Debates about macroeconomic issues (interest rates, inflation, wars, global political risks) are often esoteric and few investors fully appreciate or understand them. Even well-known experts and economists will admit that they have a very poor track record of accurately predicting macroeconomic outcomes. And yet many investors expend enormous amounts of intellectual effort and financial resources to assess the state of world affairs. Perhaps those who time the market to enter and exit securities have seen big payoffs, but what the past two and a half years has shown is that the risks hurting investors are not those they have fancifully priced in, but didn’t see those who actually did it coming at all. In an ideal world, a stock investor would spend their entire existence picking individual companies and judging whether they are worth investing in. In reality, most spend much more time rationalizing the fall or rise in company stock prices based on their assessment of the prevailing macroeconomic scenario. Of course, there’s no denying that the broader economic outlook can affect stock prices in the short term (as they currently are, with the NASDAQ down about 30%), but over the long term, it’s the inherent quality of the company that determines this Valuation. The key lesson for investors here is to understand that no one is asking them to completely ignore the larger economic reality, but rather to be largely aware of it — to the extent that it affects the future prospects of the companies they own. In all honesty, companies and corporations are vulnerable to cycles of economic boom and bust, just as the fundamental nature of stock prices is to be volatile. Some companies could benefit from temporary tailwinds, but this will not impact long-term profitability. On the other hand, some companies may see strong headwinds, but they don’t materially impact their long-term prospects. Most businesses are typically affected by a change in economic conditions and it is a) necessary to distinguish between temporary and permanent impacts on profitability; b) accepting the cyclical nature of most companies; and c) becoming more concerned about the individual company’s ability to adapt to a new economic reality.
Therefore, a better approach to stock investing would be to treat individual stocks of companies that you want to own for a long time as “family businesses.” For one thing, no sane person would start or run a family business if they a) didn’t understand the underlying business; b) do not see potentially large future returns; and c) planning a sell-off when the going gets tough. Essentially, the traits you would look for in a family business are not dissimilar to what you would look for in a public company: one that dominates the industry with little or no competition, one that has more products/services to offer sold 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 distinct “family businesses” is a powerful idea, forcing individuals to be less speculative on macro trends (short-term gains or challenges) and to view themselves as “owners” of companies. Good companies not only survive economic downturns, they actually come out stronger (killing weaker competitors). Ultimately, a company’s stock price should reflect the strength of the underlying business (although there’s just no telling when). For that reason, it’s not surprising that the highest stock returns come from owning the best companies in the world – the most dominant companies with the highest quality that are always focused on upping their game. Stock investing is really that: buying a collection of superior companies and constantly reevaluating their “superiority” as if they were your family businesses. Anyone telling you where the market is going in the next year or two is doing nothing but indulging in financial astrology. Everything else we normally hyperventilate about (the drama of inflation, the possibility of persistently high interest rates followed by a prolonged recession, the threat of nuclear war, the constant volatility of stock prices) is actually a huge distraction to getting solid over the long term financial returns. For this reason, one should bet on company fundamentals, not investor sentiment or macroeconomic results.
THE VIEWS EXPRESSED BY THE AUTHOR ARE PERSONAL
ARIHANT PANAGARIYA The author is a portfolio manager at Hundred Ten Capital in London