The Entrepreneur and the Steward of Capital
The transition from one to the other is less intuitive than it seems
As we work with more and more entrepreneurs around the world, we find a number of key differences between them and portfolio investors.
By nature, entrepreneurs feel that they can succeed at anything if they put their minds to it, so they do not initially see any obstacle to taking on new responsibilities as their family’s steward of capital. But in fact, we believe that the qualities that made them successful entrepreneurs are seldom the same ones that make successful stock market investors. The two have overlapping talents, of course, but we observe that each would often benefit from focusing on the activity that best fits their personality.
Furthermore, since entrepreneurs have had most of their net worth tied up in one business, and they have often limited investing experience beyond that, the anticipation of becoming responsible for a patrimony made up of diverse assets over which they have no management control will create anxiety, even if it is not always acknowledged at first.
It is well-known that the stock market is driven by greed on the one end and fear on the other, and the stock market investor’s skill consists of navigating between these two emotions with a clear head. There is a distinct risk that the former entrepreneurs’ anxiety may cloud their judgment, but once they realize that making money and keeping money require two very different skill sets, we may be able to help.
The big transformation
The challenge of morphing from entrepreneur to steward of capital lies in the dual influence on the stock market of psychology vs. fundamentals. It has been said that, in investment markets, price is driven by sentiment, whereas value is driven by fundamentals. As a result, price and value often diverge widely. Thus decision methods and criteria native to business often do not work as well in the stock market.
To create wealth you start a business with little financial capital and demanding, high-stakes timetables. But at least fortune seems potentially around the corner. To preserve existing wealth, you start with a larger financial capital and no time pressure. But the growth of your fortune will have to await the miracle of compounding over many years. The time factor gives you a major advantage, but it also requires you to take on a different role: to turn from fortune maker to steward of fortune.
Optimistic entrepreneur vs. skeptical investor
The biggest difference between entrepreneurs and investors lies in their nature and view of the world. Entrepreneurs tend to be optimists, while investors tend to look at the world with a healthy dose of skepticism.
Entrepreneurs are not only optimists; they are stubborn optimists. One reason for many entrepreneurs’ success has been creativity — turning ideas into businesses or, at least, into a competitive edge. They will naturally spend a good part of their time on the offensive, devising aggressive ways to gain market share from competitors, often without bothering to calculate if they are properly compensated for the risks they are taking – first, because they are inveterate optimists and second, because they are confident that they are the masters of their business’s destiny.
Good stock market investors are more likely to seek visible value over imaginary gains. They tend to focus more on the defensive because most of them know that even successful investing is fraught with occasional missteps. In contrast to the entrepreneur — constantly betting that he or she will win by making the right decision — the stock market investor aims first for fewer costly mistakes. He seeks proper diversification and, in the end, a good overall batting average. Warren Buffett, arguably the world’s most successful stock market investor says it best:
“Rule No. 1: Never lose money. Rule No. 2: Never forget rule No.1”
One big leap vs. a lifetime of compounding
Entrepreneurs’ wealth creation often happens in a relatively quick leap. In the stock market, wealth is more likely to arrive stealthily, the result of a long-lasting, repetitive, reliable investment process. The latter leads to compounding wealth at a relatively steady rate in the long run. To quote Warren Buffett again:
“My wealth has come from a combination of living in America, some lucky genes…
… and compound interest.”
The daily quote challenge and market folly
Recently an entrepreneur-turned venture capitalist told me how he tried to “dabble” in stock investing, and failed. His returns weren’t terrible, but he couldn’t handle one key aspect of it – the daily price quotes. When he started businesses or invested in companies, he didn’t rely on price quotes as the indicator of success. Instead he worked with regular reports, meetings with management, and a continuous flow of information about how the business was actually doing. This fundamental information gave him comfort and peace of mind about his investments. In contrast, stock market investors’ judgment is constantly challenged by short-term price fluctuations that seem to temporarily contradict their long-term, fundamental analysis.
This conversation made me appreciate even more the unique emotional make-up needed to be a successful stock investor. To some extent it requires a split personality: thinking like a fundamental investor while taking advantage of price fluctuations that the market folly has to offer.
Dangers and rewards of contrarianism
Contrarianism consists of taking positions that are radically different from those of the crowd. In financial investment, I find this approach to be extremely valuable. Buying something that the crowd does not like will, at the very least, insure that you are not overpaying drastically. If your idea and analysis are basically correct but your timing is not perfect (as is often the case for value investors) you also have a good chance of being bailed out by time and successive business cycles. And if the stock has declined in the meantime, you are given an opportunity to buy more shares at a cheaper price.
In contrast, being a contrarian in business could prove fatal. If, at the beginning of a down cycle, you accumulated too much time-sensitive or fashion-oriented inventory, or invested in too much new equipment, then losses, and possibly a severe liquidity squeeze, are likely to follow. In business, time seldom bails you out.
Some successful CEOs are long-term planners, but most are more nimble. They are prompt to recognize new trends for their businesses and quick to adapt when necessary, or to identify and seize new opportunities. For this reason, despite their theoretically longer-term time commitment, business owners/executives tend to have better instincts for trading than for stock market investing. Unfortunately, in our team’s long stock market experience, we have seen few sustainable fortunes made by short-term trading.
Good understanding of the business vs. poor understanding of the markets’ perception of it
Long-term successful investing may require more than recognizing a good business. These are usually well recognized, widely understood, followed by many analysts and, through the auction system of financial markets, they are often hugely overvalued.
Overpaying for a great business can lead to poor investment returns, as the market perception gets corrected over time and the price/earnings ratio shrinks along with the overly optimistic expectations. It is not unusual, as a result, for a stock price to fall despite still-satisfactory business performance. History is replete with examples of companies that transformed the world (think railroads, airlines, or radio) and yet failed to profit their early investors.
Managing a portfolio of ideas vs. one single business
Technological change offers immense wealth creation opportunities, but it is also responsible for wealth destruction.
Once omnipresent, Kodak vanished not long ago due to the proliferation of digital photography. (1)
Yahoo was once a $100B+ company, while its core assets were acquired for less than $5B this year. (2). AOL peaked at over $200B+ and ended up at $3B. Looking a bit further back in time, Radio Corporation of America (RCA) was once just as hot as many of the later technology favorites. It went public at $1.50 a share in 1920, rose to $114, only to fall to $2.50 by 1929. Excessive market valuations can turn many into millionaires and billionaires, but mean reversion eventually catches up with inflated expectations.
It might have taken the successful entrepreneur one brilliant idea, or one smart career move to create significant new wealth, but preserving that wealth requires a different strategy. Instead of putting all eggs in one basket — a reasonable tactic for an entrepreneur -— the new investor needs to start thinking beyond one business to building a portfolio of investments. There are two reasons for this:
- First, with age and the new responsibility of substantial capital to protect, investors will naturally becomes more risk averse. Diversification tends to reduce risk.
- Second, the entrepreneur-turned-investor will relinquish considerable control. When something fails to develop according to plan in your enterprise, you can react and fix it. With your portfolio companies, your only recourse is to bail out by selling. The consolation is that the shares of listed companies are relatively liquid and you don’t have to spend months looking for an elusive buyer.
Warren Buffett says “I’m a better investor because I’m a businessman, and I’m a better businessman because I’m an investor.” (3) As an entrepreneur you already have a higher, healthier risk tolerance than most stock market investors. You are also more aware and curious about new opportunities and, especially if you have negotiated the sale of your venture(s), you understand that realizing value requires a willing buyer.
All those qualities prepare you better for including wise investing among your wealth preservation strategies. The real question is whether you will put them to better use as a budding stock market investor or as the astute client of a professional portfolio manager.
- Eastman Kodak Files for Bankruptcy by Michael J. De La Merced (The New York Times, January 19, 2012)
- Yahoo Sells To Verizon In Saddest $5 Billion Deal In Tech History by Brian Solomon (Forbes July 25, 2016)
- Buffett: The Making of an American Capitalist by Roger Lowenstein (Random House, 2008)
Disclosure: This report is not intended to be a client‐specific suitability analysis or recommendation, an offer to participate in any investment, or a recommendation to buy, hold or sell securities. Do not use this report as the sole basis for investment decisions. Do not select an asset class or investment product based on performance alone. Consider all relevant information, including your existing portfolio, investment objectives, risk tolerance, liquidity needs and investment time horizon. This report is for general informational purposes only and is not intended to predict or guarantee the future performance of any individual security, market sector or the markets generally.