The Investment Perspective – August 2022

“Neither the investing method nor the fundamentals of the business are right or wrong because the mood of the market is favourable or unfavourable toward the “stock”. That is because when you really think about it, “stocks” (shares) are all about the financials and the trading price, the share price… the cash up value. What matters more is the economics of the business” 

Peter Flannery

Key Points:

• Are share prices going to be able to escape the current bear (down) market and rise again?
• One ‘trick’ the market plays that fools many.
• Does Amazon’s recent sharp share price decline mean the company is in trouble?
• What successful investors look for when investing.
• What do you choose as an investor?

The Market, The Business and You

For many investors, investing it is a matter of markets (market sentiment) and how they as investors respond to trading price changes that the market delivers.

For us at WISEplanning it is about the market (market sentiment).  How we respond to the market as investors and those changing trading prices … and the business.

The Market

Let’s take a quick overview of the market.

The above graph tracks the Morgan Stanley Capital Index (a worldwide share market index) or more specifically trading prices in aggregate from around 1987 up to earlier this year.  The horizonal dark blue bars toward the bottom of the graph and just above the horizontal axis, show the duration of the event tagged to the dark blue horizontal bar.

We all know that the market as a whole will move up and down, rise and fall, ebb and flow.

Interestingly, many investors that are new to this type of investing, as well as those that are involved in the investment world and have been for many years, still see volatile trading prices as a bad thing, risk.

It’s as though something bad is going on and if we don’t watch out, markets could sail all the way down to zero.  Their portfolios could decline, decline and decline, falling, falling, falling all the way down to nothing.  Wouldn’t we feel silly then if we watched the portfolio decline and did nothing about it!

The good news – this is just not how things work.

Trading prices reflect market sentiment rather than what’s going on in the underlying business.

Sure, in the short-term, trading prices can decline if something is temporarily not right with the business.  The lower the quality of business the more meaningful lower trading prices will be.

For better quality businesses and those that have strong economics, lower trading prices bring better buying opportunity – not investing peril.

The bottom line is, whilst we all know logically that lower trading prices mean better buying value, the problem is that psychologically, some investors can sometimes become confused.  After all, we’re only human.

The Business

There are two graphs above.  The smaller one headed up 2000 bear market shows the decline in the Standard and Poor’s 500, (the grey line near the top of that inset graph) along with the decline in the trading price of Amazon (the blue line).  Looking then at the bigger graph you can see the blue line of Amazon from 2000 up to 2022.

The above graph makes the point that when we narrow our focus to the very short-term, this can amplify the movement in the trading price (as shown in the smaller graph above).

The point here is that Amazon was not 83% less effective as a business (looking at the small inset graph above) from January 2000 through December 2000.  That’s when the trading price declined by around 83%.

When you look at the bigger graph above, whilst an 83% decline in the trading price is significant, we can also see how that is relatively meaningless in the fullness of time.

Amazon the business has continued to grow and develop strong economics although admittedly for much of that time, with profits being allocated to expansion, it was difficult for us to invest until such time as fundamental financials and those sound economics developed.

By looking at the trading price graph above it’s easy to say when we could have invested.

I say invested… I didn’t say speculate.

This could be a good example of an investment that I have recommended late in the game (don’t worry it’s far from over yet) and a good example of what Warren Buffett often referred to as the ‘error of commission’.

In other words, the most damage caused by investment advisers, analysts and investors is usually those winning businesses that they don’t invest in, as distinct from the mistakes they make from the ones they do invest in.

The damage caused by non performing investments is less than the damage caused by not getting into good investments that perform really well, soon enough.

Amazon is recommended by WISEplanning because it has strong economics.  It maintains a strong competitive advantage in a number of the sectors in which it operates.

They have a growing and already powerful eco-system.  Also they’re a largely trusted organization given their brand strength that has developed over the last couple of decades.

Just to press the point home, the recent sharp decline in the trading price that you can see towards the right side of the graph above was due in part to the write-down that they reported recently on Rivian.

This is the electric truck that Amazon have shares in and that they are looking to use for transportation as part of their network moving forward.  Legally they’re bound to record the trading price write-down along with book value write-downs against their trading profit each quarter.

It is mathematically valid and accurate although from a business point of view, it’s unlikely to make much difference, particularly as those electric trucks become more widely used because of Amazon’s significant network.  We could even see a reversal of that write-down possibly although that’s a financial that matters little in the overall scheme of things from a business perspective.

To be clear, the economics of the business matter far more than one financial write-down against income for one quarter.

Perhaps another minor point worth making is that, quite often investors will look at their portfolio and their investments.  They think that if their investments or their investment portfolio has declined by a lesser amount than other investments, that they must be in superior investments.

That could be the case but that would not be the way to work it out.  The quality of the business tells the full story rather than trading prices moving on the basis of market sentiment in the short-term.

You?

What are you choosing?

The reason I ask the question “What are you choosing?” is because smart investors at WISEplanning choose to invest in the business rather than play the share market.

Business is simple.  Share market is complex.

The point is that, if you are playing the share market like almost everybody else, then you might be feeling uneasy about markets and portfolio volatility at the moment.

On the other hand, if you are investing in the business, then you might be tolerating volatility … going with the logic that lower prices mean better buying and everything’s (hopefully!) okay.

Or, you might actually be quite happy about those lower prices, knowing that those businesses in which you have invested deliver products and services in a way that not many other businesses can replicate.

They have a competitive advantage.  They are of a certain level of quality that helps protect your capital and can deliver investment performance that will help drive your investment goals.

You know that you are playing the share market when: 

• you regularly check the cash up value on your portfolio
• you feel happy or a feeling of relief when the cash up value is higher than the last time you looked
• you feel slightly unhappy, disappointed or despondent when the cash up value is lower than the last time you looked
• you see your portfolio as an investment in the share market rather than in specific businesses
• you don’t differentiate between the methodology at WISEplanning and what fund managers, other advisers, and sharebrokers provide
• you just don’t like it when trading prices fail to rise
• you either dislike it or feel uncomfortable when trading prices decline, or broad market volatility unravels
• you become anxious / excited about market and economic events as reported by popular media
• you secretly look for the spiking share price and the investment ‘king hit’.
• you feel frustrated about how slow your portfolio is growing
• you think about other approaches to investing that look good by comparison (e.g. Kathie Woods AARK Innovation Fund 15 months ago)

You know that you are investing like a business owner when: 

• you easily resonate with investing in a business rather than the stock
• this idea is totally solid and one that you embrace willingly
• you know that you would not ever invest any other way (than invest in the business rather than the stock)
• you know that the trading price is merely a function of market sentiment and has little to do with operational profits and business performance, especially short term
• when trading prices decline or general market volatility emerges, you like it. You know that those good businesses are available at a better price than previously
• when markets are volatile, you naturally focus on the opportunity that lower trading prices provide – not the decline / loss in the cash up value of your overall portfolio
• you don’t waste time lamenting the one out of five investments that struggles to grow, or indeed that offers nothing but losses for several years from a cash up point of view
• you want to concentrate your portfolio rather than diversify because you know that supports improved performance longer term
• you’re able to look through the significant amount of popular media “noise”, knowing that it offers little value and is a long-distance from real investment analysis
• you know that even Warren Buffet has failed investments and that you and I can’t win them all
• you know that those poor performing businesses (the one in five) don’t define the portfolio
• you can be patient for as long as it takes
• you are happy to average down even when the news about a particular business looks bleak
• oh, and did I mention that you are happy being patient?!

The Market, The Business and You

The market is random in the short term. It rises over the long term.

The quality business will grow long term. It will protect your money, and make it grow too.

And so, what are you choosing?

“Rich people have small TVs and big libraries.  Poor people have small libraries and big TV screens”

                                                                                               Zig Ziglar