“Daddy, my friend and her brother are making money buying stocks, can we do that?”
Okay, I’ve been trying to interest you in this for eleven years now…
“I think we should buy Amazon and Tesla because everyone is using Amazon and everyone wants a Tesla.”
Those statements might be true, baby girl, but if most people already know that, then the prices of Amazon and Tesla stock will already reflect it. People in the market are smart and fast. Amazon and Tesla are already up thousands of percentage points for years and years now.
“Then how do you make money investing in the stock market?”
Two ways – the first way is to buy what you believe to be good stocks and hold them for a really long time. The good ones will go up enough so that the bad ones don’t hurt much. And the bad ones have a chance to eventually become good as the people who run the companies figure out what they need to fix. That’s how Warren Buffett, the best investor ever, has done it. It’s simple, but it’s not easy.
“What’s the second way?”
The second way is harder to do. You have to figure out something before everyone else does, or find something that everyone is getting wrong about a company. For example, when a company is going through a difficult time, its price falls because other investors give up on it or assume a problem will last forever. If you figure out that the problem can be solved, you have an opportunity to invest.
“What do you mean by ‘Problem’?”
When Facebook first came public, the stock got cut in half because investors didn’t think they would be able to move their users from the desktop to a mobile app on their phones. But they built a great mobile app and they also bought Instagram, which was even better. If you bought it while everyone else was worried, you made ten times your money.
“So we should buy Facebook then?”
Well, that’s the hard part. By now, the stock has gone from 18 to 180 per share because everyone now agrees that their mobile apps are great. You don’t want everyone to agree with you, because then the opportunity is low.
“So what’s something that we can disagree with people about?”
That’s the even harder part. Everyone seems to believe right now that all the retail stores in the mall and on main street are going to close because of shopping on the internet.
“They already are closing, everyone is right!”
Well, the small number of people who disagree might make some money if that turns out to be not true, or if something else happens in the future that we can’t imagine today.
“This is hard.”
That’s why everyone isn’t rich. Because it’s hard.
Jim Grant said “Successful investing is having everyone agree with you………..later.” It’s a brilliant one-liner containing the essence of investing (value investing, I suppose) within a very small amount of syllables.
Howard Marks refers to this as second-level thinking:
First level – Amazon is kicking ass.
Second level – Everyone knows Amazon is kicking ass. The stock is already priced as though they’re going to own a double-digit chunk of the total US economy and succeed in every business they get into.
But to take it a step further, it’s even more complex than that. Because in that second level, there is another calculation to be made, and it involves degrees. There’s no formula for this calculation nor is there an agreed-upon set of inputs by which to run it. It’s a guess. Is the near-universal agreement that Amazon is great under- or over-pricing the extent of this greatness?
No way to know. No way to even figure out how to know. And that’s before all of our personal biases and baggage enter into the equation!
I’ve left this last bit out for these conversations with my daughter. I’m going to need maximum enthusiasm at this stage in her education.
This post originally ran here on February 26th, 2018.