Stock Prices and Dogs

Some thoughts on what people are willing to pay for things

As part of an effort to gain more first-hand experience this year, I’ve put a lot of effort into improving the thought process and decision making that goes into my investing. I really believe that, after just a few weeks, I’ve made a lot of progress. Over time, and after many more investment rounds, we’ll get to actually see if any of that progress translates into excess gains over the S&P 500. And, even if it doesn’t, it will be by no means a failure in my eyes because actually trying to do something and gaining experience is what matters. I can’t control the outcome with certainty - just what I put into it.

The essence of this uncontrollable outcome is price. Stocks go up. Stocks go down. Stocks go sideways too! When you put effort into picking stocks, it’s easy to judge one’s effort by the outcome of price movement. Unfortunately, that metric can be misleading and notoriously time dependent.

Let me pick on an easy example. In the late 1990’s, certain stocks were soaring in price. In hindsight, it’s easy to recognize that the implicit value of these stocks were decoupled from their explicit value (i.e. the price people were paying for them). Some people paid real money to buy stocks that would go to zero just a few years later. In the very short term, some people who paid explicit prices that far exceeded the implicit price may have made really good gains. In the long run, the implicit true value was shown to be clearly decoupled from the explicit value when prices cratered.

Price, in this way, can be a bit like an energetic dog on a leash (to use a well known metaphor). It’s easy to become distracted by the dog’s frantic energy, running around in circles in a volatile fashion. But, in the long term, the dog’s eventual behavior will be dictated by the dog walker. One might say that, during that time in late 1990’s, the dog had a lot of energy and was running on a very long leash.

For stocks, the dog walker is practically invisible. We don’t see the true price. We just see the price that pops up on our screen. We can’t control that dog - the dog walker does that. But even then, the dog walker only has so much control in the short term.

With enough investing experience, it is inevitable that we will all eventually pet a dog on a very long leash that will promptly run far, far away from us. Worse yet, we may come to find that the dog walker is moving in the opposite direction to what we expected. And, then, we may eventually realize that the dog, despite all it’s energy and leash, will never return to the point at which we chose to meet it.

We can only control the work and effort we put in to understand where the dog walker is and, more importantly, where the dog walker is going. It’s a bit like the old Bruce Lee scene with the finger that points at the moon. Don’t get distracted by the finger! Look at the beauty of the moon. Look at the big picture! It’s hard to do sometimes, especially when we see a really friendly and cute dog that everyone is rushing to pet and take pictures with.

In this sense, price can be the ultimate distraction. What makes it so difficult is that, price is also the ultimate judge of our investment actions. Did we make money on our investment? Well, that depends solely on the price we paid, the price we sold, and any bones thrown our way in the meantime in the form of dividends.

But, we can’t forget that we have no control over something as volatile as price. We can only control the thought and research we put in to understand the true picture. In the short term, despite our effort and good intentions, that may still mean we “lose” in the sense that our performance as judged by price is sub par. In the long run, we still may lose! But, the longer the period, the more effort given, and the more attention paid to the dog walker instead of the dog, the better the odds of success.