Most market pundits will sing the praises of stock liquidity all day long. And investors prize the ability to buy and sell shares of businesses in a millisecond.
I say liquidity is one of most overvalued characteristics of the entire market.
And in fact, I think it does most investors more harm than good.
It’s a lot harder to make bad decisions when you have to take the time to conduct your business. Fear and greed can’t dominate your long-term thinking as easily as they do in the heat of the moment.
Warren Buffett once opined (and I’m paraphrasing) that you should not buy a stock if you would not be comfortable owning it if the stock exchange were to close down the next day and not open until five years later. That kind of attitude would keep us from trying to make silly guesses about the next quarterly earnings report or taking immediate action when the share prices of our company cross some magic line.
Instead, we would think more about the long-term value of the business than we do the day-to-day price movements. And we certainly would pay a lot more attention to the price we pay for our shares in relation to asset value and earnings power.
Almost any other capital investment we make in our lifetime requires time and effort to close a deal. Buying rental real estate can take weeks and even months to find a prime property and get a deal closed. Well, buying a business is a long, drawn-out process, too, and you certainly can not (or should not) just get up one day and decide to sell your company, then expect a check in the bank by the end of the day.
Only in the stock market can we place our money instantly at risk on a tip from our nephew who learned all about the market and tech stocks at Shifting Sands University, or sell assets because a well-dressed person on TV said the market was going to drop soon.
Think about it: In the business world, no one runs out to buy a company because the price is going up or sell their current company because the price has been falling. When I talked to friends that owned companies back when the world was falling apart in 2008, and they weren’t talking about selling out at low prices. No, the successful ones were talking about buying competitors who were undercapitalized or plowing some cash into rental properties at ridiculously low prices. Back in 1999, the people I knew in the tech world were looking to sell businesses at silly valuations … not buy new ones at stupid prices.
It makes so much sense, but this behavior is exactly the opposite of what you’re doing when you take advantage of your highly prized liquidity to buy at tops and sell at bottoms.
I buy a lot of smaller companies with low stock volume — especially in the financial sector. It can take weeks to get a position filled as many of them trade pretty much by appointment. Some of my most successful investments have been in liquidating trusts that went off the boards and never traded again. I was stuck with the position and had to just wait for the payout over time.
But before I put my money into these types of deals, I make sure I have the math of the situation correctly and there is very little chance of losing money in the long run.
The lack of liquidity makes me a much smarter and careful investor. And the lessons I’ve learned, I’ve been able to apply to more liquid stocks with a great deal of success.
Just because we have the ability to buy and sell in the blink of an eye does not mean we should. The liquidity of the stock market tends to make us less cautious than we should be and much more susceptible to the fear and greed cycles that influence the markets at extremes.
Learn more about how you should value fundamentals and patience over liquidity in the video below.