Staying the Course

#14: On trading and investing.

First, thanks for the kind messages and congratulations. This week’s post comes from a scenic perch overlooking Italian wine country (pictured below) halfway through a honeymoon. It has been nice to (mostly) separate from the screens for a week, but I already feel the itch to dive back into the numbers. Meaty analysis is coming your way, but in the meantime, let’s talk about trading and investing.

One amazing thing about the public equity market is its speed. In less than a second you can buy and sell slices of the largest companies in the world. You can be a deep value investor in the morning, pivot to the oil patch by noon, get bullish, then bearish, and cap your afternoon off with some growth tech LEAPS.

Accessibility, cost-efficiency, and liquidity allow you to invest or divest in anything at any time. The market’s liquidity provides a constantly updated mark-to-market price of a security or portfolio. Price does not need to be discovered - a quick refresh tells you how much you gained or lost in the last three seconds.

By contrast, the world of private equity is very slow. On average, it takes about six months to buy or sell a company from start to finish¹.

The process generally starts with a month or two of initial diligence, indicative bids, and navigating an auction organized by bankers. Then, allow a couple months to conduct deep diligence, put in a firm bid, arrange financing, and draft a suite of merger documents. It isn’t until binding acquisition documents are signed that a price is finalized. Even after merger documents are signed, anti-trust approvals must be obtained and post-signing conditions satisfied before the deal closes and wires are released.

After all this, a private equity fund owns a private company. It will take years before the price for the company is discovered again.

Ostensibly, both public and private investors are doing the same thing - buying companies with the hope of making a profit. But the pace is so different that the two can seem worlds apart.

In private markets, you can’t be a trader, you must be an investor. It takes too long and costs too much money to flip investments for small gains. To be successful, you must commit to owning a company for years, through thick and thin. You will come up with a valuation mark for the investment on a quarterly basis based on some cash flow model, but there is no real way to know what the company will sell for until you sell it. Once you do a deal, there is no choice but to stay the course.

In public markets, you have a choice - you can be a trader or an investor².

Traders make money by being a half-step ahead of the pack, by identifying short-term opportunities and by reading real-time sentiment. The underlying value of a company, for a trader, is largely irrelevant. So long as you have a liquid market, Apple and Dogecoin are not all that different.

Investors make money by identifying undervalued assets that appreciate over a medium to long term. You can find boring companies with overlooked cash flow, or companies that will grow larger than the market expects, or industries that you expect to benefit from larger macroeconomic trends. The key is to buy an asset when its price is lower than its value.

Neither approach is inherently superior, but they are different. The trouble comes from confusing the two.

For traders, with an explicitly short-time horizon, there isn’t much temptation to fret about a company’s³ long-term business prospects. The point is to capitalize on immediate market moves rather than on a fundamental valuation thesis. In other words - you are not concerned with long-term trends because you don’t stick around long enough to see them.

The greater challenge is for the investor who must stomach short-term volatility along the path of a long-term investment. Unlike the private investor who has no choice in the matter, the public investor must choose every day to stay the course⁴.

Here is where the up-to-the-minute refresh becomes deadly. Every day, a company’s stock will go up or down - this will be shown as a gain or loss. But in reality, you started the day with 10 shares of Apple and ended the day with 10 shares of Apple. Your investment thesis is based on an estimation of Apple’s value which doesn’t change daily⁵, even as the stock price constantly moves.

The entire point of investment is to find dislocation between price and value. But that gap will not close immediately. If you buy a company because you expect it to outperform over the coming decade, you will need to wait a decade for the company to outperform.

With a well anchored view of value, daily price moves are easy to stomach and even seem trivial⁶. Instead, if you find yourself looking at short-term changes in price to validate or discredit your investment thesis, you probably don’t have one. In other words, you are a trader who has mistaken themselves for an investor.

The challenge of trading is ignoring GDP prints, macro doomsayers, and fundamentals to focus on the here-and-now. The challenge of investing is to stay the course.

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P.S. In the first post, I compared this column to cooking chili. Fourteen bowls in, I think the recipe is okay, but there is still much room to improve. After all, we are shooting for the World’s Best - and I’m a biased judge. YOUR feedback is the most important. Please tell me all the things you loved or hated - in style, substance, or topics - in the comments or over email, so I can make a better product for you. We are just getting started.

1. In the most extreme case, with no competition, motivated buyers and sellers, and no financing, perhaps you could do a private deal in a month, but this would be an extreme outlier. More often, bankers will tell their client they can do a deal in three, and it usually takes twice as long.

2. Is this an oversimplified and overused dichotomy? Sure, but oversimplified dichotomies can be helpful for building frameworks, breaking down complicated systems, and most importantly writing Substack posts. Give me a break, I’m trying to get back to a full pour of red.

3. Or token, as the case may be.

4. Staying the course has an ugly cousin - holding the bag. Sometimes the two can be tough to tell apart. A good litmus test is to ask yourself what you think the value of the asset is and why. If you can quickly articulate a specific, numeric answer, and the assumptions which got you there still hold, then stay the course. You may still turn out to be wrong - investing involves risk - but at least you are following a process. Alternatively, if your hesitance to sell is because you don’t want to realize a loss or because you hope things will turn around, you may be holding a bag.

5. I mean, if someone nukes Foxconn or something then Apple’s value probably changes, but those things don’t happen all that often. Quarterly earnings, of course, are the big reveal of new financial information, but even those days are overhyped. The company has been around for 184 quarters, the next one won’t make or break it. Let me give you a hint. By design, the company will exceed its revenue expectations by a touch and any CFO worth his salt can find a way to hit EPS.

6. So long as you are not using borrowed money - leveraged or short. In these circumstances, your daily mark-to-market is unfortunately much more relevant, as your broker will probably not accept your long-term investment thesis in lieu of a margin call.