Friday, October 06, 2006

Can there be more lawyers than people in New York?

Someone once mentioned that there are more lawyers than people in New York. Is this possible? Definitely not. A sentence structured this way is very easy to understand and tells the answer. Assuming that all businesses in the USA are sold as an index stock, then if the sentence is - The value of the index stock is more than the value of all profits generated by all the businesses - is this possible? Think through it. Simple logic in life says: "The subset value of a product can never exceeds the aggregate value of the product. We will certainly encounter a math problem which will be unsolvable."

Between Dec 1899 to Dec 1999, the Dow went from 65.73 to 11,497 representing a compounded yearly increase of 5.3%. In aggregate, the return on stocks can never be more than what a business can churns out in aggregate. No doubt some people can invest better than some others but in aggregate, the return can never be more than 5.3% in stock investing for all the investors combined. Those who perform better than 5.3% are those who took home more from the same piece of pie at the expense of those who perform less than 5.3%. Moreover, in reality, investors as a whole cannot even hope to match this aggregate (5.3%) that a business earns. This is because in stock investing, there are intermediaries where a cut is paid for and all of these cuts are part of the aggregate that the business produces. In other words, in stock investing, it is wrong to assume that all the profits will go to the investors' pocket, part of it (a pretty substantial ratio) goes into the pockets of those who facilitate the trade.

Certainly, there are many times when the value of the subset far exceeds the value of the product. Those are the moments where logical math encounters a problem that will be addressed through time. So what is driving this mistake? It is none other than emotions. When emotions come into play, it deviates the facts that would otherwise be logical. What would then brings the facts back to reality? A pin will always lays in wait for every emotional bubble when people realize they have drifted too far off. Market is like a pendulum swinging from unsustainable emotions or optimism to unjustified emotions or pessimism, the centre between these two extremes is the efficient and logical point. The pendulum will never remains stagnant at a single point. Firstly, Wall Street will never allows it to be so. When there is no story, there is no dough. Somehow a story must always be created to generate interest to swing the pendulum to the side which is normally not to the general investor's interest.

4 comments:

renxin said...

Hi Bershire,
Congratulations on a wonderful blog site. I had come thru "frank" and "8percentpa".
Personally I am a value investor, however I do also look at charts as well to look at timing. I am reading "The Intelligent Investor" right now. The truth is that it is really taxing to be meticulous and even more so to be patient to be able to look for stocks with true value and there are strong temptations to short-cut the process.
I have been investing in US stocks and continue to do so because I had built my portfolio in the US when I was working with a US MNC. My favorite has been Pixar which unfortunately is now part of Disney. I have not traded actively on the Singapore stock exchange although I am considering shifting some funds back into Singapore.
It would be interesting to hear your views on the influences on the general economy, sectors and individual stocks.
Best of luck and my good wishes for your endeavours.
Regards

Berkshire said...

Hi Renxin, firstly, I thank you for the complements.

I really do not agree with timing the market. In fact, it makes no sense to me except trying to gauge what the next fool will do. In timing the market, when you buy a some price, you are hoping for another fool to comes by to get it at a some higher price. Just a word of caution, if you use this strategy to invest, it is best "to be greedy when others are fearful and to be fearful when others are greedy." In all such cases, there is no clock on the wall to tell you it is midnite when the party ends.

I really do try to be as patient and as logical as i can though i do succumb to certain temptations at times. Luckily so far, I have not gotten into any trouble and hopefully not. I think it pays to be patient in investing.

Some people they are fearful in putting money in stocks because they think it is too dangerous whether in the short term or long term. Some others they think too much about worrying if they have purchased a stock at its lowest even if it is at a bargain price. For such cases, I try to tell them that ultimately, you are looking at the end goal. For instance, if you buy a stock today at $100 and somewhere in between now and a year later, it falls to $50 and then a year later, it goest to $150. Then if you put in the bank, you earn say 2% yearly. Today it is worth $100, anytime in between from now to the day you can claim your interest is still $100 and at the day you claim your interest, it is worth $102. For such people, they are foregoing $48 to buy an insurance where they don't risk seeing their capital showing a paper loss.

What is the risk? The risk is people either think too much or they want something that scapes the bottom of the barrel which you need a fairy to tells you.

I will try to find some time to write some of my thoughts, whether in investing or not. But somehow, I think certain things which don't seems on the surface to be linked to investing are really linked to it in a big way.

fishman said...

Hi everyone! Like to share my thoughts about "timing the market" and "value investing".

At the moment I try to practice both (at least that's what I think I'm doing!). I achieve this with my mutual funds investment by waiting for the market to reach a over-sold or under-valued position. I do this by charting. Then I wait for the sell signal.

So I think I doing both, but do correct me if you think I'm wrong!

For more details, can refer to my recent blog post "FUNds talk"

Berkshire said...

Hi Fishman,

I do not know if timing the market can produce a positive return in aggregate for as long as you are in investing. Perhaps your results may ends up like a gambler, maybe better, sometimes you win, sometimes you loss, but overall if it is gambling, you are bound to lose cos the odds are not with you.

In charting, I am not sure about the logic behind it because I really do not see any understanding or reason behind how price can be dictated just by the arrow pointing in certain direction. If you can confidently gauge a person mood, then maybe you can be really successful in pointing at a direction.

In mixing two approaches, I think you will not be able to do well because it will cause you confusion. When you are at a crossroad, especially if you are standing in the middle, you will have to make a decision of which to follow. If you can't reason out properly, you will end up chosing the worst of the two.

Just like a person who grew up speaking two languages, English and Chinese, I think most likely people like those can hardly be an expert in either one of them. They will end up being mediocre.