Recently, I was having a conversation with a business owner who mentioned he needed to write a check for $38,000 to purchase a new piece of equipment for his shop. During the conversation, it struck me that a lot of investors don't think the same way business owners do. It isn't unusual for a business owner to buy a new machine, or upgrade the fixtures in his retail store. It isn't unheard of for a business owner to borrow large sums of money to expand a factory or spend tens of thousands of dollars installing energy efficient lights to lower costs and increase profits. That is because the mindset of a business owner is on putting money out today in order to earn a return over time.
Many investors don't think this way. Warren Buffett, arguably the most famous investor in the world with a net worth that was once as high as $60 billion before he began making large gifts to charity, said that he is a better investor because he is a business owner and a better business owner because he is an investor. It is valuable to think from both perspectives.
Investors Should Think Long-Term Like Business Owners
You rarely hear an investor say, "I want to become an owner of Coca-Cola. I'm investing $38,000 of my cash, taking physical possession of the stock certificates, and having them locked in a safe deposit box at the bank downtown. The cash dividends will be automatically deposited in my checking account each quarter. I have no plans to sell. I'll judge the success by the annual report that is mailed to me from management and the Board of Directors each year. As long as my profit, and the dividends I receive, continue to increase, that's my only concern." This is especially perplexing when you realize that blue chip companies such offer special plans such as the Coca-Cola direct stock purchase and dividend reinvestment plan.
Instead, the investor might buy $38,000 worth of Coca-Cola stock in a brokerage account, put a trailing stop order in to automatically sell if the position fell by 10%, obsessively watch the account, and not be able to tell you a damn thing about Coke's case volume shipments, profit margins, returns on capital, debt levels, or geographic sales figures. A business owner wouldn't be so negligent in his own business - why should an investor be so negligent in his stock ownership?
Investors Should Focus on Reducing Unnecessary Costs Like Business Owners
You rarely hear an investor mention, "I did the calculations and if I can cut the management fee my retirement plan charges me by rolling over my holdings to a low-cost company, I can save a few percentage points a year." How many mutual fund investors get obsessed with cutting the expense ratio? A business owner, on the other hand, is always looking for ways to cut his costs by saving a little money here or moving things around there.
Investors Should Only Buy What They Understand, Just Like a Business Owner
Can you imagine a restaurant owner adding something to his menu that he never tried or can't explain? Can you picture a laundromat operator selling on-site detergent that is untested from a company with which he has no experience? Business owners don't invest their hard earned money into something unless they understand it and believe the odds are favorable they will earn a profit. Investors, unfortunately, rarely show the same wisdom. School teachers who spend years studying their subjects will buy stock in a solar company without understanding the firm or industry. A retiree will try to trade software stocks without knowing how to turn on a computer. It makes no sense. Don't be that way.
You should be able to explain to a reasonably intelligent third grader 1.) what your company does, 2.) how it generates sales, 3.) what its biggest costs are, and 4.) how much money you expect it to earn under reasonable conditions. You should be able to do this in under 30 seconds or on the front side of an regular index card. If you can't you are not investing like a business owner, you are gambling like a fool.