Window shopping
I’d like you to picture the scene: you are walking through a quaint village somewhere on a crisp spring day, enjoying some leisurely window shopping along the local high street. Out of the corner of your eye, you spot a shop that you’ve never seen before; in the window is a small machine – almost like a typewriter – that seems to be printing… money. With gold dollar signs flashing in your eyes, you walk inside, transfixed.
The shop window is not lying to you. As it turns out, this rather special shop specialises in selling machines which do, in fact, print money. They are all different, each with various ages, printing speeds, and maintenance requirements. Some are new, printing more and more money every week, and some are older, slowing down and needing quite a bit of work to simply maintain their pace of printing. You ask the salesman how it all works: how much money does each machine print, and how often? Which machine should you buy? How much do they cost? You are giddy with excitement, enthralled at the prospect of buying one of these mystery machines and growing rich beyond your wildest dreams.
Sadly, your excitement is not to last. The shopkeeper says that the factory specifications for each machine do not include any pre-set amounts of money to be printed, any kind of schedule for them to follow, or any recommended retail price. Some machines print money for decades, some only for weeks, and some print erratic amounts, with no real sign of when there will be droughts or floods of cash. There is another frustrating catch. Rather than just printing money from thin air, all the machines require the user to feed them with a constant flow of banknotes as the raw material that they use to print more of the same. Again, the manufacturers have left blank the precise details of this requirement: some seem to need very little cash in order to print vast quantities, whilst others seem to need almost all of what they print right back in, just to churn it back out again, in an endless cycle of printing and reloading. The very worst machines, the shopkeeper whispers dolefully, actually end up requiring the user to put more money in than can ever actually be printed – costing the owner money over time.
At this point, dreams of your new yacht are beginning to fade. Maybe your machine will stop printing money as soon as you buy it, or perhaps it will require more banknote feedstock than it can print, so that it will actually lower your bank balance over time? Having already made the effort to get excited, you decide that you may as well enquire about the price range of these perhaps not-so-marvellous machines.
“Well”, begins the shopkeeper, “that depends. Yesterday, prices were lower than usual but they have all gone up today – apart from that brown one over there, I don’t know why – because, after all, it is quite a sunny day”. You peek outside to validate that claim while wondering what the weather has got to do with the price of the shopkeeper’s increasingly absurd wares. He continues, trying to salvage a sale:
“Tomorrow, of course, who knows what they will cost, so maybe buy one today and save yourself from a price rise, or maybe come back tomorrow and buy them cheaper!”
At this point, your wallet is very firmly back in your pocket, and you are preparing to leave this bizarre place. Seeing your irritation, the shopkeeper tries one final ploy to land the sale:
“If it helps, I have several regular patrons who never buy anything. They just stand there watching, and they produce forecasts for the money to be printed by each machine, and tomorrow’s price for each machine, for a modest fee.”
You stop, with the door ajar, suddenly hearing some good news. Finally, someone who can tell you some real information about what the machines are going to do, and the right price to pay for them! As you start to turn back around, the shopkeeper reluctantly adds – as if required by some sort of pesky consumer protection law – a teeny-tiny caveat:
“Just to let you know, their predictions are not always 100% accurate. I’d say that perhaps 20% of the time, they are 100% accurate, if that helps.”
Flabbergasted at the cheek of the whole enterprise, you storm out, slamming the door of the Ye Olde Stock Exchange Shoppe behind you in disgust.
Machines with no manual
We view companies as money-printing machines, each with varying rates of cash generation, growth rates, and capital requirements. The shop – kept by a fickle shopkeeper with no real clue of what the future holds, and crowded with myriad helpers relishing the chance to charge for their services – is the stock market, a hunting ground where we spend our time seeking out the best machines at the best prices.
Luckily for us, we are equipped in our efforts with a few more pieces of information than our unfortunate shopper. We know the industry in which each company operates, and the products it sells – giving us some sense of what the future might hold for the longevity of its cash production – and we have reams of historical information, telling us how much cash the machine has printed, when, and with what input of required banknotes (invested capital) over time. We can also assess the state of the internal mechanics of the machine – the balance sheet and the abilities of the management team – to give us a picture of its health, and how liable it might be to some kind of incapacitating defect, rendering it useless.
We need to consider what a fair price is for such a machine – and then to pay a whole lot less.
With this valuable information, our job is then twofold. First, we need to get some sense of these core dynamics of the machine’s cash generation, including a view of when we get our money, and how much money the machine needs to produce it. Second, we need to consider what a fair price is for such a machine – and then to pay a whole lot less. Often, our assumptions about the cash inputs and outputs for our machines will be wrong, but, if we are cautious when entering our bids to the shopkeeper, we might well be protected from incurring any real losses from such mistakes. And, hopefully at least as often, we will be right in our assumptions, and eventually someone else will take note of our marvellous machines and offer us the true fair price – or intrinsic value – earning us a handsome return. Handsome returns, and loss-avoidance, a happy investor make.
Headlines don’t hurt
Whilst this analogy is a useful one to use when thinking about what a company really is to an investor, where it is equally useful is in considering the absurdity of the behaviour of many market participants. If you truly found a shop selling such machines, it would seem very odd to think that the prices of the machines should bounce around so much day to day, and even minute to minute. Are conditions truly shifting to the extent that the estimated cash production of each machine is liable to change by substantial amounts every day? Indeed, if you found such a shop in a village somewhere, the huge swings in price should excite you, not terrify you: you would relish the chance to buy machines for a steal, and sell them at a premium, rather than worry that the unstable behaviour of the shopkeeper and his prices somehow makes your machines less valuable. After all, whatever price tag he places on a given day, your machines still print cold, hard cash.
And yet, such violent price gyrations are accepted not only as commonplace in the public markets, but ‘rational’, a supposedly efficient method for constantly incorporating new information into market prices. In our view, the real cash generative capabilities of our machines – the companies in which we have ownership stakes – do not whipsaw nearly as much as the prices for those machines (share prices in the public markets) would suggest, and as such we view volatility in prices as an asset, not a liability.
The irrational actions of our fellow customers are to our advantage.
Armed with this perspective, we relentlessly focus only on tasks one and two: to try, where possible, to estimate the cash production profiles of each machine, and to think about what those should be worth to a rational buyer. We have no interest or abilities when it comes to guessing what the next customer wants to pay for the machine, nor do we think that trying to do so is worthwhile. The irrational actions of our fellow customers are to our advantage, allowing us to pounce on bargain purchases when dejected sellers hurriedly mark down their machines as we pursue long-term returns.
So the next time that you feel the urge to check your portfolio for the tenth time in a day, or are terrified by big swings in share prices, we would urge you to reframe your perspective. Instead of tickers on a screen, consider your shares in businesses as small machines sitting quietly in a corner of your garage, earnestly going about their work of printing money – money that you can use to buy more machines with a view to growing your wealth. Headlines will come and go, but those marvellous machines, for the most part, will just keep ticking along.
Key Information
No investment strategy or risk management technique can guarantee returns or eliminate risks in any market environment. Past performance is not a guide to the future. The prices of investments and income from them may fall as well as rise and investors may not get back the full amount invested. Forecasts and estimates are based upon subjective assumptions about circumstances and events that may not yet have taken place and may never do so. The statements and opinions expressed in this article are those of the author as of the date of publication, and do not necessarily represent the view of Redwheel. This article does not constitute investment advice and the information shown is for illustrative purposes only.
