I had two well-known investment figures in mind when I started writing this: Warren Buffett and Peter Lynch. Many investors agree with Warren Buffet’s remark that you can only make so many good and informed decisions. This wisdom is widely accepted. A lot of people choose to select a very limited number of stocks to their portfolio.
Warren Buffett’s investment style is called ‘value investing’, which means that you try to find companies whose stocks trade for less than their real-economy value. For example, let’s say Company A owns an asset valued 1 million USD. The company has issued 100 stocks, which trade at 8000 USD each. If you’d like to buy all the stocks (we assume the owners are willing to sell it all), you’d pay 8000 x 100 = 800.000 USD. You got something immediately worth a million for 800k. And then there are the company’s future revenues, it’s contracts, patents etc. In other words, you buy only companies that are undervalued by the market.
Why is value investing difficult and time consuming? Well, in addition to looking at numbers such as FCFE, Warren asks questions like “Is management rational?”. Questions like these require a deep dive into the company and it’s operations. If you do not work in the company yourself, you’d probably need to talk to someone who knows the company and it’s business to get meaningful answers to questions like that.
“You are dealing with a lot of silly people in the marketplace; it’s like a great big casino where everyone else is boozing. If you can stick with Pepsi, you should be O.K.”
– Warren Buffett
I think that the above mentioned probably means that a lot of the market activity is irrational. In a global marketplace opportunities can be found all over the place, but it is important to keep a cool head. Do you understand how the company you invested in makes it’s money? Can you be sure that the company’s management is honest and won’t ruin your investment with a scandal?
The other Warren-wisdom has to do with patience. Something that is definitely not my strong suit..
“Someone is sitting in the shade today because someone planted a tree a long time ago”.
– Warren Buffett
Then I was thinking about Peter Lynch, who is considered to be an iconic fund manager. Apparently he could have over a thousand companies in his fund, but hew still consistently doubled the S&P 500 market index. What happened to careful choosing?
This takes my thoughts back to index funds. There is a lot of data suggesting that on the long run, index funds beat actively managed funds over time. Was Peter simply a pioneer of the index method, combining it to certain selection process that allowed him to build a ‘shadow index’ that swam above the actual index?
“Far more money has been lost by investors preparing for corrections or trying to anticipate corrections than has been lost in the corrections themselves.”
– Peter Lynch
The above seems to make another argument for time in market, as opposed to time to market (timing the market). It is becoming pretty clear that the marketplace today is extremely difficult to predict. It is not just the hundreds of thousands new investors coming to play that makes predicting difficult. Or the algorithmic/automatic trading. The disruptive power of technological and environmental change can really catch us by surprise.
Well then. What should I think? DO we accept the ‘time in market’ rather than ‘time to market’? If so, should I simply stay fully invested in stocks all the time and simply use cheap or even free index funds, such as Avanza Zero (provided by Avanza in Sweden)?
Books – Warren Buffett:
The Essays of Warren Buffett
Books – Peter Lynch:
One Up on Wall Street
Beating the Street
Learn to Earn