To me, investing is buying an asset for less than it is worth. That might seem self-evident, but I think hardly anyone does it. I worked in financial markets for 15 years and would guess less than one percent of financial transactions meet my investing definition. Almost all financial transactions are speculation, even some that conventional wisdom claims are safe: e.g. buying Treasuries or U.S. dollars. But, let’s look at ShockWave Medical (SWAV:NASD) stock for a speculation example. To me, SWAV is worth 1.5Xs Tangible Book Value or a little more than $12 per share, so buying for less than that would meet my definition of an investment. The most optimist valuation I can conceive of for SWAV is 13Xs sales, which equates to a share price of $105. Let’s say I’m wrong by a factor of 2X and somehow SWAV is worth 26Xs sales. That would mean buying at recent prices of around $300 is speculative at ~30Xs sales. Someone who buys at current prices could make money, but they’re simply speculating someone else will pay a higher price in the future. And, if SWAV really is worth 13Xs sales or 1.5Xs Tangible Book—or less—they are taking enormous risk. In financial markets, that kind of payoff distribution is called “picking up pennies in front of a steamroller.”
If markets were efficient, you might think investments—by my definition—shouldn’t exist. But markets are not efficient, they are emotional, and at least in the stock market—if you look far and wide—investments abound.
But, most people don’t look far and wide, which recalls another market saying: “investing is simple, but not easy.” Investing is simple because buying the relatively cheapest U.S. traded stocks historically produced market beating results while probably incurring less risk—if your holding period was long enough—than was embedded in the overall market.
So, it’s simple, but not easy because people prefer narratives to simplicity. People want to buy Tesla because they think its cool or Apple because they use its products. They want to be able to tell people they’ve discovered and invested in the next big technology or wonder drug. Basically, people want to sound smart or “be right” more than they want to make money. People become emotionally invested in their narratives and have a hard time facing reality when the narrative doesn’t hold. Bitcoin provides good examples of dangerous narratives. Bitcoin was touted as an inflation hedge, as untraceable, and unstealable, but as those things have proved false, long-time, ardent Bitcoin supporters have had to create new narratives rather than come to grips with the shortcomings of earlier narratives.
To protect myself from narratives—and speculation—I practice rules-based investing. Rather than creating a narrative and hoping it will unfold, a spreadsheet tells me what to do. Rules-based investing can be frustrating. Sometimes there’s nothing to buy. Sometimes I sell an asset that my ego or a narrative wants to hold onto. But, by sticking to a rules-based approach, investing remains simple. And, it becomes clear that investing—as a discipline— becomes measuring the differential between an asset’s fair value and market value. I consider buying when market value is below fair value and consider selling when market value exceeds fair value. How you determine fair value is ultimately your investing strategy. I’ll talk about my two buying strategies and give examples in upcoming posts. For now, beware the narrative—and speculation—and stick to the relatively cheapest assets.
-V
Disclosure: I own put options on SWAV