Investors, Traders, Guarantees & The Average Investor.

This morning I was reading about how the CNBC news personality Andrew Ross Sorkin was having lunch with Warren Buffett.  Apparently they were speaking about various topics when the Berkshire Hathaway chief criticized the trading culture of Wall Street that he says offers incentives to generate fees and fast profits.  It was stated that Mr. Buffett was skeptical of the modern-day hedge fund industry and added that his preferred strategy was still to buy and hold.

It concerned him, for instance, that he was able to buy the equivalent of 10 percent of I.B.M. in six to eight months because of the market’s liquidity. “The idea that people look at their holdings in such a way and that kind of volume exists means that to a great extent, it’s a casino game,” said Mr. Buffett.

I suppose this article caught my attention because I am constantly preaching about how our society in general has evolved to a point where people seek risk free or guaranteed results from all aspects of life including investing,

An example that I often run across is the perceived “guarantee of investment.”  This concept really gets me going.  From a capital markets perspective, we have become a society of “traders” rather than “investors.”  Some of us may have actually forgotten how to invest altogether.  When some people look to invest in a company, often times their first question is: “How and when can I get out?”  I don’t know about you, but when I look at a corporate investment, my first question tends to be “What does the company do?”

This “trading” mentality has also driven an element of risk taking out of investment.  I was recently at a financial conference and the guest speaker was a gentleman from one of the financial exchanges.  During his presentation, he made the statement that “the average hold of a private placement in the last ten or fifteen years has gone from over five years to under one year.”  This was frightening to me.  How are you supposed to build a company when you investors are looking for an immediate and guaranteed return?  If all you are doing is managing your stock price, how are you going to manage your business?

By the way, these same investors or should I say, traders, will sue you the moment that your stock price drops.  This problem is the most frustrating to me.  What makes anyone think that they should be guaranteed any level of performance from a company?  Unless there is some kind of fraud or gross negligence, there should be no ability to sue for a lack of performance.  As an investor you do your homework, make a decision to invest and then buy into the company’s game plan, including its management team.  Sometimes the plan works and sometimes it fails.  If you don’t like the way the company is being managed, become an “activist investor” and build a case for change with your fellow shareholders.  What is even more absurd is that when you purchase an investment in a private placement or IPO, the subscription documents basically states that “YOU WILL LOSE YOUR MONEY.”  The disclosures are so in-depth that it is a miracle that anyone would actually put their money into any transaction at all.

This unfortunate need for a “guaranteed quick return” is what has driven the small cap marketplace into the ground.

Unfortunately, this is also the marketplace where you often find the growth stocks that can contribute greatly towards building wealth.  This marketplace, however, is damaged.  An IPO used to be a way to raise growth capital.  The average person was able to invest in companies that were at the earliest stages of their growth curve.  Today, an IPO is an exit strategy for growth companies that have matured into large corporations.  Did you know that almost all of the appreciation in the value of Microsoft’s stock came after its IPO?  This allowed many investors, big and small, to benefit from its growth.  The converse would be the IPO that Facebook completed.  One hundred percent (100%) of the appreciation of this stock happened before the company went public.  For the most part, the only people who made any money on Facebook were wealthy investors, venture capitalists and large institutional funds.  The average investor was left out of the process altogether.

This has to change!

A friend of mine, Dara Albright, over at the NowStreet Journal is a passionate advocate for the JOBS act that was passed in Congress.  Well, it was sort of passed.  They passed the law, but you actually can’t take advantage of the law that was passed until the SEC has put a set of rules together.  Don’t hold your breath too long, they have already missed certain deadlines!  Dara and I often speak about how the government basically assumes that the general public is not capable of making investment decisions on their own.  As a citizen of average means, for the most part, you are not able to invest in private placements unless you are deemed an accredited investor.  This means that you have either achieved a certain degree of wealth or that your income is above a certain level.  This also assumes that because of one of those factors, you are now a “sophisticated” investor.  Hummm?

So why is this problematic?  What is wrong with protecting folks that don’t earn as much as others or are not as “sophisticated” as some?  Well, maybe nothing, except- and this is where the topic of financial inequality comes into play- most people are not able to invest in companies until long after the “wealthy sophisticated” investors have made their profit.  Small investors are typically not able to invest at the early stages of a business where most of the growth, upside and wealth creation occurs.

Remember, when speaking about inequality, we are not always speaking about income inequality; we are often speaking about wealth inequality as well.  However, for the record, I am pretty sure that when the Declaration of Independence was penned with the statement “that all men are created equal,” this did not mean that all men would end up being financially equal.  This is another example of “guarantee.”  Where is it stated that we should all be guaranteed the same success?

That notwithstanding, I do think that the capital markets have become so consolidated that raising smaller amounts of money for growth companies has become far too difficult from an expense and regulatory point of view.  When Microsoft went public in the mid-80s and raised approximately $58 million, it took 116 underwriters to raise that amount of growth capital.  A couple of years ago, LinkedIn went public and raised about $350 million and only had to use five underwriters.  This is a real problem.  Essentially, capital has been concentrated into the hands of a few “big investors” and the average investor will never see these opportunities until after those few “big investors” have made their return.  We need wider distribution of investment.  Oh, I almost forgot, the government, for your own protection, would rather see you invest in “safe” publicly vetted companies…………….like Enron.

By the way, don’t you find it a little hypocritical that the average person can’t easily invest in small businesses, but every state except Utah allows some form of gambling?  I think nearly 40 states now have casinos, and you are more than welcome to visit any of these fine establishments and, without limitation, gamble away as much of your hard-earned money as you wish!

Don’t you think that there is something wrong with this picture?

If you really want to promote equality and wealth creation, you first have to provide the ability for all to take the same risks.  Every investor must also accept that investing is indeed a risk.  Just like at the casino, sometimes you win and sometimes you lose.  Well, investing is essentially the same.  Have you ever seen anyone sue a casino for the money they lost on a blackjack table?

I fully understand the value of keeping capital flowing.  The value of liquidity is not lost on me at all.  However, some of the greatest fortunes that have ever been made have come from people who took the time to learn about the businesses that they were investing in and then further contributed towards the growth of those companies.

I hope that we can find ways to get back to good old-fashioned investing!