are great in
predicting prices, but they are very rare. Considering yourself as a
business owner, helps you to ignore the short-term predictions about
the prices. Both, stock ownership and the betting in the roulette can
give you hope for the better future. Most of the time, stock gives
you a legal right for the better future. And a roulette wheel gives
you a right to have a chance for the better future. Both of them can
be smart choices with the right price. Unfortunately, I am sure you
have never heard about the casino where the roulette wheel gives you
the price you should pay. If you find one, please let me know.
You should think yourself
as an owner of a company before and after purchasing a stock. By
doing so, it is easier to concentrate on the present value of the
cash the business generates in the future and on the appreciation of
its balance sheet. It is even better if you can consider yourself as
the owner of the whole business. This view makes it also harder for
you to seek action by selling shares in the near future. And it helps
you to concentrate on the numbers in the company´s income statements
and balance sheets from the past. They are your main sources for
finding the right price for buying or selling shares.
For a business owner, the
short-term changes in prices or even in earnings are mostly
insignificant. Short-term changes in earnings mostly depend on the
business cycle. After the business has reached the top of the cycle,
most of the businesses start delivering smaller quarterly earnings
than before the top of the cycle. Best businesses grow their earnings
at this point too or the earnings decline is very small. When you
think yourself as an owner, you see things differently. You probably
expect to see this decline in earnings at some point. When you are
concentrated on the share price only, you probably sell at this point
of pessimism without considering the future of the business.
Owning the whole company
mental model also helps you to analyze the whole business, company´s
financial position, and their development through a longer period.
Checking the historical improvement of the company´s income
statement and balance sheet becomes more important. And you get a
better view for the uncertain future. This also helps you to define a
better price range for the whole company and its shares. This
increases your probabilities of getting better investment returns. In
the long run, share prices follow closely the changes in business.
When you think like an owner, you invest in for decades. Your success
depends on the long term changes in the company´s earnings power and
the value of its assets and how much you paid for them. When you
think this way in all the investing operations, luck becomes
irrelevant in the long run.
When you see yourself as
a business owner, you also understand that the company directors are
your employees. Graham saw most of the investors like lambs, waiting
for butchering without any resistance. Most of the owners do not say
anything, when they see directors working into their own advantage
and against the interest of owners. Directors are legally obligated
to protect the interests of the owners, not their own. Many directors
do not think this way. They use the money, which belongs to the
owners, the way they want, without any consideration about the
owners.
On average, directors
know more about the business than the owners. This doesn´t mean that
the owners should accept anything they do for the business. For
example, the excessive amount of share options for directors, or
acquisitions that are too expensive are harmful for the owners.
Still, you can see these things often. Most of the owners do not give
their opinion by voting against them. This is a bad policy. A better
policy is finding other owners who think like you do and try to get
the message to the directors. When you think yourself as an owner,
you avoid investing into these companies. And you also evaluate the
decisions the directors have made from the owner´s point of view,
when you have already invested to the company.
I
want to give you something to think about. Choose a business, in
which you are interested. Learn about its cycles by going through its
income statements and balance sheets from the previous years. Figure
out which is the normal length of the business cycle, what are the
reasonable profit margins, earnings and growth prospects. And make a
justifiable estimate about the right price for the whole business in
your head. You can also use a calculator if the numbers are too hard
figure without it. Do not check shareprices before you have made
an estimation! It is better not to check them at all. The
idea of this exercise is not to calculate the exact price for the
business. It is for getting familiar with this mental model.
Copyright
©
Tommi Taavila 2018
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