The Intelligent Investor, a book by Benjamin Graham, is widely considered to be the best book on value investing ever written. The book (and it's author) had a profound effect on the way people think about investing. Graham was extremely influential to many titans in the world of investing...chief among them Warren Buffett. Buffet said once that the book is
By far the best book on investing ever written. If I hadn't read that book in 1949, I'd have had a different future.At the time of it's publishing, the book was revolutionary in the way that it brought a common sense approach to investing by emphasizing that when a person buys a stock, they are essentially buying a piece of the underlying business and as such the price they pay for their piece of the underlying business must reflect their opinion of the value of said piece. To many of us today, this is common sense but at the time such investing practices weren't on the radar of your average citizen. He brought a principled approach to investing; one that was centered around combining knowledge of business fundamentals with psychological behavior.
I decided to write this post after realizing that Graham's work has had a profound affect on my life as well...not just in investing but business as a whole. Most importantly in my role as farm business owner.
Here are some lessons from The Intelligent Investor that have crossed over into the way I think about farming.
- The market is your servant not your master: The allegory of "Mr Market". Graham describes the daily pricing activity in markets by introducing a character he calls Mr Market. Mr Market is one of two owners of a business who comes into work each day with wild mood swings. On a particular day, he may either wildly overestimate or underestimate the value of the business but regardless, he's willing to sell out to his partner every day. The partner is always free to decline the offer, since he knows that the next day Mr Market will come back to him with an entirely different offer.
- Graham is famous for saying that in the short term markets are like voting machines, tallying up the emotional sentiments of the market participants but in the long run they act like weighing machines, reflecting the accumulated value of the underlying business.
- Mr Market demonstrates emotional behavior but the savvy investor can know the underlying value of the business and take advantage of buying or selling opportunities when the time is right for him.
- In farming, we are selling commodities rather than buying pieces of a business but the idea is still the same. We need to remember that emotion can fuel short term movements in the markets but that it's up to us to make the call on when we want to sell. We need to be reminded that the best time to sell is when the price is attractive to you. And the only way to know if a price makes sense for you to sell at is to know the value of what you've produced, aka your cost of production. Your number is going to be different than your neighbor's. Know this number. It's probably the most important calculation you'll do all year on the farm and unfortunately not enough people really take the time to do it. In fact, one of my local Farm Credit executives estimates that less than 5% of his customers know this number for their operation.
- Finally, Graham said, "Market quotations are for your convenience, either to be taken advantage of or ignored."
- Margin of Safety: Margin of Safety is an incredible mental model that can apply to many areas of life but was introduced by Graham in the book as a way to think about the difference between a stock's intrinsic value (what your calculated value is) versus the market value (what it's being sold for). He called this difference the Margin of Safety and it can be thought of as how safe (and potentially lucrative) an investment can be. This line of thinking applies across all borders of assets from stocks and bonds to real estate to even commodities as a seller.
- If you want to think in terms of Margin of Safety when making farm investment decisions, then one of the key components you need to know is the intrinsic value of your asset. How do you determine this value? Is it based on discounted future cash flow projections? Is it based on marketable asset value? The best method of valuation will depend on what you're trying to value and also how long you plan on holding it. For example, a 100 acre field that you plan on farming for the next 50 years should be valued differently than one you plan on selling to a neighbor in 5. Equipment decisions can also be evaluated by comparing intrinsic value vs market value. Equipment's intrinsic value is basically it's utility value. How useful is it to your operation. It's market value is the price that you could easily sell it. Unless the piece of equipment is extremely old (essentially a collectible) we know it is going to depreciate in value every year. Therefore, to justify ownership of that equipment it's utility value better exceed the market value. Once equipment has zero utility value, it's time to move on from it and don't wait. How many of you have found old equipment nestled in the woodline of a farm that you work which isn't even worth salvaging for scrap iron? At one point, the utility value of that equipment fell to zero while still having some marketable value but yet the owner still couldn't part with it. This is called the "Sunk cost fallacy" and has afflicted farmers with old equipment since the first plow was hitched to a mule.
- A higher Margin of Safety offers protection in case some of your valuation methods prove inaccurate. Take the case of three farmers: Farmer A bought land in 2012 and figured a 5% margin of safety (using $7 corn to project income for the foreseeable future), Farmer B also bought land but negotiated with the sellers until he had a 20% Margin of Safety. And Farmer C, couldn't find any attractive options with greater than 20%, so he just sat on the sidelines. Fast forward to 2018 and where do you think these three farmers stand on their decisions? I would assume that Farmer A's purchase has caused him a significant setback in his business. I would assume that Farmer B is faring better than Farmer A but he's also probably a little light on working capital and is having to pass on attractive opportunities. This is where Farmer C gets redemption. At first he was a little upset to see his neighbors so active buying land but now he's got more opportunities than ever before and at significantly more attractive valuations than 5 years ago.
- Margin of Safety can also apply to sellers. When the market value of the asset you own approaches or exceeds your intrinsic value, it's time to consider selling. Now many farmers won't sell farmland and I'm right there with you. But we can and do sell commodities all year long. So when the market value, aka future prices, exceed your intrinsic value, aka your cost of production, it's time to consider selling. Again, the market is your servant and not your master if you clearly know what your goal is and have the discipline to follow your plan.
- To conclude, as Graham wrote, "The function of the Margin of Safety is, in essence, that of rendering unnecessary an accurate estimate of the future."
- Having a long-term perspective:Graham believed that one of the best pieces of psychological armor an investor could have was having a long-term perspective. By thinking in terms of decades rather than months or a year or two, the intelligent investor could more easily have the discipline to pass up trendy or mediocre investments in the short term to be able to take advantage of great investment opportunities in the long term. One of the most interesting paradoxes of business is that the best opportunities typically present themselves in bad times, but in bad times there are fewer people who can actually take advantage of these opportunities. As an aside (and perhaps a future blog post), most of the major titans of business that you know of from Buffett to Rockefeller to Carnegie to Walton (and many more) made their most impactful business investments of their careers when times were tough. As Buffett has said before, "Be fearful when others are greedy, and greedy when others are fearful." Easy to say, hard to do. Easier to do with a long-term perspective of things and the utilization of Margin of Safety when evaluating business investments. Keep this is mind when you consider the current state of ag.
- The long term mindset also allows the intelligent farmer to take advantage of the magic of compounding. Years ago, in the Millionaire Next Door, the authors raised some eyebrows when they produced statistics saying that your average farmer was wealthier than your average doctor or lawyer despite most farmers earning much less than these more affluent professions. This is possible because farmers tend to save more of their income to be reinvested into their business or investments. Over time, this can have a dramatic effect on the bottom line of one's personal wealth. Buffett has explained compounding using a vivid image of rolling a wet snowball down a really long snowy hill. It will grow exponentially. He is living proof of the extreme power of the long term effects of compounding. In fact 99% of his wealth was earned after his 50th birthday.
- Learning the difference between linear and logarithmic gains is something every farmer should have a grasp of. Every small incremental change you make in your operation to cut costs or increase yields or increase your market price combines in a multiplicative capacity. Small changes can have a tremendous effect over the long term.
- Long term thinking also comes into play when thinking about infrastructure investments and soil health. Are you improving your infrastructure with this year in mind or the next ten? Have you designed your new shop so that a potentially bigger combine will fit into it in ten years? It can take a loooong time for soil health to improve via cover crops and increased biological activity. Do you have the mindset and patience to reap the benefits of cropping system improvements that may cost a little more on the front end but pay massive dividends over the long term? As the old Chinese proverb says, "The best time to plant a tree was twenty years ago. The second best time is now."
- Lastly, buying land is the ultimate long-term investment if you're a farmer and plan to never sell it. This could mean a lot of things such as being patient on land purchase decisions, but it can also mean not structuring a land purchase loan so aggressively that you become cash poor and struggle when other opportunities present themselves. There are all kinds of platitudes out there when it comes to buying land but probably the best advice I've heard is to think of it as long term capital allocation. With that in mind, always ask yourself A) Can I purchase at a price that offers a Margin of Safety, B) Does my operation produce enough revenue to comfortably make the payments (again Margin of Safety) and C) is this the best place to allocate my capital as it currently stands.
- Be skeptical of "experts" and "forecasting": Graham was a skeptic of anyone who tried to forecast market prices in the future and you should be too. It's far easier to make valuations in the present than in the future. Any thought of projecting future circumstances should always be baselined as most likely reverting to the mean. In other words, good times nor bad times will last forever.
- In this day and age, everyone has a platform and anyone can be an "expert". Think about it...if experts were so much smarter than us they would be able to crush the markets consistently and, let's be honest, they wouldn't be crowing about their latest insights to you but rather making millions while sipping Mai Tai's on a Carribean beach somewhere. In actuality, experts are woefully inaccurate when it comes to outperforming markets. Would you believe that in the last 15 years, only 35% of mutual funds have outperformed the S and P 500 index? In our current culture, it's unfortunate that too often the loudest voice is confused with being authoritative. Remember that you can't predict the future you can only manage your current circumstances. As Graham said, "I have never specialized in economic forecasting or market forecasting either. My own business has largely been based on the principle that if you can make your results independent of any views as to the future you are that much better off."
- You should also be independent when it comes to making decisions on input selections with your crop.
- Investing is most intelligent when it is most businesslike: This could easily be changed to, "Farming is most intelligent when it is most businesslike." If you are actively engaged in farming, you likely don't have the luxury of being a passive investor in your operation. Therefore, you are what Graham would call an "enterprising" investor. In these challenging times, you need to be searching for that extra edge. This may mean negotiating on input prices or paying down your operating loan the minute you see a deposit has cleared. Small things add up in a big way when compounding is involved. And farming is the ultimate business case study in compounding.
I find people like Ben Graham, and also his disciples like Warren Buffett, fascinating case studies for farmers because so much of what they have learned and taught over the course of their lifetimes in business can be directly related to how we think about farming as a business. What valuable business lessons have you learned from those that aren't directly involved in farming but still crossover to help you in your day to day farming operation?