By: Dan Erdle

By and large, inventors take what should be a major positive—the availability of a liquid public market—and turn it in to one of their biggest detriments. They allow daily news headlines, as well as other people’s reactions to these news events, to drive their decision making. The fact that investors have access to daily price quotes, coupled with the natural human tendency to be dominated by their emotions, creates a terrible combination for investors. One consequence has been that the quick and easy ability to buy or sell investments has caused portfolio turnover to increase over time. Today even professional investors, who are supposed to make decisions with stable rationality, struggle to stick with their decisions for even a year.

In addition to the over- activity caused by investing in public markets, daily price quotations create a distraction for investors because it alters their entire framework for analyzing investments. In all of the activity investors forget what stocks really are: the ownership interest in a real business.

Because of the liquidity of public markets, most investors do not think of stocks as the ability to acquire an ownership interest in a business. Instead, investors simply view stocks as placeholders to make directional bets on market prices. In other words, at the end of the day most investor’s decisions simply turn on whether the number associated with that ticker symbol is going to get bigger or smaller. “This stock is going to go up; this stock is going to go down.” This is in contrast to the mindset that they should have which is:

Stocks are the legal ownership interests in businesses. By purchasing a stock I have a legal claim on the assets of the business and more importantly the cash flows produced by those assets for as long as I hold on to my ownership. Because of this, the right of ownership has an intrinsic economic value that is determined primarily by the ability of the underlying business to produce cash for its owners.

The average investor gets bogged down in trying to figure out which stocks are going to go up. Great investors think of themselves as owners of businesses. This difference in mindset, between stocks and business ownership, has a large impact in how we frame our decision making.

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The ease of which we can make transactions creates a disconnect between what we are doing at our computer screen and economic reality. What we are actually doing when we are buying and selling shares is transferring legal ownership to business cash flows.

The 52 week trading range of most equities provides evidence that a majority of investors do not view themselves as owners of businesses. In any given year the market price fluctuates to a much larger degree than we could possibly say is warranted by the underlying business value. This happens even with large cap equities, some with quite stable business models.

When you really stop and think about it, the fluctuations in the public markets are really quite remarkable when you remind yourself that what is being bought and sold is the ownership of businesses. Below are a few large cap equities and the range in which investors were willing to sell their ownership interest throughout the year.

June 23, 2017 — 52 Week Share Price Range
Company	52 Week High	52 Week Low	% From High To Low
Apple (AAPL)	156.65	91.5	41.60%
Disney (DIS)	116.1	90.32	22.00%
Travelers (TRV)	129.6	104.45	19.40%
Visa (V)	96.6	73.25	24.20%
Amgen (AMGN)	184.21	133.64	27.40%
Caterpillar (CAT)	108.18	70.53	34.80%

It seems incredibly unlikely that the business values of any of these investments fluctuated anywhere near these amounts throughout the year. Did Visa the business really fluctuate 25% like Visa the stock did? Probably not. This is caused solely as a result of a public market existing for the shares of these businesses. The ups and downs of the market take on a life of their own and people get sucked in. Individuals who thought of themselves as the owners of these businesses would likely not accept such varying assessments of business value throughout a short time frame such as a year.

Imagine for a moment these businesses were private rather than publicly traded. Does it seem likely that the owners of any of these businesses would offer to sell their businesses at one price at a certain point in the year and then offer to sell that exact same business at a 20%-30% discount only a few months later. This type of irrational behavior would be much less likely to in private transactions because the owners would be forced to think about exactly what they were doing. In contrast the public markets create an environment where people do not have to put all that much thought into their decision to buy or sell their ownership in these businesses. If you were the sole owner of Apple throughout the past year would you really sell pieces of your ownership off at such differing values? Yet this very thing happened in the public markets and will continue to happen every day because investors as a whole do not think of themselves as owners of businesses.

The graphic below is a helpful illustration that the intrinsic value of a business is much more stable than the stock quotes you get from a public market. The intrinsic value of the underlying business is what should ground our decision making process. The market price fluctuates around the more steadfast business value; market price is much more volatile because investors often get carried away in one direction or the other. Therefore, we should focus on figuring out what the intrinsic value of the business is. Most investors are much more concerned with the blue line below, whereas long term investment success actually requires us to focus on the black line.

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To understand how much the liquidity of the public markets affects people’s thinking, compare the differences to how they act in other areas of business and life.

Most people do not hire an appraiser to come and evaluate their home every morning to decide whether or not they should continue to keep living there. Yet many of those same people see nothing wrong with using the morning price quotes in the market to determine whether they should continue to own their stocks.

If you and I started a successful business it would be highly unlikely we would buy and sell that business on the basis of some inclination we had about the direction of the Dow Jones Industrial Average. We would not take a poll of total strangers to determine how we should act with our ownership interest in the business. Yet people allow the bunch of complete strangers that is the public market to determine how they should act with their business ownership in stocks.

Likewise if we owned an interest in productive farmland we would not make decisions by asking the neighboring farmer how much he would pay for our land on a day to day basis. Instead we would consider how many bushels we could produce per acre, the likely long term commodity price, the costs of farming the land, etc. It is likely we could go years without ever getting a price quote on our land and still be highly successful.

The same thing would go if you owned an apartment building. You might consider the location of the building, the number units you could rent, how much rent you could charge, etc. But very few landlords hire an investment bank to tell them whether they should continue collecting rent this month.

The liquidity of the public markets creates a disconnect in people’s minds and causes them to frame decisions in a very different way than they otherwise would. The human brain looks for the path of least resistance and finds it in the ability to punch in a ticker symbol and look at a price. The ease in which we can access market prices causes us to forget that when we buy a stock we are buying ownership of a business. In other words, market prices act as an easy substitute for the more boring and difficult task of figuring out what a business is truly worth.

Action Items

We need to create mental tricks to counteract the negative influences that a public market creates. For many of these action items we are going to try to completely reframe the way we are thinking about the investment decision. What is odd is that to make the correct decision we often have to imagine ourselves in a more objective rational position. We are going to be using deliberate mental fiction to help guide our thought process so we make better decisions.

First, ignore the fact that it is publicly traded. Forget about the fact that you are going to get price quotes on the business from a group of complete strangers in the market place. Instead behave as if you were buying the entirety of a private business. Literally imagine that you are going to become the sole owner of Apple, Google, Disney, or any other publicly traded stock you might be looking at.

Second, now that you are considering the investment from the position of potentially the sole owner of the business, forget about trying to figure out whether the stock price is going to go up or down. Instead focus all of your attention on figuring out what the business is worth. On a related point, do not think in terms of per share prices. Think in terms of the value of the entire business. Most investors will likely be able to easily tell you the per share price of most of their investments. But by thinking in terms of the value of entire business you force yourself to think more deliberately about what you are doing. It forces you to think in terms of acquiring a business and exactly what you think that business is worth.

• Instead of saying I am going to buy Apple for $150 per share, say I am going to buy Apple for $750 billion
• Instead of saying I am going to buy General Motors at $35 because it is going to go to $50, say I am going to buy General Motors for $50 billion because I think the business is worth $70 billion

It is incredibly surprising how few investors can tell you the market value of the entire business that their per share prices represent. From now on, any time you type in a ticker symbol, completely ignore the per share price that pops up. Focus exclusively on how much the entire business is selling for. It is amazing how much better investors would do by thinking in terms of market cap rather than price per share.

Finally, go into every investment with the idea that the market will be closed for the next three years. Imagine that there will be no available market for those shares until the end of your investment horizon. This will force you to forget about trying to predict price changes in the market, and focus your attention exclusively to receiving returns from the underlying business. We often become so accustom to getting instantaneous prices on our investments, we forget there are thousands of private businesses that don’t have the luxury of publicly traded shares.

OVERVIEW OF INVESTMENT STEPS

1. Imagine yourself the sole acquirer of entire businesses.
2. When looking at a potential investment, ask yourself: what is the entire business is worth? In other words, how much would you pay to acquire all of the shares of the business and become its sole owner?
3. Engage in the investment if the entire business is selling in the market for substantially less than what you think the business is worth in Step 2. In other words if the market cap created by the public market is a substantial discount to your assessed private business value you should make the investment.
4. Ignore the day to day price quotes. Imagine the public market for your shares will be closed over your investment horizon. Think like a business owner.