Knowledge Needed To Invest Successfully

How is taking your dog for a walk, the same as investing in stocks? What can that tell you about “risk”?

If I take the dog for a walk without a leash he runs around and checks out plants and trees and car tires. I tend to walk in a straight line or close to it. In the end we both end up at home, but he has traveled two or three times farther because of his adventures on the left and the right of the course I have chosen.

If I created a chart of his walk it would look much like the S&P 500 over the past twenty years. Some ups when he went right, some downs to the left, some others  where he walked with me. And like my walk, we end up where we are supposed to be. At home.

Risk as the market understands it is about the same variability, even though we always end up at home. Pay attention less often.

Noted European investor, Andre Kostolany, said this decades ago:

“The relation between stock market and economy is like a man walking his dog. The man walks slowly, the dog runs back and forth”

If well constructed, so it is with your portfolio. You need a little information to make it work. 

People must understand the value of a business is not well-described by its stock market price.

Market value is the price where a purchaser and a vendor agree. It may be influenced by the value of the business, but more likely it is influenced by other factors. Who needs the money?  Who has a portfolio they are trying to construct a certain way? Who has heard a rumour about growth or hidden loses? Who has something else they would rather own? Who has homeless dollars? Who has a profit and is afraid to lose it? Who has seen the stock go up and is greedy?

There are few limits on the emotional content of the closing market price.

People who trade successfully solely on market price are relying on their knowledge or intuition about how the prices are created. They believe that they understand better, or understand sooner, how their fellow traders will behave in the face of new information. They use tools of dubious provenance. Charting, social media counts, and ratios of longs anf short and small lots trades. They can be spectacularly right and spectacularly wrong.

It is safe to say that a “Get rich quick” scheme has a “B” side called “Get poor quick.”

Business value is more durable.

The value of a business is a function of several factors.  Its earnings, its free cash flow, its growth, its management, its cost structure, its ability to compete with others in its field and its prospects for the future. The value of business is very difficult to assess because it is easy to make mistakes about what you know and can discover. Worse, few of those factors will be exactly the same in the future and the differences can matter.

To be a successful investor, you must have skill in evaluating businesses. Errors here produce risk for you. Risk of real loss. As Warren Buffet has said:

“Risk is what happens when you don’t know what you are doing.”

To be successful, ultimately you must possess two skills

  1. The ability to establish reasonable business values
  2. Knowledge of how the stock market assigns prices.

Like everything else in personal finance, it is about meaning.  When you have a sound idea of value, you can tell when the market is offering you value at a discount.

Don Shaughnessy arranges life insurance for people who understand the value of a life insured estate. He can be reached at The Protectors Group, a large insurance, employee benefits, and investment agency in Peterborough, Ontario.  In previous careers, he has been a partner in a large international public accounting firm, CEO of a software start-up, a partner in an energy management system importer, and briefly in the restaurant business.

Please be in touch if I can help you.  don@moneyfyi.com  866-285-7772

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