It’s often said that the more things change, the more they stay the same. Sir John Templeton’s famous take on this was “‘This time it’s different’ are the four most expensive words in the investing language”.
Here at The Motley Fool Australia, we tend to be sceptical of what are almost always ‘get rich quick’ ideas based on some sudden divergence from previous or current experience. More often than not, investors who bet heavily on some ‘new paradigm’ end up poorer for the experience.
A Slogan Does Not An Investor Make
It is important, however, not to be caught up in ‘slogan investing’.
Yes, many truisms are words to live – and invest – by. Warren Buffett, Peter Lynch and Sir John Templeton are far from infallible, but I am convinced that their words and examples (among others) provide wonderful templates for successful investing.
None of those men, however, would ever suggest that their successes can be copied unquestioningly by investors. They have supplied, perhaps unintentionally, a framework through which investors can evaluate the range of investment candidates – not a ‘buy list’.
‘Financial Weapons of Mass Destruction’
Many commentators have taken issue with Warren Buffett’s seemingly contradictory use of investments known as derivatives, while concurrently – and very publically – calling them ‘financial weapons of mass destruction’.
What they either don’t understand or simply ignore is that Buffett is sounding a warning about the very significant risks involved – not suggesting that they should be avoided entirely.
So it is with ‘this time it’s different’.
Depending on your personality and investing style, you’ll have one of two takes on this. Either you’ll be tempted to see the post dot-com crash as vindication that ‘it’ never really is different, or you’ll see the inherent logic in the statement, pointing to the example of companies such as Apple and Amazon in the US, and our own Fortescue Metals (ASX: FMG) as examples of the gains to be made from discerning the companies and industries where ‘this time it really is different’.
Be Roughly Right
Perhaps both are right – and therefore neither is right?
At first blush, an investor with a particular bent could use either of the above examples, and go on his or her merry way, safe in the knowledge that they know best. The right answer is clearly a little more complicated, and looking deeper will help you avoid a common mistake.
At its heart, successful investing is about identifying mispriced opportunities. In doing so, an investor is comparing today’s price to tomorrow’s (or preferably next year’s) value.
The concept is straightforward, but success comes from getting that estimate of future value right. Not exactly right – that’s impossible – but roughly right. The sort of roughly right that tells you that a dot-com company with no profits or even revenues might be somewhat overpriced at a market cap in the billions of dollars, and the sort of roughly right that can foresee a time when a little web-only bookstore will become a global online retailing juggernaut.
Price isn’t Value
You’ll notice that neither of these examples refers to the ‘price’ of the investment, but rather its ‘value’. The stock market only exists because people have different views on the ‘fair value’ of a company. If we all agreed on valuations, a company would never be cheap enough to buy, nor expensive enough to sell. It is precisely this difference in opinion that makes a market in the first place.
Warren Buffett’s billions are testament to the opportunity for an investor to perceive when the market has (temporarily) mispriced an asset – and then swoop.
Everything is Different…
We are living in a truly wonderful chapter of history. The last century alone saw the reality of widespread car ownership, human flight, the invention of computers, the eradication of many diseases and the sequencing of the human genome, among many, many others. Clearly, more than any other time in human history, we have seen that ‘this time it’s different’ over and over again.
And yet, I can’t help but think Sir John Templeton is right. Despite everything we’ve seen in the past 100 years, and in the 40,000 years of human history that preceded it, human nature is still the same. As a society, we are still prone to the influence of group optimism and pessimism, we still chase ‘too good to be true’ and we continue to undervalue patience and thought.
Templeton didn’t say “an investor is always wrong when they say ‘this time it’s different’”. He simply pointed out that such an approach is dangerous. For every Fortescue or BHP Billiton (ASX: BHP) there are tens of small miners who never strike it rich. For every Amazon, there are many who fall by the wayside.
His warning should sound loudest when you are thinking about company valuations. In 1999, a book titled Dow 36,000 was published, infamously suggesting that the US Dow Jones index would reach 36,000 points in short order. Its key tenet was that in future, investors were likely to expect a lower return from shares.
Rightly, or wrongly (and history has passed its own judgement), this was during the dot-com bubble during which investor focus shifted away from profitability and onto ‘eyeballs’ – the number of visitors each website was able to attract.
Again, hindsight tells us that this approach was flawed – because in the end, an investor only ever cares how much money will flow from the business. (If in doubt, ask a media proprietor how difficult it is to make money from website visitors, compared to newspapers in the pre-internet era!).
…And Yet No Different At All
Technology will relentlessly advance, to our eternal betterment. Fashions and trends will ebb and flow. The objects of our interest and affection will continue to change, but the fact we are eternally drawn to them is a constant. Similarly, though ‘the crowd’ will switch from excitement to despondency with monotonous regularity, the cycle itself is destined to continue.
Investing has always been about understanding a business and determining a fair price based on its prospects. Warren Buffett’s own approach has moved with the times, in response to both other influences and changing opportunities.
When considering your investments, and their valuation, it pays to heed the words of Thomas Jefferson:
In matters of style, swim with the current; in matters of principle, stand like a rock.
Each time, something will be different – but the importance of valuation remains constant.