A couple of years ago I found myself writing an article about Howard Mark’s (Oaktree Capital) Memo “What does the market know?”. In that article, (now lost) I explored the differences between the intrinsic value of companies and the extrinsic pricing of the stock. The idea, better explained by Mark, is that the market’s IQ is only the average of IQs of every person in the market, which results in sometimes small and sometimes big inaccuracies in the pricing of stocks. Value investing is based on the assumption that the market has underpriced a stock but will tend to correct with time, hence if you buy that stock at an underpriced value, with time it will grow up to its correct value, allowing the investor to profit from the split.
Although this is a really dull explanation of Mark’s memo as well as intrinsic and extrinsic valuation methods, my objective with this article is not to redo my lost article not to summarize Mark’s memo. Actually, this summer I came across a situation that represented exactly how the market works and I thought it was great. Let me explain…
Ok, so at the beginning of the summer I went with my great friend Emilio (founder of Flamingueo) to one of the more popular beaches in the Mediterranean region where we live. It was quite a drive until the place, and when we got there… Surprise! There was no room to park at all.
So the parking next to the beach was full and the only option was to park on the side of the road, but even that was full of cars, which meant that we would have to park on top of the mountain, then walk down to the beach and then walk back up to the car. With all the heat… an absolute nightmare!!
So, it’s in these types of moments when Emilio and I love to think creatively and see how to solve the problems we encounter. We had a problem to park, but that day we were lucky to come up with a great solution!
The whole mountain was packed but because lunch time was soon there were some people leaving at the moment. Most of them would have to climb up the street facing the sun and with almost 40 degrees until reaching their car.
So we thought, let’s look for someone walking up to pick their car and leave and offer them a lift in our car. That way we can directly park in their spot and they avoid having to walk up with all the heat. And so we did! First person we asked was more than happy to hop on our car and use the chauffeur service we offered!
We took a young couple in our car and quickly we had our car parked in their previous spot
So, we went to the beach and when it was time to go home we were facing the next challenge, getting to the car! It’s not that we are lazy, but the idea of walking up to a car parked way up in the mountain did not really excite us. So we decided to try to get a ride with the proposition of giving out our parking spot.
Again! First car that came by allowed us to hop in with the hope of finding a good parking spot early on. This time it was a family, a husband, wife, mother of the wife and two little kids. The wife quickly understood that it was super convenient for her, her mom and the kids to step off the car down at the beach and let his husband drive up and park at our spot. They were from Russia but it only took her a second to understand our proposal and accept it.
So, we got the ride up to our car and we where set to go! The husband parked in our spot and everyone happy.
That day, the first person that arrived to the beach was able to park really easily. The parking lot was empty and so the available space wasn’t really valuable, since there were multiple spots to park and not many cars trying to park. As the day carried on, more people started getting to the beach and parking the parking spots continued to fill up.
At some point in the morning, there was a big crowd reaching the beach and parking slots became scarce. People went on to park on the road up the mountain, and the later people arrived the farther away from the beach they would have to park. At some point that day, people that arrived on the morning started to leave but also more people arrived, parking in those empty spots that were really valuable because there were not many.
At the end of the day, everyone carried on leaving the beach, taking their cars and so the parking slots start decreasing in value first and the losing their whole value as the night starts and nobody stayed on the beach.
My point is… This is exactly how companies and markets work. There are limited resources that start getting valuable, and as they get used and get demanded for.
As a new company is born and grows, it may be offering a limited resource that people or companies need/want. The more people that need those resources the more that the company will grow. Investors will find really appealing to buy the stock of a growing company, and as the stock is also limited, it’s price will go up as more investors want to buy it. This is the same as the parking space getting filled more and more. The earlier you get to the parking lot the closer to the beach you can park (for an investor the earlier you get to get the stock the cheaper you can get it.)
As the parking lot is already full and there is no more space to grow (this is exactly when a company becomes mature) the stock will not keep growing.
With time, the resource will stop being needed, like the parking lot at the beach when is getting dark. People will start leaving the beach to get home and the value of the parking lot starts decreasing. This is when companies start dying and investors want to dump the stock as quick as possible to avoid being the last one with a resource that nobody needs.
In a very simplistic wat you can draw several conclusions from this analogy.
As an investor or business owner,
You must understand what is the right timing. Is the resource I want to invest in or sell, becoming more demanded and more valuable or is it not?Is there room to keep growing? Is the resource losing its value and it’s time to exit?
The best opportunities usually are a win-win for both parties, that have different needs.
The primary market creates opportunities for other secondary markets. Can you profit from those?
Btw if you want to know more about the business life cycle theres a good explanation on this site: https://www.manrajubhi.com/4-stages-of-a-business-life-cycle/
