SKARBECK: Constant buying, selling of stocks makes no sense

Continuing my last column’s theme on stock market short-termism, one need look no further than the daily volume on the stock exchange or the daily turnover in any given stock to observe the short-term movements in and out of stocks.

A report released this spring by Credit Suisse estimates that stock trading volume from money managers and investors, both active and passive, has remained fairly consistent over the last decade at 3 billion to 4 billion shares per day. Inferring from the statistics and assigning an average price per share of $45, the dollar volume bought and sold effortlessly by these investors each day approximates $157 billion.

Other investment assets do not trade like this. What if houses or office buildings had daily prices and a liquid market to enable daily buying and selling? You could buy a building and, if the price jumped 10 percent in a couple of weeks, you could sell it. Of course, this is unrealistic. These are tangible assets with characteristics that require extensive legal documentation, and they have physical properties that do not permit them to be swapped in and out of an account statement.

Similar reasoning counters that stocks are digital entries on an account statement that are easily bought and sold without contracts or physical limitations. Stocks are often described as intangible assets.

Nevertheless, this is the wrong way to think about stocks. A stock represents a fractional ownership in a business. That business has physical assets, management, and employees that produce products or services. Frequently buying and selling of stocks makes no sense if you view stocks as ownership in businesses. If you owned a small manufacturing business here in town, would you be looking to sell it in a few months to buy a restaurant, only to tire of that soon and sell to purchase a software company? Seems silly, but that is essentially what many investors, including so-called professional investors, are doing when trading in and out of stocks.

A business also has an approximate value that can be arrived at through basic analysis. That valuation allows the investor to compare the business value to the market price and determine if he is investing at an attractive or reasonable price.

Business value doesn’t materially change day to day, even though the stock price might. Investors who let short-term stock price movements guide their decisions will typically be tugged back and forth by the emotions that swirl around markets.

And what does all the buying and selling activity get for short-term investors? The data says underperformance. Instead, investors should be thinking toward five- or 10-year commitments to a business when making their investment decisions. Businesses that are well managed and can grow at rates better than the economy over time are worth holding for a 50-year lifetime.

One of the best discussions on how investors should think about fluctuations in stock prices can be found in Chapter 8 of “The Intelligent Investor,” by Benjamin Graham.•

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Skarbeck is managing partner of Indianapolis-based Aldebaran Capital LLC, a money-management firm. Views expressed are his own. He can be reached at 317-818-7827 or ken@aldebarancapital.com.