In the "Dhandho Investor," Mohnish Pabrai mentions there are six advantages to buying shares on the stock market versus buying and selling entire businesses, which are worth remembering:
1. When you buy an entire business, there is some serious lifting required. You either need to run it or find someone competent who can. This is no small task.
2. When you buy a stock, you now have an ownership stake in the underlying business with one huge advantage: The business is already staffed and running. You can share in all the rewards of business ownership without much of the effort. The stock market enables you to own fractions of a few businesses of your choosing, over a period of your choosing, with full liquidity to buy or sell that stake any time with a few clicks on your computer. Humanity has given you a marvelous asset-compounding machine that's vastly superior to virtually all other alternatives, and made it all amazingly cheap and easy to use.
3. When humans buy or sell whole businesses, both sides have a good sense of what the asset is worth, and a rational price is usually arrived at.
4. Buying an entire business – even a small neighborhood gas station or laundromat – requires some serious capital. In the stock market, you can hitch your wagon to the future prospects of any business with what you have in your wallet right now. The ability to get started with a tiny pool of capital and add to that pool over the years is a huge advantage.
5. There are thousands of publicly traded businesses in the U.S., and you can buy a stake in any of them with a few mouse clicks.
6. At a racetrack, the track owner takes 17% of every dollar bet. The frictional costs are very high. Even when you buy a tiny private business, transaction costs between the buyer and seller are usually between 5% to 10% of the purchase price, which doesn't include the considerable time and effort expanded. In the stock market, frictional costs are very low, and ultra-low frictional costs are a huge advantage.
With the recent turmoil in the markets, I think it is critical to think in terms of what is at stake when we purchase and sell securities, and that is: We are purchasing fractions of companies. With this in mind, we can forget about the noise and remember that earnings power and business value do not erode from one day to another, but rather, that these may take several months or years to fully reflect the strategies that companies follow. This mindset can provide an important advantage as it will be reflected in patience, and patience is the hill in which we roll our snowballs.
