One of the key talents of successful investors is the ability to separate the stock from the business. A stock is just a piece of paper. It will go up and down for whatever reason, not always apparent to the holder. A business, on the other hand, is something that produces a product, incurs costs, and keeps the difference as profit. Sometimes the stock will move in the same direction as the business, sometimes not. Taking advantage of this occasional disconnect is what produces higher than average returns for the best investors.
Ben Graham, best known as the Columbia professor who taught Warren Buffet how to invest, characterized this relationship between stocks and businesses over eighty years ago. He said that in the short term the market acts like a voting machine, and in the long term acts like a weighing machine. Graham was getting at the guts of investing: understanding the long term power of cash flow, and the short term psychology of investors.
In the short term, investors fixate on headlines. Our tribal instinct propels us through the vagaries of greed and fear, motivating us to buy and sell based on the now. Looking back through any news catalogue illustrates the point: what seems so inconsequential today was market-moving news just a short while ago. Just ask the Greeks.
This short term voting is clearly at odds with more rational investing.
We know that regardless of the daily news, investing in companies that generate ample cash flow will produce substantial results over the long term. And on the contrary, investing in companies without cash flow will produce below-average results over the long term. So in Ben Graham-terms, the weight of this cash flow is what determines a company’s real value to an investor. The short term votes become weightless slips of paper.
So when it comes time this October, remember that regardless of what volatility an election may or may not bring, great companies will continue to be worth their weight, even after the short term votes have been cast.
Ben Kizemchuk is a Portfolio Manager & Investment Advisor with Altus Securities Inc. in Toronto. He offers financial planning and investment management for high net worth Canadian investors. Ben focuses on high quality investments, the Growth and Income Portfolios, low risk investing, and reducing tax.