Many people see the stock market as a big casino. Shares are purchased in the hopes that someone will buy them from you in future at a higher price than you paid. In this way you can pocket a tidy profit and look for the next opportunity to do it again. The investment industry encourages this sort of thinking since much of the income earned by industry participants is derived from this sort of activity. So long as market participants are buying and selling, the industry is making a profit.
We don’t mean to knock the investment industry or traders in general. It is the trading process that provides the liquidity that is one of the great advantages of the public stock market. Without traders, there would be no stock market.
That doesn’t mean though, that all market participants are traders by their nature. The truly great benefit of a stock market is that it offers the opportunity to buy a small piece of a business that one could not otherwise own. In fact, one can buy small pieces of several businesses, thereby spreading and moderating the risk associated with any one business. The non-trader participants are those who simply want to own businesses that create wealth.
The fundamental difference between a trader and an owner is that the trader hopes to profit from a change in price whereas an owner expects to profit from a change in value. The value of a business can be defined as the amount of money that can be extracted from the business over the time it is owned. Price is the market’s perception of what that value is. While perceptions can change rapidly, reality tends to move at a slower, more predictable pace.
When deploying investment capital we are attracted to businesses that exhibit certain attributes that give us confidence that we are receiving good value for the price we pay. We want to own businesses that will grow in value over time and if the business is successful in accomplishing that, we can be confident that the market’s perception of that value, and therefore the price, will also grow over time.
This is a key point that cannot be over-emphasized. It is the success of the business that determines our success as investors, not the short-term price swings we see daily in the public markets. An increase in the price of a share is the result of a business’ success and the success of a business is usually far more predictable than what the price of a share might be a month or a year from now.
This approach allows an investor to enjoy the benefits of an investment over a long period of time. By regularly assessing the economic value of a company and comparing it to the prevailing price, an investor can be comfortable holding shares so long as the economic value continues to exceed the then-current price.