Some Simple Investing Truths
These are some very basic lessons that I try to remind myself of every once in a while. We spend so much time in the weeds - it’s worth zooming out and remembering what actually matters in investing.
People spend too much time fixated on the downside. It makes sense - we’re wired that way1.
We worry too much about buying an index at 30x earnings when maybe it should be worth 20x.
Think about what these metrics represent. Even at 30x earnings, expected forward returns are still positive (over the long-term). At 30x earnings, we should expect to make at least 3% on our money…and even better if earnings grow (which, of course they do).
Sure, maybe you’re expecting 10% returns, and a lesser outcome is a disappointment. Or if valuations do re-rate to 20x in the interim, that results in negative short-term returns. But it’s going to be okay. The expectation still is that you’ll have more money in the long-term than you do today.
Even when things go wrong, the bias is still up. Governments and corporate leaders always have the incentive to take action countering the downside.
The Great Financial Crisis, Covid, and every recession that came before. What do these have in common? Some might see a brief moment of turmoil. I see governments, corporate leaders, and everyday citizens acting in rational ways to save a system in trouble. We see this even when looking at a more granular level. The FED stepped in when Silicon Valley Bank was about to blow up. Mark Zuckerberg reversed course when the metaverse wasn’t catching on. No one just stands by and watches their world implode…
Yes, things can go wrong, and it’s worth watching out for those trapdoors. But it pays to start from a place of optimism.
We twist ourselves into knots trying to determine whether the depreciation schedule should be five years or six. Or tracking inventory turnover and working capital.
When you start going down an accounting rabbit hole, ask yourself “how much does this matter to cash flows?” Often times, you’ll find that you’re putting a lot of mental resources into things that matter only on the margins.
The accounting stuff absolutely matters. But don’t forget the forest when inspecting the tree. Businesses are generally simple. It’s just money-in and money-out. Solve for that, and you’re most of the way there.
The other day, I heard two podcast hosts comparing the price to sales ratio of Nvidia vs Walmart. I quietly cringed, closed Spotify, and stared off into space for a bit thinking about how the machines might actually be closer to world domination than I thought a few minutes prior.
Valuation is an area where we get twisted up in heuristics. Partly because it’s misunderstood, and partly due to laziness, trying to avoid actually reading a 10-K.
On the flip side, I see analysts becoming contortionists attempting to track changes to accounts receivables several years into the future. After all, if you don’t build a full three statement model to the second decimal place, your parents probably don’t love you…
Similar to the point above about trying to over-complicate business, don’t over-complicate valuation. At the end of the day, we just have to solve for our claims to future cash flows, the likelihood that those future cashflows actually materialize, and discount them. It’s not necessarily trivial, but it is simple.
The next time that you’re worried about your favorite podcaster predicting currency debasement or the unemployment number clocking in 10 basis points higher than expected or the next FED meeting; pull up this post and remember to start from a place that actually matters.
Your point about the upward bias reminds me of something most people miss - even Japan's "lost decades" weren't actually that bad if you reinvested dividends and stayed the course. The Nikkei with dividends basically matched US bonds over that period, which everyone considers the worst-case scenario for developed market investing. Really puts those 30x P/E worries in perspective when even the poster child for market disasters still delivered reasonable returns to patient investors.