Sunday, May 24, 2015

Too Hard Pile

The more something can be reduced to a single number to explain, the easier it is to price. If you are selling cans of coke, you know all the inputs and outputs. You know how many people normally want what you sell, and you know how much is produced. Things are predictable. Things are clear. The more and more fuzzy things get, the more likely it is you are starting to wade into 'Too Hard' territory.

The Holy Book of value investing is 'Security Analysis' by Benjamin Graham. 'The Intelligent Investor' is a more accessible abbreviation. The businesses Graham liked investing in were ones with 'tangible value'. Stuff that made stuff. So if it couldn't make that stuff any more it could be sold at a predictable price. This 'fire-sale value' gave a baseline for working out what something was worth. At the time, people buying shares tended to speculate and guess what was going to happen in order to figure out what the value of the business was. Graham was more boring. He would just search for businesses where he could get a good understanding of a base value. If he could find ones that were selling below this, he would have a 'margin of safety' in case he was wrong. He tried to find enough 'cigarette butts' that had been discarded to get the last puff so that he could effectively extract value out of boring businesses that had been missed.

As soon as things were too hard to value, he moved on. His aim wasn't to value everything. He didn't have to. Warren Buffett, his most famous student, calls moving on putting something on the 'too hard pile'. As Industry has progressed, there are lots more businesses that are harder to value because the various forces affecting the business are less predictable. You can still find businesses that you can build confidence in.  Seth Klarman has said 'The real secret to investing is that there is no secret to investing. Every important aspect of value investing has been made available to the public many times over, beginning in 1934 with the first edition of Security Analysis.'



A big part of the success of value investing is that it doesn't cover all businesses. Some things are harder to value than others. Lots of businesses are too hard. That is fine. Investing doesn't require you to put a price on everything. Value is also a messy word. Warren Buffett says, 'Price is what you pay, value is what you get'. Sometimes you can get a good sense that people are paying far more than something is worth. But only when something is quantifiable. When the things that affect it are understandable. 

Michael Porter wrote another classic, 'Competitive Advantage' and has built a career around examining the various forces affecting business. The things that affect valuations include
  • other products that can do the same things (substitutes),
  • other businesses that can make the same thing (competitors), 
  • the bargaining power of buyers (supply and demand), 
  • the bargaining power of suppliers (supply and demand),
  • the threat of new competitors coming in if you make too much money
All these factors mean a good idea is only half the equation. Something having 'worth' isn't the same thing as the forces involved being manageable enough to price it. To reduce it to a number. Some things are priceless. Water is the most obvious example. Clearly it is one of the most valuable resources we have. That doesn't mean we pay the most for it.

Many of the things that are most valuable can not be reduced to a number. You can't say: without it I have this much, with it I have this much. It is worth the difference. We try price things with the hack of how many people are prepared to pay for it, and how many people have it. This is the price. This is all the price is. There is zero moral value judgement. As soon as something is remotely interesting. As soon as it is hard to box. As soon as something is hard to put into words. It is hard to price.

When things are on the Too Hard pile, price is just a hack.
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