100 Ways to Beat the Market: #31: Focus on ten years out.

At its core, investing is about putting out money now to get more in inflation-adjusted dollars in the future. To be done intelligently, this requires you to be able to predict with meaningful accuracy the future economic development of a business. If you cannot do this, it is impossible to handicap the odds and make a rational calculation of the odds of loss times the amount of the possible loss versus the odds of a payoff times the amount of that payoff (the essence of rational investing).

The right framework – and arguably the most important question – is thinking about where the business will be in ten years. It challenges you – if you are honest with yourself – to decide if you really understand the business. For some reason, this is more of an issue with buying stocks than buying an actual business. A buyer of a private business naturally thinks about where the business will be in ten years – perhaps because he intuitively knows that there will be no greater fools around to buy his stock at a higher price. His fate will be entirely determined by the economic performance of the business. The irony here is that the same applies when buying a stock. It is just that so many have been impacted by the faulty thinking so prevalent on Wall Street, which tends to view stocks as lottery tickets rather than pieces of a business.

Thinking about where a business will be in ten years gives you an edge because so many of your competitors are focused on the short term. If they don’t get the short term right, there will be no long term they reason, so they stick close to the herd where they can find refuge in mediocre relative performance.

Thinking about where a business will be in ten years is a powerful filter that will save you research time because it allows you to quickly eliminate businesses where it is impossible to determine (not necessarily impossible per se, but for you, which is all that matters). Generally speaking, change is the most common reason that makes it impossible to judge where a business will be in ten years: rapid technological changes, no moats with competitors flooding in, decaying business models, and creative destruction are all common contributing factors.

As Buffett is fond to stress, it does not matter if the number of businesses you can predict is small. Fortunes have been made concentrating in one business that is deeply understood. Think Rose Blumkin. Put a premium on certainty, even if it means giving up some potential return. Compounding is the wealth engine, and many have disrupted its magic by overreaching. If you are more or less certain that you have a good understanding of where the business will be in ten years and you wait for a price that allows you to meet your hurdle rate, the odds will favor you beating the market.

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