“Investing should be more like watching paint dry or watching grass grow. If you want excitement, take $800 and go to Las Vegas.” – Paul Samuelson
I will be the first to admit that over my 30 years in the investment field, I have wasted a significant amount of time checking stock quotes. I am also convinced that my investment returns would have been higher if I had used that time reading SEC filings and annual reports or listening to presenations or talking to other investors about ideas. Frankly, unless an investor is looking to buy or sell a stock right then or use it to calculate an enterprise value while doing research, there is little need to look up the current stock price of a company. If you are really intending on holding an investment for years, does it really matter that the stock is up or down 1% or even 5% on any given day?
Many investors think that there is a certain amount of informational content in the daily random price movements in stock. They tend to worry about what “they” know and “why” their trading is moving a particular stock price. It is my experience that rarely do “they” really “know” more than anyone else and if they are acting on information you do not know, it is almost always very short-term in nature (whisper number on earnings) or illegal (merger news) and rarely is it something fundamentally significant in the long-term. I would argue that almost every negative “surprise” that drives a stock down is actually listed as a risk in the risk section of the 10K. Good analysts and investors attempt to weigh those risks against the financial strength of the company and current and potential future valuation under “normalized” operations before they even invest. Therefore, much of the “new news” investors are reacting to should have been incorporated in the long-term investor’s analysis (both macro and company specific, good or bad).
We have pointed out numerous times about how most successful investors think like owners of businesses rather than owners of stocks. Business owners understand that wealth is created by the accumulation of cash flows over a long period of time. How much of a distraction would it be for a business owner for someone to call him up several times a day and offer to buy his business or sell a similar one at a price that was driven in by the price quote of a public “peer”? The business owner would find the process extremely distracting and an unproductive use of his time. Yet, isn’t that what investors are doing when they check the price of their stocks multiple times a day, or even just once a week?
Next time you feel compelled to look up a quote on a stock you own, ask yourself, “why” you are doing so?
- How much does it matter to your investment thesis how others are reacting to news of the day in general or company specific news? Most successful investor letters we read often speak about a position that was acquired after a large drop in the share price due to bad earnings or other announcements. They are being proactive based on their own analysis and not reactive to “new news” which they have considered in that analysis.
- If the stock is up X percent in a day, do you feel some sort of satisfaction or vindication? If the stock is down Y percent, does it make you feel uncomfortable or anxious? Does it matter that there is a news story that supposedly explains the proximate cause of that reaction?
- Many times when a stock price has changed more than 1% or so during the trading day, there is usually a news story associated with it that is attempting to explain the proximate cause of the change. How often do you find the explanation additive to your investment thesis?
In a previous post, I talked about using the right side of your brain to improve your investment process. The post also talked about Charlie Munger’s idea of “invert, always invert” when analyzing a company. I am going to suggest another way investors can “invert” to help their investment process. Oscar Wilde has been quoted as saying, “A cynic knows the price of everything and the value of nothing”. I think many investors fall into the same trap. Ask an investor or an analyst the price of a stock, they might be able to tell you off the top of their head what it is. But ask them what market cap that represents or what enterprise value to EBITDA ratio or free cash flow yield and you will most likely get a puzzled look. If you really do have to look at stock prices frequently, I would suggest setting up your quote page in a totally different way than the traditional, Open, High, Low Close format.
Instead of setting up your stock quote page to show stock quotes, set it up using valuation metrics. Pick a couple of metrics that you use in your investment process. A few metrics that we find useful are price to book value, EV/EBITDA, free cash flow yield, dividend yield and EV/revenue. I believe you will find that your emotional reaction to big changes in stock prices will start to change. Let’s use a very simple example of a stock trading at $10 a share and at that price the stock is also trading at 10X EV/EBITDA. If the stock were to drop 10%, on a typical quote set up the stock would show $9 -$1.00 (-10%). However, if we set up the quote page so that the number we see is the EV/EBITDA and set up the color code as lower is better, we would see that the stock is now trading for 9X EV/EBTIDA and the 1X decline is GREEN or positive. Investors have been so conditioned by looking at stock prices that green is good and red is bad, we can use this set up to trick our mind into understanding that lower stock prices (generally speaking) are GOOD for long-term investment returns. It has been said that there are no bad assets, just bad prices. Assuming no significant permanent impairment to long-term cash flows, as the valuation of an asset declines, its expected return increases.
Another thing you will start to see that a 1% or 2% or even 5% change in the price of a stock has little impact on the valuation of the company. Using the example above, a 2% change in the price of the stock would mean that the EV/EBITDA changed from 10X to 9.8X. I would hardly call that material, even though seeing a 2% decline in a stock in a day may feel bad. Need another reason to try this? Studies have shown that equity valuations change 19 times the underlying fundamentals. So even rather large relative changes in stock prices, which feel like they represent an adequate re-pricing of “new news” usually overstate the true change in the long-term fundamental valuation of the company. Yes this is overly simplistic. Stocks do not decline 10% in value in a day for “no reason”. Earnings estimates are most likely to be lower after such a decline, but the company’s book value probably won’t change much and neither will the long-term earnings power. This is not so say that our original thesis is not wrong and cannot change based on current events. But as a business owner, we are spending our time thinking about the long-term competitive strengths and weaknesses of the company and should understand when the near-term results may in fact be signaling a change in our thesis.
If you set up your quote screen in the way I suggest, I think you will find yourself looking at it less often because valuations don’t change as much day to day, reducing the “entertainment value” of looking up stock price movements. I think you will find your investment returns will improve over time and you will spend more of your investment process time reading annual reports, SEC filings, transcripts of conference calls and presentations and searching the internet for relevant information on the company or its products.