Invest Simply, Buy a Business
Published On: October 1, 2021
Written by: Ben Atwater and Matt Malick
American cartoonist Rube Goldberg (1883 to 1970) was famous for his illustrations of overly engineered machines designed to perform relatively simple tasks. Often, today’s investment products are akin to his “self-operating napkin.” But when it comes to investing, we do not believe that complexity yields better results than simplicity.
At the most fundamental level, we invest in businesses for our clients. The shares of each stock we purchase represent small ownership stakes in large companies. Folks will often dispute this fundamental truth and instead “play the market” like the roulette wheel at a Las Vegas casino. But at a casino – despite the occasional hot streak – the house profits while the naïve fall flat.
The gambling analogy only applies to stock investing if investors take the wrong approach. Let us consider the right approach to buying companies.
Although it is seemingly a cliché, a long-term mindset is paramount for buying businesses.
Think about a successful small business owner and ask yourself whether the owner started or bought the business with the intent to sell the company in a day, a month, or even a year. The very idea is ridiculous. Instead, the entrepreneur is committed to the business for many years, even many decades. True stock investing should be no different because, over the long-term, history shows that a company’s stock price will almost always track its earnings growth.
The inherent problem with stocks is that the market prices them on a second-by-second basis. To ignore this manic pricing is one of the most fundamental disciplines of investing.
If the local manufacturing business was valued second-to-second, what do you think would happen to its value if the factory suffered a fire? What would the talking heads on CNBC declare if a talented and popular plant manager quit? But, neither of these events fundamentally changes the long-term value of the business. Sure, these are setbacks, but if the business is properly insured and properly operated, then these hiccups are not meaningful over the long-term.
Because everyone and every business sometimes faces setbacks, for diversification reasons, we do not limit our portfolio to just one or two companies. Rather, we build a collection of businesses. The term diversification is another example of over-used investment jargon. The purpose of diversification is simply to spread risk among a variety of enterprises.
With stock investments, you can diversify among sectors, industries, sizes and geographies, even with a small amount of money. This diversification, though, only mitigates some volatility.
In other words, the secret to investing will continue to come down to your ability to withstand the manic second-to-second pricing inherent in markets, while remembering that you are a long-term owner of real underlying businesses.
Being a business owner is inherently risky. There is no such thing as a riskless business, so in addition to being diversified and thinking long-term, investors need to make personal decisions about how much they should allocate to owning businesses (stocks). Do not be fooled like many were in 2008 and believe that combinations of risky assets magically produce a riskless portfolio.
Now, more than ever, because of globalization, risk-based assets will continue to move with extreme correlation in the event of a crisis, just like they did once again in early 2020 when COVID hit.
Therefore, investors should determine how much of their assets they will commit to low risk fixed income. Matching relatively safe bonds according to anticipated cash flow needs and holding each bond to maturity is an optimal strategy. High-quality bonds are the best way to hedge your business ownership (equity exposure) risk.
15th Century Renaissance man Leonardo da Vinci once said, “Simplicity is the ultimate sophistication.” When building portfolios, we adhere to da Vinci’s words of wisdom by creating a mix of strong businesses and safe assets that meet the individual goals of our clients.