The perennially favourite discussion topic is trading versus investing. What’s the difference? Is it short time horizon versus long time horizon? Is it growth versus value? Is it Soros versus Buffet?
This post is a continuation of my 2007 article in The National. Reading the previous article is not necessary to benefit from this post, but looking at the ideas across an eight year period might be helpful.
I am not really sure why people find trader/investor classifications important. People have different styles and they may prefer yet other styles. Maybe it is useful to outline what the different characteristics of trading/investing are. So that’s what I’ll do.
One of the primary investing characteristic axis is price versus value. Clearly you want great value at a cheap price. The world, unfortunately, doesn’t usually offer such a windfall.
So what do you prefer, a great asset at an expensive price or a lousy asset at a cheap price? Don’t be a smart ass and say neither, ranking the two unpalatable options will give you great insight as to your innate style.
It could be argued that a trader would rank price over value, preferring a cheap price in the hope of quickly reaping the rewards of the price moving to neutral.
It could similarly be that investors are looking for value, an asset that keeps giving (yielding in the vernacular) over time with the idea that price is not as important with a dividend paying asset.
What about time horizons? Why are traders viewed as having short time horizons and investors as having long time horizons? The price — value issue resolves this question. If traders are looking for price movements then they make no return until they sell, and the sooner they sell the higher the return due to the shortened holding period.
On the other hand, the investor holding a yielding asset will have no interest selling that asset and looking for a new one. Why would he? He has the goose that keeps laying the golden egg. Or at least the chicken laying a silver one.
A trader asks: What in the future will make the price jump? A new patent? A disruptive technology? Irrational exuberance? A Google bid? A great idea?
An investor asks: What in the past proves to me that the asset can keep yielding? Institutionalisation? A captive market? Long term incumbent management? A great product? A great business?
Am I discounting the importance of price? No, but I am prioritising yield, which is driven by free cash flow. Instead of using extremes, let’s look at more realistic scenarios: a great business at an okay price versus an okay business at a great price. I prefer the former and I have the scars to prove it.
When I bought Zawya in 2001 my firm wasn’t the only bidder. Dozens of investors had been shown the deal and we ended up being the only bidders. This was beyond not getting the cheapest price. We were considered insane for making a bid in the first place.
At the time Zawya didn’t have revenue. But it had a strong team and a great product. So much so that we moved them to Dubai to be closer to us and their main clients. Zawya might not have been cash flow positive in 2001 but by 2004 it broke through the break even barrier.
At this point we were receiving unsolicited offers for Zawya of 2x to 3x our initial cash investment. That’s a 26% to 44% IRR over the three year holding period! But at that time we didn’t sell, because we weren’t price takers. We saw the yield coming and we held the asset for another 8 years. Many have questioned me as to why we would hold an investment for 11 years, when the conventional wisdom in private equity is 5 years. My answer remains: where else where we going to find a 35% IRR over 11 years?
If you prefer to chase prices, I wish you the best of luck. It’s clearly not impossible, Soros did it. But I believe the more effective way is to build a portfolio of yielding assets. You get the power of compounding on your side.
But don’t believe me. A mysterious man entered my life a few years ago and told me that Soros had confided in him that Buffet was the smarter investor. Soros had to wake up early in the morning and check where dollar/yen was. Buffet could wake up at a normal hour and have a leisurely breakfast before going in to work, confident in the fact that there was an army of managers busy clipping him coupons. I’m not sure who this mysterious person was. Possibly his name was Keyser Söze. I seem to recall that he wore no socks. I therefore trust what he told me.
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