Written By: ARIHANT PANAGARIYA
Debates around macroeconomic issues (interest rates, inflation, wars, global political risks) are often esoteric in nature that only few investors fully grasp or understand. Even well—known experts and economists will admit that they have had a very shabby record of accurately predicting macro— economic outcomes. And yet many investors spend enormous amounts of intellectual horsepower & financial resources to gauge the state of world affairs. Maybe those who time the market to trade in & out of securities have seen large pay—offs but what the last two and a half years has shown is that the risks that hurt investors are not the ones they imaginatively price in but those that they did not see coming at all. In an ideal world, an equity investor would spend his entire being on picking out individual businesses and judging if they are worthy of investments. In reality, most spend far more time rationalizing the decline or uptick in share prices of companies based on their assessment of the prevailing macro—economic scenario. Of—course, there is no denying that the broader economic outlook can affect share prices inthe short—term (just as they are currently with NASDAQ down around 30%) but in the longer term it is the inherent quality of the business that determines its valuation. The key lesson for investors here is to understand that no one is asking them to completely ignore the larger economic reality but be broadly aware of it—to the extent it impacts the future prospects of the businesses they own. Truth be told, companies and businesses are prone to cycles of economic boom and bust, just like it is the fundamental nature of stock prices to be volatile. A few companies may benefit out of a temporary tailwind, something that has no effect on its long— term earning power. On the other hand, some companies may see strong headwinds that have significant no impact on its long—term prospects. Most companies tend to be impacted by some change in economic conditions and it is a) necessary to differentiate between temporary and permanent impairment to earning power; b) accept the cyclical nature of most businesses and c) worry more about the individual business’ ability to adapt to a new economic reality.
A better approach to equity investing, therefore, would be to treat individual stocks of companies “family businesses” that you would want to own for long periods of time. For one, no rational person would set up or run a family business if they a) don’t understand the underlying business; b) do not see potentially great returns going forward; and c) plan to sell out as soon as the going gets tough. Essentially, the characteristics you would look for in a family business are not dissimilar to what you would look for in a publicly listed company: a business that dominates the industry with no or minimal competition, one that sells more products/services at higher prices and lower costs over a period of time and one that intelligently allocates capital to achieve the company’s mission or purpose. Owning stocks of companies as different “family businesses” is a powerful idea that forces individuals to speculate less on macro trends (short— term gains or challenges) and to think of themselves as “owners” of businesses. Good businesses don’t just survive periods of economic downturn but in—fact come out stronger on the other side (killing weaker competition in the process). Ultimately, a company’s stock price should reflect the strength of the underlying business (although one just doesn’t know when). Which is why it is not a surprise that the highest equity returns come from owning the best businesses in the world—the most dominant, the highest quality companies that are always focused on getting better at their game. Equity investing is really that: buying a collection of superior businesses and constantly re—evaluating their “superiority”, as if they were your family businesses. Anyone who tells you where the market is headed in the next year or two is doing nothing but indulging in financial astrology. So, everything else that we usually hyperventilate about (the drama around inflation, the possibility of sustained high interest rates followed by a prolonged recession, the threat of a nuclear war, the constant fluctuation in share prices) is actually a giant distraction to attaining solid long—term financial returns. Which is why one should bet on company fundamentals, not investor sentiment or macro— economic outcomes.
THE VIEWS EXPRESSED BY THE AUTHOR ARE PERSONAL
ARIHANT PANAGARIYA The writer is a Portfolio Manager at Hundred Ten Capital in London