July 2019 – Letting The Market Serve You
In business school you are taught about various push and pull strategies that relate to marketing. A push strategy is to push a product/service at a customer through tools such as aggressive media advertising, while a pull strategy pulls a customer towards a product/service through less abrasive ways such as “word-of-mouth”.
In investing I categorize a “Push” strategy as one that infers an investor is aggressively seeking to find an investment that is undervalued. This investor finds a company they like; they see the price it is trading for, and then somehow finds a way to push the business valuation into the trading price. This is likely due to the investor being so excited about the opportunity that is being offered and worried it will disappear before they have time to act. A “Pull” strategy on the other hand is one which I attempt to employ. It involves finding a business, calculating its intrinsic value and then waiting for the market to offer that price.
This is a similar idea that the famed investor Benjamin Graham promoted in Chapter 8 of his book the Intelligent Investor, “The Investor and Market Fluctuations” where Graham introduces his readers to the concept of Mr. Market.
In his book, Graham asks the reader to imagine that he/she is one of the two owners of a business, along with a partner called Mr. Market. Everyday Mr. Market offers to sell his share of the business or to buy his partners share. Mr. Market is known to be emotional, with his estimates of the business’s value going from very pessimistic to very optimistic. As his business partner you are free to decline Mr. Market’s offer an unlimited amount of times. Your goal is to practice patience with Mr. Market and let him serve you. It is easy to identify a good business. It is much more difficult to be patient enough to buy it at the right price.
When you look at a stock quote you need to train yourself not have an emotional reaction to the various stock prices that flow through on the ticker screen and have trust in your valuation method. In order to do this, you must have done enough quality research and deep thinking as to how you have decided to value a company’s stock. This confidence does not come over night. It comes from years of practice of employing a rational and methodological process to evaluating stocks.
For example, I have looked at dozens of companies that are high quality businesses that are consistently trading far above my estimates of intrinsic value. I would love to own these stocks but have no urgency to own them at prices that carry a significant amount of downside risk. Examples of these high quality yet overpriced stocks include Visa, Mastercard, Starbucks and Canadian National Railway. At this point of time Mr. Market is much more optimistic about their futures than I am as I’ve calculated a lower intrinsic value for these stocks.
However, you never know when Mr. Market will start feeling very pessimistic. For example, FedEx has dropped from $250 per share to $167. Alliance Data Systems has dropped from $250 to $151 per share. Mr.Market has clearly indicated that he thinks about these stocks differently than he did 12 months ago. Your job is to figure out if the true value of the stock has changed that much. If you have already done the research and have established an intrinsic value that you are confident in, you should know rather quickly if Mr. Market is acting irrationally.
The best way to start your research is to come up with an intrinsic valuation of what you think a company is worth without looking at the stock price. Afterwards compare this valuation to what it is trading for and postulate what the reasons are that the market is using to justify the current price it is trading at. What level of earnings must the company be achieving in order to justify Mr. Market’s price? What growth must be achieved to justify that price?
You should never force (“Push”) a puzzle piece to connect with another that clearly does not fit. That piece will only fit if you buy at the right price. Be prudent, disciplined and patient. Don’t be that person who has a fear of missing out on an investment. You don’t need many good ideas in order to achieve market beating returns, but you do need to avoid a lot of bad ideas. The less decisions you make the less likely you are to make that bad one that could cost dearly.
If you have any suggestions, comments or feedback that you would like to share feel free to email me at alex@StockWriteUps.com.
Enjoy the Journey,