A Good Analogy is Worth a Thousand Words
I love a good analogy. Several great ones about the stock market have lived rent-free in my brain for decades. In the coming weeks, I'll share some of them. They may be helpful to you as we enter a season of higher market volatility.
This first one is from Benjamin Graham, the legendary investor in the early 20th century. He was a mentor to Warren Buffett, and Buffett credits his success to Graham. The analogy comes from his classic book "The Intelligent Investor" first published in 1949.
Benjamin Graham- 1950
“In the short run the stock market is a voting machine... in the long run it is a weighing machine.”
His point was that voting is largely based on emotion. People don’t vote rationally based on cold, hard facts—they vote on personal opinion. Likewise, daily, weekly, or monthly price fluctuations in the stock market work similarly. Investors vote on personal sentiment, trends, and news cycles. Over the short run, the stock market is a popularity contest in which exciting companies get up-voted, often more than they deserve, or good companies get down-voted, often less than they deserve.
Unlike popularity votes, however, company earnings eventually get weighed on the scales of reality. It’s hard to hide the actual weight of earnings when using a scale. Strong and consistent earnings weigh more, and weak or inconsistent earnings weigh less. Each eventually gets priced accordingly. “Heavy” companies should eventually see their stock prices rise over the long run, and vice versa. But the long run is measured in years or decades, not weeks or months.
The point is what I see on any given day when I log into my brokerage account or on the daily news results from the market's voting activity. The scales' weight takes years to be revealed and is measured retrospectively over the last three, five, or ten years.
As a case in point, during much of the 2010s, tech companies were being voted on top-line growth. Think of all the companies that reached multi-billion dollar valuations without being profitable. But eventually, they were called to the scales, and what we're seeing now is investors returning to demanding earnings (the scales). This is why, despite consistent growth, many are cutting costs aggressively to deliver a more balanced combination of growth and profits.
Implications for us as individual investors:
Ignore the voting machine hype. Focus on the scale weights instead.
Invest for the coming decades, not for the coming weeks or months.
Be patient with quality investments that are temporarily being voted down.
Be skeptical of "hot stocks" with weak fundamentals.
Disclaimer: The information provided in this blog post is for educational and informational purposes only and does not constitute specific financial, tax, or legal advice. All investing involves risk, including the potential loss of principal. Market data and statistics cited are believed to be accurate as of the date of publication, but are subject to change. Please consult with a qualified financial professional to discuss your individual circumstances and risk tolerance before making any investment decisions.