We get asked the following question very often:
“How do you know which stocks to buy?”
The answer is we don’t buy stocks, we buy fractional ownership interests in businesses. Of course this answer is a bit cheeky because we are in fact buying the stock but it is the mindset that really matters. People treat stocks like they are pieces of paper to trade around and around. Thinking of buying into a business changes that mindset.
Many of you own your own business or have purchased other businesses. Would you consider buying and selling that business multiple times in the same year or even in the same month or day? Of course you wouldn’t. Then why don’t people treat stocks the same way? The answer is behavioral. It is because the market offers them a price almost every moment of every day and they can't help it.
When we think about buying a stock, outside of some funky special situations, we look for the following:
- A business we understand – People buy the stock of businesses all the time they don’t understand (have you bought a biotech or semi-conductor stock?). They would never consider buying an entire business they don’t understand.
- That should continue to grow over time – We want businesses that increase in value each year not ones getting worse
- With a capable and honest management team – You would never put someone that isn’t honest in charge of your business and yet people invest with companies that have questionable managements every day in the stock market
- At a reasonable price – A reasonable price (say 50% less than we think its worth) gives us some leeway if we get the valuation of the total business wrong. How do you decide what it’s worth? How would you decide what a small business you were buying in entirety is worth? It would be based on the cash flows the business generates for its owners. How many years’ worth of cash flow would you pay to buy a small business? Maybe 3 or 5 years’ worth? You certainly wouldn’t pay 50 years’ worth, but people do this all the time in the public markets.
Of course this is not to say that it is easy. As Charlie Munger says “only fools think it’s easy.” But if you follow these guidelines and treat stocks like businesses your chances of success will increase exponentially.
All the best,
Your Fortis Capital Management