1. Price and Value are different things

Prices are mostly the reflection of the psychological biases of market participants (individuals and institutions alike); they are driven by emotion and irrational behavior. Value, on the other hand, is based on the fundamental ability of businesses to generate free cash flow over time. Prices are objective, immediately visible, erratic. Value is subjective, not immediately visible, stable. The mainstream view is that a price decrease is automatically identified with a loss of value, and vice versa. Our view is that value, and not price, is what’s important in investing, while price is important to us only when we decide to buy and when we decide to sell. That’s why we spend the majority of our time working to understand the value of companies, rather than trying to guess what their stock prices will do. Value is what counts: there’s an overwhelming amount of evidence that – given enough time – price always follows value (and not the other way around).

2. Markets are inefficient

For the reasons described in the previous point, at least in the short term, the market price for a security might occasionally be dramatically different than the value of its underlying business. If it weren’t like this, there would be no way to make money in the market but trying to guess the direction of the stock prices – an activity that is closer to the definition of divination than to that of investing. Yet, over the decades, large fortunes have been made in the stock market by acknowledging, and taking advantage of, short-term inefficiencies.

3. Volatility is not Risk

Risk for us is not the volatility of the stock price (a company should not be considered riskier than another company only because its market price bounces around more frequently and with more intensity than the market price of the other company), but rather the probability of a permanent loss of capital. What does permanent loss of capital mean? It simply means that if the stock price of a company that we invested in falls by 30%, we haven’t lost any capital unless we decide to sell. We decide to sell a position only if we believe the original investment thesis has been permanently impaired (and therefore its value is no longer there), which will happen from time to time (everybody makes mistakes, even Warren Buffett), and might happen regardless of a drop in the market price. In such a case we would have realized a permanent loss of capital.

4. Concentration

We believe that abnormal returns are created by concentrated portfolios, as good investment ideas are few and rare. In the absence of opportunity, we have no problem with holding cash, as dry powder provides both the buffer and the opportunity in case of sharp market corrections. When opportunity presents itself, therefore, discipline and conviction are necessary ingredients to act with boldness.

5. Long-term view

It might take time before prices start to fully reflect value. Also, it takes time for value to compound: value doesn’t get created overnight. After we have built a position, in some instances it may take years for the securities to appreciate to a price at which we would consider removing them from the portfolio, in other instances it may take months. We don’t know. Nobody knows. A successful investment approach requires a long time horizon and an unusual amount of patience to tolerate volatility in short-term results. Based on evidence and personal experience, we believe that, on average, three years is the minimum period after which the market starts to cross over from being a voting machine to being a weighing machine, although five to seven years could sometimes be required for the real shift to occur.

6. Macro irrelevance

We do not believe in the relevance of general macroeconomic views when making investment decisions. Our investment decisions are company-specific, one company at a time, and not based upon the general level/direction of the stock market, inflation, interest rates or other macroeconomic indicators. If we had the power of knowing with certainty the direction of the market or interest rates, we would continue to not base our investment decisions upon that.


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