March 2001
Last month's column, wherein I quoted the USA Today's article pointing out that the housing market beat stocks for the year 2000, attracted more than the usual flurry of responses.
The whole gist of my column was that not only did housing outperform stocks in 2000, it does so in most years. It is grossly inaccurate to compare the yields on properties with the yields on other investments, or the capital growth on property with the capital growth on other investments, and yet this is what most comparisons between stocks and property are based on. It is inaccurate is because with property, you can use leverage to increase your returns. This leverage, so I pointed out, is generally not available with other investment vehicles.
Most responses were of the form "How true!". Many readers quoted examples from their own experience where despite having been told by a succession of (paid) advisors to put their money into various other investments, they still did much better with their own house or (if they were lucky enough to buy one) an investment property.
Now I concede that people who read my column are more likely than not to be proponents of property. However, to prove that my audience is not completely biased, there were numerous responses from seasoned property investors who still begged to differ.
In particular, one reader claims that "while it is easier to leverage through mortgages in real estate, it can nonetheless also be done with stocks, provided you apply the same Investment Principles". No doubt it can be done, but I think everyone would agree that banks actively promote property mortgages (as witnessed in newspaper advertisements, televisions commercials, radio spots and billboards), whereas few banks advertise to lend money for stocks or bonds! It is much easier for a new investor to successfully arrange a mortgage secured against property than secured against any other asset.
The reader's formula includes the following seven points.
First, he suggests buying stocks that are priced "below their intrinsic value, i.e. to buy wholesale". Now I like the sound of that, but are the big boys (the professional stock investors and mutual fund managers) not doing just that, and thereby driving the market price back up to the intrinsic value? You see, to buy a stock whose market value is below the intrinsic value, all potential investors in that stock worldwide have to overlook the difference (stocks can be monitored electronically from around the world). However, to buy a property whose market value is below its intrinsic value, you only have to convince one seller (the present property owner) to sell it to you, and his pool of potential buyers may be tiny in comparison.
Second, he suggests only buying companies that are "showing a steady increase of growth in earnings over a period of time (e.g. over the last 10 years)". Well, in this day and age, earnings go up and down all the time. General Motors just announced it is dropping its erstwhile popular Oldsmobiles from its line up of vehicles, as the demand for them suddenly declined. Motorola just laid off some 4,000 workers in one of its plants this week because the demand for cell phones has gone down. My contention is that because companies are in business, their earnings will be far more volatile than that of the property owners whose buildings they occupy. Business is in a constant state of flux, things become popular, and then may die a natural death. Not all companies adapt. One company in two doesn't even survive the first year. Four out of five new companies do not last five years.
Third, he suggests buying stock in companies that have "strong cash flow, low demands for further capital injections, and low debt". Again, I like the sound of this, but usually this is reflected in the purchase price. For it not to be reflected, all potential investors have to overlook the disparity.
Fourth, he suggests buying stock in companies that have a "strong repeatable consumer demand, preferably a consumer monopoly". But what constitutes a repeatable demand? The manufacturers of slide rules did not invent electronic calculators; rather, they were 'killed off' by them. The manufacturers of electronic typewriters did not develop laser printers; they will trounced by them. In other words, we can be in business, and even kidding ourselves that we are doing well, while our economic assailants may be just around the corner.
Fifth, he says to "look for excellent managers that know and apply the principles of wealth creation in the companies they manage". Again I agree in principal. But even the best managers could not avoid the effects of stock market crashes on their businesses.
Sixth, he says to "ignore the market's price, as this is manic depressive by nature; calculate the intrinsic value". The problem with the stock market in this regard is that when you want to buy or sell a stock, you cannot ignore the market price: you have to buy at the market price, and when you are ready to sell you again have to sell at the market price, even if you know it is worth more or less according to whatever rational theory you have.
Finally, he says that "if you want to sell, name your price based in the stock's intrinsic value; offer it at this price and stick to it. Wait for the market to realise the true value". Well, it is my contention that you could be waiting for a long time!
Now I am not at all trying to say that the stock market is not a good way to make money. In fact, there are many people doing exceedingly well on the stock market, and it can be an excellent vehicle for investments. However, in all I hear and read (and through my own experiences), I am not able to convince myself that the advantages I perceive with real estate can be replicated with stocks.
The most important advantage is leverage: banks readily lend money on property, and not on other things. Further, you can readily buy a property whose price is way below market value, and then sell it at market value. This is more difficult with stocks, as even if the market value is below the 'intrinsic value', you still have to wait for the market (read all investors in that stock) to change and agree with you before you make your profit. With property, you only need one buyer.
For those for whom the stock market works well, I am happy. However, I am too enamoured with the advantages of leverage, to forego this in favour of some other investment vehicle. To put it another way, I love investing with my banker's money.
Successful investing!
Dolf de Roos.
