Timing and Price
In the first article of this newsletter I discussed the factors I believe are most meaningful in selecting high quality businesses. Now let's say you've identified a company that meets these criteria and it is time to invest. Does the timing of the investment matter? Does the price matter? Definitely! Let's discuss.
⏳ Timing Matters
“In the short run, the market is a voting machine but in the long run, it is a weighing machine.” — Benjamin Graham
This quote explains most plainly why timing the market is hard. You're at the mercy of public opinion and boy can opinions change fast. On the other hand, results are much more predictable over the long run. After all, the value of a business is ultimately a function of the cash flow it produces. Nothing about that is subject to opinion. The Of Dollars & Data blog does a great job of explaining further. TL;DR: the probability of a positive return on a 1-day investment is about 52% - you might as well play roulette. But the probability of a positive return on a 20-year investment is 96%! Please, show me a safer way to make money.
There's a another good reason to favor long term investments: Imagine these two scenarios:
You're an expert trader with $1M. You trade in and out of your portfolio every day and you're incredibly good at it. In any given year you crush the market and get 30% return on your capital.
You're an expert investor with $1M. You spend a month researching the position but once you make the investment you don't touch it for at least a year. Your investments make 15% return a year - not as good as the trader but still beating the market.
Who would you rather be? 30% return seems better than 15% right? I disagree! Our trader made $300k and spent 250 working days to get that result. That's equivalent to making $150 per hour. Not bad. But our investor made $150k and spent only 20 working days to get that result - an insane $937 per hour. We haven't even mentioned that the trader is likely paying more taxes because of the difference between short term and long term capital gains. Value your time!
🏷 Price Matters
Let's get this part out of the way: great companies are usually expensive compared to the market. It's okay. In fact, it's more than okay - that's how it should be! Don't feel bad about paying a premium. The only question is how much of a premium is reasonable. One way to evaluate this is to look at more mature peers of similar quality. For example: say you believe that Slack is a top tier SaaS business (like we do). You can assess Slack's valuation by comparing it to other great SaaS companies that are more mature (say Atlassian or Salesforce?). What kind of growth and change would it take for Slack's profile to evolve into one of those benchmarks? How long would it take? This will give you a pretty good idea of the future return you might expect given their current valuation.
Occasionally there are also opportunities to buy great companies at a discount. Remember Benjamin Graham's quote about the voting machine? Sometimes the public opinion about a company is wrong. These are the moments when companies are valued much lower than what they're really worth. It can happen for any number of reasons - bad press, negativity from analysts, a bad quarter, etc. These will also be exactly the moments when it will be hard to buy. The consensus will be against you. Will you have the conviction to stand up against it?
☠️ Bonus Topic: Never Short
Okay fine, go short if you want - I'm not your mom. But I wouldn't advise it. Here's a couple of reasons I don't think it's a good idea:
Downside is unbounded. When you go long, the most you can lose is the amount you've invested. If you go short and the stock goes to the moon... you're in trouble.
Even going long on stocks can require years of patience for the pay-out. Imagine needing the same patience when you're short. Sometimes even when you're right, you can lose. Just ask Bill Ackman how Herbalife worked out for him.
It's no fun to bet on failure. Don't be that guy.