असतो मा सद्गमय। तमसो मा ज्योतिर्गमय। मृत्योर्मामृतं गमय ॥
(May we move from untruth to truth, darkness to light, and mortality to immortality.)
– Brihadaranyaka Upanishad
Truth: There are only a few eternal truths in investing. Some of them include: (a) Stocks are not pieces of paper, they represent partial ownership in live businesses. (b) The value of a business (and therefore stocks) is the present value of cash that can be taken out of the business over its life. That depends on opportunity size, competitive advantage and management quality. And, (c) Risk stems from acting without understanding this value and/ or paying above the conservatively assessed value. The closer our actions are to these truths, the better our long term performance will be.
Light: Returns lie in the future. However, future is uncertain and dark. Only an intellectually honest understanding of a business can shine light on its character and help predict its future. While perfect understanding of a business is impossible, honest working understanding of key variables is sufficient. Mistakes occur when we think we understand a business when actually we don’t. Hence there is need for humility, sceptic mindset and use of common sense, forensics, and triangulations. Unless proved otherwise, every incoming information about a company needs to be doubted. Keeping our hypothesis always in question and seeking to invalidate our most loved beliefs can allow us to move towards light.
Another aspect of darkness is our biases and emotions that prevent us from seeing the light. Greed, envy, fear of losing or missing out, overconfidence, and hubris obstruct the light of rationality. While these biases and emotions have evolutionary importance, they become counterproductive while investing. It may sound funny, but the first impulse is usually wrong in investing and it would be safe to act opposite to it. Being greedy when fearful, for example. Yes it is difficult to go against our evolutionary programming, but staying aware of our emotions and biases can take us towards right action.
Immortality: Being a custodian of wealth that is going to be useful not only for the current but even future generations, we need to think in terms of decades instead of quarters. Our first objective as investors should, therefore, be to avoid mortal mistakes, financial ruin and permanent loss of capital. Focus on risk should precede expectation of riches. This requires preference for sustainability and repeatability.
Prices often rise in short term due non-fundamental reasons including narrative, liquidity and news flow; many times against fundamental reality. While riding such rise due to luck or design looks temptingly doable, it is not sustainable (at least for us) and may eventually reverse. In longer run, paying below carefully assessed fundamental value is the only way we understand to sustainable returns.
Lastly, when assessing value or behaving, we should remember that most things – high growth, high margins, success and failure are impermanent. Prices move from being expensive to being cheap and vice versa. By retaining equanimity and behaving counter-cyclically, we can use these swings to our advantage.
In summary, we have to keep moving towards and sticking to a process that is based on eternal truths, intellectual honesty and sustainability.