The Most Important Lesson
If you take away only one idea from this book, let it be this:
A stock is not a lottery ticket. It's ownership in a real business.
How Most People Think About Stocks
Every day the stocks jostle with each other as their prices go up and down. Picking the stocks that will go up seems just like going to the races and picking the winning horse. Each stock has a ticker symbol, such as AAPL, FB, or MCD (Apple, Facebook, McDonald's). The similarity with lottery tickets strengthens—the ticker symbols are like ticket numbers. Feel like a gamble? Let's try to pick the winning ticker!
Some traders favor a stock with a price chart that is going up. They assume that the trend will continue. Others are drawn to a stock that has been in decline. It must be due for a turnaround!
If you treat the stock market like a lottery, you may have some fun. But your chances of long-term financial success are pretty close to zero.
How Great Investors Think About Stocks
The most successful investors have an entirely different outlook. Peter Lynch sums it up nicely: "Invest in companies, not in the stock market." Warren Buffett puts it like this: "Your goal as an investor should simply be to purchase, at a rational price, a part interest in an easily understandable business."
When Shelby Davis worked for the New York State insurance department, he became intimately involved with the financial details of many insurance companies. It was his knowledge of the business that enabled him to identify undervalued companies and gave him his edge. All of the great long-term investors have a "business first" approach.
Thinking Like a Business Owner
Many of us, if we had the chance, would be quite happy to own a share in a thriving local business—maybe a busy restaurant, hair salon, or automotive service center. If you held a 50% stake in such a business, how would you look after your investment? Perhaps you might check on the accounts every six months. It would be wise to pop in every now and then to make sure that trade was brisk and that the customers were happy.
Would you be constantly checking to find out the current resale value? Not likely. If you did, and you found that you could have purchased your 50% stake slightly cheaper, would you be tempted to sell out immediately in case the value of your half of the business declined further? Almost certainly not. As long as the business was doing well and profits were rolling in, you would be quite content to remain a part-owner for the long term. A business with thriving trade and good profits will surely be worth considerably more in a few years' time, irrespective of any day-to-day fluctuations in market value.
Ownership of a stock in a publicly quoted company is no different in principle from part ownership in a local business. The only major difference—and it is a significant difference—is that the price of the stock in the public company is published every day for the whole world to see. And the price may fluctuate wildly in response to interest rates, political uncertainty, the performance of the Chinese economy—or any number of other things that are highly unlikely to have any bearing on the long-term performance of the business.
Given access to this information, investors are liable to react emotionally and decide to sell out or trade their stake for another stock, which in turn will have its own gyrations and produce further anguish. The successful investor learns to tune out this "noise" and is content to focus solely on the performance of the business, holding for the long term and deciding to sell only if there is a genuine change in the business itself.
Your Journey Begins
Now that you understand what stocks really are—ownership stakes in real businesses—we're ready to begin learning how to evaluate those businesses. In the next chapter, we'll look at what makes a great business worth owning. We'll develop a checklist of qualities to look for, drawn from the methods of the world's most successful investors.
This is where investing gets interesting. This is where you'll develop the skills that will serve you for a lifetime.
