I received an interesting email this past week from a chap looking to blow off a little steam.
"My company Moonshot.com has gone to the moon since you trashed it, while your pieces of [golf word] are dying!"
Charlie Munger, chairman of WescoFinancial (AMEX: WSC ) , spoke in 2000 about the price of a stock coming from a number of different places: It's valued like a bond, like a claim on earnings, and also like a Rembrandt painting, which tends to go up in value for the sheer fact that it has recently gone up in value.
It's an interesting phenomenon -- the waxing and waning of share prices, especially over the short term. There are plenty of theories about this occurrence, including that of the efficient market, which states that a share price at any given moment represents all information available about a company, synthesized into a share price.
I think this is crazy. Not fully crazy, of course. Stock prices are informed by the performance of the underlying companies. But to say that they're always efficient strikes me as daft. I'm aware that there are Nobel Prizes, Ivy League doctoral theses, and an unending level of academic dogma that say I'm wrong, but that doesn't intimidate me. The prices of companies are simply too variable, particularly in short periods of time, to bear out an efficient market. To my mind, stock prices suggest a mostly efficient market, but that's a different matter.
A mostly efficient market is the same thing as a mostly round Earth. If you say Earth is round, you're wrong. If you say Earth is flat, you are very much more wrong. But to say that Earth is "mostly flat" is much more wrong than to say it is "mostly round." This Asimovian moment was brought to you to underscore a simple point: The market is mostly efficient.
Where the market ceases to be efficient can be found in my depiction at the top of the page of the email I received this past week. The logic is simple: "My stock rose, yours dropped; therefore, I'm right and you're wrong, and I'm smart and you're stupid."
But is that really the way that the market is supposed to work? We take as small a chunk of time as needed to define ourselves as stock market geniuses? That works in Vegas -- after all, the smartest gambler is the one who sidles up to the blackjack table, bets his entire stake on one hand, and then leaves, win or lose. But when you're investing, the halftime score doesn't matter much. It's the amount you end up with at the end of the game. And for most of us, it's a long, long game.
Take Mr. Munger, for example. Seeing how he has invested his way to being a billionaire several times over, one would have a hard time making some sobriquet like "crappy investor" stick when describing him. This is, after all, the man without whom Warren Buffett claims Berkshire Hathaway (NYSE: BRKa ) (NYSE: BRKb ) would not have enjoyed nearly the returns it has generated over the decades. Yet this same Mr. Munger has on his permanent record these consecutive years of returns: -31.9% in 1973, and -31.5% in 1974. This is the kind of compounding you'd never hope to see -- a two-year period when every dollar at the beginning is $0.46 at the end.
Stop and ask yourself -- would you be able to stomach returns like that? Charlie Munger (and his clients) did, in no small part because he was supremely confident in his abilities, and he knew, having turned in boffo returns for many years prior, that he had an intellectual approach to investing that would pay off in the long run.
And unless you're planning on living only for a few more days, that's the only "run" that really counts. Which is why we don't get very excited over short-term returns. People who bought Juniper (Nasdaq: JNPR ) in 1999 and early 2000 felt like geniuses as the stock rocketed ever higher. Instead, these were people who were sitting on ever-higher levels of unrealized risk. Some get out; many don't. Or they double down. Or they get out on the weakness, get back in because "the company's gotten so cheap from its highs," or sold and bought something else tech that was equally spectacularly overvalued. After all, with self-defined "tech investors," what was the chance that they were going to sell Juniper at the top and then suddenly buy Valero (NYSE: VLO ) with the proceeds? No, more likely they loaded up with Brocade (Nasdaq: BRCDE ) or Redback, or something almost perfectly correlated with Juniper.
But what is the long run, anyway, if not a whole long string of short runs? There's a lot of nuance in what the long run is and how you should think about companies over that period of time. Here is what it is not: The long run is NOT the excuse one should give to paper over really bad performance over the short term.
But, but, I'm a long-term holder!
How many times have you seen it, or even thought it yourself? A stock blows up, and the inevitable parry is made: "Well, I'm in it for the long term, anyway." In many cases, this is going to work out just fine. But being a long-term shareholder does not absolve you from paying attention to things that are happening right now with the companies you hold. That's the path to madness and horrible returns.
Does this make sense? The two issues are quite contradictory: On the one hand, as a long-term investor, you are best served focusing on the overall health of the company, not so much on the zigs and zags of the share price that come along with news issues, changes in the business, earnings reports, and so on. But at the same time, a long-term focus does not absolve you from paying attention to what happens in the short-term -- especially if it is really, really good, or really, really bad.
Perhaps an example would help. I've believed for some time that KrispyKreme Doughnuts (NYSE: KKD ) is a pretty good candidate for a terminal short: that the company's franchise network is enough of a disaster that it's possible it won't be able to generate enough cash flow to fund further operations. For a long time, my negative opinion of Krispy Kreme (which, at the outset, was not quite as ghoulish as it is now) looked to be extremely wrong, since the stock market awarded Krispy Kreme with ever-higher valuations, topping out at well over $2 billion in 2003.
During the period of 1999-2003, there was an extreme level of investor interest surrounding Krispy Kreme. I think it's safe to say that this interest has dissipated. But what people were excited about in the earlier years was something specific: This was a stock that was going up. Of course, Krispy Kreme did show growth, and there were police directing traffic outside many of its new stores, but the excitement was the stock. It was a Rembrandt. There was never a point at which Krispy Kreme was worth $2 billion, but that didn't matter. It had to be bought because of the properties of the stock, not the company.
Ditto poor Travelzoo. Remember this beast? I first started calling it overvalued when it hit $50 per share last year, and the stock continued to surge up to a high of $110 a stub, giving the company a total market cap in excess of $1.7 billion this past December. At the time, I heard from a guy every single day that the Fool was wrong, that I should be arrested, and that he didn't care because his buy-in price was $27. The stock's at $20 now. He doesn't write anymore. But more to the point: Can anyone make a reasonable argument claiming that a company can be valued at $50 million in November 2003, $1.7 billion in December 2004, and $375 million in October 2005 -- a period in which the company's earnings gently but consistently rose?
What my loyal correspondent missed -- what many seem to miss at one time or another -- is that stock certificates are not self-referential. They are not Beanie Babies, and they aren't baseball cards. They're pieces in ownership in businesses. And no amount of stock-market jockeying can change the fact that over the long term, the market will discount companies properly. Just the same, when AES hit $2 per share in 2002, people suddenly seemed to forget that this company had assets worth far more than its market cap. Those who didn't forget have since seen their stock rise many times over. After all, the reason that stocks like People's Express, Eastern Airlines, or Penn Central are now worth zero isn't just that people stopped wanting them, or because some nefarious market maker "bashed" them to death. The real reason? The businesses failed. The stocks followed.
This is as it should be. Stocks are ownership in a company. Forget that, and you're looking for trouble in the long term.
I will be speaking at the Value Investing Congress in New York City on Nov. 15 and 16. Other speakers include Joel Greenblatt, author of the upcoming Little Book That Beats the Market, Richard Pzena of Pzena Capital Management, and former Fool Zeke Ashton, now manager of Centaur Capital Management.
Krispy Kreme is a Motley Fool Stock Advisor pick.