Sowing Seeds: Market Value is Imaginary

DISCLAIMER: “Sowing Seeds” is a 3-part 4-part series about my uneducated approach to investing. Readers should not take any of this content as a sound recommendation. (I am not a financial professional, nor have I been trained as one.) Be a big boy or girl, and make your own decisions.
First: Part 1, Market Value is Imaginary
Then: Part 2, The Economy is Irrelevant
Finally: Part 3, The Second Best Buzz
Bonus: Part 4, Water Your Own Tree, Slowly

I tend to obsess over things… So for the last year it’s been Warren Buffett and the stock market.

I approach it like this: the most ideal situation would be to have lunch with Warren Buffett and get his take on things. I suspect that anyone who sat down with him and heard him say, “You should do A, B and C” would do exactly what he said. So how do we get that info? Actions always speak louder than words, so why not just copy what he does?

The problem with that is that journalists are a dime a dozen who can tell you what stocks Mr. B. holds, but very, very few report what he bought them FOR. WB holds a freighter full of Coke shares, but that’s not enough info, because it doesn’t detail what his cost is. It doesn’t tell us if he thinks Coke is still a good deal today.

Book value — cost, essentially — is more important than market value, because it’s real money. It’s money you made playing guitar or selling hats, and at one time it was in your bank account. In contrast, market value has never existed except in people’s imaginations. “If I sold now, I’d make…” or “If I would have kept those shares, today I’d have…” but both mean nothing. It’s like saying, “I started playing guitar when I was six. If I would have kept playing, I’d be awesome now…”

If you put money into the stock market and it doubles, it’s exciting, but it doesn’t really mean anything until you turn it into cash, put it back into your bank account and thereby increase your book value. If you put it into the stock market and the value gets cut in half, it sucks emotionally, but it means nothing in practical terms unless you sell or the stock disappears entirely (which really means you bought shares in a shitty company to start with).

A key Buffett tenet is that when you buy a stock, you’re not buying a meaningless piece of paper that someone may or may not pay you more or less for. You’re buying a real piece of a real company. That being the case, you should approach buying stocks as if you were buying the whole company, and thinking that you were going to own it for at least ten years. (If you were going to buy the corner store in your neighborhood, would you go through all that effort the due diligence required just to sell it in six months?)

From this point of view, questions that need to be asked include (but are not limited to): Is management competent and sound? Is management honest and trustworthy? Does the business have favorable long-term prospects? Does the company have a competitive advantage? Most importantly, is the company (or its shares) for sale at a significant discount that offers the investment a significant margin of safety? In other words, has the moodiness of the market unjustly determined a current stock price that severely understates the intrinsic value of the company? (From what I understand, WB likes to buy when things when, in his mind, they are discounted 40% or more…)

But who the f%$# has the time to evaluate each stock they buy as if they were buying the whole company? Answer: our buddy Warren.

Another thing in our favor is that WB’s favorite holding period is forever. If he’s confident in his investments, he plans on never selling. This tells us a couple things, most importantly, that Buffett isn’t buying stocks; he’s buying cash flow in the form of dividends. Played properly, this works way better than any fixed income investment ever will… Here’s why:

1. You buy a stock for $50 that has a dividend yield of 3%;
2. So for your $50, the company will pay you $1.50 every year;
3. If the company is sound, the stock price will probably rise over the long-term, and the dividend will likely keep pace with the stock price;
4. So if the stock value increases to $100, the yield may increase to $3. Still 3%, right?
5. No, because your cost is $50. So now you’re making 6% on your money;
6. But since the stock has hit $100 and people have an irrational resistance to high stock prices, the company splits the stock 4:1;
7. So now you have four shares worth $25/each, rather than one worth $100, each paying $0.75 (6%);
8. But if it’s a well-managed company with favorable long-term prospects…;
9. Etc, etc.

That’s how WB invested in Coke in 1988. The stock has increased in value and split a few times so that today the stock is trading at $46, paying a dividend of $1.52. But Buffett’s per-share cost is $6.50. So he’s making 23% per year on his book value…

So that’s a long explanation on why I put the “What Buffett Paid” spreadsheet together: it tells me what price he thought those stocks were worth paying for. Not only worth paying for, but heavily discounted with a big safety margin.

In the last year, there have been several opportunities to buy those companies at those prices. The market is at an incredible low, but as a result of copying Buffett, today the book value of my investments is only down -0.28%. Pretty much even after a year of investing in a nasty bear market.

Of course, it could all go to shit tomorrow, but it honestly doesn’t matter. Any depression in values just gives me another opportunity to buy great companies even cheaper and to lower my book value even more, thereby making the upcoming slingshot in market value and dividend yields even more positive.

Regardless of what happens, I wouldn’t sell any of my stocks for at least ten years. In reality, I probably never will.