When one thinks about the characteristics that make for a good value investor, there are a few non-negotiables. Temperament is key – an investor needs to be able to divorce themselves from what everyone else is doing and insulate themselves from their own emotional swings.
The other is developing a mindset equivalent to someone who owns their own business. Just imagine the level of buy-in, the amount of care and attention to detail someone has for a business they are the CEO or sole proprietor of. That’s the idea behind having a business owner mindset when it comes to value investing.
Why is having a Business Owner’s Mindset Important?
One of the founding principles of value investing is that equities are claims of ownership in a corporation. This philosophy goes back to Benjamin Graham – widely considered to be the father of value investing and an early mentor of the great Warren Buffett. Investors are buying companies, not pieces of paper (shares) or electronic blips on a screen.
Consider the types of people who go to the casino. Everyone wants to win money but when it comes down to it you are either speculate or have a strategy. Speculation looks like the guy who hits the roulette table and bets everything on red, accepting the house edge. Strategy looks like the savvy gambler counting cards at the blackjack table. Who do you think will win over the long haul?
The stock market is a bit like a casino. Everyone enters the stock market with the hope of making money, but few actually will. There are speculators in the market, and those employing a strategy. Disciplined investors can beat out the speculators by following the principles of value investing, through careful examination of a stock in order to purchase securities that are trading below their intrinsic value and offer a margin of safety.
So if you don’t want to speculate, if you know that predicting where the price of a stock will be next week, month or year is a fool’s errand then you will want to use the value investor’s toolkit. That means evaluating businesses on their fundamentals, poring through financial statements to understand what a company is truly worth. Having the mindset of “Is this a company I would be happy to run and own myself” can act as an effective lens through which one can conduct their analysis.
Putting on the Lens
Value investors who do not have an owner mentality run the risk of placing their capital in companies that will go nowhere fast. These businesses tick all the boxes but the investor has no idea whether the company will be successful or not. This is where owner mindset can help. ‘
It’s important to scrutinize the balance sheet, but the right mentality can help you evaluate the stock on business strategy, operations and whether or not the management are all-stars. Put yourself in their shoes and try to understand the business from the ground up. Where does the money come from, where does it go?
If you are the owner, then you care about every single dollar that flows through your company. That’s the difference between a value investor and a speculator.
Long Term Outlook
If one owns a stock in IBM, it means they own a piece of IBM and the rights to a portion of IBM’s profits from the moment they purchase the share…to the end of time. For the time that you own the stock you own a percentage, however small, of IBM’s manufacturing equipment, intellectual property and computer chips. When you think of it this way, it’s hard not to develop a long-term outlook.
IBM’s share price may rise or fall but as the owner, you understand the true worth of the company and are immune to short-term fluctuations. You carry out your plans unencumbered by what the herd thinks or does. You know that you will sell your stake one day for a profit because you’ve got your hands on a great company. That long-term perspective will help keep an investor sane when dealing with the financial markets.
Prioritize Cash Flows
A lot of the market buzz revolves around earnings. Apple is having its quarterly earnings call, and everyone loses their mind at what they are going to reveal or not reveal. It’s really a type of drama, a soap opera for market participants.
When you cultivate an owner’s mindset you will prioritize cash flow over earnings. A value investor cares about quality and it doesn’t matter if you generate all the revenue in the world if none of it can be reinvested or paid out as a dividend.
Cultivating the Business Owner’s Mindset
It’s not easy but it is possible to cultivate a mindset.
It involves a lot of self-awareness and the willingness to want to change. When you sit down to analyze a business you have to ask yourself certain questions.
Does this make sense if I were the CEO?
Where is this business making its money? Can it continue making money? What trends would hinder the business from continuing down its path? Who can take market share away from us?
It’s not a dramatic shift but it’s more a continual note to self to put yourself at the head of the business and evaluate the company and its business practices from there. What value is your business creating?
When you adopt this mindset you will understand your investment in a way that you would not have thought possible. It will steer you away from investing in companies you don’t understand and as a result, you will be better off.
Treating a share as ownership stake in a business and valuing it accordingly is part and parcel of being a good value investor. It’s a principle that has been passed down from Ben Graham to Warren Buffet and onwards to every value investor who came after them. Carrying yourself with this mindset will allow you to find success as an investor.
“Long-term value investing requires a business owner’s mindset”. Pensions & Investments. http://www.pionline.com/article/20130808/ONLINE/130809916/long-term-value-investing-requires-a-business-owners-mindset. Web.
Leadership Journal-Free Sample Article: Leader to Leader Journal. http://www.leadertoleaderjournal.com/sample-articles/creating-the-owners-mindset.aspx. Web.
Jiva Kalan is a writer whose work has been featured on DailyFinance, the Wall Street Survivor, Plousio and Financial Choice.