Instead of buying shares, I buy businesses (or small parts of them). The idea that I do not buy shares but rather buy small parts of businesses may seem like a very fine distinction. However, it’s a very important one.

Think of yourself as a part-owner

I invest with the mindset that I’m becoming the part-owner of a business. This attitude forces me to look at fundamentals. When I’m considering buying a part of a business (buying some shares), I look at all the business and commercial issues — just as if I were buying the entire business.

One of the investment principles I hold true is that I should understand exactly where my money is going. When it comes to buying companies, I ask myself whether, if I had the money, I would buy all of my target company. After all, if I do not understand the business well enough to buy 100 per cent of a company, why would I buy a share of it?

For example, I may wish that I had NZ$4 billion to buy all of Ryman Healthcare, but regrettably, I don’t. Instead, I use the share market to buy a small share in the business. In so doing I’m well aware that by buying a share in Ryman Healthcare, I become one of the owners of this excellent company.

Buying shares is buying into a business

It is difficult (probably impossible) to make consistent predictions of the short-term direction of a share and to make money by fast ‘buy and sell’ trades. However, it is possible to identify suitable businesses, buy them at a good price and hold them for long-term profit.

Many investors spend too much time worrying about the performance of the share market and not enough time analysing businesses. Other investors look at the volatility of shares (often remembering the crash of 1987) and avoid shares completely. This is unfortunate because by avoiding shares, they deprive themselves of benefiting from that most profitable activity — business.

The share market becomes a lot less scary if you get back to basics and recognise that buying shares is simply buying into a business. On the whole, Kiwis are comfortable with business ownership even though they may have heard bad things about shares.

Focus on the business, not the share price

In many ways the share market and share prices are distractions. Benjamin Graham, in his 1949 book The Intelligent Investor, said that buying into the share market was the same as going into business with a partner named Mr Market.

Every day, Mr Market comes into your office and makes an offer to buy your shares or to sell you his shares. That is great because it gives liquidity. But there’s one problem: Mr Market is certifiably insane. The prices at which Mr Market offers to buy and sell are all over the place — they may be far too high or far too low. And they often bear little relationship to the true value of the business.

These ridiculous prices divert the business’ partners from their real jobs, which are running the business to drive profits. People get too focused on the share price and not enough on business issues.

Warren Buffett said that “share investors should simply try to buy good businesses at a fair price”. Astute investors can take advantage of Mr Market’s insanity and pick up bargains.

Investors should embrace volatility because it allows them to buy cheap and sell expensive. The emotional nature of the share market lets you buy a good business at a good price. Provided you are patient, the share market will eventually deliver bargains.

How to identify a good business

So, given that astute and patient investors can get a good price, we have to ask what makes a good business. For me the business must have:

1. good finances and a strong balance sheet

2. a ‘moat’ around it, making it hard for prospective competitors to enter

3. proven governance and management, with well-thought-through incentives

4. growth potential and be in a good industry

5. potential to spin off lots of cash and pay good dividends to shareholders.

Plenty of excellent businesses meet these criteria and even though you cannot buy the whole business, you can buy a part of them on share markets in New Zealand and overseas.

The real money is not made by buying and selling shares. It’s made by taking part ownership (through the share market) of a business and then holding it for its profits. If you buy the right business, those profits will grow and the value of your investment will grow with it.

Martin Hawes is an Authorised Financial Adviser and a disclosure statement is available on request and free of charge, or can be found at www.martinhawes.com. This article is of a general nature and is not personalised financial advice.

DEFINITIONS

LIQUIDITY: the speed at which an investor can convert assets to cash.

MOAT: the economic moat is a term used by billionaire investor Warren Buffett. It refers to the ability of a company to retain its competitive advantage over its industry peers, typically through having the resources to provide its goods or services more profitably.

VOLATILITY: the extent to which the trading price of a share varies over time.

First published 16 November, 2016

By Martin Hawes

The editorial below reflects the views of the editorial contributor only and content may be out of date. This article is sourced from a previous JUNO issue. JUNO’s content comes from sources that it considers accurate, but we do not guarantee that the content is accurate. Charts are visually indicative only. JUNO does not contain financial advice as defined by the Financial Advisers Act 2008. Consult a suitably qualified financial adviser before making investment decisions.