Many a times when we invest in a stock the biggest urge is to sell as soon as possible and book profit. In some cases people have this temptation to sell early because of the speculation that the market might fall and the value of their investments will fall and in some cases people have this dilemma that if they don’t ever sell an investment they will not be able to make money and that money is only made by selling the investments?
In this article we will try to answer some of those questions and also try to analyse how successful investors think and try to align our strategies to theirs.
Do we make profit only when we sell?
Let’s take a moment and think about this. If the above mentioned statement was true, how are richest people in the world making money? How many times has Bill gates sold Microsoft?
The answer to the question is ZERO times. Does that mean that Bill gates has not made any money? He sure has and many of you might be thinking that this is NOT A VALID ARGUMENT since Bill gates owns the company and he might be paid Billions of $$$ in salary and other perks and you might be right in saying so but the point that I want to make here is that the owner mindset is not to look at price of the share at which the company is trading but rather focus on the earnings of his investment.
Focus of the owner is not at the price but on how to increase the earnings on a year by year basis because if earnings grow for a longer period of time, the price will surely follow.
In Warren Buffet’s words: In short run, stock markets behave like voting machines but in the long run they behave like weighing machines which means that in the short run the price of a stock might fluctuate because of P/E or other factors but in the long run it is driven by the earnings of the company.
Think like an Owner
If I ask you, how many times have you sold your business to make money? Your answer might be: NEVER. In the follow up if I ask you, how are you making money if you never sold your business then you might tell me that the business generates an income and that counts to my earnings.
In comparison when the same person owns stocks, this thinking might differ drastically along the lines of owning the stocks rather than the business. The same person starts treating stocks as a separate entity to the business and never associates him/her as the owner of the business.
Benjamin graham quotes that the first thing which a common investor should think when he/she buys a stock is to believe that he/she has bought part of a business.
Would you sell your shop?
Let’s try to understand what we have discussed earlier with help of an imaginary but real world example. Suppose you own an advisory business and you run the business from a shop in the local market. The cost of your shop is $100000 and in exchange for your services you end up making $10000 per month which means by EOY you make $120000.
Now, if a friend approaches you one day and suggests you to sell the shop because prices of the shops are going to fall by 50% in coming months, would you sell the shop?
Most probably, your answer would be NO because your focus in not on price of the shop, instead your focus is to increase the clientele and grow your earnings. Even if the price of the shop falls by 50% you will still be servicing the same number of clients if not less and thats why price is not that important to you.
Now, if the same friend comes to you after six months and tells you that now the market has reversed drastically and your shop can now be sold for $200000. Will you sell the shop now?
Again, you might give him the same reasoning and tell him that you are not going to sell the shop because you have an owner mindset and your focus is on the earnings rather than price alone and everyday when you come to start your business your focus remains to provide better services, market better to attract more clients, advertise on the right channels so that your business grows.
Similarly, when we invest in stocks we should now think like owners. For instance, when we invest in a stock we should not focus on the price fluctuation of the stock, instead, the focus should be on the earnings of the company and this is where most of the investors go wrong.
Not checking earnings of a company before investing is the biggest mistake that you can do as an investor.
If you only check the price of a stock to make investing decisions, chances are that you will get stuck in price volatility alone and base your decision on pure speculations.
Make Volatility your friend
Many of you might be thinking how to take the decision of selling while thinking like a successful investor? According to Warren Buffet:
A successful investor invests in great things, focuses on its earnings but makes volatility his/her friend.
The utility of an asset doesn’t change drastically because of which the volatility in the price of that asset is very limited. But sometimes because of the crowd behaviour even the prices of great things become highly bloated and a successful investor should take advantage of such situations.
Earnings of an asset usually stay stable most of the times but sometimes change in the sentiment can cause major disruptions in price.
As an investor we should keep an eye on the utility of an asset and try to gauge the optimum value for the utility. In the coming articles we will have a look at some techniques to calculate the value of a stock using Discounted Cash Flow(DCF) analysis.
The gist of this discussion so far is that if you bought a company or a basket of companies at a certain P/E and you did not sell them for a longer period of time, say 15–20 years then, even if the P/E stays on the same level after all those years, your investments would grow because of increased earnings and if you registered the earning growth then price of your investments would have automatically grown.
Your focus as an investor should be on buying great companies with calculated projections that the earnings of those companies will grow in future.
Sometimes, the price of these great companies might grow drastically above their earning abilities and vice versa giving a chance to us as an investor to either sell or invest in these companies to take advantage of market euphoria.
When we buy, we can not time the market with regards to price and anticipate a boom or a burst but if you buy great businesses then even if no boom or burst occurs during the lifetime of the investment, those investments will still grow because of increased earnings.
As discussed earlier, in the coming articles we will have a look at how to determine valuation of companies using DCF and know if a stock is selling at a right price or not.
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