June 5, 2024

The Stock Market Does Not Exist

Authored By Louis Stevens

In Peter Lynch's critically acclaimed book, "One Up On Wall Street," he shared a way of thinking about investing in stocks that could be most concisely conveyed via the sentence, "The Stock Market Does Not Exist."

Let's review the excerpt in which he shared his thinking in this respect, then we'll discuss it a bit for today's brief.

"What Stock Market?
The market out to be irrelevant. If I could convince you of this one thing, I'd feel this book had done its job. And if you don't believe me, believe Warren Buffett. 'As far as I'm concerned,' Buffett has written, 'the stock market doesn't exist. It is there only as a reference to see if anybody is offering to do anything foolish.'
Buffett has turned his Berkshire Hathaway into an extraordinarily profitable enterprise. In the early 1960s, it cost $7 to buy a share in his great company, and that same share is worth $4,900 today. A $2,000 investment in Berkshire Hathaway back then has resulted in a 700-bagger that's worth $1.4 million today. That makes Buffett a wonderful investor. What makes him the greatest investor of all time is that during a certain period when he thought stocks were grossly overpriced, he sold everything and returned all the money to his partners at a sizable profit to them. The voluntary returning of money that others would gladly pay you to continue to manage is, in my experience, unique in the history of finance.
I'd love to be able to predict markets and anticipate recessions, but since that's impossible, I'm as satisfied to search out profitable companies as Buffett is."

In One Up On Wall Street, Mr. Lynch went on to elaborate his thinking in the vein of "The Stock Market Does Not Exist;" however, for the sake of brevity, I will not transcribe pages of text here. I do highly encourage you to read One Up On Wall Street, if you've not already done so. Its message is indispensable in understanding why L.A. Stevens does what it does and makes the decisions that it makes.

Turning to an interpretation of the quote I shared with you, the best way to think about building a portfolio, or investing in stocks, is to imagine a world in which there is no electronic stock market.

Imagine a world where there were no CNBC; where there were no E-Trade or Fidelity; where there were no internet of any kind; where there were no electronic system that managed the presentation of the indices, which themselves are arbitrarily defined aggregations of stocks that in no way, shape, or form need exist for us to be successful investors on the road to retirement funds with millions of dollars, or more, in them.

In such a world, how would you invest in businesses?

You would be forced to physically venture out into the world and assess businesses in person. You would be forced to interact with the C-Suite of a given business, its owner-operators, its founders, and its board of directors.

You would be forced to assess the tangible characteristics of the business, i.e., the quality of its product, how its product is made, where its made, who buys it, the potential number of customers the product might capture, the product's unit economics, and more.

Upon completing your assessment, you would approach the owner-operators of the business in question and ask to purchase a stake. They would then tell you how many shares you could buy and at what price.

You would then consider that offer relative to the cash flows of the business, and, importantly, relative to your next best alternative.

For those really following LAS' work, this will call to mind our four elements of equity value:

  1. Amount of free cash flow per share
  2. The growth rate of that free cash flow per share
  3. The durability of that free cash flow per share
  4. Your next best alternative, e.g., the risk free rate (treasury bonds)

In this example, we will assume that you accepted the offer presented to you by management, and you now own shares of the company in question.

At this point, you would not feverishly review the price of the business, because you would have no ability to! 

Remember, in this scenario, there's no internet, no online brokerages, etc.

You would simply become an owner of the business, and hold your stake for the long term, occasionally checking in on the business' progress quarterly or annually via the business' quarterly or annual reports.

In America, home ownership is often seen as the guaranteed path to riches. Is this because a home appreciates faster than stocks? No. In fact, homes appreciate at a much slower pace on average.

Home ownership is seen this way because buying and owning a home is akin to the example I just shared with you of buying a business in a world with no electronic systems that may allow you to instantly sell an asset in a moment of anxiety. Home ownership is so lucrative for Americans, and it is so universally so, because Americans cannot make rash decisions in a moment of mental weakness. They cannot sell the moment a news pundit makes a scary remark about the fate of home prices. They cannot exit their position in their own within seconds, as we can do in owning stocks following the advent of electronic brokerages. One, they'd be homeless, and, two, there's simply not that much available liquidity in housing markets.

The inability to access instant liquidity forces home owners to retain their positions in their homes, and, invariably, the panic subsides in the days and weeks ahead, they continue to enjoy the benefit of being a long term investor in their own.

To close, we should invest in stocks as if the stock market does not exist, because it actually doesn't exist: the S&P 500 Index and Nasdaq are fabrications of the human mind, arbitrary aggregations of stocks based on essentially, in the grand scheme of things, made up and unnecessary rules. They are like the laws of man: ethereal and shifting; whereas, long term business ownership is like the laws of the universe: immutable and unyielding.

We should invest in businesses and hold them for the long term as true business owners.

This is how Mr. Buffett has thought. This is how Mr. Lynch has thought.

And it's what L.A. Stevens espouses.

Importantly, the key here is to buy right and sit tight, so if you'd like to further your understanding of buying right, i.e., if you'd like to develop a strong understanding of the key characteristics that define a quality business worth owning for the long run, stick with us, and you will learn those characteristics over time.

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