The Future is Now - Value Investing & The Long Term Part I
Introduction
I am obsessed with thinking ahead many steps in the future. Conventional wisdom would have it that this makes me a good long-term planner. I am not so sure about that. Living in the future like this can be a rather wasteful way to spend energy, at least for me. For instance, while knee-deep in my Ph.D. in sociology, I spent endless hours internally debating what my next theoretical work should be about – only to end up leaving academia to follow my strong desire to get into business and closer to investing. This is just one of many similar examples. It turns out that not only do I love long-term planning – I also love to pivot. Hence, in most cases, my endless pondering not of the next move, but of the one after the next move seems like a dramatic waste of energy and resources to me. I know and have read a hundred times that to get anywhere, I must focus on putting one foot in front of the other as well as I can. “You have to be here, to get there.” And yet, I do know that without this desire for the future I would lack my enthusiasm and energy for, say, going ahead with decisions to pivot and actually see them through. There probably must be some desire for growth and a focus on the future to even want to get anywhere; but there also has to be a strong focus on the present to actually get there – and to notice and enjoy the process, which obviously ends up being anything there is:
„Mountains should be climbed with as little effort as possible and without desire. The reality of your own nature should determine the speed. If you become restless, speed up. If you become winded, slow down. You climb the mountain in an equilibrium between restlessness and exhaustion. Then, when you’re no longer thinking ahead, each footstep isn’t just a means to an end but a unique event in itself. This leaf has jagged edges. This rock looks close. From this place the snow is less visible, even though closer. These are things you should notice anyway. To live only for some future goal is shallow. It’s the sides of the mountain which sustain life, not the top. Here’s where things grow. But of course, without the top you can’t have any sides. It’s the top that defines the sides.” (Robert Pirsig: Zen & The Art of Motorcycle Maintenance, p. 191 f.)
Over the last years, I have noticed a similar pattern and paradox within value-investing for the long-term. Almost everybody claims to be a long-term investor – yet few truly walk the walk. Many of the ones who do so most successfully belong to the investment school of value investing – most famously Warren Buffett. Buffett’s evolution from a classic, Benjamin Graham deep-value style – buying cheap and significantly under value, selling close to actual value – to a long-term focus on quality – ‘buying a wonderful company at a fair price’ – is widely known. However, on closer inspection this shift appears far more surprising, even paradoxical, than is widely acknowledged. This is what I want to focus on in this and a few subsequent essays: Reaching a successful long-term view by focusing on the present. While the main field of application is value-investing, I also want to address a broader question: How can we plan in the future without losing touch with the present? My conviction is that bringing different lenses together helps to better understand each of them conversely: to better understand value-investing with long time-horizons, and to learn to become better at aiming at a bright and ambitious future without losing the focus on the present moment and the concrete tasks at hand. “It’s the sides of the mountain which sustain life, not the top. Here’s where things grow.” This first essay aims to lay the foundation for the broader argument by carving out value investing’s original radical focus on the present, implying a disdain for any forecasts.
An Open Future Is not Knowable
To elaborate on this point, we need to briefly dig into the most influential origin of value investing – Benjamin Graham’s The Intelligent Investor – and specifically the temporality that underlies his most important concept, the margin of safety.
“The bond investor does not expect future average earnings to work out the same as in the past; if he were sure of that, the margin demanded might be small. Nor does he rely to any controlling extent on his judgement as to whether future earnings will be materially better or poorer than in the past, if he did that, he would have to measure his margin in terms of a carefully projected income account, instead of emphasizing the margin shown in the past record. Here the function of the margin of safety is, in essence, that of rendering unnecessary an accurate estimate of the future. If the margin is a large one, then it is enough to assume that future earnings will not fall far below those of the past in order for an investor to feel sufficiently protected against the vicissitudes of time.” (Benjamin Graham: The Intelligent Investor, p. 513)
Graham’s idea of the margin of safety is not to help us successfully predict the future. Quite the opposite, its job is to “render[…] unnecessary an accurate estimate of the future”! By carefully obtaining an estimate of the current value of a business – enriched by looking into its past – and limiting ourselves only to those instances where a significant gap arises between this estimate and the quoted price arises, we forego any aspiration to know anything about what the future might bring. This follows from an “endless series of experiences over time that have demonstrated that the future of security prices is never predictable.” (Graham: The Intelligent Investor, p. 24)
It is important to pause here to become aware of the radical nature of this idea. Think of the last pitch about a stock you read on the internet, the last conversation you had with somebody talking about their current favorite investment idea, the advertising brochure of any big, corporate backed investment fund: chances are that convictions about what the future will bring come up not only once but multiple times. AI will disrupt this and that field, energy consumption will rise by factor x, demand for EVs might stagnate, China will dominate the field of robotics; the list goes on. Cathie Wood, from Ark Invest, talks about “taking a look around the corner” to assess future disruptors. Graham’s entire investing philosophy, on the other hand, rests on the fundamental conviction that the future is open and therefore not knowable. We need to double-click on this point to fully appreciate how forceful the idea is. “Not knowable” is something entirely different from ‘hard to know’. In Graham’s terms, there is no corner to look around – only past and present, and a future that is yet to come. Let us take a brief detour into our historical understanding of the future to get a better sense of where Graham stands.
From Closed to Open: The Historical Shift
For most of human history, the future was closed. The dominant conceptions across cultures were grounded in some basic understanding of cyclicality. Things might change, but – like the seasons – they come and go repeatedly. Nature provides many inspirations for this view, and religious beliefs such as reincarnation fit intuitively into it. The deistic, mostly Western cultures, on the other hand, came to believe in a world steered by one or many Gods, imagined as deeply involved in human affairs. These beliefs allow room for more fundamental types of change, especially given the rash depictions of a Greek god like Zeus or even the God from the Old Testament who plays wagers with the devil. Even so, any room for change was small by today’s standards, and ultimately predetermined by the deity in charge. Consider the classical hero not as someone who changes the course of battle, but as someone who endures his fate with bravery and honor. Or take a person born in the Middle Ages: Society was divided into fixed social estates; in most cases you were not only born into the exact same socioeconomic position as your parents but even into the exact same profession of your father if you were male. You naturally encountered the world as predestined, although you did not know which exact turns you would encounter – what God might have in store for you. Several of your many children probably died before reaching the age of four. If you had yet another quarrel with your neighbor and he hit you with his shovel, an infected wound might well mean your death. Options were drastically more limited than they are today.
The future, therefore, was preexisting but not known and hardly changeable. From such a point of view, it makes a lot of sense to arrange some bones and take deep, hard looks into the clouds to get a glimpse of the future – say, the outcome of an important battle. Looking around the corner, that is. If everything is already laid out by some all-knowing deity, it does not seem absurd to try to gather evidence from very diverse contexts. If you believe in a worldview where everything has been pre-arranged by the same mysterious force, the way the clouds move and how your battle unfolds are not that far removed from each other. If you went to a new bakery, tried the sour-dough bread, hated it, and thus decided not to try the croissants, this might prove to be a wrong judgment; but it would still be a reasonable conclusion.
While technological progress did exist, it was much slower than it is today – or even a few centuries ago. It is, however, much easier for us today to imagine a world of very slow change than to imagine a world where all existing change is seen as fully predetermined by some divine creature beyond our understanding. Slow change is essentially intelligible with our current worldview – all we need to do is to imagine the pace of that change increasing over a few hundred years. This change being completely out of our hands, on the other hand, runs counter to our very basic understanding of individual liberty and the nature of time.
We have to keep this in mind when trying to grasp the radical shift of the modern understanding of the future as principally open. The concept of an open future brings with it previously unthinkable implications regarding both our capabilities – literally shaping the future – as well as our responsibilities. Our modern political understanding of liberalism fundamentally rests on this shift. The tension between freedom and responsibility is also reflected in our ability to influence the modern future: On one hand, unlike the predetermined future of premodernity, it has become fundamentally malleable; on the other, a truly open future can never be fully controlled – or predicted.
Maybe it’s because most of us usually take an open future for granted that so many traces of a preconceived and closed future still linger in our contemporary lives. Astrology is an obvious example, as are the many superstitions. Conspiracy theories also seem to tap into an understanding of major world events as fundamentally steered – if not by a deity, then by some equally unknowable and mighty puppet master. Superstitions, however, are also easy to find within the world of finance and investing: sometimes in pure form, especially within trading, but also in more sophisticated ways, such as technical analysis. In a worldview that accepts a truly open future, every attempt to “look behind the curtain” — or Cathie Wood’s corner – is destined to fail.
Working Predictions as Functions of The Present
There are, however, obvious instances of forecasts that are reliable, that genuinely work. Think of the weather forecast for later this day. We are aware that this afternoon’s weather might turn out differently than forecasted – but it would be completely ridiculous to dismiss any weather forecast as pure guessing. There clearly exists a difference between a weather forecast and the ritualistic arrangement of animal bones. Why? We would not hesitate to point out that the former relies on scientific methods while the latter doesn’t. Simple, right? Well, things become a bit murkier once we consider the weather forecast for the end of next week. People certainly pay attention to such forecasts, for instance when planning vacations. And no doubt, these forecasts rest on scientific methods just the same. However, any serious meteorologist will tell you that such a long-range forecast must be considered highly uncertain at best. Whilst the methods remain just as scientific, the number of variables piles up with each additional day the forecast extends into the future.
Rather than glimpsing around the corner, this near-term forecast can be understood as a function of the present. As soon as a huge number of variables enter the equation and a relatively precise outcome is sought, the reliable timeframe for forecasting shrinks significantly. The equivalent in investing is the common obsession with forecasting the second decimal place of earnings per share for the next quarter.
Cigar-Butt Investing
Graham seems deeply aware of this inability to look around the corner. The rigor with which he thinks through how to operate in the face of a truly open future becomes clear in the following:
“A final retrospective thought. When the young author entered Wall Street in June 1914 no one had any inkling of what the next half-century had in store. (The stock market did not even suspect that a World War was to break out in two months, and close down the New York Stock Exchange.) Now, in 1972, we find ourselves the richest and most powerful country on earth, but beset by all sorts of major problems and more apprehensive than confident of the future. Yet if we continue our attention to American investment experience, there is some comfort to be gleaned from the last 57 years. Through all their vicissitudes and casualties, as earth-shaking as they were unforeseen, it remained true that sound investment principles produced generally sound results. We must act on the assumption that they will continue to do so.” (Graham: The Intelligent Investor, p.10)
According to Graham, the “sound investment principles” – the ones he lays out in The Intelligent Investor – were able to successfully deal with all the unforeseen twists and turns that occurred over a span of 57 years. As Graham concludes: “We must act on the assumption that they will continue to do so.” These are words written by someone who has truly accepted the future to be open. No, there is no certainty that the notions of Mr. Market and the margin of safety will remain functional in the future. Instead, these are merely tools that worked well in the past – despite the inability to accurately forecast the future. Hence, “we must act on” them – simply following the assumption that they are the best currently at hand. This line of thinking is similar to Popper’s concept of “falsification”, considering something only provisionally true until it is disproven.
That insight is important for my own undertaking in two ways: First, it exemplifies how serious Graham takes the acknowledgement of the future as unknowable. Even the tools he devised to navigate such an uncertain world are themselves potentially subject to the uncertainty and radical novelty the future may bring. There are no certainties in this understanding of the world, only tools that have proven effective in the past and that must be critically reassessed continuously, analyzing if they still work under ever-changing conditions. Second, this openness, the unwavering commitment to deal with constant change, creates room to build on and further expand these tools. This will be my focus in later pieces. Reading these lines, it is no wonder that Graham was not only successful in developing a fundamentally new approach to investing, but also in founding a school of thought that continues to evolve and innovate.
The well-known metaphor for the classic investment style that follows Benjamin Graham’s recommendations – today often termed ‘deep value’ – is the cigarette butt: carelessly left behind on the street, there is one free puff left. Graham emphasizes the importance of investing in securities that trade close to or ideally below tangible book value. In fact, he appears to place more weight on price-to-book ratios than on price-to-earnings multiples. Regarding earnings, his focus lies on stability over many years, mainly aiming to avoid investing in a melting ice cube. While it is a common trope in today’s investing discourses to dismiss the fundamental dichotomy between value and growth investors, Graham repeatedly stresses the differences between these approaches:
“The whole structure of stock-market quotations contains a built-in contradiction. The better a company’s record and prospects, the less relationship the price of its shares will have to their book value. But the greater the premium above book value, the less certain the basis of determining its intrinsic value – i.e., the more this ‘value’ will depend on the changing moods and measurements of the stock market. Thus we reach the final paradox, that the more successful the company, the greater are likely to be the fluctuations in the price of its shares. This really means that, in a very real sense, the better the quality of a common stock, the more speculative it is likely to be – at least as compared with the unspectacular middle-grade issues.” (Graham: The Intelligent Investor, p. 198 f.)
The higher the quality of a business – both in terms of its historical growth and its future outlook – the higher the premium paid in the market. This premium obviously depends on the shared assumptions of the various market participants – and thus opens the door for Mr. Market to intervene suddenly and vehemently. It is interesting to note that Graham explicitly states volatility as a marker for how speculative it is to buy into such securities – a perspective that is almost unanimously dismissed by today’s value investors. The argument could simply focus on the uncertainties of the future: paying extra for better future prospects fails to take into account that the future remains essentially unpredictable, therefore violating the margin of safety. This line of reasoning is clearly implied in Graham’s overall argument. However, he adds another dimension in the passage cited above: To pay significantly more than tangible book value means to become more dependent on the sentiment of other market participants and how they evaluate the future prospects. This makes you vulnerable to the shifting moods of the crowds.
This same theme recurs throughout the partnership letters written by the young Warren Buffett:
“This is the cornerstone of our investment philosophy: ‘Never count on making a good sale. Have the purchase price be so attractive that even a mediocre sale gives good results. The better sales will be the frosting on the cake.’“ (Warren Buffet: Letter to Limited Partners 1963 (I))
The epitome of the classic value investing approach: buying below the intrinsic value of a given security – determined by the most solid and unemotional measures possible – in order to immunize oneself as much as possible from both the sentiments of future buyers as well as the vagaries of an open and unknowable future. The fundamentals of this approach have not changed over the following decades. Rather, how these fundamentals are practically applied has changed significantly.
Outlook
The origins of value investing rest on a deep commitment to the present, stemming from the acknowledgement of a truly open, that is unknowable, future. How could this insight give rise to a school of investment thought that excels at long-term investing? To better understand this, I want to zoom in on the evolution from classic ‘deep value’ to quality-oriented and long-term investments – specifically by focusing on Warren Buffett and Nick Sleep. This will be the focus of the next part of this series. Finally, in a third step, I plan to synthesize what I’ve learned in the second part and intertwine it with insights on how to position oneself toward the future more broadly. To do so, I will opportunistically draw ideas from other domains – most notably from writings and discourses on mindfulness and personal growth. My conviction is that combining these different lenses helps clarify each one: to better understand value investing over long time horizons, and to learn how to get better at aiming at a bright and ambitious future without losing touch with the present moment and the concrete tasks at hand. “It’s the sides of the mountain which sustain life, not the top. Here’s where things grow.”