Here’s a helpful article on allocating capital, by John Mihaljevic at The Manual of Ideas, The Ideas Report For Serious Investors. John emphasizes the need to have the mindset of a Capital Allocator in making investment decisions.
Investors: You’re Not Buying Stock, You’re Allocating Capital
By John Mihaljevic, CFA, Managing Editor, The Manual of Ideas
I’d like to share with you some thoughts on investing and the need to have the right mindset when evaluating investment opportunities.
You’re Not Buying Stock, You’re Allocating Capital
Buying a stake in a publicly traded company is deceptively easy. Log into your brokerage account, type in the ticker of the company whose stock you wish to buy, and — voilà! — you own a stake in the enterprise. Many investors don’t even refer to companies by their name; they simply invoke the ticker symbol. The ease with which stocks are bought and sold obscures the underlying nature of a stock market transaction and invites bad decision-making. The trick is to avoid thinking of a stock as a readily disposable piece of paper and instead consider that you are buying a percentage of a business whenever you purchase a share of stock. Your purchase makes sense only if you would invest your capital directly in the business at the terms implicit in the market price of the stock.
Your Role in the Stock Market
Your role as an investor may at first glance seem like a trivial issue. After all, every rational investor wants to attain the highest-possible risk-adjusted after-tax return on invested capital. Isn’t each investor’s role, therefore, to make the most money for him- or herself by buying and selling securities? The answer is no because the question confuses objective (making money) and role.
Most investors, especially those managing small amounts of capital, view their role in the market as insignificant. While it’s true that you will probably not move the market, the accompanying "small fish" mindset is one that doesn’t lend itself to successful investing. Regardless of the size of your portfolio, you should adopt the mindset of Chief Capital Allocator. Imagine your role as distributing the world’s financial capital to activities that will generate the highest return on equity.
The Buck Stops Here
If you embrace the mindset of Chief Capital Allocator, you’ll make better investment decisions. You may have an easier time deciding whether auto firms, for instance, are a good investment because of their large sales and typically low P/E ratio. Instead of simply analyzing GM versus Ford, as Chief Capital Allocator, you will know instinctively that you don’t have to invest in the auto industry at all. Perhaps you’ll decide to allocate capital to a biotech company and forgo current profits (and the reinvestment of such profits) in expectation of a windfall in the future. Note that as Chief Capital Allocator, your focus should be solely on return on investment and not on ensuring that every sector, no matter how critical to society, receives capital. While funding socially important activities deserves a place in private and public budgets, you should not make sub-optimal investment choices out of a desire to be charitable.
How can the mindset of Chief Capital Allocator help you distinguish between value and price? If you were in charge of allocating capital around the world, you wouldn’t be able to rely on the market to bail you out of bad investments. The greater fool theory of someone buying your shares at a higher price breaks down if the buck stops with you. Successful investors believe their return will come from the investee company’s return on equity rather than from sales of stock. This mindset produces a very different process of estimating value than if you rely on the market to establish value and then try to gauge whether a company was likely to beat or miss consensus earnings estimates.
Continue reading here.
Regards,
John Mihaljevic, CFA
Managing Editor, The Manual of Ideas
