“Be a business analyst, not a market, macroeconomic, or security analyst.” -Charlie Munger
This concept, although a very simple one, has taken me a long time to internalize. For many years, I approached investments from a market or macroeconomic perspective. As I result, I suffered from psychological misjudgements which prevented insights from surfacing. What does it mean to be a business analyst?
- When studying a new investment, security analysts first look at stock charts and trading history. Business analysts read the annual report.
- Security and market analysts spend mornings looking at the futures market and price action in certain stocks. Business analysts read financial reports and relevant company/industry news, and speak with experts they can trust. When no new information is available, which is usually the case, business analysts sit still and spend time researching other opportunities.
- Security analysts spend a lot of time calculating financial ratios such as price/earnings, free cash flow yield, compound annual growth rates, valuation vs. peers, etc. Business analysts determine whether they can understand the business and whether the business has a sustainable competitive advantage.
- After earnings releases, security analysts pay close attention to the price action in the stock and the company’s results vs. street expectations. Business analysts focus on whether the long term thesis is still in tact, whether the company is extending its advantage in its core market, management’s ability and credibility, and whether other key metrics (e.g. market share, unit cost, investment in r&d, brand awareness) are improving.
- Security analysts use historical and one year forward valuation metrics when evaluating the suitability of an investment. Business analysts carefully study the long term record of the company, then try to see 5-10 years into the future. Business analysts view a company as an unfolding movie, not a still photograph.
- Security analysts let price action dictate their views and moods. Business analysts understand that the market is there to serve them and instead focus on business fundamentals.
- Macroeconomic analysts worry incessantly about inflation, interest rates, China, Europe, the debt bubble, etc. Business analysts purchase fractional ownership in businesses which provide a large margin of safety, can survive (and even benefit from) market cycles, and will outperform over a long time horizon.
- Security analysts run screens for low price/earnings ratio, 52-week lows, high free cash flow yield, high returns on investment capital, etc. Business analysts read Value Line and annual reports, building a database of targets in their mind.
Business analysts approach investments as if there were no daily trading in the market. They have an almost myopic focus on business fundamentals and do not let Mr. Market dictate their mood. In the past, I suffered from first conclusion bias by approaching investments as a security, market, and macroeconomic analyst. I committed errors of commission by buying stocks which traded at low multiples and high free cash flow yields, or by buying businesses which I thought would benefit from a loose theory of where the macroeconomic environment was heading. Similarly, I committed errors of omission by avoiding high multiple stocks, stocks which had run up 50-100% in the prior 12 months, and businesses which would be harmed by high interest rates or a slowdown in Europe. Often times, heuristics lead to the wrong conclusion. I could have avoided many of these misjudgements had I taken the approach of a business analyst.
As Howard Marks says, the job of the analyst is to know the knowable: securities, businesses, and industries. If a wonderful business is acquired at a reasonable price, the investment should perform commendably given a sufficient time horizon. Be a business analyst.