Once Warren Buffett was presenting a presentation to the great entrepreneurs of IT industry at the time of 1990’s and his presentation motto was how to price the stocks, which does not involve predicting their course of action next month or next year. Valuing is not the same as predicting.
“In the short run, the market is a voting machine. In the long run, it’s a weighing machine.”
Weight counts eventually. But votes count in the short term. And it’s a very nondemocratic way of voting. Unfortunately, they have no literacy tests in terms of voting qualification, as we’ve all learned.
Now lets have a look on the Dow index:
Industrial Average:
31st December 1964 874.12
31st December 1981 875.00
During these 17 years, the size of the economy grew fivefold. The sales of the fortune 500 companies grew more than fivefold. Yet, during these 17 years, the stock market went exactly nowhere.
When a person invests in a company then he expects to get more money back at a later stage. And to get that there are only 2 questions which one should ask:
1. How much you are going to get back?
2. When you will get back?
“A bird in the hand is worth two in the bush” – Aesop
But big question remains when???
Interest rate & the cost of borrowing are the price of when. They are to finance as gravity is to physics. As interest rate vary, the value of all financial assets like houses, stocks, bonds changes, as if the price of birds had fluctuated. And that’s why sometimes a bird in the hand is better than two birds in the bush and sometimes two in the bush are better than one in the hand.
Buffett related Aesop to the great bull market of 1990s, which he described as baloney. Profits had grown much less than in that previous period, but birds in the bush were expensive because interest rates were low. Fewer people wanted cash – the bird in the hand – at such low rates. So investors were paying unheard of prices for those birds in the bush. Casually, Buffett referred to this as the “Greed Factor”.
There are only 3 ways the stock market could keep rising at 10 % or more a year. And they are following:
1.) If interest rates fell and remained below historic levels.
2.) If the share of the economy that went to investors, as opposed to employees and government and other things, rose above its already historically high level.
3.) The economy could start growing faster than normal.
He called it “Wishful Thinking” to use optimistic assumptions like these.
Some people were not thinking that the whole market would flourish. They just believed they could pick the winners from the rest.
To understand the human behavior of optimistic assumptions for share market we can see an example:
There were 2000 auto companies: the most important invention, probably of the first half of the 20th century. It had an enormous impact on people’s lives. If you had seen at the time of the first cars how this country would develop in connection with autos, you would have said, ‘This is the place I must be. But of the 2000 companies, as of few year ago, only 3 car companies survived. And at one time or another, all three were selling for less than book value, which is the amount of money that had been put into the companies and left there. So, auto had an enormous impact on America, but in the opposite direction on investor.
Ultimately, the value of the stock market could only reflect the output of the economy.
Ben Graham, always used to say,
‘You can get in more trouble with a good idea than a bad idea,’ because you forget that the good idea has limits.
Lord Keynes, in his preface to the book – ‘Common Stocks as Long Term Investments’, said,
‘There is a danger of expecting the result of the future to be predicted from the past.’
One can understand that how behavior can impact the investment. One needs to keep his or her eyes open in investment. It might happen you are hoping that this is the next big thing and investing on that philosophy but you need to understand when you have to get out from that. Many a times people become too optimistic about one sector and they forget the value investing philosophy.
If you have something to add, Please post your thoughts in comments. I would love to hear from you.
Happy Investing!!
